Reducing Complexity in Reporting Financial Instruments
The ABI’s response to the IASB’s Discussion Paper
Introduction
1. The ABI is the voice of the insurance and investment industry in the UK. Its members constitute over 90 per cent of the insurance market in the UK and 20 per cent across the EU. They control assets equivalent to a quarter of the UK’s capital. They are the risk managers of the UK’s economy and society. Through the ABI their voice is heard in Government and in public debate on insurance, savings, and investment matters.
2. The ABI is grateful for the opportunity to respond to the International Accounting Standards Board (IASB’s) Discussion Paper Reducing Complexity in Reporting Financial Instruments.
3. The ABI has also worked closely with the Comite Europeen des Assurances (CEA) and CFO Forum in considering the European insurance industry’s response to the discussion paper. The ABI has agreed the joint CEA/CFO Forum response to the discussion paper and fully supports the positions set out in that paper.
4. The CEA/CFO Forum response identifies a number of matters that must be addressed before any significant changes can be made to the current accounting requirements for financial instruments. Given the complexity of the issues, it seems likely that their resolution will take some time. The purpose of the ABI’s response is to suggest that, nevertheless, some intermediate improvements to the current requirements should be made to enhance the stable platform that the IASB seeks to establish for 2011.
5. The discussion paper recognises that the many ways of measuring financial instruments and the associated rules are one of the causes of complexity and suggests that a long-term solution of measuring all financial instruments in the same way would reduce this complexity. It suggests that fair value would be the only basis appropriate for that single approach.
6. As users of accounts ABI Members consider that the introduction of fair value has been an important step in achieving accounting that better reflects the economic substance of many types of financial instrument. However the application of the fair value approach in very volatile market conditions has exposed problems that need to be ironed out to ensure confidence in accounts on the part of users. The full implications of these events for accounting are as yet unclear. It will be necessary to address satisfactorily the problems highlighted by recent significant market corrections before reaching conclusions on whether the long-term goal of universal application of fair value for financial instruments should be pursued.
Intermediate improvements – to hedge accounting
7. The prime candidate, we suggest, for intermediate improvements to the current accounting requirements for financial instruments is the area of hedge accounting. We consider that hedge accounting remains an essential part of the accounting framework for financial instruments. However, even at the most mundane level, a significant reduction in the daunting 125 pages of material on hedge accounting in IAS 39 would of itself contribute to reducing that standard’s complexity. But more pertinently, a move to a more principles-based approach to hedge accounting requirements would enable the impact of proper risk management to be reflected better in accounts. Examples of how this might be achieved are given below.
8. We recommend is that the very complex rules for hedge effectiveness could be relaxed. Ineffectiveness, we acknowledge, should then be taken to profit and loss. But as long as that happens and – and for that, ineffectiveness needs, of course, to be measurable - we consider that the rules could be made much simpler. An example might be to change to ‘highly effective’ threshold test to one of ‘reasonably effective’, as proposed recently by the FASB for the improvement of its Statement 133. This would reflect better the way in which risk is managed in practice.
9. We also recommend that the use of hedging beyond that of single financial instruments (which, in practice, are not often hedged) be made easier to permit more global hedging, of portfolios or parts of portfolios. In practice, the current requirement for similarity is restrictive. This change would enable the way that entities manage economic risk, often very much on a portfolio basis, to be reflected better in the accounting.
10. However, we note that one of the IASB’s suggestions is that partial hedges might be prohibited. We consider that they should continue to be permitted. In practice, risks are properly managed in this way, and a search for simplicity in requirements should not result in an arbitrary distinction in relation to the same risk as between simple instruments on the one hand and, on the other hand, more complex instruments that carry other risks as well.
Association of British Insurers
September 2008
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