Z E N T R A L E R K R E D I T A U S S C H U S S

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1 Z E N T R A L E R K R E D I T A U S S C H U S S MITGLIEDER: BUNDESVERBAND DER DEUTSCHEN VOLKSBANKEN UND RAIFFEISENBANKEN E.V. BERLIN BUNDESVERBAND DEUTSCHER BANKEN E.V. BERLIN BUNDESVERBAND ÖFFENTLICHER BANKEN DEUTSCHLANDS E.V. BERLIN DEUTSCHER SPARKASSEN- UND GIROVERBAND E.V. BERLIN-BONN VERBAND DEUTSCHER PFANDBRIEFBANKEN E.V. BERLIN Sir David Tweedie Chairman International Accounting Standards Board 30 Cannon Street EC4M 6XH LONDON GROSSBRITANNIEN Berlin, 31 July 2009 Schellingstraße 4 Tel.: / Fax: / MW/AM Exposure Draft ED/2009/3: Derecognition Proposed amendments to IAS 39 and IFRS 7 ZKA REF.: IASB BVR REF.: EG-VSK-IAS39 Dear Sir David, Thank you for the opportunity to comment on the Exposure Draft ED/2009/3: Derecognition Proposed amendments to IAS 39 and IFRS 7. General Comments The different derecognition concepts currently covered by IAS 39 are indeed extremely complex and, as a result, are difficult to understand for users of annual financial statements. Based on the foregoing, we welcome the present Exposure Draft s objective, i.e. simplification and harmonisation of the current derecognition rules. At first glance, the idea of replacing the existing derecognition criteria risks and rewards and control by a single criterion, i.e. control seems to be impressive. However, upon closer examination it becomes apparent that the approach proposed in the Exposure Draft still contains risks and rewards elements. (cf. Alternative View (AV)3).

2 - 2 - In our mind, it is doubtful whether the present Exposure Draft indeed succeeds in meeting the goal of simplification and harmonisation. We doubt whether the new rules would always lead to appropriate results and increase the information value and transparency. Our doubts are further underpinned by the fact that the current derecognition rules may indeed feature a high degree of complexity. On the other hand, in terms of manageability/feasibility they have proven fit for purpose. In the meantime, practitioners have got used to the risks and rewards approach and know how to handle it. Hence, from the preparers point of view, the current regulatory framework is rather manageable. Based on the foregoing, we do not perceive any compelling need for a revision of the requirements as contemplated by the present Exposure Draft. In particular we have concerns over the Exposure Draft s implications for the recognition of securities lending and repo transactions. In large numbers, especially banks carry out such transactions. Hence, the accounting treatment thereof is of paramount importance. To date, in the case of genuine repo transactions the transferor do not need to derecognise the underlying security. This is due to the fact that from an economic point of view - the transferor is generally in the same position as if he had borrowed a loan from the transferee at the amount of the purchase price and the underlying asset had been assigned to them as security. The risks and rewards of a change in value of the underlying asset are entirely incumbent upon the transferor. Contrary to this, in cases where the securities are readily obtainable in the market at any time, the control concept proposed in the Exposure Draft envisages that the transferor must derecognise the securities accompanied by a concurrent recognition of a derivative. In our view, this treatment fails to provide a true and fair view of the economic substance of these transactions. Economically speaking, repo transactions and securities lending transactions are collateralised money market transactions which are solely used for funding purposes. Besides the huge effort involved in adjusting to such an amendment, a number of followup questions would arise on which the Exposure Draft remains silent. This regards such as the treatment of capital gains and losses as well as the transferor s or transferee s allocation of the repo transaction s underlying assets to the IAS 39 categories. For instance, the question comes up how a repurchase agreement s underlying assets should be treated if they were designated as held to maturity during first-time recognition. If, in future, it would lead to a derecognition of the underlying asset this would have a knock-on effect on the tainting rule under IAS Potential problems may also result in those cases where the repo securities are the subject of a hedge accounting relation which would be rendered obsolete in the event of derecognition. Regardless of these technical accounting difficulties the question arises concerning potential knock-on effects on the legal/contractual framework of such transactions. All in all, we feel that the present Exposure Draft gives rise to the risk of substantially calling into question the existing business model of repo and securities lending transactions. Potentially, this could further exacerbate banks liquidity situation and as a result cause problems in the money market.

