Policy Proposals Business Law Comments on Post-implementation Review of IFRS 9 Financial Instruments -- Classification and Measurement
To the International Accounting Standards Board (IASB)
Subcommittee on Corporate Accounting
Committee on Financial and Capital Markets
Keidanren (Japan Business Federation)
In response to the request for public comments on the Post-implementation Review of IFRS 9 Financial Instruments—Classification and Measurement, Keidanren submits the following comments:
Question 3: Contractual cash flow characteristics
(a) Is the cash flow characteristics assessment working as the Board intended?
Some Japanese financial institutions have noted that there are cases where investments in instruments that are not held for short-term profits are classified as measured at fair value through profit or loss (FVPL), resulting in an inaccurate representation of operating results. The matters described in (i) and (ii) below may adversely affect the business of financial institutions and are regarded as one of the issues Japanese financial institutions take into account when considering whether to voluntarily apply to IFRS Standards.
- (i) Asset Liability Management (ALM) not aiming for short-term profits is part of the operations of financial institutions. Given that interest rates and stock prices are inversely correlated, in many cases Japanese financial institutions hold interest rate products such as bonds, and equity products such as equity index funds. Under IFRS 9, bonds are classified as measured at fair value through other comprehensive income (FVOCI). Meanwhile, stock investment trusts are categorized as debt instruments but do not meet the solely payments of principal and interest (SPPI) test, partly because discretion is left in their dividend payments. As a result, equity investment trusts are classified as measured at FVPL.
- (ii) Investments in private equity funds are also classified as measured at FVPL. This is because, although they take the legal form of investment in partnerships, etc., they are categorized as debt instruments and do not meet the SPPI test since these funds are composed of stocks.
We ask the Board to allow the flexible use of the other comprehensive income (OCI) option for such financial instruments that are not held for short-term profits and are similar to equity instruments.
(b) Can the cash flow characteristics assessment be applied consistently?
In regard to new financial assets whose contractual cash flows are linked to ESG targets, given that IFRS 9 is a principle-based accounting standard, we believe that it is highly likely to be able to respond to these new types of financial instruments even without making particular revisions to IFRS 9. If so, we would ask the Board to provide clarification to that effect.
Meanwhile, if sustainability-linked loan and bond instruments that are not derivatives are not classified as measured at amortized cost, this may hinder a wider use of these instruments. Therefore, we ask the Board to carefully and thoroughly communicate with market participants when engaging in discussion on accounting for sustainability-linked loans and other instruments as planned going forward.
Question 4: Equity instruments and other comprehensive income
In order to faithfully represent fair value changes on equity instruments during the holding period in the balance sheet, providing the OCI option in addition to measurement at FVPL is helpful, and therefore we believe that the OCI option should be retained.
However, when an entity has elected the OCI option for an equity instrument, unrealized gains and losses recognized in OCI are not recycled to profit or loss on sale of the instrument (paragraph B5.7.1 of IFRS 9). We have strong concerns over this provision for the following reasons. Unrealized gains and losses recognized in OCI should be recycled to profit or loss on sale of the instrument.
- (i) All items in OCI should be subsequently recycled to profit or loss. If some items are not recycled, the value of profit or loss information would be undermined. In order to ensure the usefulness of profit or loss as an overall performance indicator, recycling is necessary to reflect cash flows arising from the sale of financial instruments in profit or loss.
- (ii) We believe that recycling unrealized gains and losses from holding financial instruments to profit or loss on sale of the instruments would enable a faithful representation of investment success or failure in the statement of profit or loss, thereby contributing to better understanding among users of financial statements. Conversely, the situation where investment failure is not represented in the statement of profit or loss is unhealthy also from the viewpoint of investment discipline.
- (iii) The Conceptual Framework for Financial Reporting (paragraph 7.19) implies non-recycling if there is no clear basis for identifying the timing of recycling and the amount that should be recycled. In this regard, the sale of equity instruments determined by management reflects management's decision, and the timing and amount of the sale can be said to be "a clear basis for identifying the period in which reclassification would have that result, or the amount that should be reclassified." Even under the current provisions of the Conceptual Framework, there is no ground for non-recycling.
- (iv) Under IFRS 9, while valuation gains or losses are recycled to profit or loss for financial assets classified as measured at FVOCI (paragraph 5.7.10 of IFRS 9), recycling is prohibited for equity instruments classified as measured applying the OCI option. There is no consistency regarding this accounting treatment.
Question 5: Financial liabilities and own credit
IFRS 9 requires that when financial liabilities are designated under the fair value option, fair value changes related to the entity's own credit risk should be presented in OCI. We can support this accounting treatment. This is because this practice will remove "the paradox of liabilities (counterintuitive effects resulting from accounting for liabilities)," where a gain is recognized when the value of financial liabilities decreases.
Meanwhile, IFRS 9 prohibits the recycling of gains and losses in OCI to profit or loss in subsequent periods (paragraph 5.7.9 of IFRS 9). We are concerned about this prohibition for the following reasons.
- (i) All items in OCI should be subsequently recycled to profit or loss. If some items are not recycled, the valuation of profit or loss information would be lost for that portion.
- (ii) Specifically, when early redemption of financial liabilities or other events actually give rise to cash flows reflecting credit risk, non-recycling would result in the inability to reflect these cash flows in profit or loss.