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Sep 2007
Introduction
A key challenge ahead of financial reporting in 2007 is the adoption of HKFRS 7 (Financial Instruments: Disclosure). HKFRS 7 deals with financial instruments disclosures and replaces the requirements of HKAS 30 (Disclosure requirement for banks and similar financial institutions) and the disclosure requirement in HKAS 32 (Financial Instruments: Disclosure and Presentation). This new standard becomes effective for annual periods beginning on or after 1 January 2007 and applies to all entities.
While there may be as many as 70 additional disclosures that entities need to make in order to comply with the HKFRS 7, some of these information may be readily available from existing systems and processes, other disclosures may require the development of new processes, data sources and analysis tools.
In this issue, we will talk about some practical application issues/considerations that banks may encounter and should consider in preparing for its first set of HKFRS 7 disclosures.
Concept of "class" under HKFRS 7
HKFRS 7 requires certain disclosures to be given by "class" of financial instrument. There is no prescriptive list of "class" in HKFRS 7. A bank needs to determine its own class of financial instruments on an entity specific basis, based on how management see the risk and nature of financial instruments the entity is holding.
Key questions to address:
- Who should be involved in determining the appropriate "class" for the bank?
- What is the appropriate level of "class" best represent the risk and nature of each type of financial instruments held by the bank?
- Is the "class" used for financial statements disclosure consistent with how management internally manage the financial instruments?
- Is the data to be disclosed by "class" readily available (e.g. movement of impairment allowance account for credit losses by class)?
Credit risk disclosures
HKFRS 7 requires disclosures of risk arising from use of financial instruments based on the information provided internally to key management and the extent and way of disclosures will be different for each bank, but it also prescribes some minimum disclosures to be given by all entities. Credit risk disclosure is probably the area with the most minimum disclosure requirements.
Practical application issues may arise from some of these minimum disclosure requirements, for example:
- Is data relating to "collateral" (e.g. fair value of collateral) for financial assets that are "technically" past due (e.g. for a small number of days) readily available?
- The adoption of HKFRS 7 increases the transparency of disclosure about credit quality of financial assets, e.g. credit quality of loans and advances and debt investments that are neither past due nor impaired; analysis of age of financial assets past due but not impaired (include those "technically" past due for 1 day). With the increased transparency of disclosure, how to manage the communication with stakeholders about the banks' credit risk management policy?
Liquidity risk disclosures
HKFRS 7 requires a maturity analysis for financial liabilities showing the remaining contractual maturities and a description of the approach to manage the inherent liquidity risk. The amounts disclosed in the maturity analysis are the whole term of contractual undiscounted cash flows (i.e. include principal and coupon) based on earliest remaining contractual maturities. Such undiscounted cash flows differ from the amount included in the balance sheet because the balance sheet amount is based on discounted cash flows.
For banks, issues include:
- Is the data readily available in the system, in particular, for financial liabilities in the bank's trading book, which are often held intentionally for short-term resale and the contractual cash flows bear little/no relevance to what the bank will actually pay out on those contracts?
- Is system modification required or do "queries" need to be developed to generate the required disclosures e.g. undiscounted contractual cash flows for net-settled derivative financial instruments with negative value and the pay leg of gross-settled derivatives?
- Does the entity have the appropriate level of internal control in place to ensure accuracy and integrity of the information newly presented, in particular the disclosure on liquidity risk which no longer reconcile to the balance sheet?
Besides the credit risk and liquidity risk disclosures, there are other new disclosures that banks need to action (e.g. methods used to measure the risk and processes for managing the risk).
Conclusion
The practical application of HKFRS 7 may pose challenge to the bank's management information system and the financial reporting process. To get ready for the new HKFRS 7, management would need to:
- be aware the complexity and disclosure requirement under HKFRS 7
- get senior management input
- review what others have done already, some banks such as HSBC, Hang Seng bank, SEB, Svenska Handelsbanken have already adopted HKFRS 7/IFRS 7
- conduct a proper "gap analysis" to identify areas to action
- design and implement the appropriate level of internal control to ensure accuracy and integrity of the new information
- develop a communication plan that clearly articulates their strategy for holding financial instruments, how risks from those instruments are managed
Don't forget that HKFRS 7 disclosures also requires comparatives! It is time to take action and get ready for the first set of HKFRS 7 disclosures. |
