Department's Response to the Financial Accounting Standards Board's Invitation to Comment
and the International Accounting Standards Board's Discussion Paper on Reducing Complexity in Reporting Financial Instruments
September 19, 2008
Mr. Robert Herz
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116
Sir David Tweedie
International Accounting Standards Board
30 Cannon Street
London EC4M 6XH
Dear Chairmen Herz and Tweedie:
The New York State Banking Department (the "Department") has reviewed the Discussion Paper, Reducing Complexity in Reporting Financial Instruments, and appreciates the opportunity to present the following comments.
Do current requirements for reporting financial instruments, derivative instruments and similar items require significant change to meet the concerns of preparers and their auditors and the needs of users of financial statements? If not, how should the IASB respond to assertions that the current requirements are too complex?
The Department believes that a simplified, principles-based approach should be taken in accounting for financial instruments, and changes should be made to the extent required to achieve this goal. While some accounting complexities are unavoidable due to the complexities of the instruments themselves, this approach should be kept in mind throughout the standard-setting process. Unnecessary complexity can be avoided and convergence promoted by the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) agreeing on common definitions for financial instruments and fair value.
The Department has three primary recommendations to improve accounting:
(1) Record instruments with no observable inputs (e.g., Level 3 under FASB Statement 157) at the lower of cost or fair value when inputs were last observable. While this could be criticized for avoiding further write-downs in the current environment, it both increases reliability in financial statement balances and reduces earnings management under better economic conditions. Such instruments would be subject to other than temporary impairment write-downs which are based on individual facts and circumstances.
(2) Eliminate liabilities from the fair value option unless following the liquidation basis of accounting. The practice of recording profits due to deterioration in an entity's own liabilities raises a question of relevance and prevents a broader public acceptance of fair value accounting. This would continue to allow trading liabilities to be recorded at fair value.
(3) To provide financial statement users with additional fair value information, require a separate disclosure containing each entity's fiscal year-end balance sheet with all financial assets/liabilities at fair value and each entity's fiscal year-end income statement reporting the effects of all fair value changes in earnings.
(a) Should the IASB consider intermediate approaches to address complexity arising from measurement and hedge accounting? Why or why not? If you believe that the IASB should not make any intermediate changes, please answer questions 5 and 6, and the questions set out in Section 3.
Intermediate approaches should not be considered because such temporary fixes delay a more comprehensive solution and add complexity and confusion. To offer our full views for comprehensive solutions, we have also answered the other questions in this section.
(b) Do you agree with the criteria set out in paragraph 2.2? If not, what criteria would you use and why?
The Department agrees with paragraph 2.2 except for item (b), which presumably would not allow our first two recommendations in Question 1. However, we question whether "fair value" based on unobservable inputs, multiple assumptions, or hypothetical analysis truly represents fair value.
We strongly agree with item (d) of paragraph 2.2 to avoid revising accounting standards which are expected to be modified again in the near future.
Approach 1 is to amend the existing measurement requirements. How would you suggest existing measurement requirements should be amended? How are your suggestions consistent with the criteria for any proposed intermediate changes as set out in paragraph 2.2?
See responses to Questions 1 and 2(b).
Approach 2 is to replace the existing measurement requirements with a fair value measurement principle with some optional exceptions.
(a) What restrictions would you suggest on the instruments eligible to be measured at something other than fair value? How are your suggestions consistent with the criteria set out in paragraph 2.2?
The "held-to-maturity" category should be retained. This more accurately reflects economic reality for entities which have the positive intent and ability to hold debt securities to maturity and are thereby unaffected by fluctuations in fair values except for other than temporary impairment. Accounting for the tainting of the held-to-maturity category should also be retained to eliminate this special accounting when entities do not comply with its conditions.
(b) How should instruments that are not measured at fair value be measured?
Held-to-maturity debt securities should be recorded at amortized cost.
(c) When should impairment losses be recognized and how should the amount of impairment losses be measured?
Impairment losses should be measured consistent with current U.S. generally accepted accounting principles (“GAAP”).
(d) When should unrealised gains and losses be recognised on instruments measured at fair value? Why? How are your suggestions consistent with the criteria set out in paragraph 2.2?
Unrealized losses on financial instruments measured at fair value should be recorded in current earnings to best capture existing economic conditions and simplify financial statements consistent with paragraph 2.2. Consequently, the available-for-sale category should be eliminated.
(e) Should reclassifications be permitted? What types of reclassifications should be permitted and how should they be accounted for? How are your suggestions consistent with the criteria set out in paragraph 2.2?
Reclassifications to earnings of deferred gains and losses for cash flow hedge accounting should not be permitted. See Question 5 for additional discussion on hedging.
Approach 3 sets out possible simplifications of hedge accounting.
(a) Should hedge accounting be eliminated? Why or why not?
(b) Should fair value hedge accounting be replaced? Approach 3 sets out three possible approaches to replacing fair value hedge accounting.
Which method(s) should the IASB consider, and why?
- Are there any other methods not discussed that should be considered by the IASB? If so, what are they and how are they consistent with the criteria set out in paragraph 2.2? If you suggest changing measurement requirements under approach 1 or approach 2, please ensure your comments are consistent with your suggested approach to changing measurement requirements.
