Statistical Notices to Reporting Banks 2004/06
Statistical Notices should be received by all those responsible for the completion of Bank of England returns. To add names to the circulation list please contact Leigh Church (Tel. 020 7601 3644).
- International Accounting Standards (effective January 2005)
1. International Accounting Standards (effective
January 2005)
Statistical
Notice 2003/07, issued on 14 November 2003, noted
that a project had begun in the Bank to identify and provide
guidance on the implications for statistical reporting following
the adoption of International Accounting Standards (IAS) / International
Financial Reporting Standards (IFRS)* from 2005. This project
has now been completed. The Bank has held consultative discussions
with industry representatives and has gathered information on
the potential impact on statistical source data that the adoption
of IAS will produce. This notice describes the principal conclusions
from the exercise and presents guidance to reporters on the
approach to be followed on statistical returns relating to periods
covering the period beginning on or after 1 January 2005.
* Referred to as International Accounting Standards (IAS) throughout this notice, and within reporting form definitions
1.1 General Approach
The first phase of the project sought to identify those aspects
of IAS guidance which appeared to differ materially from currently
accepted accounting practice - primarily UK GAAP - and hence
where banks might be expected to be planning to adapt or replace
their accounting systems. One output from this investigative
phase was a summary inventory of issues, considered to carry
potential implications for statistics. This was sent to the
BBA in early March for consultation within the industry. The
inventory identified a range of issues which included: interest
recognition; netting and rights of offset; financial derivatives,
including the treatment of embedded derivatives; and balance
sheet valuation. The views of users have been sought on some
of these issues. The Bank met with representatives from the
industry at an open meeting hosted by the BBA in late March.
This led to a series of intra-industry meetings in June, without
the Bank present, to discuss responses to issues in the inventory.
The Bank met again with industry representatives in late July
to consider the outcome of the intra-industry discussions and
to signal the direction in which reporting guidance was expected
to move.
The Bank supports the wider move to International Accounting Standards, and considers that the longer term benefits from sourcing economic statistics from IAS based management systems should be positive. It also recognises the need to balance the requirements of users against the cost to data suppliers and, as part of this concern, seeks to avoid changing form structure and definitions with undue frequency.
A number of the changes implied by the full adoption of IAS appear consistent with international statistical standards and/or with user requirements so that changing the Bank's reporting guidance might appear uncontroversial. However, the consultation process described above revealed that most reporters consulted expect to implement IAS for financial reporting purposes through macro adjustments to aggregated portfolios, rather than by way of accounting changes to source systems at the level of the individual customer or instrument. Since much of the detailed statistical data reported to the Bank derive from these customer facing systems, banks consulted are, for the most part, agreed that a full move to IAS based statistical reporting is not feasible, on grounds of cost and a lack of sufficient sectoral detail at an IAS level, and that statistical reporting should therefore continue according to existing rules as presented in the Yellow Folder.
Nevertheless, this conclusion does not relate to all aspects of IAS adoption. One of the banks consulted is developing an information system which will eventually permit IAS based data to be extracted at the level of detail required by the Bank. Others have indicated that some aspects of IAS will be applied at the most detailed level within management systems. The Bank has therefore concluded that no single guidance can be given to cover all aspects of IAS rules and that specific guidance is needed for each of the principal topic areas covered by the investigation.
The Bank has accordingly reviewed the whole of the Yellow Folder instructions. The revised pages are, for the most part, intended to clarify existing instructions and do not constitute any change of intention. In most cases this reflects the preference of banks to continue reporting on the current basis; in a few cases it reflects the Bank of England requiring data to be provided on a different basis from that which the banks would prefer to provide; and in other cases the Bank's requirements are unchanged but IAS adoption brings source data into closer alignment with statistical instructions. The following paragraphs provide a summary statement of the Bank's intentions and indicate the context in which the guidance was prepared. Guidance is based on those standards and parts of standards confirmed at the time of this notice. Where IAS Exposure Drafts are still outstanding, so that standards are not yet confirmed, it is possible that a further Statistical Notice may be required to clarify reporting guidance.
