31 August 2009

Sir David Tweedie
Chairman
International Accounting Standards Board
30 Cannon Street
London EC 4M 6XH
UNITED KINGDOM
commentletters@iasb.org.uk

Dear Sir David

ED/2009/7 Financial Instruments: Classification & Measurement

The Group of 100 (G100) is an organization of chief financial officers from Australia’s largest business enterprises whose primary purpose is to advance Australia’s financial competitiveness. The G100 comments on the Exposure Draft are attached.

The G100 supports the efforts of the IASB to address concerns about the complexity and inconsistency of the requirements of IAS 39 ‘Financial Instruments: Recognition and Measurement’, by developing proposals to simplify the requirements using a principles-based approach in place of detailed rules. However, we believe that the simplification could have been achieved by other means. For example, although the classification of available-for-sale securities deals with some of the concerns raised in response to the global financial crisis, the requirements in respect of equity securities would be unnecessary if impairment losses were able to be reversed and recognized in the profit or loss.

A significant concern we have about the approach being taken by the IASB is that requirements relating to classification and measurement are being addressed separately from issues relating to asset impairments, accounting for hedges, credit risk and derecognition of financial instruments. The G100 believes that the requirements developed in each phase of the replacement of IAS 39 project must be internally consistent. There is a risk that the piecemeal development of requirements could lead to entities implementing changes in accounting policies that may need to be unwound because of decisions made in later phases of the project.

Our responses to the questions raised in the Exposure Draft are included in the Appendix.

Yours sincerely

Tony Reeves
National President

Appendix - Group of 100 responses to questions

ED/2009/7 Financial Instruments: Classification & Measurement

CLASSIFICATION APPROACH

Q1	Does amortised cost provide decision-useful information for a financial asset or financial liability that has basic loan features and is managed on a contractual yield basis? If not, why? Yes. The G100 believes that the use of amortised cost is justified in respect of financial instruments that the entity is holding (issued) with the purpose of generating (incurring) interest revenue (expense) and the return of principal at maturity, that is, for instruments that have basic loan features and are managed on a contractual yield basis.
Q2	Do you believe that the ED proposes sufficient, operational guidance on the application of whether an instrument has ‘basic loan features’ and ‘is managed on a contractual yield basis? If not, why? What additional guidance would you propose and why? The G100 believes that the proposed approach is a step in the right direction and that the guidance provided may be adequate. However, we have not tested the guidance in a practical sense and consider that issues are likely to arise in applying the ‘basic loan features’ notion consistently to different types of instruments. This is a particular issue in respect of the treatment of hybrid and convertible instruments as clarification is required on whether the classification is intended to be dealt with solely by IAS 32 ‘Financial Instruments: Presentation’ or by this ED.
Q3	Do you believe that other conditions would be more appropriate to identify which financial assets or financial liabilities should be measured at amortised cost? If so, what alternative conditions would you propose? Why are those conditions more appropriate? The G100 does not propose alternative conditions for identifying those financial instruments to be measured at amortised cost.

EMBEDDED DERIVATIVES

Q4(a)

Do you agree that the embedded derivative requirements for a hybrid contract with a financial host should be eliminated? If not, please describe any alternative proposal and explain how it simplifies the accounting requirements and how it would improve the decision-usefulness of information about hybrid contracts.

The G100 is not convinced that the proposals will simplify the existing requirements which have given rise to a number of issues in application and that a compelling reason for change has been provided. Bifurcation of instruments will not necessarily resolve issues of interpretation and application. For example, we have been informed of conflicting advice on how to account for a bifurcated instrument held in a foreign currency.

The G100 does not normally support the existence of options. However, if the IASB is to proceed with the proposals regarding embedded derivatives, we suggest it would be appropriate for bifurcation to be optional. If this were the case entities that consider it preferable to measure a hybrid instrument at fair value would be able to do so and those entities that separate embedded derivatives from the host contract as part of their risk management strategy would be able to so do. Such an approach would also be consistent with dealing with items from the perspective of how the business is managed.

Additionally, the migration of financial instruments to fair value measurement will result in former host contracts being measured at fair value as a component of the whole financial instrument. The G100 considers that the additional detailed disclosure requirements at each level of the fair value hierarchy are excessive and onerous.

Q4(b)

Do you agree with the proposed application of the proposed classification approach to contractually subordinated interests (ie tranches)? If not, what approach would you propose for such contractually subordinated interests? How is that approach consistent with the proposed classification approach? How would that approach simplify the accounting requirements and improve the decision-usefulness of information about contractually subordinated interests?

In many respects these tranches, if recognized in the balance sheet, are similar to units in a trust that have different rankings in the event of insolvency. We believe that it is artificial and arbitrary to specify that the top tranche is the only tranche that is debt.

FAIR VALUE OPTION

Q5	Do you agree that entities should continue to be permitted to designate any financial asset or financial liability at fair value through profit or loss if such designation eliminates or significantly reduces an accounting mismatch? If not, why? Yes. However, the G100 considers that the impact of accounting mismatches would need to be reviewed in the context of work on hedge accounting.
Q6	Should the fair value option be allowed under any other circumstances? If so, under what other circumstances should it be allowed and why? The G100 believes that the fair value option should be available in respect of hybrid instruments where embedded derivatives are bifurcated.

