Transition challenges for Asian banks

Conclusion

Pricing and product design

With IAS 39, the demand for financial products is likely to change. For example, a bank’s corporate clients that have been willing to use derivatives to accommodate the bank’s variable rate lending preference may change their operations to altogether avoid transactions impacted by IAS 39. These corporate clients may be reluctant to enter into swaps and may pressure the banks to offer more customized loan arrangements, rather than entering into a loan and customizing it with a swap.

Investors, on the other hand, may be reluctant to invest in structured products such as convertible bonds, dollar-linked peso notes, or structured notes because of the accounting implications that embedded derivatives present under IAS 39. IAS 39 contains safeguard provisions to ensure that the new requirements for marking derivatives to market are not avoided by "embedding" a derivative contract in a host contract that is accounted for either at amortized cost or revalued through equity.

IAS 39 will require many financial and non-financial contracts with embedded derivative should be separated from the host contract. The principle is that an embedded derivative should be separated from the host contract and accounted for separately if its economics are not "clearly and closely related" to those of the host contract. The principle of "clearly and closely related" economics is further explained in the standards by ways of examples. Assessment of what is clearly and closely related requires understanding of the economics of both instruments and by analogy to the example given in IAS 39.

Disclosure and public relations

The disclosures required by IAS 39 are extensive and complex. This requires banks to adopt a new way of communicating with the public. For example, the balance sheet may change materially from the valuation date to the date earnings are released, and then to the date of the stockholders meetings. In addition, as a result of the disclosure requirements of IAS 39, we foresee clients‚ increased dependence on banks for risk management information. In addition to the requirements of IAS 39, IAS 32 requires greater risk management and fair value disclosures as follows:

a. Financial risk management objectives and policies, including policy for hedging each major type of forecasted transaction for which hedge accounting is used;

b. Terms and conditions of financial instruments and accounting policies used;

c. Interest rate risk (contractual repricing or maturity dates, effective interest rates);

d. Credit risk (maximum exposure and significant concentrations);

e. Fair values for each class of financial assets and financial liabilities, both recognized and unrecognized; and

f. Financial assets carried at an amount in excess of fair value (carrying amount and fair value and reason for not reducing carrying amount, among others).

In summary, bank management needs to start considering the impact that IFRS will have on their existing strategy and operations as well as reporting processes. Adopting IFRS clearly goes beyond numbers. It poses both financial and operational challenges, and will surely require a great deal of time and resources to implement. Proper planning is key to ensuring a smooth transition to IFRS.

(Reprinted from The SGV Review, December 2003 issue)