1.2 Interest Recognition and the Effective yield concept
The International Accounting Standard, as set out in IAS 18
and confirmed by IAS 39, uses an "effective yield"
concept which amortises all incremental transaction costs and
any fees and expenses that are integral to the return on the
instrument, over its expected life and, similarly, amortises
any discounted or premium rates applied for the calculation
of interest receipts or payments. The inclusion of fees/expenses
constitutes a change from current practice and differs from
the reporting guidance for forms PL and ER, agreed with the
industry in 2002. The Bank has concluded, following a user consultation,
that whilst analytical arguments might support the IAS approach
to interest measurement, the case for a change at this point
in time is not strong.
Most banks expect to adopt the IAS effective yield interest measure through macro adjustments at portfolio level and, as a consequence, would be unable to provide sectoral/geographical detail on the IAS measurement basis. These banks have accordingly proposed that statistical reporting, which derives from customer facing systems in this area, should continue to be provided on a contractual basis.
The Bank has therefore agreed that interest should continue to be reported on the current contractual basis with any associated fees reported as such within items 5 and 6 of form PL - in line with existing guidance.
For those reporters who are developing core management systems capable of delivering statistical data on an IAS basis, and who would prefer to report in this way, the Bank will discuss future reporting on a case by case basis.
Amended pages of the Forms ER and PL definitions are attached. If you have questions on this guidance, or wish to discuss your future basis for reporting interest, please contact either Martin Udy (Tel.020 7601 4731), or Jonathan Bailey (Tel.020 7601 5479).
1.3 Impaired Assets, associated income and provisions
For statistical purposes, the Bank will continue to require
loan assets to be reported gross of provisions (see below).
This means that associated interest flows must also be based
on the gross value of the loan in order to protect the integrity
of effective interest rate measures.
In practice, most banks expect the computation of interest on impaired assets to occur at a macro level by reference to provisioning models and, as a consequence, they will not be able to provide sectoral and other detail on the IAS measurement basis. Accordingly, they have proposed that statistical reporting, which derives from customer facing systems in this area, should continue to be provided on a contractual basis with no reconciliation between statistical and financial reporting measures other than at an aggregate level.
The current requirement for statistical reporting is that impairment losses/reversals - for both the parent instrument and associated income - taken through the Profit and Loss are captured on form PL - box 20A captures the P&L charge for net provisions for bad and doubtful debts. Net provisions are defined as provisions made against impaired financial assets, including interest, less releases and recoveries. (This includes financial assets/income assessed individually and/or collectively as impaired, see paragraph 64 IAS 39). The Bank has examined the potential implications of the introduction of IAS in this area and is content to receive the breakdowns of box 20A in whichever way best fits individual banks treatment within their financial accounts. Amended pages of the Form PL definitions are attached. If you have questions on this guidance, or wish to discuss your future basis for reporting interest, please contact either Martin Udy or Jonathan Bailey as above.
1.4 Netting and Rights of Offset IAS 32
IAS 32 sets stricter criteria for offsetting assets and liabilities
than those currently permitted for statistical reporting, offering
the potential for balance sheets to be inflated. Netting under
IAS will only be permitted when both (a) the right to settle
net and (b) the intention to settle net, or simultaneously,
are present.
The Bank is content with current statistical guidance on netting, as given in the Yellow Folder but considers that the stricter rules implied by IAS would also be consistent with international statistical standards. The Bank would therefore be content to accept a change to the statistical netting rules, if this were considered to improve the analytical content of the data, but must ensure that all banks apply a common interpretation of the netting rules for statistical reporting.
In practice, all banks consulted have indicated a preference for retaining current statistical netting rules for future statistical reporting i.e. to apply separate netting rules for statistical and financial reporting - the basis for this preference is a general view amongst banks that the statistical netting rules better capture the economic reality of the bank/customer relationship. The Bank has accepted this position and will accordingly retain existing Yellow Folder guidance. Any amendments to the text of the guidance in this area are intended to clarify this position and do not signal any change in requirements.
