International Accounting Standards 39 and 32 (IAS 39 & IAS 32) are the pioneer standards issued by the International Accounting Standard Board. IAS 39 is a standard to establish principles for recognising, measuring, and disclosing information about financial instruments in the financial statements of business enterprises. IAS 32 requires securities services companies to record derivatives transactions at gross; even those with the same counterparty and under a master netting agreement.
Asia's IAS implementation: Where are we?
In the Asia-Pacific region Singapore and Australia have, since 1 January 2005, been IAS compliant. In Singapore the Council on Corporate Disclosure and Governance (CCDG) issued FRS (Financial Reporting Standards) - the Singaporean equivalent to IAS standards. In Australia the standards are published by the Australian Accounting Standard Board.
Elsewhere in the Asia-Pacific region, Malaysia, Taiwan, New Zealand and Japan are in the process of adopting IAS 39 and have issued timetables for adoption.
Impact on securities services clients:
Securities services clients may be subject to IAS requirements that differ in significant ways from local industry practices today. Some key issues faced by securities services clients are:
? Fund Accounting: The impact on the financial statements of investment funds is likely to be significant. In particular, implementation of IAS standards within funds is expected to result in changes in the way investments are valued (IAS requires bid as opposed to mid price) and, in some cases, the accounting methodology adopted.
? Property Funds: In many jurisdictions, property funds account for changes in the fair values of investment properties through reserves rather than the income statement. Reserves will no longer be possible under IAS and all movements in fair values must be accounted for through the income statement.
? The implementation of IAS will significantly change the accounting for formation costs in jurisdictions where currently these are capitalized by the fund and amortised. IAS requires such expenses to be written off as incurred and thus they will be borne entirely by either the investment manager or the initial shareholders of a fund. Where such expenses are material, this will benefit subsequent investors.
Defining and identifying hedge transactions
A hedging relationship qualifies for hedge accounting if, at inception of the hedge, there is formal documentation of the hedging relationship and the entity's risk management objective and strategy for undertaking the hedge.
Accounting of embedded derivatives
Accounting of embedded derivatives is difficult because most of these are recorded as composite derivatives in the system. Most of the existing applications do not support recording of embedded derivatives so the challenge here is to identify and account for them.
Fair value calculation
Fair value is the value where the asset can be exchanged and liabilities can be settled. Some instruments are not active and their price information is not readily available, so there are concerns about the reliability of measurements of the market value of these financial instruments. At the time of implementation we need to decide the method of calculating those instruments.
To calculate the hedge effectiveness of transactions and to post accounting entries, banks need to have connectivity with their front-office and back-office systems for seamless processing. Unfortunately, most banks have discrete systems and their compliance teams calculate and post accounting entries in the financial statements manually. Hence there is a need for internal straight through processing (STP) to reduce cost and risk.
Banks and financial institutions face major challenges in interfacing with legacy systems to get the required, clean data (e.g hedge items, instruments, yield curves, pricing details) to calculate fair value, and hedge effectively.
Technically complex accounting system
Accounting systems in most organizations are complex and are difficult to change. This must be taken into consideration when implementing IAS 39 standards.
Lack of products in the market
There are few software products in the market that address effectiveness; so many companies are still using traditional methods of calculation, i.e. Excel spreadsheets. Excel calculation is tedious and chances of manual errors are very high.
IAS implementation has some way to go yet, but worth the effort. For instance, where before, derivative transactions were regarded as off-balance sheet items, it is now mandatory to measure and include these transactions in a company's financial statements. These measures will likely lead to true and fair accounting. IAS brings visibility for financial statements users.