Financial Guarantees
Financial Guarantees
Recently IASB published amendments to IFRS 9 Financial Instruments where it talks about the practical expedient for financial instruments measured at amortised cost (para 5.4.5. to 5.4.9), however what would happen if the financial instrument such as financial guarantee is measured at FVTPL, will the practical expedient (paraB5.4.5) not apply?
Re: Financial Guarantees
I'm not sure what you mean, there's no practical expedient in para. B5.4.5...
Re: Financial Guarantees
Amendments to IFRS 9 Financial Instruments were issued in Aug 2020 (these should be available from IFRS website) and in there para 5.4.7 says:
As a practical expedient, an entity shall apply paragraph B5.4.5 to account for
a change in the basis for determining the contractual cash flows of a financial
asset or financial liability that is required by interest rate benchmark reform.
This practical expedient applies only to such changes and only to the extent
the change is required by interest rate benchmark reform (see also
paragraph 5.4.9). For this purpose, a change in the basis for determining the
contractual cash flows is required by interest rate benchmark reform if, and
only if, both these conditions are met:
(a) the change is necessary as a direct consequence of interest rate
benchmark reform; and
(b) the new basis for determining the contractual cash flows is
economically equivalent
Will the practical expedient (by applying para B5.4.5) be applicable to financial guarantees measured at FVTPL? thanks
As a practical expedient, an entity shall apply paragraph B5.4.5 to account for
a change in the basis for determining the contractual cash flows of a financial
asset or financial liability that is required by interest rate benchmark reform.
This practical expedient applies only to such changes and only to the extent
the change is required by interest rate benchmark reform (see also
paragraph 5.4.9). For this purpose, a change in the basis for determining the
contractual cash flows is required by interest rate benchmark reform if, and
only if, both these conditions are met:
(a) the change is necessary as a direct consequence of interest rate
benchmark reform; and
(b) the new basis for determining the contractual cash flows is
economically equivalent
Will the practical expedient (by applying para B5.4.5) be applicable to financial guarantees measured at FVTPL? thanks
Re: Financial Guarantees
Do you need the practical expedient for FVTPL? You are supposed to remeasure FVTPL instruments at every reporting date using the latest available contractual cash flows, so you won't want to reconstruct LIBOR once the old index has gone, will you?
Re: Financial Guarantees
If I understand the question correctly, LIBOR reform could change the contract for a financial asset or liability that could (without the expedient) trigger derecognition because the standard treats the change effectively as a new contract. The expedient is designed to smooth the transition allowing you to recalculate using new actual or implied terms without having to test for derecognition.
The amendments throw a wide net "To meet the objective described in paragraph BC5.290, the IASB concluded that the scope of the Phase 2 amendments in paragraphs 5.4.5–5.4.9 of IFRS 9 should include all changes to a financial asset or financial liability as a result of the reform, regardless of the legal form triggering those changes." If the reforms change the calculation of the cash flow for measuring the guarantee then yes presumably it applies.
But they have to be a result of the change "The IASB decided to limit the scope of the practical expedient so that it applies only to changes in the basis for determining the contractual cash flows of a financial asset or a financial liability that are required by the reform. For this purpose, applying paragraph 5.4.7 of IFRS 9, a change is required by the reform if, and only if, the change is necessary as a direct consequence of the reform and the new basis for determining the contractual cash flows is economically equivalent to the previous basis (ie the basis immediately preceding the change)."
If you haven't already done so you might want to review the IASBs project summary: https://cdn.ifrs.org/-/media/project/ib ... ug2020.pdf
The amendments throw a wide net "To meet the objective described in paragraph BC5.290, the IASB concluded that the scope of the Phase 2 amendments in paragraphs 5.4.5–5.4.9 of IFRS 9 should include all changes to a financial asset or financial liability as a result of the reform, regardless of the legal form triggering those changes." If the reforms change the calculation of the cash flow for measuring the guarantee then yes presumably it applies.
But they have to be a result of the change "The IASB decided to limit the scope of the practical expedient so that it applies only to changes in the basis for determining the contractual cash flows of a financial asset or a financial liability that are required by the reform. For this purpose, applying paragraph 5.4.7 of IFRS 9, a change is required by the reform if, and only if, the change is necessary as a direct consequence of the reform and the new basis for determining the contractual cash flows is economically equivalent to the previous basis (ie the basis immediately preceding the change)."
If you haven't already done so you might want to review the IASBs project summary: https://cdn.ifrs.org/-/media/project/ib ... ug2020.pdf
Re: Financial Guarantees
Thank you all for your responses so far.
