european commission investment and company … · 1.3.1. during the development of the amendments...

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EUROPEAN COMMISSION Directorate General Financial Stability, Financial Services and Capital Markets

INVESTMENT AND COMPANY REPORTING

Accounting and financial reporting

Endorsement of Amendments to International Financial Reporting Standard 4,

Applying IFRS 9 Financial Instruments with IFRs 4 Insurance Contracts

Introduction, background and conclusions

Attachment 1: Endorsement advice prepared by EFRAG

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INTRODUCTION

European Commission services and the European Financial Reporting Advisory Group

(EFRAG) analyse the effects of new accounting standards and interpretations before they

are endorsed by the European Union. This paper sets out an explanation of the

accounting areas covered by the Amendments to IFRS 4, "Insurance Contracts"; the

process of stakeholder consultations involved in the development of the Amendments to

the Standard, and an analysis of the effects of using the new accounting requirements in

the EU.

EFRAG's endorsement advice has been developed and adopted by the EFRAG Board

taking into account the input from the observers to the Board: the European Central Bank

(ECB), the European Securities Markets Authority (ESMA), the European Banking

Authority (EBA) and the European Insurance and Occupational Pensions Authority

(EIOPA).

EFRAG's endorsement advice to the European Commission on the Amendments to IFRS

4 assessed whether they meet the endorsement criteria in Regulation (EC) no 1606/2002

of the European Parliament and Council for the adoption of international accounting

standards into EU law and whether their overall benefits outweigh costs. EFRAG’s

endorsement advice is included in attachment 1.

1. BACKGROUND

The IASB published the Amendments to IFRS 4 on 12 September 2016 following a

faster than usual development and consultation process. The Amendments address

concerns arising from the different effective dates of IFRS 9, "Financial Instruments",

and the forthcoming insurance contracts Standard.

1.1. Reasons for the Amendments

IFRS 9 was published by the IASB in July 2014 and endorsed in the EU in November

2016. The standard is effective for financial years beginning on or after 1 January 2018.

During the endorsement process of IFRS 9, the Commission stated that,

notwithstanding, its decision to endorse this standard, the issue of the non-alignment of

the effective dates of IFRS 9 and the forthcoming insurance contracts Standard, IFRS 17,

should be addressed in a satisfactory manner. This position is reflected in Recital 5 of the

Regulation endorsing IFRS 9: "The adoption of international accounting standards by the

Commission has to be done in a timely manner so as not to undermine investor

understanding and confidence. Nevertheless, while endorsing IFRS 9, the need for an

optional deferral of its application for the insurance sector is recognised". The recital

acknowledged that the IASB was developing a solution to the problem. The Commission

services undertook to monitor, with EFRAG's input, the progress of the IASB's solutions

for the insurance industry and noted that a deferral:

• should be optional given that part of the insurance industry is willing to apply IFRS

9 as of 2018, and

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• should be limited in time (until 2021) so that the insurance industry adopts IFRS 9

and the new insurance contracts standard as soon as possible.

The problem of the non-alignment of effective dates of the two standards stems from the

way in which insurance companies manage their business. They generally operate a

business model in which they invest in financial assets in order to generate income and

capital gains to cover liabilities arising from the insurance contracts they have written.

The accounting for their financial assets will be determined by IFRS 9, which requires

that certain financial assets are measured at fair value, while the accounting for insurance

liabilities is currently covered by IFRS 4 which effectively permits insurance companies

to continue using their national Generally Accepted Accounting Principles (GAAP).

Hence, some insurance companies in Europe use a cost-based measurement to measure

their liabilities from insurance contracts while others use a value based on more up-to-

date information. IFRS 4 is currently being substantively changed by the IASB and will

be replaced by IFRS 17. The new standard will require that liabilities arising from

insurance contracts are measured on a consistent basis using relevant current

assumptions. It has been developed so that insurance companies can reflect their business

model as far as possible. Thus, if IFRS 9 and IFRS 17 had been finalised by the IASB at

about the same time, their effective dates could have been aligned which would have

meant that, in implementing them, the insurance industry could more appropriately

reflect in their financial statements their business model of managing financial assets and

insurance contract liabilities together. The IASB is expected to finalise IFRS 17 in the

first half of 2017 with an effective date of 1 January 2021.

In its endorsement advice on IFRS 9, EFRAG assessed the effects on the insurance

industry of the non-alignment of the effective dates between IFRS 9 and the future IFRS

17. EFRAG noted that this non-alignment would create disruptions in the financial

reporting of many entities undertaking insurance activities during the period until IFRS

17 is applied. Such disruptions include accounting mismatches (for example, arising

from financial assets reported at fair value while the liabilities relating to these assets are

reported at cost) and volatility arising from market-driven fluctuations in fair values of

financial assets measured at fair value. In some cases, these issues already arise under the

existing accounting for financial assets (under IAS 39). However, the application of IFRS

9 before the forthcoming insurance contracts Standard may move some accounting

mismatches and volatility from Other Comprehensive Income (OCI) to profit or loss

making the issues more prominent as well as introducing some additional mismatches

and volatility beyond that which already exist. EFRAG noted that the extent of the

difficulties created by the non-alignment of the effective dates of the two standards varies

between companies. These disruptions could make financial reporting less

understandable for users while potentially increasing costs for preparers who would have

to explain their results to their investors and may also incur additional costs in relation to

their accounting choices under IFRS 9.

During the endorsement process of IFRS 9, the IASB also acknowledged that the non-

alignment of dates of the effective dates of IFRS 9 and the future IFRS 17 posed

particular problems for insurance entities. The IASB developed two approaches to

resolve the problems. Both are optional given that the accounting rules applying to

liabilities from insurance contracts vary across jurisdictions.

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1.2. Content of the Amendments

The IASB's two approaches are now reflected in the Amendments to IFRS 4. First, the

deferral approach, allows reporting entities with predominant insurance activities to defer

the application of IFRS 9 between 1 January 2018 and 31 December 2020.The scope of

the IASB deferral solution will exclude some significant insurance companies in Europe

that are part of bank-led financial conglomerates. This matter is covered in further detail

in Section 4. Secondly, the "overlay approach", could be used by insurance entities that

would not qualify for a deferral of IFRS 9 or which choose to adopt IFRS 9. The overlay

approach would allow for increased volatility reported in profit in loss as a result of

applying IFRS 9 to be removed from profit or loss to the Statement of Other

Comprehensive Income (OCI).

1.2.1. IASB Deferral Approach

The conditions for applying the deferral approach are that the reporting entity has not

previously applied any version of IFRS 9 and that its activities are predominantly linked

with insurance at its reporting date immediately preceding 1 April 2016 (this can be

subject to a reassessment where there has been a significant change in activities). The

predominance test is in two parts: (i) the proportion of liabilities falling under IFRS

compared to total liabilities should be significant and (ii) the total amount of liabilities

connected with insurance activities compared to total liabilities should be greater than

90%1.

The IASB considered that a reporting entity meeting the above criteria would provide

more understandable and useful information by accounting for its financial assets and

financial liabilities applying either IFRS 9 or IAS 39. Thus the Board decided that the

temporary exemption from IFRS 9 should be available only if the entity as a whole

qualifies by considering all of its activities in order to avoid having the use of two

different accounting standards within the consolidated financial statements of a group.

Nevertheless, this decision means that some sizeable insurance companies in Europe that

are part of bank-led financial conglomerates would not be able to take advantage of the

temporary exemption from applying IFRS 9 and would have to apply it from 1 January

2018 onwards. The IASB considered that groups that do not meet the predominance test

could as an alternative use the overlay approach. This scope issue is covered further in

Section 4 below.

