Global Banking: Paradigm Shift
IAS 39 (Opportunities & Challenges)
Sanjeev Agrawal
CFO, India & South Asia
Standard Chartered Bank
Contents
IAS 39: Financial Instruments: Recognition & Measurement
• Introduction to IAS/IFRS
• Herald of a new era
• Business Implications
• Challenges
• Summary
IAS/IFRS* : Major force in world accounting
What is IAS ?
Why IAS ?
Who develops
IAS ?
.. And since
when ?
 Single set of high quality, global accounting standards
 To increase transparency in financial reporting
 To enhance comparability of financial information
 For local banks with global aspirations, exchange listing
 More effective/consistent quality of compliance & audit
 Sole responsibility rests with IASB
 Pronouncement aims to be country neutral
 Standards issued after Apr’01 designated as IFRS
 Now Mandatory for “European Union” listed companies
* International Accounting Standards Board (IASB)
International Financial Reporting Standards (IFRS)
2
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
3
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
4
(..cont’d) 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 Implications
Financial Instruments: Recognition & Measurement
Strategic
Classification
related
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
Products
• Higher Impairment loss charge  Discounted future receivable
Income
Recognition
• Acquisition Cost (DAC) and Yield Fees (YEF)  capitalized using
Effective Interest method:
 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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(..cont’d) Business Implications
Financial Instruments: Recognition & Measurement
Conceptual rules
• Derivatives to be stated in balance sheet at fair value
Derivatives & Hedge
Accounting
• Satisfy hedge conditions & classification
• Documentation of hedging relationships
• Hedge effectiveness testing & documentation (80-125 rule)
Criterion & consequences
• Transfer of control is not enough
Financial asset
de-recognition
• Risk and rewards need to be transferred
Consequences :
• On de-recognition, difference taken as “income”
• On failed de-recognition, taken as collateralised borrowing *
* Securitized portfolio will most likely stay in balance sheet as collateralised borrowing
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Key changes in IAS 39
IAS 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 NPA’s
Interest upto impairment taken to income
8
(.. cont’d) Key changes in IAS 39
IAS 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
Business
leadership
 Impact on products, clients and performance measurement
 Communicating change without unsettling investors, regulators or
rating agencies
 Maintain control as processes change (e.g. hedging , impairment)
Ops/product
control
 Product valuation. Assets not previously revalued, will now do so
 Hedging effectiveness: difficult to achieve and operationally manage
 Regulatory capital – possible volatility due to greater use of ‘fair
Risk & capital
management
value’
 Impact on Credit risk processes and Basel II
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(..cont’d) Challenges: Implementation
Financial Instruments: Recognition & Measurement
 Vast scope and coverage
Finance/tax
 Educating users of financial statements, impact of policy changes
 Changes to HO tax rules + local changes as countries move to IAS
 Systems capacity/scale of change in multiple locations
Technology
 Procedure and system for new hedge accounting rules
 Impact on downstream users
 Information supporting remuneration policies
Human
Resources
 For many staff training, knowledge transfer will be essential
 Possible manual workaround solutions in initial stages
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In Summary... What does IAS 39 mean to business
Financial
Operational

Change in revenue/cost recognition

New reconciliation process

Changes to Net Debt charge

Improved product programs

Variance in customer Assets/Liability

System changes
Strategic

New business opportunities

Product strategy

Profitability models
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