The European Parliament has provisionally approved a transitional regime that will dilute the effect of new rules governing the valuations of financial assets.
In a plenary session vote on 29 November, lawmakers for the 28-member bloc approved a five-year plan that could see banks adding up to 90% of impairments back on to their financial-asset holdings to Tier 1 core equity.
The proposal for the International Accounting Standards Board’s (IASB) new impairment rules for financial institutions must now be adopted by both the parliament and the European Council before it is formally published in the EU’s official journal.
From 1 January 2018, banks, pension funds and insurers will use the new standard, IFRS 9, to account for their holdings of financial assets such as equity and debt instruments.
Jyrki Katainen, vice-president of the Commission, signalled during the debate that the EU wanted to use the hiatus to assess the full impact of the new IFRS 9 accounting requirements.
He said: “At this point, the impact of IFRS 9 on capital raises may be relatively limited for the majority of banks.
“However, nobody will really know the impact until the standard is applied. More importantly, nobody knows what the effect of IFRS 9 would be should the economic situation suddenly deteriorate.”
IFRS 9 is supposed to improve the financial reporting of financial instruments by addressing concerns that arose in that area during the financial crisis.
In particular, the standard features a forward-looking impairment model to counter the criticism that its predecessor, IAS 39, meant banks and other financial institutions made no allowance for future losses.
Long-term investors and equity holders had complained that the IAS 39 impairment model meant losses were only reported once they had been incurred.
In particular, the Local Authority Pension Fund Forum (LAPFF) complained that accounts prepared under International Financial Reporting Standards failed to give a true and fair view.
Now, however, some in EU financial circles fear IFRS 9 will lead to “a sudden significant increase in expected credit loss provisions” with a knock-on reduction to banks’ Common Equity Tier 1 capital.
In response, the EU has developed a transitional relief model for financial institutions, while the Basel Committee on Banking Supervision assesses the longer-term regulatory treatment of the new impairment model.
Under the proposal, where IFRS 9 impairments cause an institution’s Common Equity Tier 1 capital to drop, it will be allowed to add back in a portion of the impairments for a transitional period.
The parliament has proposed that the transitional period will last for a maximum of five years from 2018.
The transitional allowance will, however, drop over time on a sliding scale until it reaches zero at the end of 2023.
Institutions can either apply the transitional relief in 2018 or seek regulatory approval to do so after the move to IFRS 9.
Sources in the US have told IPE that they believed EU banks were wary of competing US proposals because their capital position was weaker.
Last year, German Green Party MEP Sven Giegold, a vocal IFRS critic, told IPE the Commission should “prove that IFRS 9 will not harm macroeconomic stability and long-term investment”.
Meanwhile, the development raises the prospect of further carve-outs by the EU in the future.
The move comes as the UK contemplates its own endorsement mechanism for IFRSs in the wake of the June 2016 Brexit vote.
Also speaking during the 29 November debate, French Socialist MEP Pervanche Beres raised the spectre of a carve-in to the standard’s requirements. She also urged the Commission to press ahead next year with an impact assessment of IFRS 9.