The Amendments contain provisions for disclosure to address the lack of comparability

between entities that will use IFRS 9 and those that will opt to defer its application and

remain using IAS 39. Given that IFRS 9 introduces significant improvements over IAS

39, in particular, in the area of recognition of expected credit losses, the disclosures

include some improved credit risk information for certain financial assets. There are also

disclosure requirements of fair value information separated into groups similar to those in

IFRS 9.

1 • If less than or equal to 90% but greater than 80%, the insurer should not engage in significant activities

unconnected with insurance.

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1.2.2. The Overlay Approach

The overlay approach is available for all companies and groups that have financial assets

connected to liabilities for insurance contracts accounted for under IFRS 4 and can be

applied until the time the future insurance contracts Standard is first applied (which is

expected to be on 1 January 2021). Under this approach, an insurer applies IFRS 9 and

adjusts profit or loss so that it reports the same overall amount of profit or loss that it

would have reported under IAS 39. This adjustment to profit or loss can only be made for

certain financial assets (the so-called "designated" financial assets as defined by the

Amendments) however, within those designated assets an insurer has the option to apply

the overlay to all, none or some of the assets. The approach allows insurers reporting

under IFRS 9 to address accounting mismatches and volatility in profit or loss that may

arise from reporting under IFRS 9 before applying the forthcoming insurance contracts

Standard, IFRS 17. The Amendments include presentation and disclosure requirements to

make the effects of the overlay transparent.

In complying with the presentation and disclosure requirements for the overlay approach,

an insurer will provide information under IFRS 9 and also on the application of the

overlay, for example, explaining how the adjustment is calculated and its effect upon the

financial statements.

1.3. IASB due process and EFRAG consultations

1.3.1. During the development of the Amendments to IFRS 4

The IASB finalised IFRS 9 in 2014. However, in late 2015, although the IASB

considered it was at an advanced stage of developing IFRS 17, it concluded that the

effective date of the replacement standard would be after that of IFRS 9. Recognising

that this misalignment of dates could give rise to undesirable accounting effects such as

mismatches and volatility when IFRS 9 is applied with the existing IFRS 4, the Board

agreed these issues should be addressed.

An Exposure Draft was published on 9 December 2015 with a 60-day comment period,

which ended on 8 February 2016. Ninety six comment letters were received. IASB staff

also conducted an extensive outreach with affected preparers and held discussions with

70 users.

EFRAG consulted on the IASB proposals by publishing a draft comment letter on the

proposals on 24 December 2015. EFRAG received twenty comment letters and finalised

its comment letter on the proposals on 14 March 2016.

1.3.2. Following the publication of the standard

Following the publication of the IASB Amendments to IFRS 4 in September 2016,

Commission services wrote to EFRAG on 13 October 2016 asking for an opinion on

whether the standard meets the criteria set out in Regulation (EC) no 1606/2002 of the

European Parliament and Council for the adoption of international accounting standards

into EU law.

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As noted above, a company or a group of companies whose predominant activities are

insurance activities would be allowed to defer the application date of IFRS 9 from 2018

until 1 January 2021. However, insurance entities within bank-led financial

conglomerates are excluded from the scope of the IASB deferral. In some Member States

these insurance entities have very significant amounts of liabilities arising from their

insurance contracts and hold financial assets to match them. Accordingly, the

Commission's letter asked EFRAG to consider whether from an economic perspective

the scope of the IASB amendments could give rise to any competition issues within the

EU for financial services companies reporting under IFRS and to explain the extent to

which the amendment to IFRS 4 would contribute to a level playing field among

European businesses carrying out significant insurance activities.

EFRAG issued its draft endorsement advice on 15 November 2016 for consultation until

13 December 2016 and 23 comment letters were received.

EFRAG provided the Commission with its endorsement advice on the new standard on

13 January 2017. This advice provides detailed analysis of the Amendments to the

Standard against the endorsement criteria and includes analysis in respect of the issues

raised in the Commission services' letter.

2. EFFECTS STUDY

This effects study is based on the EFRAG endorsement advice which took into

consideration the views expressed by the ECB and the ESAs in their role as observers to

the EFRAG Board. It covers both the temporary deferral of IFRS 9 and the overlay

approach.

It is a general feature of the application of IFRS that it is difficult to arrive at a

quantification of its benefits such as those identified by EFRAG for preparers and users

of the financial statements.

2.1. Impact on financial statements - assessment against technical endorsement criteria

EFRAG considered the impact of the Amendments on the quality of financial statements

by assessing whether they are not contrary to the principle of true and fair view and

whether they meet the criteria of understandability, relevance, reliability and

comparability2. EFRAG concluded that these criteria were met.

2.2. Impact on European public good

2.2.1. Effect on the quality of financial reporting

EFRAG concludes that the Amendments are a necessary solution to the very specific

short term problem of the misalignment of the effective dates of IFRS 9 and the

2 Regulation (EC) No 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the

application of international accounting standards (OJ L 243, 11.9.2002, p. 1).

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forthcoming insurance contracts Standard. Thus EFRAG considers that the Amendments

will serve to improve the quality of financial reporting in comparison to a situation

without any remedies for insurers to reduce the impact of the misalignment.

2.2.2. Cost-benefit analysis

EFRAG considered to what extent implementing the Amendments might result in

increased costs for preparers and / or users and whether those costs are likely to be

exceeded by the benefits to be derived from its adoption.

Costs for Preparers

Depending on their circumstances, preparers will have the ability to apply IFRS 9 from 1

January 2018; to defer application of IFRS 9 until 1 January 2021; and / or to use the

overlay approach.

If preparers defer the application of IFRS 9, they are likely to incur some incremental

costs in explaining and providing users with relevant information about the deferral.

However, preparers that defer IFRS 9 may benefit from cost savings in implementing

IFRS 9 and IFRS 17 simultaneously as opposed to consecutively in 2018 and 2021

respectively. This is because some accounting choices made in applying IFRS 9 in 2018

would have to be reconsidered and possibly changed in 2021 when IFRS 17 is first

applied. In addition, having more complete information about the forthcoming insurance

contracts Standard when first implementing IFRS 9 could lead to costs savings.

Preparers using the overlay approach will incur costs in applying IFRS 9 and also some

incremental costs in applying the overlay relating to tracking and reporting information

about the designated assets under both IFRS 9 and IAS 39. The disclosures relating to the

overlay approach will also cause some additional costs. However, the extent of the

incremental costs of applying the overlay approach will vary between organisations.

Overall, EFRAG concludes that preparers would incur some incremental costs under

either option. However, the deferral may give rise to cost savings in implementing IFRS

9 that might exceed the additional costs.

Costs for Users

EFRAG draws a distinction between specialised and non-specialised users.

If preparers defer the application of IFRS 9, they will continue to report under IAS 39

and therefore EFRAG considers that specialised users would not incur additional costs

other than in understanding the basis for application of the deferral. By contrast, EFRAG

notes that non-specialised users have concerns that they will incur higher costs from the

continued use of IAS 39 which will create difficulties in comparing insurers with non-

insurers. However, EFRAG considers that the majority of users of insurance financial

statements are specialised.

In respect of the overlay approach, EFRAG considers that users will incur costs in

understanding the adjustment and additional costs if there are changes in the designated

assets to which the adjustment relates.

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Overall, EFRAG's assessment is that users will incur some additional costs under both

options as they will need to understand the reasons for and the impact of the approach

used by the preparers. Furthermore some generalist users will incur additional costs in

comparing entities undertaking insurance activities with other entities.

