Global Banking: Paradigm Shift IAS 39 (Opportunities

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Global Banking Paradigm ShiftIAS 39
(Opportunities Challenges)
Sanjeev Agrawal CFO, India South Asia Standard
Chartered Bank
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Contents

• IAS 39 Financial Instruments Recognition
  Measurement
• Introduction to IAS/IFRS
• Herald of a new era
• Business Implications
• Challenges
• Summary

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IAS/IFRS Major force in world accounting

• Single set of high quality, global accounting
  standards
• To increase transparency in financial reporting

What is IAS ?

• To enhance comparability of financial
  information
• For local banks with global aspirations,
  exchange listing
• More effective/consistent quality of compliance
  audit

Why IAS ?

• Sole responsibility rests with IASB
• Pronouncement aims to be country neutral

Who develops IAS ?

• Standards issued after Apr01 designated as
  IFRS
• Now Mandatory for European Union listed
  companies

.. And since when ?
International Accounting Standards Board
(IASB) International Financial Reporting
Standards (IFRS)
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Understanding IAS 39 - Herald of a new era
Financial Instruments Recognition Measurement

• Objective
• Set accounting principles for recognition,
  measurement of financial assets/liabilities,
  rules (i.e. instruments/policies) for hedge
  accounting
• First introduced in 2000 since undergone decisive
  changes
• Latest promulgation of IASB. Also most
  deliberated, due to implications
• Effective from Jan 1, 2005
• Intention to bring international GAAP similar to
  US GAAP
• New concepts having far reaching implications on
  financial reporting
• Broadly divided into following categories

Classification of assets/ liabilities
De-recognition, securitization, factoring, etc
Measurement principles, i.e. cost or fair value
rule
Derivative and hedge accounting
Income recognition, effective interest, impairment
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Understanding IAS 39 through the
maze..Financial Instruments Recognition
Measurement
On Balance Sheet Items
Off Balance sheet Items
Derivatives (FX, FW, SWAP, OP)
Loans receivables
Consolidated Statement
Debt / Equity instruments
Commodity futures
SCOPE COVERAGE
Cash equivalents
Financial Guarantee
Debt / loan payables
Loan commitment
Exclusions (covered by other standards)
Inventory
Fixed Assets
Disclosure
Acctg. for own debt / equity
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(..contd) Understanding IAS 39 Financial
Instruments Recognition Measurement

• An attempt to move international GAAP to relevant
  US GAAP
• New classification categories

Category Balance Sheet valuation basis Changes in carrying amount Illustratives
Held for trading Initially designated at fair value Fair Value Income Statement Debt/equity/receivables acquired for profit
Loans receivables Amortised cost Income Statement Fixed determinable payments. Unquoted
Held to maturity investments Amortised cost Income Statement Fixed payments maturity (debt., redeemable shares)
Available for sale Fair Value Equity reserves Residual category
(Trading) Financial liabilities Fair Value - -
Other Financial liabilities Amortised cost - -

• Applicable for accounting periods beginning from
  Jan 1, 2005

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Business ImplicationsFinancial Instruments
Recognition Measurement

• Strategic
• Selection of Fair Value or AFS ? Income or
  Equity volatility
• Choice of HTM can throw up liquidity
  management issues
• Tainting rules. Restricted usage of this
  category for 2 yrs

Classification related

• Products
• Higher Impairment loss charge ? Discounted
  future receivable
• Acquisition Cost (DAC) and Yield Fees (YEF) ?
  capitalized using Effective Interest method

Income Recognition

• New (and logical) way of profitability analysis

• Re-alignment of product features, fees, interest
  rate cost

• Systems requirements for transaction accounting

Direct Acquisition cost (DAC) Yield
Enhancing Fees (YEF)
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(..contd) Business ImplicationsFinancial
Instruments Recognition Measurement

• Conceptual rules
• Derivatives to be stated in balance sheet at fair
  value
• Satisfy hedge conditions classification
• Documentation of hedging relationships
• Hedge effectiveness testing documentation
  (80-125 rule)

Derivatives Hedge Accounting

• Criterion consequences
• Transfer of control is not enough
• Risk and rewards need to be transferred
• Consequences
• On de-recognition, difference taken as income
• On failed de-recognition, taken as
  collateralised borrowing

Financial asset de-recognition
Securitized portfolio will most likely stay in
balance sheet as collateralised borrowing
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Key changes in IAS 39IAS 39 vis-à-vis UK GAAP -
Differentials
A. Income related
SN Existing UK GAAP / Indian Accounting IAS 39
1 Write off product acquisition cost, as incurred Capitalize and amortize over actuarial life
2 Up-front recognition of fees and commission income Capitalize fees/commission and amortize
3 Income recognition at contractual rates Recognition on Effective Interest basis
4 NPA specific provision based on actual cash flow Provision at discounted cash flow
5 Interest Income suspended for NPAs Interest upto impairment taken to income
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(.. contd) Key changes in IAS 39IAS 39
vis-à-vis UK GAAP - Differentials
B. Classification related
SN Existing UK GAAP / Indian Accounting IAS 39
1 Classification and valuation into Banking Trading Books 4 categories of assets and 2 of liabilities
2 Accrual basis of accounting for derivatives / hedges Derivative hedges at Fair Value (MTM)
3 Only one classification of hedges Fair Value hedge, Cash flow hedge and Economic hedge
4 Securitized assets could be de-recognized even if risks/rewards retained Assets to be de-recognized ONLY if risks/ rewards are transferred
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Challenges Business Regulatory Financial
Instruments Recognition Measurement

• Impact on strategy, policies, shareholder
  message P/L volatility
• Impact on products, clients and performance
  measurement
• Communicating change without unsettling
  investors, regulators or rating agencies

Business leadership

• Maintain control as processes change (e.g.
  hedging , impairment)
• Product valuation. Assets not previously
  revalued, will now do so
• Hedging effectiveness difficult to achieve and
  operationally manage

Ops/product control

• Regulatory capital possible volatility due to
  greater use of fair value
• Impact on Credit risk processes and Basel II

Risk capital management
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(..contd) Challenges ImplementationFinancial
Instruments Recognition Measurement

• Vast scope and coverage
• Educating users of financial statements, impact
  of policy changes
• Changes to HO tax rules local changes as
  countries move to IAS

Finance/tax

• Systems capacity/scale of change in multiple
  locations
• Procedure and system for new hedge accounting
  rules
• Impact on downstream users

Technology

• Information supporting remuneration policies
• For many staff training, knowledge transfer will
  be essential
• Possible manual workaround solutions in initial
  stages

Human Resources
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In Summary... What does IAS 39 mean to business
Financial
Operational

• Change in revenue/cost recognition
• Changes to Net Debt charge
• Variance in customer Assets/Liability

• New reconciliation process
• Improved product programs
• System changes

Strategic

• New business opportunities
• Product strategy
• Profitability models