Accounting for Financial Instruments Designated as Fair Value Option

Document Properties

• Type of Publication: Guideline
• Category: Accounting
• Date: June 2006
• Revised: July 2010
• No: D-10
• Audiences: Life / P&C / IHC

Introduction

This Guideline provides application guidance to life insurance companies & fraternal benefit societies, property and casualty insurance companies, and insurance holding companies (collectively referred to as “Federally Regulated Entities” or “FREs”) applying the fair value option in International Accounting Standard 39 Financial Instruments: Recognition and Measurement as issued by the International Accounting Standards Board (IASB) that allows entities to designate a financial asset or financial liability at fair value through profit or loss upon initial recognition. This option is referred to as the “Fair Value Option.”

Canadian legislation governing FREs allow OSFI to specify accounting principles. OSFI’s ability to make specifications is addressed in International Standard on Auditing 210 and the equivalent Canadian Auditing Standard 210. Given that using the Fair Value Option is a choice, OSFI believes that the specifications made in this Guideline will not impair an FRE’s ability to obtain an audit opinion that states that the financial statements are in accordance with International Financial Reporting Standards as issued by the IASB. OSFI believes this Guideline is essential in maintaining the integrity of regulatory capital when applying the Fair Value Option.^{Footnote 1}

I. Basel Committee on Banking Supervision’s Supervisory Guidance on the Fair Value Option

OSFI expects all institutions using the Fair Value Option to meet the supervisory expectations set out in Principles 1 – 4 of the Basel Committee’s Supervisory guidance on the use of the fair value option for financial instruments by banks.^{Footnote 2} OSFI intends to follow principles 5-7 in assessing risk management, controls and capital adequacy related to all institutions’ use of the Fair Value Option.

II. International Accounting Standard (IAS) 39 Guidance on the Fair Value Option

OSFI understands that institutions using the Fair Value Option will apply IAS 39, as amended from time to time, including IAS 39.9 “Definitions of four categories of financial instruments – A financial asset or financial liability at fair value through profit or loss” paragraph (b).

IAS 39.9 (b)

Upon initial recognition it is designated by the entity as at fair value through profit or loss. An entity may use this designation only when permitted by paragraph 11A, or when doing so results in more relevant information, because either

1. it eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as ‘an accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases; or

2. a group of financial assets, financial liabilities or both is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity’s key management personnel (as defined in IAS 24 Related party Disclosures (as revised in 2003)), for example the entity’s board of directors and chief executive officer.

For IAS 39.9(b)(i), or as read by screen readers, IAS 39.9(b)(1), institutions may apply the Fair Value Option under this criterion if: (a) consistent with a documented risk management strategy, it eliminates or significantly reduces^{Footnote 3} the measurement or recognition inconsistency of measuring financial assets or liabilities together on a different basis^{Footnote 4}, and (b) the fair values are reliable at inception and throughout the life of the instrument.

For IAS 39.9(b)(ii), or as read by screen readers, IAS 39.9(b)(2), institutions may apply the Fair Value Option under this criterion if: (a) the institution has a documented risk management strategy to manage the group of financial instruments together on a fair value basis and can demonstrate that significant financial risks are eliminated or significantly reduced,^{Footnote 3} and (b) the fair values are reliable at inception and throughout the life of the instrument.

Using the Fair Value Option for Loans and Receivables

Generally, the Fair Value Option should not be used for loans and mortgages to companies having annual gross revenue below $62.5 million, for loans and mortgages to individuals, or for portfolios made up of such loans and mortgages.