Benefits for preparers and users

The temporary exemption from IFRS 9 (deferral) will allow preparers to avoid

recognising volatility in profit or loss and accounting mismatches arising from applying

IFRS 9 before the forthcoming insurance contracts Standard. Users will be able to

continue using their existing models until 2021.

The overlay approach will allow preparers to remove the volatility resulting from the

misalignment of the effective dates of IFRS 9 and the forthcoming insurance contracts

Standard. Users will benefit from this removal of the volatility as well as from the

relevant and transparent information under IFRS 9 and complementary information in

order to understand the effects of the overlay adjustment.

Overall, EFRAG concludes that the benefits arising from the Amendments for both

preparers and users are likely to exceed the costs relating to their application.

2.3. Conclusion

EFRAG considers that the Amendments will generally bring improved financial

reporting when compared to the mandatory application of IFRS 9 from 1 January 2018

with an acceptable cost-benefit trade off. EFRAG has not identified that the Amendments

would hinder European economic development or endanger financial stability. EFRAG

has not identified any other factors that would mean adoption is not conducive to the

European public good. Therefore, EFRAG concludes that adopting the Amendments is

conducive to the European public good.

While arriving at the conclusions stated above, EFRAG notes that the Amendments do

not address the cost concerns of many insurance companies that are not predominant

insurers. EFRAG cannot exclude that the Amendments could create a competition issue.

However, EFRAG is not in a position to conclude on whether such an issue could be

material from an economic perspective. This topic is considered further in Section 4

below.

3. CONCLUSION ON THE ENDORSEMENT OF THE AMENDMENTS TO IFRS 4

As stated above, EFRAG's endorsement advice takes into consideration the views

provided by the ECB and the ESAs in their role as observers to the EFRAG Board. The

ECB and the ESAs all support the endorsement of Amendments to IFRS 4.

On the basis of EFRAG endorsement advice, the Commission services conclude that the

Amendments to IFRS 4:

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are not contrary to the principle3 set out in Article 4(3) of Directive 2013 /34 EU [the "Accounting Directive"] and are conducive to the European public good, and

meet the criteria of understandability, relevance, reliability and comparability required of financial information needed for making economic decisions and

assessing the stewardship of management.

While recommending the endorsement of the Amendments to IFRS 4, the Commission

services have further assessed whether the scope of the IASB deferral could give rise to

any competition issues taking into account EFRAG's endorsement advice. This

assessment is covered in the following section.

4. COMMISSION ASSESSMENT OF THE SCOPE OF THE IASB'S DEFERRAL SOLUTION

4.1. Scope of the deferral

4.1.1. Background

The IASB's Amendments permit a company or a group of companies whose predominant

activities are insurance activities to defer the application date of IFRS 9 from 2018 until 1

January 2021. Most of the biggest European insurance companies (19 out of 20 insurance

companies in EFRAG's analysis) could elect for this deferral. However, entities with both

significant insurance and significant non-insurance activities such as bank-led financial

conglomerates would fail the predominance test and be excluded from the scope of the

IASB deferral.

EFRAG reviewed the 2015 consolidated financial statements of 50 European groups that

conduct significant insurance activities and based on disclosed insurance liabilities,

EFRAG estimated that entities representing approximately 20 – 25% of the total

insurance activity within the sample would not be eligible to use the temporary

exemption. These entities include bank-led groups with significant insurance activities so

that the percentage varies between jurisdictions as the bancassurance model is not

equally used across Europe.

4.1.2. IASB Position

The IASB decided that the temporary exemption from IFRS 9 should be available only if

the entity as a whole, by considering all of its activities, has predominant insurance

activities (see section 1.2.1 above). Thus the assessment is made at reporting entity level

taking into account all the activities such as insurance, banking and asset management

within a group. The rationale was that the group would provide more understandable and

useful information to investors by reporting under the same accounting standard (IFRS 9

or IAS 39). By contrast, the use of two different accounting standards within the financial

statements of a group (IAS 39 for the insurance entities and IFRS 9 for the banking and

other entities) would make financial statements more complex. Moreover the IASB was

3 Article 4(3) states that the annual financial statements shall give a true and fair view of the undertaking's

assets, liabilities, financial position and profit or loss.

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concerned that the use of two different accounting standards could create incentives to

transfer assets around the group to benefit from a more favourable accounting treatment

and lead to further complexities in reporting. This means that the IASB rejected the

possibility for groups such as bank-led financial conglomerates to defer the application of

IFRS 9 for their insurance entities. Their position is in line with the long established and

fundamental accounting principle that consolidated financial statements should be

prepared using consistent accounting policies. However, IFRS 4 itself departs from this

principle in respect of measurement of liabilities arising from insurance contracts.

Finally, the IASB observed that if a group fails to qualify for the temporary exemption

then it could choose to use the overlay approach.

4.1.3. Commission request for advice to EFRAG

The Commission services were concerned that the IASB's decision not to allow the

deferral approach to insurance subsidiaries of a financial conglomerate could introduce

discrimination vis-a-vis stand-alone predominant insurance groups that will be able to

benefit from deferring IFRS 9. Furthermore, there could be a risk that the difference in

treatment between these insurers could affect the competitiveness of the bank-led

insurers.

Accordingly, Commission services asked EFRAG, in delivering its endorsement advice

on the amendments, to consider whether from an economic perspective, the scope of the

IASB's amendments could give rise to any competition issues within the EU for financial

services companies reporting under IFRS.

4.1.4. EFRAG's Opinion

EFRAG received comments concerning a number of potential competition issues that

could arise from the scope of the IASB's deferral solution. Broadly, these comments

related to three main areas: investment strategy; financial performance reporting and

costs.

Investment Strategy

Some bank-led financial conglomerates argue that an inability to defer IFRS 9 for their

insurance activities could have an adverse effect on their investment strategies, such as

moving from investments in equities to less volatile instruments such as bonds although

these would provide a lower return.

This change in behaviour would arise because IFRS 9 does not allow "recycling" of

profits on equity instruments held at fair value through other comprehensive income

upon disposal. The category equity instruments measured at fair value through other

comprehensive income means that fair value changes are not reflected in profit or loss as

usual for equity instruments but in the category other comprehensive income. The use of

this category allows long-term investors to avoid reporting short-term volatility in profit

or loss. However, the gains (or losses) from equity investments may not be recognised in

profit or loss when they are realised (ie when the shares are sold). This is referred to as

the prohibition on "recycling" and it is a change in treatment in IFRS 9 compared to the

existing treatment in IAS 39 which requires that gains and losses on sale of equities are

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recognised in profit or loss. Some entities argue that this prohibition would prevent them

from fairly reporting their performance in profit or loss which they also consider is a

more important performance measure for investors than total comprehensive income.

In respect of the "no-recycling" provision, EFRAG concluded in its endorsement advice

on IFRS 9 that, for long-term investors, the "broader economic considerations such as the

need to obtain a yield on their asset portfolio sufficient to meet their obligations to policy

holders are likely to outweigh any accounting concerns in deciding whether or not to

invest in equity investments."

Some entities raised a further concern that the ban on "recycling". Predominant insurers

using the temporary exemption will have until 2021 to sell and realise gains on some of

their equity investments and report them as profit in profit or loss. By contrast, insurance

entities that cannot use the deferral would only have until 2018 initial application of

IFRS 9 to realise and report such gains in the same way. Thereafter, unrealised gains on

equity instruments would be "frozen" in retained earnings.