Amended pages of the General Notes and Definitions are attached. If you have questions on this guidance, or wish to discuss your future basis for reporting, please contact Anne Smith (Tel. 020 7601 4216).
1.5 Securitisations and SPE/SPVs
IAS 39 rules covering the recognition and derecognition of assets
have raised some concern that, under certain circumstances,
securitised assets might be recorded on both the balance sheet
of the originating bank and the special purpose vehicle used
for the securitisation. This issue accordingly formed part of
the consultation process with industry representatives.
The Bank is now satisfied that these concerns are unfounded. Accordingly, no changes are proposed to the reporting guidance in the Yellow Folder. The Bank will continue to monitor those securitisation operations which it becomes aware of, to ensure that no change in treatment is identifiable within the data.
1.6 Financial Derivatives
(i) IAS 39 rules on balance sheet valuation carry important
implications for the recording of derivative instruments - requiring
market or fair valuation in most circumstances. Statistical
reporting should already be on this basis so it is not expected
that IAS implementation will give rise to any material data
changes.
In a few cases, banks currently value their banking book derivatives on an accruals basis on the BT (even if fair valued on the DQ). The move to fair value for these derivatives should result in offsetting changes to BT 19CB and BT 19B.
A few Form DQ reporters have already sought agreement to report all their derivative positions within the trading book section of this form. The Bank intends to formalise this process by removing the banking book section of the form as one aspect of the DQ review process, which is currently under way. However, in the meantime, the reporting instructions have been amended to remove references to the banking book and reporters should treat all derivatives consistently, irrespective of the reason for which they are held. All positions in derivatives should accordingly be reported in sections 1 and 2 of form DQ while section 3, relating to banking book positions, will cease to be used. This change can be made immediately, but in any event, Section 3 of Form DQ should not be used after the June 2005 reporting date.
(ii) IAS 39, Paragraph 95, Section (a) states, "the portion of the gain or loss on the (Cash Flow) hedging instrument that is determined to be an effective hedge…shall be recognised directly in the equity through the statement of changes in the equity…"
Where IAS implementation results in a move to fair value for these (derivative) cash flow hedges, the change in equity will be reported in the change in valuations line BT 19CB. The separate, but related, change to the fair value of the derivative contracts involved in the cash flow hedges will be included in the total net balance of outstanding derivatives, in BT 19B.
Amended pages of the General Notes and Definitions, and Form BT and DQ definitions are attached. If you have questions on this guidance, or wish to discuss your future basis for reporting, please contact Graham Semken (Tel. 020 7601 5908).
1.7 Embedded Derivatives
IAS 39 considers the valuation treatment for complex financial
products which include derivative elements. Where the derivative
and the underlying instrument are not closely linked economically,
then IAS requires either the separation and fair valuation of
the derivative, or the fair valuation of the structured product
with the derivative included. Where the derivative is closely
linked to the underlying instrument, IAS 39 prohibits the separation
and fair valuation of the derivative. In this case IAS 39 permits
fair valuation of the entire product but does not require it.
The Bank continues to require all deposit and loan data to be reported at nominal value for statistical purposes. If some loan products were to be fair valued because of the presence of an embedded derivative this could carry adverse implications for the analytical value of important areas of the monetary statistics.
Some banks consulted have indicated that they expect to implement IAS guidance on embedded derivatives at source and therefore favour providing statistical data on this basis. However, they indicated that structured loans of this type were rare within their balance sheets so that any impact from such instruments on reported aggregates was unlikely to be material.
In the light of these discussions, the Bank has concluded that loans and deposits containing embedded derivatives should continue to be reported at nominal value on statistical returns in order to protect the integrity and analytical value of the monetary statistics. Wherever possible, the derivative element of such structured products should be reported at market or fair value on form DQ, in line with existing guidance. However, notwithstanding this preferred position, the Bank wishes to remain flexible where the cost to a reporter would be high and where the impact on the statistics would be very small.
Amended pages of the General Notes and Definitions and Form BT, DQ and PL definitions are attached. If you have questions on this guidance, or wish to discuss your future basis for reporting, please contact Anne Smith as above.
