Circular 2/2018 of the Bank of Spain, of December 21, amending Circular 4/2017 on financial information standards and Circular 1/2013 on the Risk Information Central

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Circular 2/2018, of December 21, of the Bank of Spain, amending Circular 4/2017, of November 27, to credit institutions, on public and reserved financial information standards and models of financial statements, and Circular 1/2013, of May 24, on the Risk Information Central. (BOE of December 28)

I

The main objective of this circular is to adapt Circular 4/2017, of November 27, to credit institutions, on public and reserved financial information standards and models of financial statements, to Commission Regulation (EU) 2017/1986 of October 31, 2017, amending Regulation (EC) No 1126/2008 adopting certain International Accounting Standards in accordance with Regulation (EC) No 1606/2002 of the European Parliament and of the Council, regarding International Financial Reporting Standard (IFRS-EU) 16 on leases.

In this way, the Bank of Spain continues with the strategy, already manifested in the preamble of Circular 4/2017, of November 27, to maintain the compatibility of the accounting regime of Spanish credit institutions with the principles and criteria established by IFRS-EU – in accordance with Regulation (EC) No 1606/2002 of the European Parliament and of the Council of July 19, 2002, on the application of international accounting standards – within the framework of the Commercial Code.

Finally, it should be noted that this circular also amends Circular 1/2013, of May 24, on the Risk Information Central (CIR), incorporating minor changes to introduce clarifications and improvements.

II

This circular consists of two regulations, two transitional provisions, one final provision, and an annex.

Regulation 1 updates Circular 4/2017, of November 27, in the following way:

– Regulation 33, on leases, is replaced by a new text that sets out accounting criteria compatible with those of IFRS-EU 16. The main difference with the current regulation lies in the accounting treatment for the lessee, as the accounting for these contracts by the lessor remains unchanged in relevant aspects.

Under the current regulation, the lessee distinguishes between finance leases – for which it recognizes an asset for the leased item and a liability for the committed lease payments – and operating leases – for which it recognizes an expense charged to profit or loss in accordance with the accrual principle. Under the new criteria, the lessee will record lease contracts on the balance sheet, recognizing a lease liability and a right-of-use asset; that is, following a criterion similar to that used until now for finance leases. As a simplification, lease contracts with an initial term of twelve months or less, as well as those in which the leased item is of low value, may be treated as operating leases were previously accounted for. Therefore, no new approach has been introduced for the accounting treatment of leases, but rather the scope of contracts that need to be recognized on the balance sheet has been expanded.

The accounting treatment for contractual modifications of lease liabilities follows specific criteria distinct from the general criteria for financial liabilities, since the former do not reflect an obligation to repay funds received, but rather outstanding payments, as consideration for a right of use. In this regard, while to determine the accounting treatment for modifications of lease liabilities, changes in the scope of the rights of use and the corresponding consideration are evaluated, in issued debt instruments, it is evaluated whether there has been a substantial change in the amounts and payment schedules.

Sale and leaseback transactions (known as "leasebacks") also undergo changes, fundamentally to adapt their accounting record to the new treatment of the lessee. First, the entity must determine whether the transfer of ownership of the item subject to the contract should be accounted for as a sale of goods. If not, the seller-lessee will keep the asset subject to the contract on its balance sheet and recognize a financial liability for the amount of the consideration received in the transaction, while the buyer-lessor will recognize a financial asset for the consideration delivered. If, on the contrary, the requirements to account for a sale of goods are met (i.e., the buyer-lessor acquires control of the item), the seller-lessee will derecognize the sold asset, and recognize the right of use retained by the subsequent lease for a fraction of the previous book value of the sold asset and a lease liability; as a consequence, in this case, the seller-lessee must recognize a liability for the financing received and only recognize the result corresponding to the rights of use ceded.

The exclusion from the scope of regulation 33 of exploitation rights of intellectual property by a licensee is maintained. These exploitation rights follow a regime of termination, extension, and replacement of the item subject to the contract different from that of the rights of use of tangible assets, and consequently, are regulated in regulation 28, on intangible assets (valuation at cost with the allocation of payments using a systematic criterion).