Financial Performance Reporting

Since the recycling of gains (or losses) upon disposal of equity instruments held at fair

value through the OCI would be prohibited, an insurer reporting under IFRS 9 would

either:

reclassify the equity to fair value through profit or loss in which case the results would be affected by short-term price fluctuations; or

maintain the equity instrument at fair value through OCI in which case gains or losses on sale would not be reported in profit or loss.

In either of these situations, there is a distortion of reported results which would have to

be explained to investors.

Costs

All entities that undertake insurance activities will in due course be required to

implement IFRS 9 and will incur costs in so doing. However, in the absence of a

temporary deferral, entities would have to revise some of the accounting choices made

when first applying IFRS 9 in 2018 and again when they first apply the new insurance

standard in 2021. Such revision could lead to material incremental implementation costs.

However, EFRAG notes that implementing IFRS 9 throughout an entire group at the

same time could give rise to cost synergies (for example, in introducing an expected

credit loss model) as certain aspects of the implementation are centrally managed in some

groups.

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4.2. The overlay approach

4.2.1. EFRAG's Opinion

The IASB considered that the overlay approach can be used by entities that are not

predominant insurers.

EFRAG notes that this approach can substantially mitigate the accounting mismatches

and volatility in profit or loss that would arise from applying IFRS 9 before the

forthcoming insurance contracts Standard. However, EFRAG recognises that it does not

address all the effects of applying IFRS 9. Some assets will be at fair value through profit

or loss under IFRS 9 that would have been at amortised cost under IAS 39 and for such

assets there is additional volatility that the overlay approach does not remove from the

balance sheet but only moves from profit or loss to Other Comprehensive Income.

However, only a small proportion of insurers' assets should be affected in this way.

The overlay approach can also be used to address the restrictions on recycling in IFRS 9,

except for new investments.

Furthermore, EFRAG notes that the overlay approach does not allow an entity to

eliminate the effects of the application of the expected credit loss model introduced by

IFRS 9. Entities that are not predominant insurers will have to apply the expected loss

model in 2018 while predominant insurers will be able to defer it until 2021. However,

EFRAG assesses this as a positive feature of the approach since the new model should

bring improvements in financial reporting. EFRAG notes that insurers' holdings in debt-

type instruments are typically concentrated in investment grade assets and hence the

effect of IFRS 9 is not expected to be significant in most cases.

The main drawback to the overlay approach is that some bancassurers consider its costs

of implementation too high to make it a viable option.

4.2.2. Conclusion

EFRAG's overall assessment is that the overlay approach substantially addresses the

concerns of bank-led groups that undertake insurance activities relating to accounting

mismatches and volatility in profit or loss. However the use of the overlay would result

in additional implementation costs. As a result EFRAG cannot exclude that the scope of

the IASB deferral could create a competition issue. However, EFRAG was unable to

conclude on whether this is material from an economic perspective.

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4.3. Commission Services Opinion

The bancassurers account for a significant market share of the EU insurance industry.

Their insurance activities in Europe are so sizeable that some of them rank alongside the

biggest global insurance groups. As noted above, EFRAG has found that in a sample of

50 European-based groups that conduct significant insurance activities, approximately

20-25% of the total insurance activity within the sample would not be able to use the

IASB's temporary exemption. This significant proportion is largely made up of

bancassurers.

For insurance entities within bancassurers, the Commission services consider that there is

a potential risk that the competiveness of their insurance businesses might be damaged if

they could not benefit from the deferral option available to other European insurance

groups that meet the predominance criterion for two main reasons:

Changes in investment strategy

There is a risk that strategic investment decisions could be affected as a result of the change in accounting requirements. In particular, the prohibition on recycling gains

or losses on equity reported at fair value through other comprehensive income may

lead to sales of equity instruments; also investments in other instruments may change

to avoid reporting fair value changes through profit or loss.

While the overlay approach could mitigate these risks, the costs associated with it would be so significant according to some financial conglomerates that it would not

be a viable option for them.

Higher implementation costs:

The insurance entities unable to defer the application of IFRS 9 until the implementation of forthcoming insurance contracts Standard would face higher costs

in implementing IFRS 9 in 2018 and revisiting the accounting choices made when

implementing IFRS 17 in 2021. In other words, predominant insurers that are

eligible to use the temporary exemption from IFRS 9 will be able to make use of

certain cost mitigations that are not available to other entities.

In order to remedy this potential competition issue, the Commission has extended the

scope of the IASB deferral to include the insurance entities of bank-led financial

conglomerates. This extension of scope is consistent with the IASB's deferral in that it is

optional and only a temporary measure from 1 January 2018 until 2021. The effect of

introducing such an option means that the financial conglomerate could opt for its

insurance entities to continue reporting under IAS 39 until 2021 while the rest of the

group, including the banking entities, would report under IFRS 9 from 1 January 2018.

Insurance entities within bank-led financial conglomerates wanting to defer the

application of IFRS 9 until 1 January 2021 will have to satisfy strict criteria designed to

address concerns arising from the application of non-uniform accounting policies across

a group. These concerns primarily relate to risk of "earnings management" and

complexity for investors. Accordingly, two types of safeguards are included:

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A temporary ban on transfer of financial assets to prevent the group moving financial instruments from the banking part to the insurance part in order to benefit from a

more favourable accounting treatment (so called "earnings management") and to

protect the level playing field between banks and banking entities of bancassurers.

This ban applies from the date of entry into force of the Regulation.

Additional disclosure requirements to facilitate the understanding of the financial statements by investors.

The ban on transfers provides a safeguard against earnings management and it also helps

minimise any complexity that could be caused by moving financial instruments around

the group such that they would be measured on one basis under IAS 39 and another

under IFRS 9; loans and advances provide a good example as the measurement of

impairment is different under the two standards. For this reason, the ban does not apply

to instruments that are measured at fair value through profit or loss under both IAS 39

and IFRS 9 as no earnings management could be achieved by moving these instruments

around a group. The ban also excludes instruments such as debt and equity shares that

one part of the group has issued and another part holds as an investment because such

intra-group holdings are dealt with on consolidation.

The additional disclosure requirements that should be made are described in the

regulation. Their objective is to show the extent to which IAS 39 has continued to be

applied in the group as a result of the deferral. The IASB Amendments contain further

disclosure requirements for insurance entities that defer IFRS 9 and these also apply to a

financial conglomerate that chooses to defer IFRS 9 as these disclosures aim to provide

some comparability between groups that defer IFRS 9 and groups that apply it.

5. OVERALL CONCLUSION

On the basis of EFRAG’s endorsement advice, Commission services have considered the

main costs and benefits of endorsing the above mentioned amendments to IFRS 4.

Commission services agree with EFRAG that the benefit of the amendments outweigh

the associated costs and therefore considers that the EU should endorse them.

Moreover, the Regulation adopting the Amendments to IFRS 4 into EU law includes

provisions to extend the scope of entities eligible to use the deferral under the

Amendments. Specifically, the Regulation permits the entities within the insurance sector

within a financial conglomerate as defined under the Financial Conglomerates Directive

(FICOD) to defer IFRS 9 until 2021 provided that the Financial Conglomerates meet

certain criteria.

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EFRAG’s Letter to the European Commission Regarding Endorsement of Applying IFRS 9 Financial Instruments with

IFRS 4 Insurance Contracts: Amendments to IFRS 4

Olivier Guersent Director General, Financial Stability, Financial Services and Capital Markets Union European Commission 1049 Brussels 13 January 2017

Dear Mr Guersent,

Adoption of Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts: Amendments to IFRS 4

Based on the requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards, EFRAG is pleased to provide its opinion on the Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts: Amendments to IFRS 4 (the Amendments), which was issued by the IASB on 12 September 2016. An Exposure Draft of the Amendments was issued on 9 December 2015. EFRAG provided its comment letter on that Exposure Draft on 15 February 2016.

