The world wants to be deceived and deceived it will be. The Roman satirist Petronius’s acerbic critique of human nature is a convenient introduction to an issue in front of the IFRS interpretations committee in May. It all starts with a letter from the European Securities and Markets Authority (ESMA).
ESMA asked the committee in April to develop guidance on how holders of Greek government debt ought to account for it in light of the 12 March restructuring.
Under the bailout package, bondholders agreed to exchange defaulted Greek debt for a new long-term debt issuance. The new instruments are substantially different to the original ones, not least because the bondholders agreed to write-off a hefty percentage of principal. In addition, there is a bond exchange in which a percentage of the principal on the surrendered bonds is converted into 20 new bonds.
These new bonds bear interest at stepped, fixed-coupon rates over fixed maturities ranging between 11 years and 30 years. The remaining percentage of the original holding goes into short-term securities guaranteed by European Financial Stability Facility - taxpayers for short. Finally, with what has to be the must-have investment of the year, bondholders share in an issue of securities linked to Greece’s gross domestic product on which the holder receives neither principal nor interest payments.
So what does the regulatory might of ESMA make of it all? Somewhat depressingly, ESMA notes that IAS 39 - Financial Instruments: Recognition and Measurement - “does not provide explicit guidance on the accounting treatment of a debt exchange or more generally the modification of terms for financial assets.” The letter continues: “This results in difficulties to understand how the standard should be applied to the bond exchange and could raise enforceability issues.”
ESMA’s plea for a lifeline continues: “While for this specific case ESMA identified strong arguments to account the transaction as a derecognition of the original financial asset, we anticipate difficulties in terms of enforceability in case a different approach would be followed by issuers.
“ESMA would wish to have your views as to whether the rationales outlined in this appendix are in line with the principles set out in IFRS. Due to the lack of explicit guidance on a type of transaction that is quite widespread and the importance for the financial markets and investors, ESMA would also invite the IFRS Interpretations Committee to clarify the standard.”
ESMA summed up the position as follows:
• Option 1: Derecognise the old Greek debt in accordance with paragraph 17(a) of IAS 39 because the cash flows of the original asset are no longer due and have expired;
• Option 2: Treat the cash flows on the original debt instruments as unexpired.
In other words, do you carry on as you have been, holding the original debt at cost, or do you derecognise it, take all the losses to P&L, and start again with the new debt.
Interpretations committee member Andrew Vials thought the answer was obvious. “What you’ve got now is 20 bonds with different maturities, different law, collective action clauses. To try and pretend that’s the same as what you started with, I don’t think you need a lot of technical analysis.” But ESMA, apparently, does.
Although not one member of the committee stepped forward to identify the ‘territory’ where this issue might be in doubt, one source has: Greece.
The accounting challenge facing regulators is how Greek banks ought to account for their holdings of Greek debt. The source added that as a result of the Greek debt restructuring falling on 12 March, the question mark hangs over second-quarter reporting by some Greek financial institutions.
If the regulators have done their job properly, expect to see detailed footnotes about ‘derecognition events’ in the interim reports of Greek banks in relation to Greek debt.
That assumes, of course, the banks do not pull another accounting rabbit out of the hat in the meantime.