The Committee of European Securities Regulators (CEBS) has published its comments on the draft response of the European Financial Reporting Advisory Group (EFRAG) to the International Accounting Standards Board’s (IASB) discussion paper on credit risk in liability measurement.
CESR agrees with the premise that own credit risk should only be taken into account in the initial measurement of a liability if that credit risk is priced into the transaction that gave rise to the initial recognition of that liability.
CESR also agrees that subsequent measurements of financial liabilities should, in principle, not reflect changes in own credit risk. It might be thought counter-intuitive to report a gain when the credit quality of a liability declines (or a loss when its credit quality improves), seeing that an entity can almost be bankrupt but still report profits by reflecting the deterioration of its own credit risk when valuing its liabilities.
The organisation does, however, agree that realisation should not be required in all cases for changes in fair value to be recognised. There is scope in some cases for credit risk-based changes in the fair value of a liability to be considered as part of the calculation of the value of that liability, for example when an entity is able to buy back its own liability that is in the form of a debt instrument traded in an active market with published prices.
CESR emphasises that whatever direction the IASB decides to take on this project, appropriate disclosures will be necessary to provide users with the information they require to value an entity appropriately and to provide investors with sufficient market transparency.