The objective of the Amendments is to address concerns arising from the different effective dates of IFRS 9 Financial Instruments and the forthcoming insurance contracts Standard. The Amendments aim to meet this objective by providing two alternative, optional accounting treatments that an entity can select subject to specified eligibility criteria.

The Amendments become effective for annual periods beginning on or after 1 January 2018 for the temporary exemption or upon first applying IFRS 9 for the overlay approach. A description of the Amendments is included in Appendix 1 to this letter.

In order to provide our endorsement advice as you have requested, we have first assessed whether the Amendments meet the technical criteria for endorsement, in other words whether the Amendments would provide relevant, reliable, comparable and understandable information required to support economic decisions and the assessment of stewardship, lead to prudent accounting and are not contrary to the true and fair view principle. We have then assessed whether the Amendments would be conducive to the European public good.

We provide our conclusions below.

Do the Amendments meet the IAS Regulation technical endorsement criteria?

EFRAG has concluded that, in the specific circumstances arising from the misalignment of effective dates referred to above, the Amendments meet the qualitative characteristics of relevance, reliability, comparability and understandability required to support economic decisions and the assessment of stewardship and lead to sufficiently prudent accounting.

Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts EFRAG’s Letter to the European Commission

Page 2 of 37

EFRAG has also assessed that the Amendments do not create any distortion in their interaction with other IFRS, especially in that they were developed to address concerns arising from the misalignment of effective dates and that these concerns were raised in EFRAG’s endorsement advice on IFRS 9. EFRAG has also concluded that all necessary disclosures are required. Therefore EFRAG has concluded that the Amendments are not contrary to the true and fair view principle. EFRAG’s reasoning is explained in Appendix 2 to this letter.

Are the Amendments conducive to the European public good?

EFRAG has assessed that the Amendments would serve to reduce the negative financial reporting and cost consequences that would otherwise arise from implementing IFRS 9 before the forthcoming insurance contracts Standard and would reach an acceptable cost-benefit trade-off.

EFRAG’s analysis is that the Amendments address the main concerns of entities whose activities are predominantly related to insurance (“predominant insurers”). EFRAG further notes that predominant insurers are the most significantly affected by the issues arising from the misalignment of the effective dates of IFRS 9 and the forthcoming insurance contracts Standard. On that basis, EFRAG assesses that adopting the Amendments would be conducive to the European public good. EFRAG’s reasoning is explained in Appendix 3 to this letter, which includes certain elements of an impact analysis.

Other issues raised in your request for endorsement advice

Your request for endorsement advice specifically noted that:

The amendments to IFRS 4 arise from the interaction between requirements for accounting for liabilities arising on insurance contracts with the requirements for accounting for financial instruments under IFRS 9. Your endorsement advice on IFRS 9 commented on this interaction and your advice on these amendments should take into consideration your previous comments. In particular, we should be grateful if you would consider whether, from an economic perspective, the scope of the IASB's amendments could give rise to any competition issues within the EU for financial services companies reporting under IFRS and explain the extent to which the amendments to IFRS 4 would contribute to a level playing field among European businesses carrying out significant insurance activities.

EFRAG’s conclusion on whether endorsement of IFRS 9 would be conducive to the European public good was positive, except for the impact on the insurance industry of the misalignment of effective dates referred to above. EFRAG’s endorsement advice on IFRS 9 stated:

EFRAG has confirmed its preliminary view that the benefits to users of consistent financial reporting until IFRS 9 and the future insurance contracts standard are both applied, together with the cost savings for preparers and users, made a strong case for having the IASB defer the effective date of IFRS 9, so as to align it with the effective date of the future insurance contracts standard, albeit only for entities undertaking insurance activities and as an option. … Furthermore, in the absence of uniform accounting policies for insurance liabilities, and considering that some insurance activities are conducted in the context of conglomerates, the impact of the non-alignment of the effective dates of IFRS 9 and the future insurance contracts standard varies from one company to the other. Therefore any remedy provided to mitigate the negative impact of the non-alignment of effective dates should be granted on an optional basis.


Page 3 of 37

EFRAG assesses that the Amendments address many of the concerns raised in its endorsement advice on IFRS 9. In particular, the Amendments provide an optional, temporary exemption from the application of IFRS 9 for predominant insurers. However, this option is not available to entities undertaking insurance activities that are not predominant insurers.

The Amendments also provide an alternative approach (the overlay approach) that would be available to all entities undertaking insurance activities and which can substantially mitigate the financial reporting-related concerns arising from the misalignment of effective dates referred to above. The main drawback of the overlay approach is that it would not provide the cost savings referred to in our endorsement advice on IFRS 9 and would in fact increase costs for entities compared to implementing IFRS 9 in the normal way. Accordingly, EFRAG considers that the Amendments would not result in a completely level playing field among entities undertaking insurance activities.

In making these observations, EFRAG notes that the misalignment of effective dates is a unique and short-term situation. This situation gives rise to a complex set of concerns, the impact of which varies from one entity to another. There is unlikely to be any single, perfect solution to these concerns (especially given the short time available to develop one) and any solution put forward would inevitably reflect certain trade-offs between competing factors.

For these reasons EFRAG considers that the Amendments address many of the concerns in our endorsement advice on IFRS 9 but do not address the cost concerns of many entities undertaking insurance activities that are not predominant insurers. EFRAG could not exclude that the Amendments could create a competition issue. However, we are not in a position to conclude on whether this is material from an economic perspective.

EFRAG’s reasoning is further explained in Appendix 3.

Our advice to the European Commission

As explained above, we have concluded that the Amendments meet the qualitative characteristics of relevance, reliability, comparability and understandability required to support economic decisions and the assessment of stewardship, raise no issues regarding prudent accounting, and are not contrary to the true and fair view principle. We have also concluded that the Amendments are conducive to the European public good for the period for which they are needed. Therefore, we recommend the Amendments for endorsement.

Without qualifying our advice, we note that the Amendments address many of the concerns raised in our endorsement advice on IFRS 9 but do not address the cost concerns of many entities undertaking insurance activities that are not predominant insurers. EFRAG could not exclude that the Amendments could create a competition issue. However, we are not in a position to conclude on whether this is material from an economic perspective.

On behalf of EFRAG, I would be happy to discuss our advice with you, other officials of the European Commission and the Accounting Regulatory Committee as you may wish.