3 - 3 - Conceptually, the proposals appear to be shifting away from the economic substance over form principle towards a more formalistic approach. In our view, this constitutes a step backward rather than forward. Neither would the approach set out in the Exposure Draft lead to a reduction in complexity nor would it increase transparency for users of financial statements. Based on the foregoing, we reject the proposed changes. On the other hand, the Exposure Draft spells out an alternative view approach that might offer a suitable approach for a meaningful amendment of the derecognition provisions (cf. question 7). However, it remains silent on the details of this approach and only paints a very cursory picture. Please find our more specific comments on the individual questions below: Question 1: Do you agree that the determination of the item (ie the Asset) to be evaluated for derecognition and the assessment of continuing involvement should be made at the level of the reporting entity (see paragraphs 15A, AG37A and AG47A)? If not, why? What would you propose instead, and why? We endorse this provision. The derecognition rules should be applied at group level after consolidation of subsidiaries as well as after the inclusion of special purpose entities. As we understand it this is in line with the current requirement under IAS Question 2: Do you agree with the criteria proposed in paragraph 16A for what qualifies as the item (ie the Asset) to be assessed for derecognition? If not, why? What criteria would you propose instead, and why? In our understanding, compared to the present provisions under IAS 39.16, no material differences arise from the language under section 16A. It would be helpful to have additional guidance on the treatment of financial instruments which may be considered either an asset or a liability during the time to maturity. Question 3: Do you agree with the definition of a transfer proposed in paragraph 9? If not, why? How would you propose to amend the definition instead, and why? From our point of view, the definition of the term transfer proposed under ED-IAS 39.9 is extremely far reaching. Even if a broad definition was the explicit goal of IASB such an approach would make the application of this rule more difficult for the reporting entity. This is especially true since the definition fails to provide a definition of the terms used, i.e. economic benefits or other exchange. Hence, it is virtually impossible to draw a

4 - 4 - line whether or not a transfer within the meaning of the ED exists. Therefore, we see the danger that suddenly scenarios which (to date) did not require a derecognition test will now have to be assessed with a view to their potential qualification for derecognition (e.g. total return swaps). Even if such cases were to be exempted from derecognition, the question remains whether the comprehensive disclosure requirements will need to be met. Under ED-IAS 39.BC9, the Exposure Draft s Annex clarifies that for financial assets (future) economic benefits translates into the right to the cash flow resulting from these financial assets ( The future economic benefits embodied in a financial asset generally are the contractual right to future cash flows ). It would be worth considering an incorporation of this clarification for financial assets from the Annex into the main text of the standard under ED-IAS This could facilitate application of this provision. Question 4: Do you agree with the continuing involvement filter proposed in paragraph 17A(b), and also the exceptions made to continuing involvement in paragraph 18A? If not, why? What would you propose instead, and why? We agree with the fundamental principle that an asset needs to be derecognised once the future economic benefit ceases to exist. However the application of the continuing involvement filter, is likely to cause problems in practice. It remains doubtful, whether the proposed ascertainment of a continuing involvement would always lead to appropriate results. Particularly in the case of transfers of genuine true sale securitisation there will probably be many cases where - pursuant to the proposed test - a continuing involvement would contradict a derecognition despite the fact that the derecognition would be warranted as far as the economic benefits are concerned. In this context, the concept of the alternative view provides for a less ambiguous policy. We therefore propose fine-tuning and further evolution of the alternative view concept and suggest dropping the continuing involvement filter. Question 5: Do you agree with the proposed practical ability to transfer derecognition test in paragraph 17A(c)? If not, why? What would you propose instead, and why? Do you agree with the for the transferee s own benefit test proposed as part of the practical ability to transfer test in paragraph 17A(c)? If not, why? What would you propose instead, and why? The evaluation of the practical ability to transfer test has to be seen in the context of the derecognition concept based on a control approach (cf. general comments). The application of the practical ability to transfer test, will, in practice, frequently prove difficult to apply and involve discretionary interpretation. Contrary to the present regulatory framework, the provisions under the Exposure Draft feature less complex

