Download “Financial Instruments: Amortised Cost and Impairment”.

Comments on Exposure Draft on “Financial Instruments: Amortised Cost and Impairment”.
General:
Securities and Exchange Board of India (SEBI) is generally in agreement with the proposals in
the exposure draft for inclusion of credit loss expectations in the amortised cost measurement
of financial assets. It would, however, invite attention to the following aspects of the exposure
draft.
a) The stated objective of the draft is “to provide information about the effective return on a
financial asset or financial liability by allocating interest revenue or interest expense over
the expected life of the financial instrument” and it clarifies the type of amounts that are
allocated over the expected life of the financial instrument. It however provides no
guidance as to how this has to be done in respect of “open portfolios” that is, financial
instruments which have no finite life e.g. perpetual bonds, cash credit limits granted by
banks within which borrowers can operate fluctuating borrowings etc. One solution for
such “open portfolios” could be to provide for an assumed useful life e.g. a period of 10
years or the renewal date whichever is earlier.
b) The methods of providing for “expected loss” are unnecessarily complex and can be
simplified. Simplification cannot be a worse option than not making provision for expected
losses.
c) Appendix A defines a write-off and provides that “A financial asset is considered
uncollectible if the entity has no reasonable expectations of recovery and has ceased any
further enforcement activities”. In many jurisdictions, the legal process of recovery is often
prolonged over several years and it is customary not to wait for the completion of the legal
1
process before writing off a recoverable amount of which there is no reasonable
expectation of recovery. SEBI would therefore suggest that the words “and has ceased any
further enforcement activities” be deleted in the definition.
Question 1:
The description of the objective of amortised cost measurement in the exposure draft is
clear.
Question 2:
The objective of amortised cost is appropriate for the measurement category.
Question 3:
SEBI agrees with the way the exposure draft is drafted but would suggest that in paragraph
8, the words “probability-weighted possible outcomes” should be replaced by the words
“most likely outcomes”.
The concept of probability-weighted outcomes requires quantification in numerical terms
of each possible outcome and the assignment of weightages to each possible outcome.
Apart from the complexity involved in measuring each outcome and the possibility that
some outcomes may be difficult to measure in numerical terms, it is by no means certain
that the end result would be more satisfactory than a measurement of the most likely
outcome.
Question 4:
2
SEBI agrees with the measurement principles.
Question 5:
The description of the objective of presentation and disclosure is clear but SEBI would
invite attention to the following:a) Para 13(d) requires a line item for “gains and losses resulting from changes in estimates
in relation to financial assets and liabilities that are measured at amortised cost”.
b) This would suggest that the whole amount of such change must be debited or credited
in comprehensive income and not amortised over the balance period of the useful life.
c) In contrast, in para B22 of the Application Guidance given in Appendix B, the words
used are “increases” and “decreases’ instead of “gains and losses”. It is submitted the
words used in Appendix B are more appropriate and should be used in para 13(d).
Questions 6 and 7:
SEBI agrees with the proposed presentation requirements subject to the following:a) The disclosure required in para 20 “stress testing” is confidential information and it
would be damaging to the interest of the entity if such disclosure is made.
b) The disclosure required in para 22 “vintage information” would be too voluminous and
does not serve any useful purpose.
Consequently, both these items should be eliminated.
3
Question 8:
A mandatory effective date of about three years should allow sufficient lead-time.
Question 9:
SEBI would suggest that the transition requirements should give an option to the entity to
use either the transition requirements proposed in the Exposure Draft or the alternative
simplified transition approach described in the summary of transition requirements.
Question 10:
SEBI agrees with the proposed disclosure requirements.
Questions 11 and 12:
a) As stated in its General Comments, SEBI believes that it is essential that the method of
calculation of amortised cost is simplified through the use of practical expedients.
b) The practical expedients should be available to the following types of entities.
i)
SMEs and other small entities which may not have sophisticated credit risk
management systems or not sufficient volume of transactions of a similar
nature to provide an adequate data base.
ii)
Banks and financial institutions which have large volumes of transactions and a
sufficient data base to arrive at an average loss rate derived from past
experience.
4
c) For “open portfolios”, the use of an average loss rate as a practical expedient seems
unavoidable.
d) The reference in para B15 to the requirement that an entity may use practical
expedients only if the overall effect is immaterial seems misplaced. The materiality or
otherwise of a practical expedient can be known only if calculations are made both by
the prescribed method and the practical expedient and compared and to do so would
defeat the very purpose of using the practical expedient.
5