1.8 Financial Guarantees
IAS 39 extends balance sheet recognition to cover certain forms
of financial guarantee, regarded as off balance sheet under
UK GAAP.
Current statistical standards regard such contracts as contingent instruments and guide that they should not be recorded as assets or liabilities on the balance sheet. Accordingly, the Bank favours retaining the existing Yellow Folder guidance which excludes the value of the contract from Form BT and requires that fees associated with the presence of a guarantee be retained within fees and commissions on form PL.
Some banks, taking part in the industry consultation, considered that the changes due to IAS were cosmetic in nature and unlikely to impact on the balance sheet in a way that might compromise the monetary data. The Bank has, nevertheless, concluded that Yellow Folder guidance will not change in respect of these contracts, but that the Bank will be prepared to consider requests from individual reporters on a case by case basis.
If you have questions on this guidance, or wish to discuss your future basis for reporting, please contact Anne Smith as above.
1.9 Balance Sheet valuation
Under IAS 39 financial assets/liabilities are divided into four
categories - financial assets/liabilities at fair value through
profit and loss (comprised of held for trading, and assets to
which the fair value option has been applied); held to maturity
investments; loans and other receivables; and available for
sale financial assets. One effect of this change should be to
increase the share of the balance sheet subject to market or
fair value recording.
Statistical standards require that all traded instruments, assets and liabilities, be presented at market value with non-traded instruments - principally loans and deposits - presented at nominal value. The new IAS guidance accordingly appears generally closer to the statistical standard than did UK GAAP. IAS 39 states that loans will normally be reported at amortised cost but specifies circumstances in which fair valuation is required or permitted. The presence of an embedded derivative provides one such circumstance (see 1.7 above) but other possibilities might exist, depending on the final text of the fair value option provisions.
Most banks participating in the consultation process have indicated that they favour the continued use of nominal valuation for statistical reporting, subject to the qualification noted under 1.7 above. This again reflects the sourcing of statistical data from customer facing systems and the widespread practice of applying IAS adjustments to an amortised cost basis at a macro level.
Accordingly, the Bank will continue to require all loans to be reported at nominal value. The Yellow Folder guidance is therefore unchanged in this respect, although a number of textual changes have been made to reflect the disappearance of the banking and trading book concepts; amended pages of the General Notes and Definitions, and Forms BT, QX definitions are attached.
If you have questions on this guidance, or wish to discuss your future basis for reporting, please contact Anne Smith as above.
1.10 Classification of debt and equity liabilities
Under IAS 32 there will be changes to how items are classified
as debt or equity to ensure definitions of instruments are brought
more closely into line with their economic characteristics.
For example redeemable preference shares will move from being equity, under UK GAAP, to being a liability under IAS - there will also be an interest expense under IAS. For the purposes of statistical reporting, the Bank is content to accept the changes to debt/equity classification under IAS 32 - and associated income flows. Following any such reclassification, preference shares will continue to be reported in BT 19CD/QX 19CD2/3. (Specifically, redeemable preference shares should be moved to 19CD3 if they meet the criteria regarding original maturity and subordination, otherwise they are regarded as debt liabilities which should be included under item 5 on form BT). Associated interest will be reported on PL 2D.
Amended pages of the Form BT, PL and QX definitions are attached. If you have questions on this guidance, or wish to discuss your future basis for reporting, please contact Anne Smith as above.
1.11 Software Development
IAS 38 changes the classification of staff costs associated
with in-house software development from a current to a capital
expense. The Bank considers the IAS treatment to be consistent
with statistical standards.
The Bank will expect those staff costs affected by this change of treatment to be removed from operating expense - item 12 on form PL - and to be recorded as acquisitions of intangibles within section 6 of form QX.
Amended pages of the Forms ER, PL and QX definitions are attached. If you have questions on this guidance, or wish to discuss your future basis for reporting, please contact Martin Udy as above.
2. Contents page for Yellow Folder (update)
Attached.
Bank of England
Monetary & Financial Statistics Division
28 September 2004
