COVID-19 – modifying everything, except maybe these financial instruments

We previously looked at how the ongoing COVID-19 crisis affects the application of some aspects of IFRS 9, Financial Instruments

Here’s another issue. An entity removes a financial liability from its balance sheet when and only when the obligation is extinguished – that is, discharged or cancelled or expires. A substantial modification of the terms of an existing financial liability is accounted for as such an extinguishment, recognizing a new financial liability. The standard indicates that this occurs when the discounted present value of the cash flows under the new terms is at least 10% different from that of the original liability. An entity derecognizes a financial asset when and only when the contractual rights to the cash flows from the financial asset expire, or it transfers the financial asset in a way that qualifies for derecognition. But the standard doesn’t set out a comparable principle for addressing modifications of financial assets – IFRIC emphasized a few years ago that this is an area where an entity applies judgment to develop its own accounting policy. Many issuers reportedly use a comparable “10% test” at least as a reference point, but in a way influenced by qualitative considerations (for example, the policy might differ based on the reasons for the modification.

Against that backdrop, here are some extracts from a public statement issued by the European Securities and Markets Authority (ESMA):

  • In light of the spread of COVID-19 across the globe, a variety of measures have been, and continue to be, taken by European governments to prevent the transmission of the virus along with economic support and relief measures aimed at addressing the economic consequences of the outbreak on individuals, households and businesses. Such relief measures include, but are not limited to, moratoria on repayment of loans, overdraft facilities and mortgages, loan guarantees as well as other forms of business support targeted at individual firms or specific industries (e.g. for liquidity purposes).
  • ESMA also notes that issuers might be providing measures on a voluntary basis to borrowers in the context of COVID-19. These might take the form of renegotiations, rollovers or rescheduling of cash-flows that might or might not have an impact on the net present value of these cash-flows.
  • ESMA considers that issuers should carefully assess the impact of the economic support and relief measures on recognized financial instruments and their conditions. This includes the assessment of whether such measures result in modification of the financial assets and whether modifications lead to their derecognition. In the absence of specific guidance in IFRS 9, issuers develop their accounting policies in accordance with IAS 8…ESMA notes that such assessment should include both qualitative and quantitative criteria and, especially given the situation, might be subject to significant judgement. In light of the current circumstances, ESMA considers that if the support measures provide temporary relief to debtors affected by the COVID-19 outbreak and the net economic value of the loan is not significantly affected the modification would be unlikely to be considered as substantial.

Of course, in the current environment, it may be particularly important to disclose the accounting policy applied in determining whether a modification is or isn’t substantial and to disclose the significant related judgments.

I cited previously how, in the context of estimating expected credit losses, ESMA had commented that “given the current state of uncertainty linked to the COVID-19 outbreak, within the framework provided by IFRS, issuers give a greater weight to long-term stable outlook as evidenced by past experience and take into account the relief measures granted by public authorities – such as payment moratoria).” The sense of that, as with the commentary on identifying modifications, is a concern to avoid short-term measurement volatility that might with hindsight be seen as excessive. The IASB’s statement on IFRS 9 and COVID-19 carried a similar sense, emphasizing for instance that the extension of payment holidays to all borrowers in particular classes of financial instruments should not automatically result in all those instruments being considered to have suffered a significant increase in credit risk, and emphasizing: “Although current circumstances are difficult and create high levels of uncertainty, if ECL estimates are based on reasonable and supportable information and IFRS 9 is not applied mechanistically, useful information can be provided about ECLs. Indeed, in the current stressed environment, IFRS 9 and the associated disclosures can provide much needed transparency to users of financial statements.”

It’s certainly a defensible position, although the current uncertainty is so intense and pervasive that you could argue for just about any future state with equal articulacy. As of now, it doesn’t seem to me (possibly naively) that the crisis will present a basis for damning IFRS 9 as a failure, in the way that aspects of the standards have been rightly or wrongly targeted in the past. But that’s not to say it will be viewed as a great success…

The opinions expressed are solely those of the author

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