While hedge accounting represents an attempt to properly record entities' risk management, it has created significant levels of complexity and increased errors and abuse. The discipline needed to enforce hedge accounting also contradicts the principles-based approach. Consequently, the Department would eliminate hedge accounting and take the following steps:
* Allow for the expansion of the fair value option to fair value both sides of transactions where entities seek to obtain "economic hedging." With the elimination of hedge accounting, we would facilitate this treatment by considering applicable liabilities to be within the trading account.
* Allow "synthetic accounting" to replace relevant cash flows in those transactions currently accounted for as cash flow hedges (e.g., by converting a fixed rate security to a security with floating rates).
Section 2 also discusses how the existing hedge accounting models might be simplified. At present, there are several restrictions in the existing hedge accounting models to maintain discipline over when a hedging relationship can qualify for hedge accounting and how the application of the hedge accounting models affects earnings. This section also explains why those restrictions are required.
(a) What suggestions would you make to the IASB regarding how the existing hedge accounting models could be simplified?
(b) Would your suggestions include restrictions that exist today? If not, why are those restrictions unnecessary?
(c) Existing hedge accounting requirements could be simplified if partial hedges were not permitted. Should partial hedges be permitted and, if so, why? Please also explain why you believe the benefits of allowing partial hedges justify the complexity.
(d) What other comments or suggestions do you have with regard to how hedge accounting might be simplified while maintaining discipline over when a hedging relationship can qualify for hedge accounting and how the application of the hedge accounting models affects earnings?
See response to Question 5.
Do you have any other intermediate approaches for the IASB to consider other than those set out in Section 2? If so, what are they and why should the IASB consider them?
The Department favors a single comprehensive solution instead of intermediate approaches, but we have provided our thoughts throughout to help improve the relevant accounting.
To reduce today’s measurement-related problems, Section 3 suggests that the long-term solution is to use a single method to measure all types of financial instruments within the scope of a standard for financial instruments.
Do you believe that using a single method to measure all types of financial instruments within the scope of a standard for financial instruments is appropriate? Why or why not? If you do not believe that all types of financial instruments should be measured using only one method in the long term, is there another approach to address measurement-related problems in the long term? If so, what is it?
The Department agrees with using a consistent definition of fair value for all financial instruments other than as explained for held-to-maturity debt securities, financial instruments with no observable inputs, and liabilities which are neither trading nor subject to the liquidation basis of accounting. See our responses to Questions 1 and 4 for further details.
Part A Section 3 suggests that fair value seems to be the only measurement attribute that is appropriate for all types of financial instruments within the scope of a standard for financial instruments.
(a) Do you believe that fair value is the only measurement attribute that is appropriate for all types of financial instruments within the scope of a standard for financial instruments?
(b) If not, what measurement attribute other than fair value is appropriate for all types of financial instruments within the scope of a standard for financial instruments? Why do you think that measurement attribute is appropriate for all types of financial instruments within the scope of a standard for financial instruments? Does that measurement attribute reduce today’s measurement-related complexity and provide users with information that is necessary to assess the cash flow prospects for all types of financial instruments?
See response to Question 8.
Part B of Section 3 sets out concerns about fair value measurement of financial instruments. Are there any significant concerns about fair value measurement of financial instruments other than those identified in Section 3? If so, what are they and why are they matters for concern?
The Department suggests that greater emphasis be placed on the reliability of fair values for illiquid financial instruments, as discussed more fully in our first recommendation to Question 1.
Part C of Section 3 identifies four issues that the IASB needs to resolve before proposing fair value measurement as a general requirement for all types of financial instruments within the scope of a standard for financial instruments.
(a) Are there other issues that you believe the IASB should address before proposing a general fair value measurement requirement for financial instruments? If so, what are they? How should the IASB address them?
We reiterate the need for the FASB and IASB to agree on the definitions of financial instruments and fair value.
(b) Are there any issues identified in part C of Section 3 that do not have to be resolved before proposing a general fair value measurement requirement? If so, what are they and why do they not need to be resolved before proposing fair value as a general measurement requirement?
To the extent that disclosures are expected to delay accounting standards, the Department suggests the deferral of such disclosures.
Do you have any other comments for the IASB on how it could improve and simplify the accounting for financial instruments?
The Department encourages the FASB and the IASB to work closely together to provide the highest quality, consistent accounting standards possible.
The FASB’s separate document asked: How should the Board proceed in reducing the complexity and improving reported information about financial instruments in the near term in the United States while also facilitating convergence with IFRS? Some possibilities to consider are:
Are the measurement-related problems and complexities (including presentation of changes in fair value) so significant and urgent that the Board should continue to consider undertaking short-term U.S.-only projects (in addition to a longer-term joint project or projects with the IASB)?
Should the Board work only on joint projects with the IASB and avoid undertaking additional U.S.-only projects related to financial instruments until a determination is made about whether and when the United States will adopt IFRS?
Should the Board eliminate differences between IFRS and U.S. GAAP by replacing U.S. GAAP for financial instruments with IAS 39, Financial Instruments: Recognition and Measurement, and then either work with the IASB to improve IAS 39 or simply adopt any improvements the IASB chooses to adopt?
If you would like to discuss our letter, please call me at (212) 709-1532 or email me at email@example.com.
Very truly yours,
Chief of Regulatory Accounting