He points out that allowing the reclassification in “rare circumstances” is a relatively minor concern compared with allowing the retroactive pricing. “Had it not been for the look-back option, this would likely not have been a comment-worthy issue,” posits Enman.
To be sure, the retroactive pricing permits banks to “opportunistically” select assets “based on their performance during the most difficult period of the financial turmoil,” argues Tremblay. He reckons that under the IAS 39 rewrite, banks can probably avoid significant charges to equity — and possibly earnings — that would have been required under the original accounting treatment.
Banks that report under international financial reporting standards had until November 1 to commit to using the look-back option, which means the results of the rule change will appear in the third and fourth quarters, surmises Enman. Indeed, some of the impacts can already be seen.
In its report, Moody’s cites several financial institutions that used the look-back option, including Germany’s Deutsche Bank and Commerzbank, and the U.K.’s Royal Bank of Scotland, HSBC, Lloyds TSB, and HBOS. In Deutsche Bank’s third-quarter results, Germany’s largest bank applied the option to $32 billion of assets, on which it otherwise would have had to take more than $1 billion worth of markdowns.
Although choosing the look-back option did not affect the bank’s credit rating, notes the report, “Deutsche Bank’s 3Q results would have been more comparable to the results of other wholesale investment banks which did not use the look-back option if it had recognized the markdowns on these assets in the current period.”
In another example, the Royal Bank of Scotland reclassified some trading assets to avoid a $1.5 billion write-down in the third quarter. Of that amount, only $870 million was charged to equity through an “available for sale” reserve. Again, there was no immediate rating impact, but without shifting the assets, the bank’s results would have been more comparable to like banks that did not use the look-back.
As the results of the rule change trickle out, the IASB insists the revision was necessary, despite being criticized for bypassing due process in an effort to push out the amended version. In testimony before a Parliamentary treasury committee last week, IASB chairman David Tweedie said the board had little choice but to rush through the rule changes to IAS 39 and IFRS 7 because the European Commission was bearing down on the organization and threatening to pass legislation that would allow reclassification of loans without also requiring proper controls or disclosures. Tweedie asserted that the IASB faced a standard-setting dilemma that he hoped he would never encounter again — “a blunt threat to blow the organization away that came very, very rapidly.”
For its part, the European Commission was calling for quick action to avoid “any distortion of treatment between U.S. and European banks due to a difference in accounting rules,” according to an October 7 statement released by the group.
The Moody’s report acknowledges that the IASB disclosure rules went a long way to strengthen the revised rule. “Fortunately, the IASB also required disclosure with respect to reclassification that will enable investors to understand the impact” of the rule change on current and future financial statements, says the report. “The disclosures should facilitate ‘topside’ adjustments by investors who feel that the opportunistic use of the IAS 39 amendment is inappropriate given a bank’s particular business model,” it concluded.