5 - 5 - wording. However, in our view the complexity has merely shifted to the application level. Application of the present derecognition rules, on the other hand, is less difficult than the complex language of the respective provisions would initially suggest. In our understanding, the practical ability to transfer test shall generally be carried out at the time of the transfer. If and when there is a derecognition at that time, a subsequent reassessment shall be impossible (i.e. no subsequent re-recognition of financial assets once they have been derecognised). For transactions, however, where the practical ability to transfer at the time of the transfer does not exist and where, as a consequence, the transferred asset cannot be derecognised, the derecognition will have to be carried out later on once the possibility for a (further) transfer of the asset arises (for instance because a market becomes active). The asymmetrical reassessment rules leads to inconsistencies and thus to a different treatment of similar scenarios. Apart from this, we also feel that there will be considerable difficulties during the practical implementation of this provision; it will result in the constant need to make difficult discretionary decisions. Cases where a derecognition has not taken place would require the reporting entity to constantly monitor whether the contractual partner of the transfer may in the meantime have become entitled to dispose of the transferred asset. Furthermore, the Exposure Draft stipulates that if a transfer of a financial asset does not qualify for derecognition by the transferor, the transferee does not recognise the transferred asset as its asset (cf. ED-IAS 39.AG34). This would require a close liaison between the transferor and the transferee also concerning the treatment of the transfer in terms of accounting (both at the time of the transfer and also beyond). We feel that this is not feasible. For repurchase agreements, the criterion readily obtainable in the market" also will have to be applied. The Exposure draft is silent on clear definition of this term or an indication on how to differentiate it from the term active market Especially the present financial crisis has highlighted that, in practice, establishing whether an active market exists or not can prove difficult. As mentioned above, repo transactions serve primarily for financing purposes. The mandatory derecognition and subsequent re-recognition of the transferred securities would result in a transitional gain or loss, provided that there is a difference between the carrying amount and the repurchase price. This would result in an income statement volatility that would lack any economic explanation. As a result, this could create confusion amongst users of the financial statements. Furthermore, during the term to maturity of the repo agreement it would be necessary to additionally recognise a derivative: Similar to forward purchases, this derivative would show the difference between the repurchase price and the respective market price of the asset that is about to be bought back; in effect, this would tie up additional, significant amounts of labour resources. With regard to the disposal of assets within the framework of true sale securitisation transactions, the main concern is that under the present proposals a derecognition would

6 - 6 - become more difficult. In view of the current market environment this would equally give rise to major concerns. Question 6: Do you agree with the proposed accounting (both recognition and measurement) for an interest retained in a financial asset or a group of financial assets in a transfer that qualifies for derecognition (for a retained interest in a financial asset or group of financial assets, see paragraph 21A; for an interest in a financial asset or group of financial assets retained indirectly through an entity, see paragraph 22A)? If not, why? What would you propose instead, and why? We endorse the proposal under paragraph 21A concerning the accounting treatment of interests retained. It is in line with the current IAS 39 provision. However, the proposal under section 22A concerning the treatment of purchased interests in the transferring entity, which form part of the transfer compensation, appears problematic. The requested split of the interests into one part which is assigned to the original asset and one part which is assigned to potential other assets of the transferee is not feasible in practice. Apart from this, we feel that the Exposure Draft does not clarify beyond any doubt how various cases are supposed to be treated where the transferor has a financial stake in the transferee. For instance, it is possible that a transferee (the latter being a fully operational company and not an SPV) pays with own shares for the acquisition of financial assets. By virtue of receiving these shares, the transferor indirectly continues to participate in the performance of the assets previously held by said transferor. In the view of the IASB, such a constellation would apparently not hinder derecognition of the transferred assets. ED-IAS 39.AG52L example (h), discusses the case where the reporting entity acquires the first-loss piece of an SPV which previously bought financial assets from the reporting entity. According to the example, the derecognition of the transferred assets is ruled out by the acquired first-loss-piece. At the same time, pursuant to ED-IAS 39.22A, a derecognition of financial assets shall generally be possible even in cases where like in the aforementioned example the transferor turns out to acquire a financial interest in the buyer. At this juncture, a more precise language of the Exposure Draft would be preferable. For instance, the draft remains silent on the derecognition policy for securitisation transactions where an SPV tranche is retained that features a higher seniority as opposed to the firstloss-piece and which is consequently materially different to the previously transferred financial assets in terms of the exposure and the payment profile.

