The European Financial Reporting Advisory Group (EFRAG) says it will not, at present, endorse the IASB project to improve accounting for financial instruments - IFRS 9. The move is expected to lead to greater fragmentation of reporting.

"It has been decided that more time should be taken to consider the output from the IASB project to improve accounting for financial instruments," says EFRAG. "Therefore, at this stage, EFRAG will not finalise its endorsement advice on IFRS 9."

It has been suggested that EFRAG yielded to pressure from the German financial industry, as German banks - as well as French and Italian institutions - would be hit the most by the accounting changes and would have to book more losses on their large derivatives books. Conversely, HSBC has reportedly been pressing the group to accelerate the adoption of the new rules, which it says are badly needed on the grounds that less transparency would put EU banks at a competitive disadvantage.

"Such divergence of view is a reflection that the financial crisis will continue to expose the differences between 'winners' and 'losers', with some banks having been more prompt at recognising losses - and therefore being better positioned for the future - compared to others," credit strategists at BNP Paribas note.

However, Moody's analysts indicate in the agency's latest Weekly Credit Outlook that the new rule was suspended over concerns that it does not strike the proper balance between fair value accounting and amortised cost accounting. "The EC's decision to delay implementation within the EU was based on concerns that the changes do not go far enough to limit the use of fair value accounting," they note. "In a letter sent to the IASB prior to the finalisation of the rules, the EC indicated its opinion that IFRS 9 could lead to more instruments being carried at fair value for certain firms, potentially exacerbating income volatility and affecting financial stability."

The analysts say that the EC's decision is concerning in that it will likely lead to greater fragmentation of reporting and deals a significant blow to the IASB/FASB convergence effort. FASB's preliminary conclusions around its financial instruments project differ significantly from those adopted by the IASB, they explain. In particular, the majority of financial instruments will be recorded at fair value.

The IASB on 12 November issued a new reporting standard on the classification and measurement of financial assets. IFRS 9 will use a single approach to determine whether a financial asset is measured at amortised cost or fair value, replacing the many different rules in IAS 39.

The approach in IFRS 9 is based on how an entity manages its financial instruments (its business model) and the contractual cashflow characteristics of the financial assets. The new standard also requires a single impairment method to be used, replacing the many different impairment methods in IAS 39.

The views expressed to the IASB during its consultations resulted in the proposals being modified to address concerns raised and to improve the standard. For example, IFRS 9 requires the business model of an entity to be assessed first to avoid the need to consider the contractual cashflow characteristics of every individual asset. It also requires reclassification of assets if the business model of an entity changes.

The IASB changed the accounting that was proposed for structured credit-linked investments and for purchases of distressed debt. It also addressed concerns expressed about the problems created by the mismatch in timings between the mandatory effective date of IFRS 9 and the likely effective date of a new standard on insurance contracts.

Furthermore, in response to suggestions made by some respondents, the IASB decided not to finalise requirements for financial liabilities in IFRS 9. It has begun the process of giving further consideration to the classification and measurement of financial liabilities and it expects to issue final requirements during 2010.

The publication of the IFRS represents the completion of the first part of a three-part project to replace IAS 39 Financial Instruments, the IASB notes. Proposals addressing the second part, the impairment methodology for financial assets were published for public comment at the beginning of November (see last week's issue). Proposals on the third part, on hedge accounting, continue to be developed.

The effective date for mandatory adoption of IFRS 9 is 1 January 2013. Consistent with requests by the G20 leaders and others, early adoption is permitted for 2009 year-end financial statements.

EFRAG says it is currently considering how it will proceed in its work to address the package of standards that are expected to replace IAS 39.

AC & CS