What I am hoping to clarify is that under IASB project - Interest rate benchmark reform, there is a practical expedient (Phase 2 amendments in paragraphs 5.4.5–5.4.9 of IFRS 9) that an entity shall apply para B5.4.5 (see below for the paragraph itself) which will result in an update to the EIR without adjustments to the carrying amount. So, would this practical expedient be applicable to financial guarantee contracts which are measured at FVTPL? I am certain there will be financial guarantees which will affected by LIBOR reform i.e. interest rate will be updated, so thinking, if this practical expedient is applied to FGs how will there not be a change in the carrying amount? Is there an example where the EIR is updated for financial guarantee but does not affect the carrying amount. I have seen one example related to bond (which is measured at amortised cost (link here https://ifrscommunity.com/knowledge-bas ... rest-rate/) where cashflows are recalculated with the revised EIR and do not result in the recognition of one off gain or loss in PL (doing exactly what this practical expedient requires) but trying to see how this works for the financial guarantees. Will appreciate comments on this.
Also, asking the above questions because the Phase 2 amendments in paragraphs 5.4.5-5.4.9 are under the Amortised cost measurement heading which makes me wonder if the Phase 2 amendments are only applicable to financial instruments that are measured under Amortised cost basis?
B5.4.5 ( Update of the EIR without adjustments to the carrying amount)
For floating rate financial assets and floating rate financial liabilities, periodic re-estimation of cash flows to reflect movements in market rates of interest alters the effective interest rate. If a floating rate financial asset or floating rate financial liability is recognised initially at an amount equal to the principal receivable or payable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or liability.
What I am hoping to clarify is that under IASB project - Interest rate benchmark reform, there is a practical expedient (Phase 2 amendments in paragraphs 5.4.5–5.4.9 of IFRS 9) that an entity shall apply para B5.4.5 (see below for the paragraph itself) which will result in an update to the EIR without adjustments to the carrying amount. So, would this practical expedient be applicable to financial guarantee contracts which are measured at FVTPL? I am certain there will be financial guarantees which will affected by LIBOR reform i.e. interest rate will be updated, so thinking, if this practical expedient is applied to FGs how will there not be a change in the carrying amount? Is there an example where the EIR is updated for financial guarantee but does not affect the carrying amount. I have seen one example related to bond (which is measured at amortised cost (link here https://ifrscommunity.com/knowledge-bas ... rest-rate/) where cashflows are recalculated with the revised EIR and do not result in the recognition of one off gain or loss in PL (doing exactly what this practical expedient requires) but trying to see how this works for the financial guarantees. Will appreciate comments on this.
Also, asking the above questions because the Phase 2 amendments in paragraphs 5.4.5-5.4.9 are under the Amortised cost measurement heading which makes me wonder if the Phase 2 amendments are only applicable to financial instruments that are measured under Amortised cost basis?
B5.4.5 ( Update of the EIR without adjustments to the carrying amount)
For floating rate financial assets and floating rate financial liabilities, periodic re-estimation of cash flows to reflect movements in market rates of interest alters the effective interest rate. If a floating rate financial asset or floating rate financial liability is recognised initially at an amount equal to the principal receivable or payable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or liability.
Re: Financial Guarantees
What kind of financial guarantees are you working on and what kind of LIBOR impacts do you expect? I’m not even aware whether you are concerned about LIBOR you are receiving as premium or LIBOR the debtor is paying to the bank on the underlying debt.
IMO 5.4.5-5.4.9 don’t sound to or need to apply to FVTPL or ECL measurement because the paragraphs are under the amortized cost measurement section plus the issues they try to address (eg derecognition due to contractual CF change) are not really applicable to those mark-to-market measurements. But the concepts may indirectly apply to your problem depending on the facts and circumstances.
IMO 5.4.5-5.4.9 don’t sound to or need to apply to FVTPL or ECL measurement because the paragraphs are under the amortized cost measurement section plus the issues they try to address (eg derecognition due to contractual CF change) are not really applicable to those mark-to-market measurements. But the concepts may indirectly apply to your problem depending on the facts and circumstances.
Re: Financial Guarantees
Yes, it only applies to items measured at amortised cost.
Re: Financial Guarantees
Thanks @exIFRS and @pub_acco
The LIBOR, the debtor is paying to the bank on the underlying debt, could have an impact on the financial guarantee carrying amount, right? I mean, IFRS 9 says the subsequent measurement of the financial guarantees is at the higher of:
- the amount of the loss allowance, and
- the amount initially recognised less cumulative amortisation, where approporiate
If the loss allowance is higher, due to LIBOR reform, then the carrying amount of the financial guarantee will be revised (i.e. will go up). So, my concern is how does such an outcome interact with the practical expedient, para B5.4.5 below (which says the carrying amount will not change, simply the EIR will be updated)?