The new criteria of regulation 33, on leases, bring about changes in the models of public balance sheets – individual and consolidated –, in the rules for preparing the public balance sheet and public income statement, and in the breakdowns required in the notes, as well as minor modifications to ensure the internal coherence of Circular 4/2017, of November 27. In particular, the asset for the right of use of the leased item will be presented together with the rest of the assets of the same nature.

– The wording of regulation 1 is modified to improve it, clarifying the scope of Title II, on reserved financial information. The clarification introduced, which does not alter the scope of said title, is consistent with the European accounting framework and with Commission Implementing Regulation (EU) No 680/2014 of April 16, laying down implementing technical standards with regard to the reporting of information by institutions for supervisory purposes in accordance with Regulation (EU) No 575/2013 of the European Parliament and of the Council, known as FINREP, and, therefore, with the treatment that institutions have been applying.

– In regulation 4, the frequency of submission of the individual public balance sheet changes from monthly to quarterly.

– Points 97, 99, and 116 of Annex 9 are modified to establish that operations included in a special debt sustainability agreement, which will continue to be not reclassified into the doubtful risk category, will be identified as refinancing, refinanced, or restructured operations.

– The models of the public income statement, individual and consolidated, are modified to include, as a breakdown of existing items, the new minimum items introduced in IAS-EU 1. Changes are also introduced in the public statements on assets acquired or received in payment of debts, to specify their scope.

– Regarding individual reserved statements, certain requirements of the balance sheet and income statement are simplified, and the frequency of submission of information on related parties is reduced. As for consolidated reserved information, for monetary policy and statistical purposes, the FINREP statement F 40 is submitted quarterly, which entails the elimination of statement FC 200 and its replacement by a new individual reserved statement.

In the annex of this circular, a new format of statement FI 142.1-1 and the new statement FI 151 of Annex 4 of Circular 4/2017, of November 27, are presented.

– Finally, corrections of minor errors detected in the first months of application of Circular 4/2017, of November 27, are made.

Regulation 2 amends Circular 1/2013, of May 24, on the CIR. Specifically, changes are introduced in regulations second, third, fourth, sixth, eleventh, and fifteenth, in order to correct errors and introduce clarifications and improvements identified in the first months of application of the modifications incorporated in said circular by Circular 1/2017, of June 30. This will improve the alignment with the information required by European Central Bank Regulation (EU) 2016/867 of May 18, 2016, on the collection of granular credit and credit risk data (AnaCredit Regulation), and homogenize some terms with those used in the accounting circular. Additionally, minor changes have been made in Annexes 1 and 2 of Circular 1/2013, of May 24.

The first application rules of the new lease criteria, which are set out in the first transitional provision, are also adapted to those of IFRS-EU 16. The entity may apply the new lease standard fully retrospectively, as if the new criteria had always been applied, or opt for a regime with various simplification alternatives.

On the other hand, the second transitional provision specifies that the new criteria for operations included in a special debt sustainability agreement will not apply to operations carried out before the entry into force of this circular, but only to those agreed by institutions from January 1, 2019.

Finally, according to the sole final provision, this circular, like IFRS-EU 16, will enter into force on January 1, 2019. As an exception, certain changes in the statements, not related to the new lease criteria, will enter into force on December 31, 2018.

III

This circular complies with the principles of necessity and effectiveness required by Article 129.1 of Law 39/2015, of October 1, on the common administrative procedure of Public Administrations, as it undertakes changes in the accounting regulation of credit institutions necessary to maintain a development of the Commercial Code in line with the IFRS-EU framework.

As for the principles of proportionality, legal certainty, and efficiency established in said law, they are achieved by establishing this circular, for its scope of application, a complete, integrated, and clear accounting regulation for credit institutions, which, being harmonized with IFRS-EU, avoids the coexistence of two different accounting frameworks within the same group. The circular limits itself to including only those requirements necessary to meet the objective of convergence with IFRS-EU, avoiding burdens on institutions, without imposing additional obligations on them.

The principle of transparency is achieved through the prior public consultation with potential affected parties, fixed by Article 133 of Law 39/2015, of October 1, and the public hearing with interested parties, both forming part of the processing process of this circular.