INVESTMENTS IN EQUITY INSTRUMENTS THAT DO NOT HAVE A QUOTED MARKET PRICE AND WHOSE FAIR VALUE CANNOT BE RELIABLY MEASURED

Do you agree that reclassification should be prohibited? If not, in what circumstances do you believe reclassification is appropriate and why do such reclassifications provide understandable and useful information to users of financial statements? How would you account for such reclassifications, and why?

The G100 does not support the proposed prohibition on reclassification. We believe that an entity should be able to reclassify a financial instrument where there is demonstrable and verifiable evidence that the nature of the business activity has changed and the purpose for holding instrument has changed. We agree that reclassification should not be at the whim of management and directors. Consistent with an approach based on how the business is managed an instrument may no longer meet the criteria for how it is presently classified. In these circumstances not to reclassify the instrument may be misleading to users of financial statements.

INVESTMENTS IN EQUITY INSTRUMENTS THAT ARE MEASURED AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

Do you believe that more decision-useful information about investments in equity instruments (and derivatives on those equity instruments) results if all such investments are measured at fair value? If not, why?

The G100 does not support the proposal to measure all these equity instruments at fair value. However, the proposals may not achieve a simplification of the requirements for practical purposes. We are not satisfied that, say, applying the Level 3 fair value hierarchy measurement would provide reliable information in respect of these equity instruments. Replacing the existing exemption for equity instruments that do not have a reliable fair value with a requirement to measure at fair value does not necessarily improve the reliability of information.

Are there circumstances in which the benefits of improved decision-usefulness do not outweigh the costs of providing this information? What are those circumstances and why? In such circumstances, what impairment tests would you require and why?

There is a risk that fair value measurement in accordance with Level 3 of the hierarchy will not provide reliable information in a number of cases. We do not consider that the benefits of fair value measurement in these circumstances will outweigh the costs particularly if the ‘cost’ of relying on information that is not reliable is taken into account.

Q10

Do you believe that presenting fair value changes (and dividends) for particular investments in equity instruments in other comprehensive income would improve financial reporting? If not, why?

The G100 acknowledges the arguments supporting the presentation of value changes in equity instruments held for strategic purposes (and not trading) in OCI and that for consistency with the strategic nature of the investment distributions from the investment should also be included in OCI (i.e. dividends). When the investment is no longer held for a strategic purpose any gains and losses on the investment should be included (recycled) in profit or loss.

However, the G100 believes that dividend revenue should be recognized as a component of operating profit or loss. If dividend revenue is to be classified separately in OCI consistency would imply that associated costs such as funding costs should also be recognized in OCI.

EFFECTIVE DATE AND TRANSITION – AN ALTERNATIVE APPROACH

Q11	Do you agree that an entity should be permitted to present in other comprehensive income changes in the fair value (and dividends) of any investment in equity instruments (other than those that are held for trading), only if it elects to do so at initial recognition? If not: a. how do you propose to identify those investments for which presentation in other comprehensive income is appropriate? Why? b. should entities present changes in fair value in other comprehensive income only in the periods in which the investments in equity instruments meet the proposed identification principle in (a)? Why? The G100 supports the proposal that ‘designation’ occur at initial recognition of the investment because of the business objective underlying the investment. As indicated above the ‘designation’ would be unwound where those circumstances changed such as derecognition of the investment and gains and losses included in profit or loss.
Q12	Do you agree with the additional disclosure requirements proposed for entities that apply the proposed IFRS before its mandated effective date? If not, what would you propose instead and why? The G100 considers that the detailed disclosure requirements may act as an impediment to an entity early adopting the new requirements. A further impediment would be that the requirements for impairment and hedge accounting have not been developed which opens the possibility that an early adopter may be making accounting policy decisions and choices before the completion of the project and then be confronted with the need to make further changes. If user needs are to be served it would appear that the disclosure requirements, if retained, should apply to all entities on transition to the new requirements and not just to those who are early-adopters.
Q13	Do you agree with applying the proposals retrospectively and the related proposed transition guidance? If not, why? What transition guidance would you propose instead and why? The G100 believes there should be a long lead-time for implementation of the new requirements and accordingly supports the proposed effective date. The G100 also believes that entities should be able to early-adopt the requirements. The G100 also agrees with applying the requirements retrospectively because when the new standard is effective all entities will be subject to the same requirements, thus enhancing the quality and comparability of the information. However, the G100 believes that the disclosure load should be reduced rather than extended in these circumstances.
Q14	Do you believe that this alternative approach provides more decision-useful information than measuring those financial assets at amortised cost, specifically: a. in the statement of financial position? b. in the statement of comprehensive income? If so, why? No. The alternative approach would not in our opinion provide more decision useful information.
Q15	Do you believe that either of the possible variants of the alternative approach provides more decision-useful information than the alternative approach and the approach proposed in the ED? If so, which variant and why? No. The G100 does not support these variants because of the narrowing of the application of amortised cost and the use of fair values for all instruments.