REPARIS - World Banksiteresources.worldbank.org/.../Session4_IFRS7_disclosures.pdf · THE ROAD TO...
Transcript of REPARIS - World Banksiteresources.worldbank.org/.../Session4_IFRS7_disclosures.pdf · THE ROAD TO...
THE ROAD TO EUROPE: PROGRAM OF ACCOUNTING REFORM AND
INSTITUTIONAL STRENGTHENING
with generous support of
REPARIS
Analyzing disclosures: IFRS 7 and capital
requirements disclosures
Shamim Diouman REPARIS IFRS Seminar for banking supervisors
Croatia National Bank, Zagreb – April 18-19, 2012
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Section 1: IFRS 7 Disclosures
Overview IFRS 7
Recent amendments
IAS 1 Disclosure requirements
Why analyse disclosure requirements?
Disclosure requirements credit risk
Disclosure requirements market risk
Examples Credit risk and market risk disclosures
Section 2: Analysing Disclosures: Prudential Filters
Objectives of prudential filters
List of prudential filters
Disclosures of prudential filters
Section 3: IFRS 7 and capital disclosures developments
IFRS 7 developments
Capital disclosures developments
Outline
The objectives are to update participants of the key issues on:
IFRS 7 disclosures
Prudential filters and their related disclosures
Capital requirements disclosures
The session is divided into three sections
The three sections are related and international regulators are
currently focussing on them
Each section is highly topical and important as closely related
to prudential capital
Objectives of the session
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Section 1 covers IFRS 7 Disclosures and focuses mainly on
market and credit risk
This section includes an overview of IFRS 7 and practical
examples of disclosures
Other points included are:
Why is IFRS 7 relevant for regulators?
Why should regulators review the disclosures?
Can the disclosures provide an early warning system to
the next financial crisis?
Section 1: IFRS 7 Disclosures
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Section 1 ‒ IFRS 7 disclosures
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IFRS 7: Disclosures about financial instruments
IFRS 7 issued in 2005 and replaced IAS 30 and IAS 32
The IFRS 7 disclosure requirements incorporate many
of the requirements of IAS 32
There are exceptions: such as pensions, insurance
contracts, etc.
Applicable to all entities even if they have only a few
financial instruments
But the extent of disclosure required depends on their
use of financial instruments and exposure to risk
Overview – IFRS 7
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Qualitative and quantitative disclosures i.e. words and
numbers
The IASB believes that users of financial statements
need information about an entity‟s exposure to risks and
how those risks are managed
Disclosures in IFRS 7 are around 3 main areas: Credit
risk, market risk and liquidity risk
Overview – IFRS 7
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A number of amendments made to IFRS 7 pre and post
crisis
Some amendments related to changes to IAS 39 and
firms‟ management of exposures to risk keeps evolving
March 2009 – enhanced disclosures about fair value
measurements and liquidity risk
October 2010 – transfers of financial assets – to help
users of financial statements evaluate the risk exposures
relating to transfers of financial assets and the effect of
those risks on an entity‟s financial position
Recent amendments to IFRS 7
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IAS 1 also include a number of key disclosure
requirements:
Summary of significant accounting policies
Measurement basis
Accounting policies used that are relevant to an understanding of
the financial statements
The disclosure requirements in IAS 1 are directly related
to the disclosure requirements in IFRS 7
IAS 1 Disclosure requirements
Regulators have access to prudential data on a regular basis
A significant part of the prudential data is in tabular format
IFRS 7 disclosures are mainly for investors and other
stakeholders
IFRS 7 disclosures are about risks based on accounting
framework
Can regulators learn more about the firms they supervise by
reviewing accounting disclosures?
Why analyse IFRS 7 disclosures?
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At the beginning of the crisis some regulators considered
analysing IFRS 7 disclosures as an early warning system:
Loan exposures
concentration of loan exposures to industries or
geographical regions
Impairment
Exposures through Special Purpose Vehicles (SPVs)
Foreign currency loans
Loans to emerging markets
IFRS 7 can in some cases provide to regulators the “big
picture” that data in a tabular format may miss
Example: IFRS 7 disclosures already provided information
about SPVs before the crisis
Why analyse IFRS 7 disclosures?
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According to IFRS 7: Providing qualitative disclosures in the context of quantitative disclosures enables users to link related disclosures and form and overall picture of the nature and extent of risks arising from financial instruments
According to IFRS 7: The interaction between qualitative and quantitative disclosures contributes to disclosures in a way that better enables users to evaluate an entity‟s exposure to risk
What does the above mean?