7 - 7 - Question 7: Having gone through the steps/tests of the proposed approach to derecognition of financial assets (Questions 1 6), do you agree that the proposed approach as a whole should be established as the new approach for determining the derecognition of financial assets? If not, why? Do you believe that the Alternative Approach set out in the alternative views should be established as the new derecognition approach instead, and, if so, why? If not, why? What Alternative Approach would you propose instead, and why? In our view, the present draft does not lead to any material improvement nor does it simplify the current derecognition requirements. Hence, it does not warrant the expenditure of the resources necessary for its potential implementation. In terms of the overall concept, the "Alternative View" presented in the exposure draft appears preferable. The "alternative view" could be a suitable starting point for developing derecognition rules that would be consistent with the framework. Additionally, it might make a contribution towards simplification. At present, however, only the broad outlines of the alternative view have been presented; therefore any final assessment would be premature. From our point of view, the concept of the alternative view should be finetuned and specified in greater detail. Furthermore, it should be discussed as an alternative that is on a par with the approach set out in the ED. In order to avoid a derecognition of genuine repo transactions, (c.f. General Comments), the Alternative Approach should be expanded to include a risks and rewards component. The risks and rewards approach has become a standard market practice; users and preparers acknowledge its practicability and feasibility. Furthermore, the preceding determination steps (assessments at the level of the reporting entity, etc.) should be incorporated into an expanded, updated assessment scheme for the alternative view. Question 8: In December 2008, the Board issued an exposure draft ED 10 Consolidated Financial Statements. As noted in paragraphs BC28 and BC29, the Board believes that its proposed approach to derecognition of financial assets in this exposure draft is similar to the approach proposed in ED 10 (albeit derecognition is applied at the level of assets and liabilities, whereas consolidation is assessed at the entity level). Do you agree that the proposed derecognition and consolidation approaches are compatible? If not, why? Should the Board consider any other aspects of the proposed approaches to derecognition and consolidation before it finalises the exposure drafts? If so, which ones, and why? If the Board were to consider adopting the alternative approach, do you believe that that approach would be compatible with the proposed consolidation approach?

8 - 8 - Generally, we feel that consistent and compatible rules are both necessary and meaningful. Both ED 10 and also the present Exposure Draft mark a shift away from the risks and rewards approach (which tends to lend emphasis to economic aspects) towards a more legally-based control approach. From an economic point of view, the rationale for this is difficult to understand. Furthermore, it is doubtful whether the exclusive focus on the control concept will indeed lead to a qualitative improvement of IFRS accounting. This is especially true since provided an appropriate implementation the risks and rewards approach has proved its worth in practice. Question 9: Do you agree with the proposed amendments to the principle for derecognition of financial liabilities in paragraph 39A? If not, why? How would you propose to amend that principle instead, and why? We feel that the proposed amendments do not lead to material changes. Question 10: Do you agree with the proposed amendments to the transition guidance in paragraphs 106 and 107? If not, why? How would you propose to amend that guidance instead, and why? In general we are in favour of the envisaged transition rules. Pursuant to IFRS 7.44H, the comprehensive disclosure obligations requested under IFRS 7.42C 42F are also mandatory for those assets and liabilities which prior to the time of first-time application were derecognised under the currently applicable IAS 39 but which under the new rules would not have been derecognised. The same applies to assets and liabilities which qualify for derecognition under the new rules but not under the current rules. Compliance with the aforementioned disclosure obligations requires an analysis of past business transactions. This would incur considerable costs. Given that information may not be very meaningful for users of financial statements, this disclosure obligation should be deleted under cost-benefit aspects. Question 11: Do you agree with the proposed amendments to IFRS 7? If not, why? How would you propose to amend those requirements instead, and why? The plans to expand the disclosure obligations are perfectly understandable when seen against the backdrop of the financial market crisis. However, whether the volume and level of detail of the proposed disclosures makes sense to users of the financial statement should be subjected to a critical and careful review. Furthermore, it is worth highlighting that the current IFRS 7 already contains comprehensive disclosure obligations some of

9 - 9 - which are being duplicated at this juncture. Hence, in our view, cost-benefit considerations would point to an urgent need for a review whether the proposed disclosure obligations will be relevant in practice. Yours sincerely, For ZENTRALER KREDITAUSSCHUSS Bundesverband der Deutschen Volksbanken und Raiffeisenbanken e.v. by proxy Dr. Andreas Martin Stefanie Morfeld-Wahle