The authorizations of the Bank of Spain to issue this circular are the same as those used for the approval of Circular 4/2017, of November 27, and Circular 1/2013, of May 24; that is, the Order of the Ministry of Economy and Finance of March 31, 1989, empowering the Bank of Spain to establish and modify the accounting standards of credit institutions, and Order ECO/697/2004, of March 11, on the CIR, respectively.

Consequently, in exercise of the powers granted, the Governing Council of the Bank of Spain, upon proposal of the Executive Committee, and in accordance with the Council of State, has approved this circular, which contains the following regulations:

Regulation 1.

Amendment of Circular 4/2017, of November 27, to credit institutions, on public and reserved financial information standards and models of financial statements.

The following modifications are introduced in Circular 4/2017, of November 27:

a) In regulation 1, on "Scope and Object", paragraph 4 is modified, which reads as follows:

"4. The rules contained in Title II of this circular shall apply to the individual reserved financial statements of credit institutions and branches of foreign credit institutions operating in Spain, including those whose head office is located in a Member State of the European Economic Area and those that are not, as well as to the consolidated reserved financial statements for purposes other than supervision regulated in this circular of consolidatable groups of credit institutions.

The accounting criteria for the preparation of said individual and consolidated reserved statements shall be those applicable for the formulation of the corresponding public financial statements, in accordance with the aforementioned paragraph 3, with the specificities established in that Title II."

b) In regulation 4, on "Other Individual Public Financial Information", paragraphs 1 and 2 are modified, which read as follows:

"1. Regardless of the obligation to prepare and publish individual annual accounts, credit institutions and branches of foreign credit institutions whose head office is not located in a Member State of the European Economic Area shall submit to the Bank of Spain, for dissemination, their individual primary financial statements. These comprise the balance sheet, the income statement, the statement of comprehensive income, the statement of total changes in equity, and the individual statement of cash flows. These primary financial statements, prepared by fully applying the rules contained in this title, shall conform to the models contained in Annex 1.

Credit institutions, as well as branches of foreign credit institutions whose head office is not located in a Member State of the European Economic Area, shall submit the balance sheet, the income statement, and the statement of comprehensive income quarterly, and the statement of total changes in equity and the statement of cash flows annually.

2. Branches of foreign credit institutions whose head office is located in a Member State of the European Economic Area shall submit to the Bank of Spain, for dissemination, information on their activity, adjusted to the model of Annex 2, applying the corresponding criteria in accordance with paragraph 2 of regulation 2.

These branches shall submit quarterly information relating to the balance sheet and information relating to the income statement, which constitute their individual primary financial statements. The rest of the information, annually."

c) In regulation 14, on "Considerations Regarding Fair Value", paragraph 37 is modified, which reads as follows:

"37. In the case of real estate assets acquired or received in payment of debts classified as non-current assets held for sale, the estimation of fair value shall be carried out applying the criteria of points 166 to 172 of Annex 9 of this circular, and therefore, the reference valuation must be updated annually. The aforementioned criteria shall also apply to the estimation of fair values of real estate assets acquired or received in payment of debts classified as investment properties for which any of the requirements established in letters a) and b) of point 175 of Annex 9 are not met."

d) In regulation 19, on "Definition of Financial Instruments", paragraph 9 is modified, which reads as follows:

"9. Financial assets and liabilities resulting from lease contracts, which shall be treated in accordance with what is established in regulation 33, shall also be subject to both the presentation criteria indicated in regulations 52 and 53 for financial instruments and the information criteria to be provided in the notes indicated in regulation 60 for these, but shall not be subject to the recognition and valuation criteria of this section. Notwithstanding the foregoing, they shall be treated according to what is provided in this section for the purposes of their recognition and valuation:

a) The impairment of receivables from finance lease contracts, if any, carried out by the lessor, as well as the derecognition from the balance sheet of these and certain modifications, in accordance with paragraphs 14 and 15 of regulation 33.

b) The implicit derivatives that may be incorporated into the lease contract, in accordance with what is established in the second paragraph of paragraph 2 of regulation 33.

c) Financial assets and liabilities that, in accordance with paragraph 30 of regulation 33, arise in sale and leaseback transactions."

e) In regulation 26, on "Owner-occupied assets and investment properties", the last paragraph of paragraph 2 is modified, which reads as follows:

