IFRS update December 2005 – Banking

IAS39 on
financial instruments has been a tough call for the banking and financial
services sector over the past 12 months.

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Jeremy Foster, a partner in the PricewaterhouseCoopers IFRS banking and
capital markets team, says: ‘Experiences have varied, but, generally, for those
entities having to convert to IFRS, a significant amount of the overall project
time, effort and resources has gone into compliance with IAS39, with hedging,
interest rates and impairments being the big three challenges.’

Banks have set up large, cross-organisation teams to deal with the
implementation of IFRS, focusing in particular on accounting issues relating to

‘The real test in the next year or so will be moving from the current
tactical fixes to more comprehensive, strategic IFRS solutions which are then
embedding throughout the organisation,’ Foster says.

‘This should contribute to improving processes generally, to enhancing
controls and contributing to efficiencies, cost savings and more accurate,
and transparent financial reporting, both generally for management and for

The most difficult aspects of the IAS39 implementation have included hedge
accounting, particularly effectiveness testing, where methodologies, systems and
data availability and accuracy have been the main obstacles.

Hedging continues to be a key area for companies due to the stringent
effectiveness testing criteria that have to be passed on a regular basis if
hedge accounting is to be applied.

With the increased use of fair value throughout the primary financial
statements, Foster also highlights the need for more robust controls around fair
values, especially the models which generate these values.

Other particularly difficult aspects of IFRS implementation for banks include
the derecognition and treatment of special purpose vehicles, embedded
derivatives (which are complex and can be found in many different products), and
debt/equity issues around hybrid capital instruments.

Tony Clifford, banking and regulatory partner at Ernst & Young, says that
IAS39 caused some problems in terms of day one profit recognition.

‘One of the rules is that you can’t recognise profits at once on complex
derivative transactions unless all the inputs to the model are observable in the
marketplace,’ he says.

‘That has resulted in some reduction in the value of derivatives. Clarity is
required on when you can recognise that profit. Changes are being made in the
US, which the IASB plans to expose. So we should see some resolution on that in

Clifford also says the loan impairment rules under IAS39 are complicated.
‘Some people have interpreted them differently,’ he says. Past local loan
impairment rules tend to influence the interpretation of IAS39 now, creating
potential differences between countries. ‘The challenge will be to make sure
there’s some consistency across the industry,’ he adds.

Andy Simmonds, technical partner at Deloitte and chairman of the ICAEW’s
financial reporting committee, describes IAS39 as ‘a ghastly standard’ but says
the IASB will no longer make minor tweaks to it.

‘They have said publicly that they are not interested in continuing to fix
minor things, and have drawn a line under further amendments,’ he says. ‘They
are looking for the big fix.’

Simmonds says that whenever the ICAEW’s financial reporting committee meets
the IASB, chairman Sir David Tweedie always asks how IAS39 could be improved and
what the next generation of the standard should be.

‘My response is always that everything be shown at fair value through the
profit and loss account,’ Simmonds says. ‘Anything short of that will be a

This isn’t likely to happen fast. Meanwhile standard-setters, analysts,
investors and banks will continue to argue the merits and challenges of fair
value accounting.

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