ISDA
International Swaps and Derivatives Association, Inc.
ISDA Workshop – The practical
implications of the new
accounting rules
8 November 2004
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ISDA
Overview of current position of IFRS
• Significant differences between current UK GAAP and
IFRS
• Accounting for financial instruments under IFRS is rules
based, UK GAAP is principles based
• Adopted IFRS mandatory for all listed EU companies in
their consolidated accounts after 1 January 2005
• Extension of IFRS to non-consolidated accounts varies by
country
• EU adopted IAS 39 will differ from that issued by the
IASB. Certain “carve outs” have been proposed by the
ARC
• Changes still being proposed to IAS 39 with four
Exposure Drafts issued since January 2004
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ISDA
IFRS – Key standards for financial
instruments accounting
IAS 39: - Recognition and measurement of financial assets and
liabilities;
- Treatment of certain other non-financial items eg,
commodity contracts;
- Derecognition of financial assets and liabilities
IAS 32: - Presentation of financial instruments from the perspective
of the issuer;
- Provides detailed rules covering netting;
- Requires disclosures to enable a user to understand
significance of financial instruments to an entity’s financial
position
SIC 12: - Consolidation of Special Purpose Entities
IFRS 4: - Insurance contracts
IAS 37: - Provisions, contingent liabilities and contingent assets
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ISDA
The measurement categories
Category
Loans and
receivables
Held to maturity
(HTM)

Held at Fair Value
Through Profit &
Loss
(FVTPL)

to profit and loss
Available for sale
(AFS)

Non-trading
liabilities
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Fair value

to equity – unless
impaired

Cost / amortised cost

At effective yield

At effective yield
Only if FV cannot be
reliably measured (very
limited – use only for
unquoted equity
instruments and
derivatives thereon)
ditto

•
IAS 39 includes an option to designate ANY financial instrument at fair value
at inception
•
Detailed guidance also provided on separating embedded derivatives from
host contracts
ISDA
Hedge Accounting - Key steps to
achieving a qualifying hedge
1.
Identify the type of hedge – fair value or cash flow or net
investment
2.
Identify the hedged item or transaction
3.
Identify the nature of the risk being hedged
4.
Identify the hedging instrument
5.
Demonstrate that the hedge has and will continue to be
highly effective
6.
Document the hedging relationship above, including the risk
management objectives and strategy for undertaking the
hedge
7.
Monitor effectiveness
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ISDA
Fair Value measurement
• Defined as:
“The amount for which an asset could be exchanged, or
a liability settled, between knowledgeable, willing parties
in an arms length transaction”
• It is not the amount that an entity would receive or pay in a
forced transaction or distressed sale
• Active markets – defined as those where quoted prices are
readily available and representative of actual, regular market
transactions. Financial Instrument valued using quoted price
• No active market – models that are commonly used by the
market are considered appropriate for valuing financial
instruments
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ISDA
Presentation – Netting & debt v equity
•
Financial liability – a contractual obligation to deliver cash or another
financial asset to an entity
•
Equity instrument – a contract that evidences a residual interest in the
assets of an entity
•
Some instruments have both a liability and equity component – eg
convertible bonds. The fair value of the liability should be classified in
the liability section of the balance sheet and the “plug” in equity
•
Ownership by an entity of its own shares is never an asset of that
entity
•
Complex rules for derivatives on own shares
•
Financial assets and liabilities may only be offset in the balance sheet
when there is both:
-
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a legal, enforceable right of set-off; and
an intention to exercise the right or settle simultaneously
ISDA
Consolidation and Derecognition
Consolidation Principles (SIC 12)
• An enterprise should consolidate enterprises it controls
• Control of SPEs is determined by considering factors outlined in
SIC 12
Derecognition Principles (IAS 39)
• Applied to transferor’s consolidated group, including SPEs if
consolidated
• Mixed model, based on both risks and rewards and control.
Revised standard based on a decision tree:
– Has there been a transfer or pass-through of cash flows?
– Has there been a substantial change in the exposure to the
risks and rewards?
– Has there been a transfer of control (as evidenced by
transferee’s ability to sell assets)?
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ISDA