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B5.4.5 ( Update of the EIR without adjustments to the carrying amount)
For floating rate financial assets and floating rate financial liabilities, periodic re-estimation of cash flows to reflect movements in market rates of interest alters the effective interest rate. If a floating rate financial asset or floating rate financial liability is recognised initially at an amount equal to the principal receivable or payable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or liability.
The LIBOR, the debtor is paying to the bank on the underlying debt, could have an impact on the financial guarantee carrying amount, right? I mean, IFRS 9 says the subsequent measurement of the financial guarantees is at the higher of:
- the amount of the loss allowance, and
- the amount initially recognised less cumulative amortisation, where approporiate
If the loss allowance is higher, due to LIBOR reform, then the carrying amount of the financial guarantee will be revised (i.e. will go up). So, my concern is how does such an outcome interact with the practical expedient, para B5.4.5 below (which says the carrying amount will not change, simply the EIR will be updated)?
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B5.4.5 ( Update of the EIR without adjustments to the carrying amount)
For floating rate financial assets and floating rate financial liabilities, periodic re-estimation of cash flows to reflect movements in market rates of interest alters the effective interest rate. If a floating rate financial asset or floating rate financial liability is recognised initially at an amount equal to the principal receivable or payable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or liability.
Re: Financial Guarantees
The short answer is that you will have to revise the carrying amounts of the financial guarantees after the reform. You have to update credit loss allowance at every reporting date using the latest information including the alternative interest rate benchmarks, so you will have no justification to maintain the old LIBOR-based measurement once the reform is complete.
That said, the fair value of floating rate loans are approximately close to the par value, and this characteristic of floating interest rates is expected (or hoped) not to change through the interest rate benchmark reform. Therefore, I would expect there are not many changes in the carrying amounts of floating rate instruments because of the LIBOR retirement, hopefully.
That said, the fair value of floating rate loans are approximately close to the par value, and this characteristic of floating interest rates is expected (or hoped) not to change through the interest rate benchmark reform. Therefore, I would expect there are not many changes in the carrying amounts of floating rate instruments because of the LIBOR retirement, hopefully.
Re: Financial Guarantees
thanks @pub_acco
Can I please just clarify one further point - why would the IASB not talk about the FVTPL measurement basis. All the Phase 2 reform papers, articles and discussions seem to be focused on the changes to basis for determining the contractual cash flows (which appears to be only relevant to amortised cost basis and not to FVTPL, right?) otherwise the amendments to IFRS 9 would not have been under the heading 'Amortised cost measurement'.
Sorry perhaps I keep on asking silly questions, but would appreciate clarification if possible.
Can I please just clarify one further point - why would the IASB not talk about the FVTPL measurement basis. All the Phase 2 reform papers, articles and discussions seem to be focused on the changes to basis for determining the contractual cash flows (which appears to be only relevant to amortised cost basis and not to FVTPL, right?) otherwise the amendments to IFRS 9 would not have been under the heading 'Amortised cost measurement'.
Sorry perhaps I keep on asking silly questions, but would appreciate clarification if possible.
Re: Financial Guarantees
Not a silly question at all. I was thinking it over too in connection with IFRS 13 disclosures.
I haven’t reviewed IASB’s discussions or am aware of what they are actually thinking, but their decision to limit the scope to amortized cost and hedge accounting sounds natural to me. Fair values have to be always up to date and ultimately arm’s length transactions reveal the truth no matter whether accounting provides some smoothing treatments. In addition, fair value isn’t supposed to change through the reform; if one does, then it suggests the actual existence of a gain/loss event. On the other hand, para 5.4.3 does cause an unintuitive and impractical consequence because of a kind of logical flaws of IFRS 9, so this has to be taken care of.
I haven’t reviewed IASB’s discussions or am aware of what they are actually thinking, but their decision to limit the scope to amortized cost and hedge accounting sounds natural to me. Fair values have to be always up to date and ultimately arm’s length transactions reveal the truth no matter whether accounting provides some smoothing treatments. In addition, fair value isn’t supposed to change through the reform; if one does, then it suggests the actual existence of a gain/loss event. On the other hand, para 5.4.3 does cause an unintuitive and impractical consequence because of a kind of logical flaws of IFRS 9, so this has to be taken care of.