Financial Reporting Brief January 2016

Insights

Financial Reporting Brief

January 2016

Our featured article for January is - 'Transparency of Reporting: Importance to Financial System' - with Brendan Sheridan commenting on the initiatives being taken to improve the quality and transparency of disclosures in banks’ financial statements and whether that has helped restore confidence in the banking system?

Transparency of Reporting: Importance to Financial System

Some eight years since the financial crisis erupted with such trauma, the question arises as to whether the public’s confidence in banks has been restored. The public is more keenly aware than ever of the key role of banks as fundamental pillars of the stability and strength of the economy.

There is increasing sensitivity today about the complexity and possible absence of sufficient transparency of banks’ business models and their future strategies.

High-quality risk disclosures should be viewed as contributing to the awareness of the investment community and the public in general regarding the systemic importance of banks and the contingent liability they represent for tax payers. Poor quality disclosures can result in higher uncertainty with regard to a bank's stability and strength and this can undermine the extension of credit needed to support employment and productive investment in economies.

By enhancing investors’ understanding of banks’ risk exposures and risk management practices, high-quality risk disclosures may reduce uncertainty premiums and contribute to broader financial stability. For well-managed banks, the benefits of proactively enhancing risk disclosures are clear. The importance of well functioning capital markets is a clear focus of the EU Capital Markets Union, which was commented on in our December article.

In response to the need for a more transparent disclosure environment, the Financial Stability Board (FSB) established in 2012 the Enhanced Disclosure Task Force (EDTF) composed of members representing both the users and preparers of financial reports. The EDTF has benefitted greatly from the collective experience of asset management firms, investors and analysts, global banks, credit rating agencies and external auditors. It has focused on areas where investors seek better information about banks’ risks which the banks have agreed need improvement.

Moving on from 2012, and with the publication of IFRS 9 ‘Financial Instruments’ and its impending implementation in 2018, subject to EU endorsement for European entities, the EDTF has supplemented its 2012 report to consider:

  • What additional information will be valuable in the run up to the adoption of the new Expected Credit Loss (ECL) accounting approach to asset impairment losses; and 
  • Best practice disclosure following adoption of these approaches.

EDTF – The Principles and Recommendations

The first report of the EDTF, published in October 2012, identified seven fundamental principles to provide a firm foundation for developing high-quality, transparent disclosures that clearly communicate the business models of banks and the key risks that arise from them. The seven fundamental principles are: -

  • Disclosures should be clear, balanced and understandable;
  • Disclosures should be comprehensive and include all of the banks’ key activities and risks;
  • Disclosures should present relevant information;
  • Disclosures should reflect how banks manage risks;
  • Disclosures should be consistent over time;
  • Disclosures should be comparable among banks; and
  • Disclosures should be provided on a timely basis.

There were thirty three recommendations in the first report which are intended to cover all areas of risk, with the objective of enhancing existing disclosures and requirements to better meet users’ needs. In particular, implementing the recommendations should enable users to better understand the following key areas: -

  • A bank’s business models, the key risks that arise from them and how those risks are measured;
  • A bank’s liquidity position, the sources of funding and the extent to which its assets are not available for potential funding needs;
  • The calculation of a bank’s risk-weighted assets (RWAs) and the drivers of change in both RWAs and the bank’s regulatory capital;
  • The relationship between a bank’s market risk measures and the balance sheet, as well as risks that may be outside those measures; and
  • The nature and extent of a bank’s loan forbearance and modification process and how they may affect the reported level of impaired or non-performing loans.

Application of EDTF Recommendations

The ultimate success of the EDTF efforts will be judged on the willingness of banks to enhance their risk disclosures proactively by implementing the recommendations. Since publication of the initial 2012 report, the EDTF has produced a report annually providing an update on how the recommendations are influencing risk reporting and whether they have proved helpful in meeting users’ needs. In 2015, the EDTF again carried out a survey to identify the extent to which the 2012 recommendations were implemented in 2014 annual reports. The survey found that banks continue to make steady progress, with banks reporting an 82% implementation rate.

Despite substantial progress in the implementation of quantitative disclosures in 2014 reports, qualitative recommendations remain more widely implemented. Banks have previously indicated that qualitative recommendations are generally easier to implement than quantitative recommendations, some of which may pose system or operational challenges.

One of the main areas that the user group of investors and analysts found is that significant opportunity remains for banks to improve credit risk disclosures, including quantitative information about counterparty credit risk from derivatives transactions and details about the composition of collateral held.

The FSB has published a second report by the EDTF which considers the changes banks will need to make to their financial disclosures with the implementation of a new expected credit loss approach for impairment under IFRS 9. The FSB requested the EDTF to consider disclosures that may be useful to help the market understand the upcoming changes and to provide consistency and comparability. 

Recommendations include additional disclosures on:

  • Key concepts of the expected loss approach
  • Differences and similarities between IAS 39 and IFRS 9
  • Default and whether the 90 day rebuttable presumption is intended to be used and in what circumstances
  • The concept of credit-impaired exposures
  • Significant increase in credit risk and the policies and procedures applied
  • Initial recognition of exposures where it may be difficult to determine credit risk,
  • Treatment of modifications

A previous article commented on the challenges of implementation of IFRS 9, and in particular the findings of the survey carried out by Deloitte in preparing its fifth Global IFRS Banking Survey published in May.

A recent Deloitte publication looks at what the new EDTF report means for the banks and urges banks to consider the EDTF guidance for their next annual reports and the implementation projects that need to be planned and scoped out in light of new requirements regarding ECL.

An even more recent development is the publication of final guidance on accounting for expected credit losses by the Basel Committee on Banking Supervision. Comprising 11 fundamental principles, the guidance sets out supervisory expectations for banks relating to sound credit risk practices associated with implementing and applying an expected credit loss (ECL) accounting framework.

IFRS 9 Endorsement – The Insurance Issue

In September 2015 the European Financial Reporting Advisory Group (EFRAG) finalised its long-awaited endorsement advice on IFRS 9, but withheld comments on the insurance industry. The International Accounting Standards Boards (IASB) has recently published an exposure draft – ‘Applying IFRS 9 with IFRS 4 Insurance Contracts (Proposed Amendments to IFRS 4)’ with proposals which are intended to provide two options for entities that issue insurance contracts within the scope of IFRS 4:

a. An option that would permit entities to reclassify from profit or loss to other comprehensive income some of the income or expenses arising from designated financial assets – the so-called overlay approach
b. An optional temporary exemption from applying IFRS 9 for entities whose predominant activity is issuing contracts within the scope of IFRS 4 – the so-called deferral approach

The application of both approaches would be optional and an entity would be permitted to stop applying them before the new insurance contract standards is applied.

Conclusion

The FSB and the EDTF believe that they continue to have a significant role to play in supporting the disclosure initiatives, including keeping the banking sector alert to risks and emerging issues which may benefit from revised or additional disclosures in the future.

The FSB considers that further work is needed on post-crisis reforms in three main areas – (a) completion of the capital framework for banks, (b) measures to help end the ‘too big to fall’ perception, and (c) initiatives to make derivatives markets safer. The FSB is also alert to two specific vulnerabilities – (a) market-based finance and the risks in capital market and asset management activities, and (b) misconduct within the banking system – with the potential to create systemic risks and the threat of undermining trust in the banking system.


 

 

What's New- Monthly Reporting Pack

Irish GAAP / GAAS & Related Developments

IFRS & Related Developments

Regulatory & Related Developments

Publications

 
Did you find this useful?