Banking & Capital Markets

Even for Europe, Two Sets of Standards

Banks will have a choice between two sets of rules for hedge accounting for derivatives.
Stephen TaubOctober 5, 2004

On Friday, the European Union — whose 25 members are scheduled to adopt a uniform set of International Financial Reporting Standards on January 1 — agreed to a compromise that will allow banks to choose between two sets of rules for hedge accounting, according to Reuters.

Under the compromise hammered out last week, the EU approved less onerous requirements under International Accounting Standard 39 (IAS 39), the rule for treating derivatives investments. However, added Reuters, individual EU states would be able to permit their banks to use tougher provisions that comply with U.S. accounting rules.

The upshot is that when some 7,000 listed European companies publish their financial reports next year, many banks will have the option to follow certain IAS 39 standards — or not. “Because there will be a certain degree of optionality,” said Ken Wild, global IAS leader at Deloitte & Touche, according to Reuters, “this will defeat the objective of trying to get a common standard.”

An EU representative asserted that the changes affected less than 5 percent of the text of the standard and that a full-scale international review of the rule would follow. “We shouldn’t over-exaggerate the impact of this, said commission spokesman Jonathan Todd, according to the wire service. “This is one standard out of many.”

IAS 39 requires companies to value derivatives, shares, and bonds at fair or market value as opposed to historical cost. Banks — which have been heavy users of derivatives — can reduce volatility through hedge accounting, but the original, tougher version of IAS 39 imposes strict limits on such practices, Reuters pointed out.

The wire service reported that a number of banks, especially financial institutions based in France, opposed IAS 39 in the belief that it could damage their risk management practice and lead to wildly fluctuating earnings. Reuters added that French President Jacques Chirac and European Central Bank President Jean-Claude Trichet had also publicly weighed in with opposition to the stricter interpretation of the standard.

In the end, the European Commission, which is in charge of endorsing accounting standards in the EU, decided to impose a compromise by removing the most controversial features of IAS 39, but allowing banks to comply with the original standard if they choose.

Deloitte’s Wild told the wire service that he expects only a small number of banks, mostly in France in Italy, to apply the watered-down standard.