Pensions Accounting: Discount-rate saga runs
Back in January, this column posed a simple question: Can they fix it? The ‘it’ was the so-called six-A discount rate question. This teaser started in October 2012 as a request to the International Financial Reporting Standards Interpretations Committee from the German Accounting Standards Board (GASB). The national standard-setter asked whether corporate bonds rated below double-A count as high-quality corporate bonds.
As a result of recent deteriorating credit quality, the potential basket of corporate bonds rated as either triple-A or double-A has fallen drastically. The committee considered the issue on November 2012 and arrived at four broad conclusions. Arguably, none of them answer the question that it was invited to address.
First, the committee told you what you already knew: practitioners have treated triple-A or double-A rated debt as high quality. And on a second point, it noted that IAS19 does not dictate how preparers should determine the market yields on HQCBs. In particular, IAS19 does not specify which bonds can qualify as high quality.
In a third finding, the committee observed that entities must apply judgement when determining current yields on HQCBs. This process, it said, must take account of the guidance in paragraphs 84 and 85 of IAS19. Fourth, the committee reminded preparers that “an entity’s policy for determining the discount rate should be applied consistently over time”.
In a report in the committee’s official journal, IFRIC Update, this reminder continues: “In particular, the requirement that the discount rate excludes the effects of actuarial risk and investment risk should be applied consistently from period to period.
“Consequently, the interpretations committee does not expect that an entity’s method of determination of the discount rate so as to reflect the yields on HQCBs will change significantly from period to period, other than to reflect changes in the time value of money and the estimated timing and amounts of benefit payments.”
To expect the committee to develop a timely response would be to hope against hope. So what guidance might be on offer from securities regulators? On 12 November 2012, the European Securities and Markets Authority issued statement ESMA/2012/725.
It begins: “ESMA is aware that the IFRS IC has planned to discuss the notion of high-quality corporate bond [sic] during its November 2012 meeting. Based on this information, ESMA believes that entities should wait for a clarification to come from the IFRS IC and should not change their approach to determining discount rates.”
The statement continues: “In the meantime, ESMA emphasises that there is a particular need for transparency in this area. Therefore entities are expected to disclose: if they used yields coming from high-quality corporate bonds or other means, a description of how they determined yields from high-quality corporate bonds (including any significant judgement used, or any reference to a regional market to which the issuer has access).”
In short, defined benefit plan sponsors are caught in an eternal loop between standard setters and regulators, both of which are institutionally incapable of taking a decision.
Fast forward to the 22 January meeting of the interpretations committee, and the staff had come up with a solution. The staff proposed widening the discount rate objective in IAS19 so as to permit preparers to include “corporate bonds with minimal and very low credit risk plus corporate bonds with higher credit risk adjusted to remove the market premium for the additional credit risk.” In other words, in order to arrive at a discount rate to meet the object of discounting for the time value of money, you would have to adjust a wider basket of yields for credit risk.
The committee rejected the proposal. In his summary, chairman Wayne Upton said: “I don’t hear a lot of support for the staff proposal as it is crafted.” As a result, he declined to put the staff recommendation to a vote. Instead, the saga will rumble on. Committee staff will now deliver a proposal to the board for an amendment to