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CESR Releases Statement Regarding Instrument Reclassification for Fair Value Accounting

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Originally appeared in MiFID Monitor

Following a request by the European Commission last October, the Committee of European Securities Regulators (CESR) has released a statement regarding the reclassification of financial instruments for fair value accounting. The regulatory body has worked in cooperation with the International Accounting Standards Board (IASB) to tackle the issues identified by the Commission.

In October 2008, the IASB approved an amendment to IAS 39 and IFRS 7 concerning the reclassification between some categories of a number of financial instruments. At the same time the amendments were endorsed to be used in the European Union. CESR has previously expressed its support for this initiative taken by the IASB and by the European Parliament, as its implementation would avoid a new European carve out.

The European Commission requested, in a statement dated 15 October 2008, that the IASB and CESR begin work immediately to find appropriate solutions to the issues associated with the fair value option, embedded derivatives, insurance questions and other problem areas in IAS 39 and IFRS 7, which in CESR’s view were of concern to the public interest, taking into account an appropriate level of transparency.

The issue of fair value accounting has been a topic of discussion within the European Council for some time and the European Commission has stressed the urgency of the endeavour to deal with the issues involved. Accordingly, CESR has considered the issues raised by the Commission and has produced its statement regarding the “fair value option”, embedded derivatives and the impairment of available for sale items.

According to the amendment to IAS 39 from October 2008 it is possible to reclassify some financial instruments out of the category of financial instruments through profit and loss to other categories. This option does not apply if the financial instruments have been classified into this category using the “fair value option”, indicates the statement.

The European Commission has therefore stated that it is important that financial instruments currently classified under the fair value option can be reclassified into other categories that are not, or no longer, measured at fair value. CESR agrees that this should be made possible for the same reasons, and under the same conditions, as the assets reclassified out of the held for trading category.

“CESR notes that some other parties believe that, in order to avoid earnings management, it should not be possible to reclassify financial instruments recognised under the fair value option, even if the same conditions are met that apply according to the amendment to IAS 39 from October 2008,” the statement says. “CESR concludes that there is a need to examine the effects of the use of the fair value option in more detail within a short timeframe.”

The regulatory body has therefore indicated that it will be further examining these concerns, along with the IASB, and also seek the advice of the newly formed advisory group on this issue.

With regards to issues raised concerning embedded derivatives, CESR refers to the IASB and its amendments to IFRIC 9 and IAS 39, which were published on 22 December. “CESR would recommend that the IASB provides guidance on the main types of synthetic structures covered and on which factors are important for issuers in determining whether an embedded derivative exists and if so, whether it should be measured separately,” the statement reads.

CESR also recommends in the statement that the IASB examines the issues surrounding impairment for available for sale financial instruments.

The regulatory body has also been engaged in reviewing whether European firms have applied the recent amendments to IAS 39 regarding the reclassification of some financial instruments. In order to assess this, CESR examined 100 companies across the region and found that over half had not reclassified these instruments for their third quarter 2008 financial statements.

CESR has indicated that it will continue to closely monitor future developments in the area of financial instruments and fair value accounting. It will in particular follow up and review the disclosures required by the amendments to IFRS 7 regarding reclassification in the annual financial statements for 2008 when these financial statements are published during spring 2009. CESR has said that it will also consider reviewing other aspects of IFRS 7.

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