"Investment properties include real estate held by the owner or by the lessee as a right-of-use asset, to earn rentals or for capital appreciation or both, and that are not expected to be realized in the ordinary course of business nor are intended for own use or social work."

f) In regulation 27, on "Inventories", the last paragraph of paragraph 8 is modified, which reads as follows:

"Net realizable value shall be estimated in accordance with what is established in Annex 9 of this circular in the case of real estate obtained by adjudication or dation in payment of debts and, on the reference date, are classified as inventories in a dependent entity."

g) In regulation 29, on "Impairment of Financial Assets and Other Credit Exposures", the penultimate paragraph of paragraph 1 is modified, which reads as follows:

"Receivables from lease contracts, recognized in accordance with paragraph 9 of regulation 33, as well as trade credits and items receivable from commercial operations without a significant financing component, recognized in accordance with paragraph 20 of regulation 15, are included in the item 'loans and advances', defined in paragraph 1 of regulation 52, so that the criteria of this regulation shall apply to them."

h) Regulation 33, on "Leases", is replaced by the following:

"Regulation 33. Leases.

Scope and General Issues.

1. This regulation shall apply to all lease contracts, with the exception of lease contracts on exploration or use of non-renewable natural resources; lease contracts on biological assets held by the lessee; exploitation licenses of intellectual property granted by the lessor, which shall be treated in accordance with what is established in regulation 15; as well as exploitation rights of intellectual property held by the lessee by virtue of a license, which shall be treated in accordance with what is established in regulation 28.

2. At the inception of the contract, the entity shall determine whether this constitutes or contains a lease, which shall be the case if the contract entails the right to control the use of an identified asset for a certain period of time in exchange for a consideration.

The entity shall use the criteria of paragraph 2 of regulation 44 to determine whether the contract has as its object an asset or groups of assets, or whether it has as its object a business. In the latter case, the contract shall be accounted for in accordance with the criteria of regulations 43 to 45.

The entity shall account for each lease contract individually. However, it may apply the criteria of this regulation to a portfolio of lease contracts with similar characteristics if it expects that exercising this option will not differ significantly from accounting for each contract individually.

To determine whether a contract constitutes a lease or if it is another type of contract, such as a service contract regulated in regulation 15, the entity must analyze whether the following two conditions are met: the asset is identified in the contract and the party receiving the asset has the right to control its use.

On the one hand, the asset may be explicitly identified in the contract; for example, when its serial number is specified in it. Or it may also be implicitly identified by its specification when the provider makes it available to the other party to the contract for use.

An asset is not considered identified if the provider has the substantive right to substitute it throughout the entire use period contemplated in the contract.

The right of substitution will not be considered substantive when the provider has the right to substitute the asset on a specific date or from that date onwards.

The provider will have a substantive right of substitution when, simultaneously, it has the practical ability to substitute the asset with alternative assets (such as when it has these alternative assets and the party receiving the asset cannot prevent the substitution) and expects to benefit economically from the substitution (that is, the benefits derived from the substitution will exceed the costs).

The evaluation to determine whether a substitution right by the provider is substantive shall be based on the facts and circumstances existing at the inception of the contract, excluding those future events whose occurrence before the beginning of the use period, or concurrence during it, is not considered probable at the time of the evaluation.

Examples of cases in which the provider does not have a substantive right of substitution include the following:

a) The practical ability to substitute, or the expected benefit, depends on the introduction of new technology and this is not substantially developed at the inception of the contract.

b) The practical ability to substitute, or the expected benefit, depends on a substantial difference occurring between the use that the other party to the contract makes of the asset, or the return it obtains from it, and the use, or return, considered probable at the inception of the contract.

c) The practical ability to substitute, or the expected benefit, depends on a substantial difference occurring between the market price during the use period and the market price considered probable at the inception of the contract.

d) The practical ability to substitute, or the expected benefit, derives from a future agreement of a third party to pay a price higher than the market price for the use of the asset.

On the other hand, the party receiving the asset has the right to control the use of the identified asset when during the total period of the contract it has, simultaneously, the right to obtain substantially all the economic benefits from the use of that identified asset and to