Important that words and numbers complete each other and are meaningful to users
Words explain the numbers
Words should be relevant and not “boiler-plate”
Words should be contextual
IFRS 7 disclosure requirements
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Qualitative disclosures (for market, credit and liquidity risk)
For each type of risk arising from financial instruments, an entity shall disclose:
The exposures to risk and how they arise
Its objectives, policies and processes for managing the risk and the methods used to measure the risk
Any changes from previous periods
IFRS 7 disclosure requirements
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Classes of financial instruments and level of disclosure
When disclosure requirements are by class of financial instruments,
an entity shall group them by classes that are appropriate to the
nature of the information disclosed and that take into account the
characteristics of those financial instruments.
An entity shall provide sufficient information to permit reconciliation
to the line items presented in the statement of financial position
Implications
Users should be able to see the trail from notes to statement of
financial position and vice-versa
Information should be sufficiently detailed ie too much aggregation
not useful
Not to confuse between classes and categories (4 in IAS 39)
IFRS 7 disclosure requirements
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By class of financial instruments
The amount that best represent its maximum exposure to credit risk
without taking into account collateral
Description of collateral held as security
Information about credit quality of financial assets that are neither past
due nor impaired
For either past due or impaired financial assets:
An analysis of the age of financial assets that are past due as at the end
of the reporting period but not impaired; and
An analysis of financial assets that are individually determined to be
impaired as at the end of the reporting period , including the factors the
entity considered in determining that they are impaired
If collateral meets the recognition criteria in other IFRSs, an entity shall
disclose the nature and carrying amount of the assets
IFRS 7 disclosure requirements – Credit risk
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Credit risk: the risk that one party to a financial
instrument will cause a financial loss for the other party
by failing to discharge an obligation
Past due: a financial asset is past due when a
counterparty has failed to make a payment when
contractually due
IFRS 7 disclosure requirements – Credit risk
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Disclosures required for credit risk (and also market and liquidity
risk) should be given in the financial statements or incorporated by
cross-reference from the financial statements to management
commentary or risk report available to users of the financial
statements
Without the information incorporated by cross-reference, the
financial statements are incomplete
When management uses several methods to manage risks, the
entity shall disclose information using the method or methods that
provide the most relevant and reliable information
IFRS 7 disclosure requirements – Credit risk
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Market risk: The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises 3 types of risk: currency risk, interest rate risk and other price risk
Currency risk: The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates
Interest rate risk: The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates
Other price risk: The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices (other than interest rate or currency risk) eg equity or commodity
IFRS 7 disclosure requirements – Market risk
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Sensitivity analysis
To reflect the impact of market risk on the valuation of the
financial instruments, the entity shall disclose a sensitivity
analysis for each type of market risk, showing how profit or
loss and equity would have been affected by changes in the
relevant risk variable that were reasonably possible at that
date
To disclose: Methods and assumptions used in preparing the
sensitivity analysis
To disclose: Changes from previous period in the methods
and assumptions used and reasons for such changes
IFRS 7 disclosure requirements – Market risk
Sensitivity analysis is a kind of stress test with less radical
assumptions
Although supervisors may have access to more detailed data
re. sensitivity analysis or may require firms to perform more
stringent tests on the impact of market risks on profit and loss
and capital, the IFRS 7 disclosures on market risk is a good
place to start
Supervisors can also review these disclosures to check for
consistency with prudential data
IFRS 7 disclosure requirements – Market risk
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Section 2 ‒ Analysing disclosures: Prudential
filters
Section 2 will cover prudential filters and the key disclosures
related to prudential filters
The section will explain why prudential filters are used and
discuss what developments can we expect around prudential
filters
Objectives of prudential filters and related disclosures
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Why do we need prudential filters?