Yours sincerely,

Jean-Paul Gauzès President of the EFRAG Board


Page 4 of 37

Contents

Appendix 1: Understanding the changes brought by Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts: Amendments to IFRS 4 ..................... 7

Temporary exemption from IFRS 9 ............................................................................ 8

Overlay approach ...................................................................................................... 9

Appendix 2: EFRAG’s technical assessment on Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts: Amendments to IFRS 4 ................... 11

Does the accounting that results from the application of the Amendments meet the technical criteria for endorsement in the European Union? ..................................... 11

Relevance ...................................................................................................................... 13

Providing two options – the overlay approach and the temporary exemption from IFRS 9 ......................................................................................................................... 13

The temporary exemption from IFRS 9 ....................................................................... 13

Scope and eligibility criteria ..................................................................................... 13

Reassessment of eligibility for the temporary exemption from IFRS 9 ..................... 14

Disclosures .............................................................................................................. 14

Temporary exemption from specific requirements in IAS 28 and for first-time adopters .................................................................................................................. 14

Effect of the application of the temporary exemption ............................................... 15

The overlay approach ................................................................................................. 15


Presentation ............................................................................................................ 16

Conclusion on relevance ............................................................................................. 16

Reliability ...................................................................................................................... 17



Reassessment of eligibility for the temporary exemption from IFRS 9 ..................... 17

Disclosures .............................................................................................................. 17



Conclusion on reliability .............................................................................................. 18

Comparability ................................................................................................................ 19

Introducing two options – the overlay approach and the temporary exemption from IFRS 9 ......................................................................................................................... 19


Predominance ratio ................................................................................................. 20

Disclosures .............................................................................................................. 20

Effect of the application of the temporary exemption ............................................... 21



Page 5 of 37

Difference between de-designation of specific financial assets or ceasing to use the overlay approach ..................................................................................................... 21

Applicability of the overlay approach and the temporary exemption from IFRS 9 to first-time adopters of IFRS ................................................................................................. 22

Conclusion on comparability ....................................................................................... 22

Understandability ......................................................................................................... 24

Temporary exemption from IFRS 9 ............................................................................. 24


Applying IFRS 9 Financial Instruments ........................................................................ 24

Conclusion on understandability .................................................................................. 24

Prudence ....................................................................................................................... 25


Eligibility criteria ....................................................................................................... 25


Eligibility criteria ....................................................................................................... 25

Conclusion on prudence ............................................................................................. 26

True and Fair View Principle ........................................................................................ 27

Conclusion .................................................................................................................... 27

Appendix 3: Assessing whether the Amendments are conducive to the European public good ................................................................................................................... 28

Introduction .................................................................................................................. 28

Whether the Amendments are likely to improve the quality of financial reporting ........ 28

Costs and benefits of the Amendments ...................................................................... 29

Costs for preparers ..................................................................................................... 29

Temporary exemption from IFRS 9 .......................................................................... 29

Overlay approach .................................................................................................... 29

Conclusion – cost for preparers ............................................................................... 30

Costs for users ............................................................................................................ 30



Conclusion – cost for users...................................................................................... 30

Benefits for preparers and users ................................................................................. 30



Conclusion – benefits for preparers and users ......................................................... 31

Potential competition issues within the EU ................................................................ 32


Adverse effect on investment strategies .................................................................. 33

Less relevant information on performance ............................................................... 33


Page 6 of 37

Cost mitigations available to predominant insurers .................................................. 34

Overlay approach ........................................................................................................ 35

Conclusion on European public good ........................................................................ 37


Appendix 1

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Appendix 1: Understanding the changes brought by Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts: Amendments to IFRS 4

A - Background of the Amendments

1 The amendments contained in Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts: Amendments to IFRS 4 (“the Amendments”) are designed to address concerns arising from the different effective dates of both IFRS 9 and the forthcoming insurance contracts Standard. These concerns have been described as follows1:

(a) Accounting mismatches. If entities undertaking insurance activities were required to change the accounting for financial assets by applying IFRS 9 Financial Instruments without a corresponding change in the accounting for insurance liabilities backed by those financial assets, it would result in accounting mismatches for those entities undertaking insurance activities applying the cost model under IFRS 4 Insurance Contracts. This is because some debt instruments currently accounted for at amortised cost or at fair value through other comprehensive income and most equity instruments currently accounted for at fair value through other comprehensive income with recycling are likely to be accounted for at fair value through profit or loss when applying IFRS 9. Fair value movements on these assets would be recognised in profit or loss, while insurance liabilities backed by those assets remain measured at cost, resulting in accounting mismatches in profit or loss even where the insurance liabilities are perfectly matched by financial assets.

(b) Information needs of users of financial statements. Users will find difficulties in understanding the financial performance and position of entities undertaking insurance activities during the period between the adoption of IFRS 9 and the forthcoming insurance contracts Standard. Entities undertaking insurance activities are likely to provide non-GAAP measures to explain the impact of accounting mismatches caused by a change in the measurement of financial assets that is not accompanied by a change in the measurement of the insurance liability. This is likely to require users to perform complex analyses to understand the results of an entity undertaking insurance activities by linking non-GAAP measures to the financial statements.

(c) Costs for preparers. In the event IFRS 9 is implemented before the forthcoming insurance contracts Standard, entities undertaking insurance activities would incur additional costs for having to first implement IFRS 9 and then reassess that implementation when implementing the forthcoming insurance contracts Standard.

B - How the issues have been addressed

2 The Amendments provide two options that will permit qualifying entities to take alternative approaches to the application in full of IFRS 9 in order to mitigate the concerns described above:

(a) An optional temporary exemption from IFRS 9 which permits an insurer to continue using IAS 39 Financial Instruments: Recognition and Measurement if

1 See EFRAG’s Endorsement Advice on IFRS 9 Financial Instruments, Appendix 3 relating to European public good, dated 15 September 2015, pp. 79-83.


Appendix 1

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its activities are predominantly connected with insurance (“the temporary exemption from IFRS 9”); and

(b) An optional overlay approach that permits insurers that issue contracts within the scope of IFRS 4 to apply IFRS 9 to designated financial assets and then to reclassify, from profit or loss to other comprehensive income, some of the income or expenses arising from these designated financial assets (“the overlay approach”).

3 The result of introducing these options is that an entity that meets the relevant qualifying conditions may apply one of the following approaches to their financial assets:

(a) IFRS 9 – this is available to all entities;

(b) the temporary exemption from IFRS 9 – available to entities whose activities are predominantly connected with insurance; and

(c) the overlay approach – available to all entities that issue contracts within the scope of IFRS 4 and may be applied to financial assets that are not held in respect of an activity that is unconnected with those contracts.

C - What options have been introduced?

Temporary exemption from IFRS 9

4 An entity is permitted to apply the temporary exemption from IFRS 9 when:

(a) The entity has not previously applied any version of IFRS 9 (except for the “own credit” requirements in isolation); and

(b) The entity’s liabilities are predominantly connected with insurance, determined at the level of the reporting entity (i.e. at consolidated level for the purpose of the consolidated financial statements). Liabilities connected with insurance comprise:

(i) Liabilities arising from issuing contracts within the scope of IFRS 4 (including deposit components or embedded derivatives that are unbundled from insurance contracts and financial instruments that contain a discretionary participation feature) and these contracts give rise to liabilities whose carrying amount is significant compared to the total carrying amount of all the entity’s liabilities;

(ii) Non-derivative investment contract liabilities that are measured at fair value through profit or loss (FVPL) by applying IAS 39; and

(iii) Liabilities that arise because the insurer issues, or fulfils obligations arising from, the contracts in (i) and (ii) above.

5 An entity’s activities are treated as being predominantly connected with insurance if, and only if, the entity’s so-called predominance ratio meets specified thresholds. The predominance ratio is calculated as the ratio of:

(a) the sum of the carrying amounts of the liabilities referred to in paragraph 4(b) above; to

(b) the total carrying amount of all the entity’s liabilities.

6 An entity’s activities are deemed to be predominantly connected with insurance only if the predominance ratio:

(a) is greater than 90 per cent; or


Appendix 1

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(b) is less than or equal to 90 per cent but greater than 80 per cent and the entity does not engage in a significant activity that is unconnected with insurance.

7 In order to assess whether it qualifies for the temporary exemption from IFRS 9, an entity is required to compute the predominance ratio by using the carrying amounts of the liabilities reported on the entity’s balance sheet, in accordance with IFRS Standards, at the annual reporting date immediately prior to 1 April 2016.

