Balance sheet offsetting of financial assets and liabilities

PwC Offsetting financial assets and liabilities Background Joint project to address single largest difference in reported numbers in statements prepared under US GAAP vs. IFRS for financial institutions. Broadly speaking, the netting criteria is similar under US GAAP and IFRS, however US GAAP has two exceptions: Under US GAAP an election can be made to net: derivatives and cash collateral posted subject to a master netting arrangement, and repo and reverse repos if certain criteria are met. IFRS generally does not allow netting of derivatives or repos unless the netting criteria are met. 2

PwC Offsetting financial assets and liabilities Project timing ED issued 28 January Comments due 28 April Roundtables in North America, Europe and Asia Q Final amendments to standards issued December

PwC4 Offsetting financial assets and liabilities US GAAPIFRS A right of set off exists when all of the following conditions are met (ASC ): a. Each of two parties owes the other determinable amounts. b. The reporting party has the right to set off the amount owed with the amount owed by the other party. c. The reporting party intends to set off. d. The right of setoff is enforceable at law. Exceptions exist for : Derivative instruments subject to a master netting agreement Collateral amounts posted against derivative balances Repurchase agreements transacted through a qualifying clearing facility Netting is optional A financial asset and financial liability shall be offset if an entity has: (a) Currently has a legally enforceable right to set off and (b) Intends to either settle on a net basis, or realise the asset and settle the liability simultaneously. (IAS 32.42) A master netting arrangement does not provide a basis for offsetting unless both of the criteria above are satisfied. Current requirements

PwC5 Offsetting financial assets and liabilities Exposure draft proposals Offsetting would be similar to IAS 32 requirements today. Right of set-off must be legally enforceable in all circumstances. Unconditional means its exercise is not contingent on a future event. Simultaneous means at the same moment in time.

PwC6 Offsetting financial assets and liabilities Feedback received in comment letters 162 comment letters received in addition to outreach with users, preparers, regulators, clearing houses, industry groups and auditors. Supportive of the boards’ efforts toward achieving the convergence of offsetting criteria. IFRS preparers supportive of principles since similar to IAS 32 US preparers objected for derivatives and repos on the basis that a net presentation, taking into account collateral posted, more faithfully represents how they manage the business and risk exposures.

PwC7 Offsetting financial assets and liabilities Way forward In light of feedback received, the IASB and FASB decided to maintain their current offsetting models, but agreed to bring consistency through disclosures. IASB also decided that whilst retaining the basic IAS 32 offsetting requirements, it would add application guidance to improve consistency of application in the following areas: -The meaning of ‘currently has a legally enforceable right of set- off’, and -That some (non-simultaneous) gross settlement systems would be considered equivalent to net settlement.

PwC8 Offsetting financial assets and liabilities New application guidance in IAS 32 The meaning of ‘currently has a legally enforceable right of set-off’ Must not be contingent on a future event,and Must be legally enforceable in the: -Normal course of business; -Event of default; and -Event of insolvency or bankruptcy of the entity and all of the counterparties.

PwC9 Offsetting financial assets and liabilities New application guidance in IAS 32 Some (non-simultaneous) gross settlement systems would be considered equivalent to net settlement: Where it has features that eliminate or result in insignificant credit and liquidity risk, and That will process receivables and payables in a single settlement process or cycle.

PwC10 Offsetting financial assets and liabilities New IFRS 7 disclosures Scope Financial instruments netted under IAS 32 requirements, and Financial instruments subject to enforceable master netting arrangement or similar agreement irrespective of whether they are set off under IAS 32 (eg derivatives subject to master netting agreements, repos and reverse repos, securities lending, etc.).

PwC11 Offsetting financial assets and liabilities New IFRS 7 disclosures Requirements Gross amounts of recognized financial assets and liabilities. Amounts offset in accordance with IAS 32. Net amounts presented in the balance sheet according to IAS 32. Amounts subject to enforceable master netting arrangements that are not offset in balance sheet including amounts related to financial collateral. By counterparty or type of transaction. Reconcile back to balance sheet.

PwC12 Offsetting financial assets and liabilities New IFRS 7 disclosures Example abcde Gross carrying amounts (before offsetting) Gross amounts offset Net amounts presented on balance sheet (a-b) Amounts not offset in balance sheet Net amount (c-d) CategoryFinancial Instruments Collateral - Derivatives X(X)X X - repos and similar arrangemen ts X(x)X(X) X - OtherX(x)X(X) X

PwC13 Offsetting financial assets and liabilities Effective date and transition Retrospective application required. Early application permitted. Effective date for IFRS 7 disclosures 1 January Effective date for IAS 32 application guidance 1 January 2014.