Accounting standards may affect the magnitude, quality and
volatility of bank‟s available capital
The IASB defines fair value as “the amount for which an asset
could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm‟s length transaction”
(IAS 39.9)1
Use of this measurement basis gives information that is more
relevant to users of the financial statements, but the results
can be less reliable and more volatile than using historical
cost conventions
Objectives of prudential filters
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Because of the inherent volatility in the measurement basis of
some instruments under IFRS , it was deemed necessary to
smooth the impact of this volatility on prudential capital
Prudential filters was henced introduced only in specific cases
To summarise we need prudential filters to:
Remove or reduce volatility
Address effects of accounting standards on components of
capital
The prudential filters listed in the next slides are the most
common form of prudential filters
Objectives of prudential filters
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Gains/losses on available for sale debt securities
Own credit spread
Defined benefit pension fund
Gains/losses on available for sale equities
Cash flow hedging reserves
List of prudential filters
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Gains and losses on AFS debt are unrealised
Some assets in this category are not actively traded
Fair value of these instruments are volatile
A prudential filter is applied to gains and losses on AFS debt
In some countries, a prudential filter is also applied for AFS
equities
Prudential filters ‒ Available For Sale debt
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The actuarial gains and losses on pension liabilities can be
large and volatile
The filter is applied because the liabilities are long term and
will not need to be funded over a period of 12 months
Prudential filters ‒ pension liabilities
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Cash flow hedges are used to swap fixed for floating cash
flows
The different treatments of a derivative instrument used as a
cash flow hedge (at fair value) and the hedged exposure
could potentially create significant volatility in equity. This
volatility arises because the portion of the fair value gain or
loss on the cash flow hedging instrument that is determined to
be an effective hedge is recorded in equity, but there is no
corresponding loss or gain recorded against the hedged
exposure
The hedging instrument is a derivative measured at fair value
The hedged item is usually measured at cost
A filter is applied to reverse the fair value gain or loss in equity
Prudential filters ‒ cash flow hedges
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Disclosures of prudential filters
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Disclosures of prudential filters
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Section 3 ‒ IFRS 7 and capital disclosures
developments
The third and last section of this session will explain
developments and on-going work taking place in the area of
public disclosures by accounting standard setters and
regulators
Despite the number of changes made in IFRS 7 and changes
recommended by regulators over the past 3 years, there are
still a number of initiatives taking place on public disclosures
IFRS 7 and capital disclosures developments
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Increasingly in the spotlight since the crisis
Regulators analyse financial statements and the public
disclosures (Pillar 3 and IFRS 7) since the beginning of the
crisis
Senior Supervisors Group (SSG) also performed a cross-
banks analysis at the beginning of the crisis
Exercise of the SSG is currently being repeated
Various exercises tend to compare and contrast the
disclosure practices across banks and look at good versus
bad examples and also at outliers
IFRS 7 developments
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Key areas considered tend to vary depending whether you
are analysts, regulators, etc.
For example disclosures around CDSs; securitisations, CDOs
were hot topics at the beginning of the crisis
More recently disclosures around valuations and sensitivity
analysis have become hot topics
Disclosures and analysis of disclosures should be seen as an
evolution and a never ending game
It is a continuous process
IFRS 7 developments
Basel Committee on Banking Supervision (BCBS) has
recently published a consultation paper on: Definition of
capital disclosure requirements- A consultative document
The reason to publish the paper was:
“Many market participants and supervisors have attempted
to undertake detailed assessments of the capital positions
of banks and comparisons of their capital positions on a
cross jurisdictional basis. The lack of consistency in the
way that it was reported typically made this task difficult
and often made it impossible to do with accuracy.” BCBS
December 2011
Capital disclosures developments
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According to the paper: to achieve a meaningful comparison,
it is essential that banks disclose the full list of capital items
and regulatory adjustments
BCBS believes “…banks should be required to publish their
capital positions according to common templates
BCBS is also proposing a common disclosure template post 1
January 2018
The template is designed to disclose all regulatory
adjustments to enhance consistency and comparison in the
disclosure of the elements of capital between banks and
across jurisdictions
Capital disclosures developments
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The BCBS is also proposing some disclosures on or after
January 2013
A common template is proposed for banks to use to meet
Basel III requirements to provide a description of the main
features of capital instruments
Banks should publish the completed disclosure template (post
January 2018) with the same frequency as the publication of
their financial statements (typically quarterly or half yearly)
Template should be included in the banks‟ published financial
reports or at a minimum these reports should provide a direct
link to the completed template on the banks‟ website
Banks should also make available on their website an archive
of all templates relating to prior reporting periods
Capital disclosures developments
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BCBS is also proposing new disclosures re. a full
reconciliation of all regulatory capital elements back to the
balance sheet in the audited financial statements
The objective of the above disclosure is to address the
problem that there is currently a disconnect in many banks „
disclosure between the numbers used for the calculation of
regulatory capital and the numbers used in the published
financial statements
The disconnect is mainly because the scope of consolidation
is different between accounting and prudential framework
However there is no template for the reconciliation disclosures
Capital disclosures developments
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Regulators are increasingly paying attention to public
disclosures even if they have access to more frequent and
more detailed information from the industry
Public disclosures may provide the “big picture” view and
could act as an early warning system
Conclusions
“When investors and analysts want to know how the
banking industry is performing or well governed in a
particular jurisdiction, they do not always discuss with
the regulators…they analyse the financial statements
of the firms. The quality of financial statements may
reflect the quality of regulation in a particular
jurisdiction” An analyst
The views expressed in this presentation do not
necessarily reflect those of the Executive Directors of
The World Bank or the governments they represent.
Thank you