8 If there is a significant change in the entity’s activities during the reporting period:

(a) an entity that previously qualified for the temporary exemption shall reassess whether its activities are still predominantly connected with insurance; and

(b) an entity that previously did not qualify for the temporary exemption is permitted to subsequently reassess whether its activities are predominantly connected with insurance at an annual reporting date before 31 December 2018.

9 First-time adopters of IFRS are permitted to apply the temporary exemption when fulfilling the criteria in paragraph 4 above.

10 When using the equity method to account for an entity’s investments in associates and joint ventures, the entity is granted relief from using uniform accounting policies. That relief is available on an investment-by-investment basis and is valid when (i) the entity uses IFRS 9 in its financial statements and the associate or joint venture uses the temporary exemption from IFRS 9; or (ii) the entity uses the temporary exemption from IFRS 9 but the associate or joint venture uses IFRS 9.

11 An entity that applies that temporary exemption from IFRS 9 will be required to disclose information to enable users of financial statements to understand how the insurer qualified for the temporary exemption and to compare with entities applying IFRS 9.

12 In particular, an entity shall disclose fair value information about financial assets that would be measured at FVPL in accordance with IFRS 9. In doing so, the entity shall differentiate between:

(a) financial assets that have cash flows that are solely payment of principal and interest (excluding financial assets that are held for trading as per IFRS 9 or that are managed and whose performance is evaluated on a fair value basis); and

(b) financial assets that do not have such cash flows including financial assets that are held for trading as per IFRS 9 or that are managed and whose performance is evaluated on a fair value basis.

13 Entities are also required to disclose information about the credit risk exposure, including significant credit risk concentrations, inherent in the financial assets referred to in paragraph 12(a) above and that do not have low credit risk in accordance with IFRS 9.

14 The temporary exemption from IFRS 9 will be available for annual reporting periods beginning on or after 1 January 2018 and ends no later than for annual reporting periods beginning on or after 1 January 2021.

15 Entities may cease to apply the temporary exemption from IFRS 9 at any time. When doing so, they may at the beginning of any subsequent annual period irrevocably elect to apply IFRS 9.

Overlay approach

16 An entity that issues contracts within the scope of IFRS 4 and applies IFRS 9 is permitted, but not required, to reclassify from profit or loss to other comprehensive


Appendix 1

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income, an overlay adjustment equal to the difference, for qualifying financial assets, between:

(a) the amount reported in profit or loss by applying IFRS 9; and

(b) the amount that would have been reported in profit or loss by applying IAS 39.

17 Financial assets qualify for the overlay approach when they are designated as not being held in respect of an activity that is unconnected with contracts that are within the scope of IFRS 4. In addition, these designated financial assets are measured at FVPL in accordance with IFRS 9 but would not have been measured at FVPL in their entirety in accordance with IAS 39. Qualifying financial assets include surplus assets that an entity holds for the purposes of regulatory requirements or internal capital objectives.

18 An entity may apply the overlay approach to any or all eligible financial assets. First-time adopters of IFRS are permitted to apply the overlay approach to qualifying financial assets.

19 Presentation in profit or loss of gains or losses on financial assets to which the overlay approach is applied must reflect the application of IFRS 9, with a separate line item for the overlay adjustment. In addition, entities will be required to present, in other comprehensive income (OCI), the overlay adjustment separate from other components of OCI, consistently with IAS 1 Presentation of Financial Statements.

20 An entity that applies that overlay approach is required to disclose sufficient information to enable users of financial statements to understand how the amount of the overlay adjustment is calculated and the effect of the adjustment on the financial statements.

21 The overlay approach may only be first applied when an entity first applies IFRS 9 (other than the “own credit” requirements in isolation) and this approach does not have a fixed expiry date. Entities may cease to apply the overlay approach at any time. When doing so, the accumulated effect of the total overlay adjustment is reclassified to retained earnings without impacting profit or loss. In addition, the future insurance contracts Standard will replace IFRS 4 and, accordingly, the overlay approach in IFRS 4 will no longer be available when an entity first applies that future Standard.


Appendix 2

Page 11 of 37

Appendix 2: EFRAG’s technical assessment of Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts: Amendments to IFRS 4

Does the accounting that results from the application of the Amendments meet the technical criteria for endorsement in the

European Union?

1 EFRAG has considered whether the Amendments meet the technical requirements of the European Parliament and of the Council on the application of international accounting standards, as set out in Regulation (EC) No 1606/2002 (the IAS Regulation), in other words that the Amendments:

(a) are not contrary to the principle of ‘true and fair view’ set out in Article 4 (3) of Council Directive 2013/34/EU (The Accounting Directive); and

(b) meet the criteria of, relevance, reliability, comparability and understandability required of the financial information needed for making economic decisions and assessing the stewardship of management.

2 EFRAG’s assessment on whether the Amendments are not contrary to the true and fair view principle set out in Article 4(3) of Council Directive 2013/34/EU is based on the assessment of whether they meet all other technical criteria and whether they lead to prudent accounting. EFRAG’s assessment also includes assessing whether the Amendments do not interact negatively with other IFRS and whether all necessary disclosures are required. Detailed assessments are included in this appendix in the following paragraphs:

(a) relevance: paragraphs 8 - 30;

(b) reliability: paragraphs 31 - 42;

(c) comparability: paragraphs 43 - 68;

(d) understandability: paragraphs 69 - 78;

(e) whether overall it leads to prudent accounting: paragraphs 79 - 86; and

(f) whether it would not be contrary to the true and fair view principle: paragraphs 87 - 92.

3 In its endorsement advice on IFRS 9, EFRAG assessed: “that the mismatch in timing of the future insurance contracts Standard and IFRS 9 would create disruptions in the financial reporting by many entities undertaking insurance activities during the period until the forthcoming insurance contracts Standard is applied, which will make financial reporting less understandable for users while increasing costs for preparers”.

4 These disruptions arise because the business model of entities undertaking insurance activities is based on asset/liability management, with the objective of investing in assets in order to generate income and capital appreciation to cover insurance liabilities and provide profit for shareholders.

5 EFRAG’s assessments below take into account this interrelationship between assets and liabilities as managed by insurers. In providing its assessments on whether the Amendments result in relevant, reliable, comparable and understandable information, EFRAG has relied on the fact that the Amendments do not introduce any recognition or measurement requirements. Instead, the Amendments either affect the


Appendix 2

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timing of the full implementation of IFRS 9 (the temporary exemption), or affect the presentation of certain gains or losses arising from the application of IFRS 9 (the overlay approach), and contain disclosure requirements to explain the effect of these approaches.

6 EFRAG has focused its assessment on those aspects of the Amendments it considered most significant in relation to each of the criteria. EFRAG has accordingly focused on guidance that:

(a) is fundamental to the options in the Amendments;

(b) has been subject to substantial debate (evidenced by the comments EFRAG has received from constituents);

(c) may be problematic to apply; or

(d) relates to the issues raised by the European Commission in its request for endorsement advice dated 13 October 2016.

7 EFRAG has assessed the Amendments against each of the technical criteria for each of the following requirements (where relevant):

(a) providing two options – the overlay approach and the temporary exemption from IFRS 9;

(b) temporary exemption from IFRS 9 (the temporary exemption); and

(c) the overlay approach.


Appendix 2

Page 13 of 37

Relevance

8 Information is relevant when it influences the economic decisions of users by helping them evaluate past, present or future events or by confirming or correcting their past evaluations. Information is also relevant when it assists in evaluating the stewardship of management.

