Unless you managed to enjoy a proper holiday this summer, you cannot fail to have missed the rumbling Greek debt crisis. Hans Hoogervorst’s summer holiday seems to have been neatly bookended on 4 August by a letter written in his capacity as IASB chairman to Steve Maijoor, head of the European Securities and Markets Authority, and the publication of that letter on 31 August. Europe’s banks, it seems, might not have been observing the spirit of IAS 39’s impairment methodology.
IAS 39 [IAS 39.45] details four categories for the classification of financial assets:
• Financial assets at fair value through profit or loss;
• Available-for-sale (AFS) financial assets;
• Loans and receivables; and
• Held-to-maturity investments.
The Hoogervorst letter deals with instruments classified under the second of these four categories. And just as in 2007-08, the crisis today is largely concentrated on the asset rather than the liability side. Plus ça change, as they might well be thinking at any French bank.
At its most simple, an AFS financial asset is any non-derivative financial assets that an entity, on initial recognition, designates as AFS. It is also, according to paragraph IAS 39.9, any other instrument that does not fall into any of the other three categories listed above. Typically it is an instrument, other than trading, that an entity does not plan to hold to maturity.
Gains and losses on AFS arising out of fair value changes go to a reserve in shareholder equity and from there into profit or loss when an entity derecognises an AFS asset - unless it is a fair value change that is deemed impaired. IAS 39 requires entities to report impairments or a gain or loss on sale in net income. The 2008 amendment to IAS 39, which permits the reclassification of financial assets, offers no escape route because if an asset is impaired, the fair value loss will hit profit or loss immediately.
So this poisonous mix of a dodgy impairment methodology that David Tweedie had three years - arguably four - to fix, large numbers building up in reserves on supposedly temporary value changes, and unrecognised impairment losses, finally came to a head when the IASB released the above mentioned letter.
So what does Hoogervorst, or rather the people who helped draft the letter, make of the situation? It raised the concern that some companies differ from the objectives in IAS 39, particularly in accounting for Greek debt. “This is a matter of great concern to us,” the letter reads.
It continues: “We are aware that, as an accounting standard-setter, the IASB does not have the authority to ensure compliance with…IFRSs. However, the IASB and ESMA have a mutual interest in ensuring the highest quality in the application of IFRSs.”
“It appears that some companies are not following IAS 39 when determining whether the Greek government bonds that they classify as AFS are impaired. They are using the assessed impact on the present value of future cash flows arising from the proposed restructure of those bonds, rather than using the amount reflected by current market prices as required in IAS 39.
“In addition, some companies holding Greek government bonds classified as AFS have stated that they are relying on internal valuation methodologies, rather than on market prices, to measure the fair value of the assets as at 30 June 2011. The reason generally given for using models rather than market prices is that the market for Greek government bonds is currently inactive (and therefore, in their view, does not provide reliable pricing information).”
This letter fits into a much wider context than the letter itself acknowledges. Addressing the 2011 IFRS annual conference in Zurich in July, Hoogervorst said: “The endorsement of IFRS by Europe has been extremely important for IFRS. We still have a small problem now with IFRS 9. I think there are many people who now think that they should adopt it quickly because it gives a little bit more leeway in terms of the Greek government bonds.
“Right now, most of them are held available for sale. If you impair them, you have to impair them at the going market rate - not very high, I believe, 30% - whereas if they are at amortised cost, as IFRS 9 makes possible, then you still have the possibility of making at least some sort of judgement.” It is hardly a ringing endorsement of IFRS 9.