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FASB Exposure Draft Summary: Accounting for Financial Instruments and Revisions to Derivative Instruments and Hedging Activities

Core Content

The Committee of European Banking Supervisors (CEBS) has provided detailed comments on the Financial Accounting Standards Board (FASB) exposure draft (ED) regarding the accounting for financial instruments and derivative instruments and hedging activities. CEBS, composed of representatives from banking supervisory authorities and central banks in the European Union, emphasizes the importance of high-quality, transparent, and comparable accounting standards for the banking and financial sector.

Main Views and Key Points

1. Measurement Model for Financial Instruments

• CEBS strongly supports a mixed attribute measurement model, which allows entities to reflect their business model in the accounting treatment.
• They do not support the FASB’s proposal to use an (almost) full fair value model for financial instruments, as it may lead to lack of comparability and reduced reliability.
• The G20 and Financial Stability Board have mandated that fair value principles not be expanded in scope, which the FASB’s model does not align with.
• CEBS believes that amortised cost is more relevant for financial liabilities, especially those held to collect cash flows, as it reflects the contractual cash flows.

2. Presentation of Amortised Cost Information

• CEBS opposes the presentation of both fair value and amortised cost on the balance sheet, as it may lead to confusion for users and be interpreted as “two versions of the truth.”
• They support the disclosure of fair value information in the notes, which is considered sufficient and appropriate under current IFRS and US GAAP.
• CEBS argues that the mixed model is essential to achieve convergence between IFRS and US GAAP, and to eliminate the need for reconciliation.

3. Impairment Model

• CEBS questions the clarity of the FASB’s proposed impairment model, especially regarding the interaction between individual and collective impairment.
• They believe the FASB’s model is essentially an incurred loss model but with earlier provisioning than current US GAAP.
• CEBS supports the IASB’s expected loss model, which allows for a broader range of credit information to be considered in impairment calculations.
• They acknowledge the FASB’s approach includes some improvements, such as addressing 'open' versus 'closed' portfolios, but feel it does not align with the expected loss concept.

4. Embedded Derivatives

• CEBS recognizes that the FASB’s fair value model reduces the need for bifurcation of hybrid instruments, but maintains that bifurcation is necessary in a mixed attribute model.
• They argue that amortised cost is often the most appropriate measurement for straightforward host contracts, especially for financial liabilities.

5. Own Credit Risk

• CEBS questions whether gains and losses from own credit risk should be recorded in profit or loss, as it may mislead users in a prudential context.
• They support the IASB’s approach of recording such changes in Other Comprehensive Income (OCI), but do not agree with the FASB’s model, which places all such changes in profit or loss.
• CEBS urges both boards to discuss which approach is more appropriate and to converge on a solution.

6. Demand Liabilities

• CEBS believes demand deposits should be measured at the amount contractually owed, as this reflects the actual obligations to depositors.
• They oppose the proposed present value-based measurement for core deposits, which is seen as increasing complexity and raising reliability concerns.
• This approach is inconsistent with IFRS, where amortised cost is the standard for financial liabilities.

7. Hedge Accounting

• CEBS considers hedge accounting an inherent part of a mixed attribute model.
• They acknowledge that hedge accounting is less significant in a fair value-based model, but stress the need for principles-based approaches.
• CEBS supports the FASB’s move towards principles-based hedge accounting, including relaxing effectiveness testing but retaining documentation requirements.
• They believe hedge accounting should only be discontinued if the criteria are no longer met or the instrument is no longer relevant.

8. Recycling of OCI

• CEBS supports the FASB’s proposal for recycling OCI elements to profit or loss when they become realised, as it aligns with their view on transparent financial reporting.

Conclusion

CEBS urges collaboration between the IASB and FASB to achieve convergence in financial instrument accounting. They emphasize the importance of a mixed attribute model that aligns with the business model of banks and enhances comparability and transparency. CEBS also caution against the overuse of fair value and highlight the need for robust documentation and disclosure in all areas of financial instrument accounting.