9 EFRAG considered whether the Amendments would result in the provision of relevant information – in other words, information that has predictive value, confirmatory value or both – or whether they would result in the omission of relevant information.

Providing two options – the overlay approach and the temporary exemption from IFRS 9

10 When alternative accounting options are made available, it is reasonable to expect that entities will select the option that is appropriate to their circumstances and that this selection will take into account the relevance of the resulting information for the users of their financial statements. As a result, EFRAG expects that:

(a) entities that are eligible for both the overlay approach and the temporary exemption from IFRS 9 will consider which approach (applying IFRS 9 in the normal way or applying one of the options in the Amendments) provides the most relevant information for their users, while also taking into account cost-benefit considerations; and

(b) entities that are eligible for the overlay approach but not for the temporary exemption from IFRS 9 will consider whether the overlay approach provides more relevant information for their users than applying IFRS 9 in the normal way, again while also taking into account cost-benefit considerations.

11 It follows that the inclusion of two options in the Amendments does not inhibit the provision of relevant information in the specific circumstances in which the Amendments have been developed. Given the options in IFRS 4 for the measurement of the insurance liability, and the short period until the forthcoming insurance contracts Standard is effective, allowing some flexibility for continuity in financial reporting has the potential to provide relevant information.

The temporary exemption from IFRS 9

Scope and eligibility criteria

12 The temporary exemption is intended to target those insurance entities that are most significantly affected by the different effective dates of IFRS 9 and the forthcoming insurance contracts Standard (i.e. those that are predominant insurers). Entities that conduct both insurance activities and substantial other activities, including bank-led groups that undertake insurance activities, are not eligible to apply the temporary exemption in their consolidated financial statements because they fail the predominance test described in Appendix 1, paragraphs 5 - 6.

13 The qualifying criteria in the Amendments reflect the complexity of the insurance business model and recognise that the activities of insurers are not limited to issuing insurance contracts as defined in IFRS 4. As a result, the types of liability regarded as being connected with insurance for the purpose of the predominance test have been extended to address the range of contracts entered into by many insurers. For example, the accounting for non-derivative investment contracts, if measured at FVPL, would be the same under IAS 39 and IFRS 9. Because these contracts are common in an insurer’s business model, including them in the predominance test supports the relevance of the predominance test in assessing eligibility to apply the temporary exemption from IFRS 9.


Appendix 2

Page 14 of 37

14 There may be insurers that are regarded by the market as predominant insurers but that fail the 90 per cent predominance test. EFRAG notes that the Amendments also include a second test of predominance. This second test is met if less than or equal to 90 per cent but more than 80 per cent of an entity’s liabilities are connected to insurance and the entity does not engage in a significant activity that is unconnected with insurance. EFRAG considers this second test smooths the bright line that could arise from a single quantitative threshold.

Reassessment of eligibility for the temporary exemption from IFRS 9

15 An entity is required to reassess its application of the temporary exemption from IFRS 9 if and only if there is a change in the entity’s business activities during the reporting period. This reassessment provides relevant information by ensuring that an entity that ceases to be a predominant insurer will start to prepare financial statements on the same basis as other entities that are not predominant insurers.

16 In addition, an entity that did not initially qualify for the temporary exemption is permitted to reassess whether its activities are predominantly connected to insurance at an annual reporting date before 31 December 2018 if, and only if, there was a change in the entity’s business activities during that reporting period. This reassessment provides relevant information by ensuring that an entity that becomes a predominant insurer before the effective date of IFRS 9 will be permitted to use the same option as other entities that are predominant insurers.

Disclosures

17 The Amendments require disclosure of fair value information for: (i) financial assets that give rise to cash flows that are solely payments of principal and interest (SPPI) on the principal amount outstanding (excluding any financial assets that meet the definition of held for trading in IFRS 9, or that are managed and whose performance is evaluated on a fair value basis); and (ii) all other financial assets.

18 EFRAG assesses that disclosure of this fair value information is relevant to users of financial statements because the entities that apply the temporary exemption from IFRS 9 would not apply the impairment requirements in that Standard. Therefore, the fair value of these financial assets will provide relevant information such as an indication of expected credit losses under IFRS 9.

19 The Amendments also require an entity to disclose information about credit risk exposure for financial assets that meet the SPPI test. EFRAG considers that this disclosure requirement provides relevant information because of the different impairment requirements under IFRS 9 and IAS 39.

20 Finally, the Amendments require disclosure of the fair value and the gross carrying amount under IAS 39 for financial assets that do not have low credit risk. This does not require the collection of new information because fair value disclosures are already required by IFRS 7 Financial Instruments: Disclosures. EFRAG considers that fair values (compared to the carrying amounts when applying IAS 39) will be relevant for users of financial statements in assessing the credit risk exposure for those riskier assets and the potential effect of applying the expected credit loss requirements in IFRS 9 because the fair values may provide a potential indication of impairment of the financial assets.

Temporary exemption from specific requirements in IAS 28 and for first-time adopters

21 The Amendments include additional exemptions in specific situations which may affect the relevance of information provided. These additional exemptions include:

(a) a temporary exemption from requirements in IAS 28 Investments in Associates and Joint Ventures to use uniform accounting policies for the purpose of applying the equity method. This exemption could result in entities that apply


Appendix 2

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IFRS 9 in their own financial statements using financial statements of an investee that are based on IAS 39 for the purpose of applying the equity method; and

(b) a temporary exemption from IFRS 9 for first-time adopters subject to the qualifying criteria being met. First-time adopters may have similar concerns about the misalignment of effective dates of IFRS 9 and the forthcoming insurance contracts to other entities undertaking insurance activities. This may be especially relevant for those first-time adopters that have previously applied requirements for financial instruments under national GAAPs that are not significantly different to IFRS Standards.

22 EFRAG acknowledges that one of the reasons for these additional exemptions is the potential significant practical difficulties and/or additional costs that may arise for affected entities. EFRAG considers that the Amendments include adequate disclosures to compensate for the potential reduction in relevant information.

Effect of the application of the temporary exemption

23 In assessing whether the temporary exemption addresses the issues summarised in Appendix 1, EFRAG considers that classifications, designations and assessments made on application of IFRS 9 on its effective date might not be the same as those that would have been made had the forthcoming insurance contracts Standard been applied at the same time as IFRS 9. Predominant insurers will be in a position to implement IFRS 9 with more complete information, and thereby achieve a higher quality implementation, if doing so in conjunction with the forthcoming insurance contracts Standard. This supports an assessment that the temporary exemption from IFRS 9 is conducive to the provision of relevant information for users of the financial statements of predominant insurers.

The overlay approach

Scope and eligibility criteria

24 The overlay approach permits the reclassification from profit or loss to other comprehensive income (OCI) of the additional accounting mismatches and temporary volatility in reported earnings that could arise from the application of IFRS 9 to specific financial assets before the forthcoming insurance contracts Standard is applied. The Amendments permit the entity to apply the overlay approach to any or all eligible financial assets.

25 The overlay approach provides entities with additional optionality by permitting flexibility to select the qualifying financial assets to which it is applied. This additional flexibility could detract from the relevance of the resulting information. EFRAG however considers this potential detriment to relevance should be assessed against the background of the very specific circumstances in which the Amendments have been issued. As discussed above, the overlay approach has been developed to address very specific short-term concerns, and eligible entities can be expected to consider the relevance of the resulting information in selecting their approach.

26 Additionally, EFRAG notes that the designated financial assets will be accounted for under IFRS 9. This results in a balance sheet that is fully consistent with the application of IFRS 9 in the normal way.

european commission investment and company … · 1.3.1. during the development of the amendments...

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