Circular 5/2013 of the Bank of Spain, of 30 October, amending Circular 4/2004 on financial information standards and Circular 1/2013 on the Risk Information Central

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Circular 5/2013, of 30 October, of the Bank of Spain, amending Circular 4/2004, of 22 December, on standards for public and reserved financial information and models for financial statements, and Circular 1/2013, of 24 May, on the Risk Information Central. (BOE of 9 November) (Error correction BOE of 11 December)

Circular 4/2004 of the Bank of Spain, of 22 December, on standards for public and reserved financial information and models for financial statements, states that "this Circular, by its very nature, connects both with International Financial Reporting Standards and with the Spanish accounting framework, and will be subject to adaptation as that global framework evolves over time."

Commission Regulation (EC) No 1254/2012 adopted International Financial Reporting Standards (IFRS) numbers 10, 11, and 12 for the European Union. IFRS 10 establishes financial reporting criteria related to the presentation and preparation of consolidated financial statements, and replaces International Accounting Standard (IAS) 27 and SIC Interpretation 12. IFRS 11 establishes financial reporting criteria for participants in joint arrangements, and replaces IAS 31 and SIC 13. IFRS 12 establishes the information to be disclosed related to interests in subsidiaries, joint arrangements, associates, and special purpose entities. The revision proposed in this circular aims to adapt to Community regulations, on the one hand, by eliminating potential conflicts in the application of the concept of control when the entity does not hold the majority of voting rights or when agency relationships exist, and, on the other hand, by improving transparency and eliminating the proportional integration method for joint ventures.

On the other hand, Regulation (EC) No 475/2012 adopted for the European Union the amendments to IAS 19, on employee benefits, and to IAS 1, on the distinction within "other comprehensive income" of items that may be reclassified to the profit and loss account. The amendment to IAS 19 eliminates the possibility in defined benefit pension plans of deferring actuarial gains and losses according to a corridor, while including new information and a new method of expense recognition.

Another relevant aspect collected in Regulation 1255/2012 relates to the measurement of fair value, which IFRS now collects in a single standard (IFRS 13) and which nuances some aspects collected in Circular 4/2004, while including new information requirements.

Additionally, novelties are included regarding information on the transfer of financial assets and on offsetting. As a result of all this, new information requirements related to the proposed modifications have been added, and certain technical improvements have been incorporated into several reserved statements, including the replacement of the current credit classification statement by purpose with a new monthly statement of broader content.

Finally, the circular incorporates certain modifications affecting Circular 1/2013, of 24 May, on the Risk Information Central. Its motivation is, on the one hand, to require entities to provide information on financing activities for small and micro-enterprises, in order to be able to evaluate the financing policy towards this type of company, and, on the other hand, to request specific information on the real guarantees received by entities to facilitate their weighting when estimating the need for regulatory capital. Additionally, it slightly extends the deadline for sending the first data to the new Risk Information Central, due to the complexity of its implementation and the coincidence in time with restructuring processes of some of the entities.

Consequently, in exercise of the powers granted, the Board of Governors of the Bank of Spain, upon proposal of the Executive Committee, has approved this circular, which contains the following rules:

First Rule.

The following modifications are introduced in Circular 4/2004, of 22 December, to credit institutions, on the Standards of public and reserved financial information, and models for financial statements (hereinafter, Circular 4/2004):

1. In section 2 of the second rule, the expression "or, where appropriate, proportional integration" is eliminated.

2. The second paragraph of section 3 and section 4 of the third rule are given a new wording, and sections 4 bis, 4 ter, and 4 quater are added, with the following text:

"3. [...] To these effects, it shall be understood that an entity controls another when it:

i) has power over the relevant activities, that is, those that significantly affect its performance, by legal, statutory, or agreement provision;

ii) has present, i.e., practical, capacity to exercise the rights to use that power in order to influence its performance, and

iii) due to its involvement, is exposed or has rights to variable returns from the invested entity.

When facts and circumstances indicate that there have been changes in any of the three previous conditions, the entity must reassess control over an invested entity.

4. The power to direct relevant activities arises from rights, which are sometimes evidenced simply and other times complexly, which may lead to considering a variety of factors and circumstances. To evaluate power over the relevant activities of an entity, only substantive rights shall be considered, that is, those that grant power in the current circumstances. Generally, for rights to be substantive, they need to be exercisable on the date to which the financial statements refer.

Generally, voting rights will be those that provide the power to direct the relevant activities of an invested entity. To determine the voting rights of the dominant entity, those held directly shall be added to those corresponding to entities dominated by it or through other persons acting in their own name but on behalf of some entity in the group, or those that it holds jointly with any other person, provided they have a mechanism evidenced by a contractual agreement to exercise their rights collectively.

Exclusively for the purposes of what is provided in this circular, in the calculation of voting rights, all voting rights shall be taken into account, including potential ones, such as call options acquired on equity instruments, including those held by other entities, over which the holder has practical capacity for exercise, which will normally be convertible or exercisable on the date to which the financial statements refer, and which, in any case, must be exercisable when it is necessary to adopt decisions, for example at the next general meeting of shareholders.

In valuing the contribution of potential voting rights to the existence of a group, the entity shall take into consideration all facts and circumstances affecting this, such as conditions or barriers to their exercise, or whether the holder of the rights would benefit from the exercise of said rights. In turn, potential voting rights held by third parties shall be considered to determine if there is power to direct relevant activities.

In certain situations, it may happen that the entity has power to direct activities without holding the majority of voting rights, such as when the rest of voting rights holders are very dispersed and the entity has more rights than any other holder, or if it has contractually arranged with other holders to cede their votes. When two or more entities each hold a significant number of voting rights of the same invested entity, the rest of factors determining the existence of control must be analyzed to determine which of them is the dominant entity.

When it is difficult to determine if the entity has sufficient rights to obtain power over an invested entity, it must be assessed whether it has practical capacity to direct its relevant activities unilaterally. For example, even if contractual rights are not held, the rights held by the entity will be sufficient to have power over the investee when, for its own benefit, it has the capacity to appoint key management personnel, to orient the strategic direction of the business, or to veto changes in the most significant transactions. It may also be indicative of power to direct relevant activities that the entity is responsible for ensuring the investee operates as designed, or that its activities are directed according to its own needs.

Generally, relevant activities will be financial and operational, or related to the appointment and remuneration of governing bodies, but sometimes they may be limited to decisions regarding specific situations or events that affect the profitability of the invested entity, in which case contractual agreements on the basis of which these decisions are made must be evaluated. This would be the case for entities designed so that their activities are predetermined, and power over relevant activities only arises under particular circumstances that significantly affect their returns. For example, when the only activity of an invested entity is the purchase of receivables so that its performance is only significantly affected when defaults arise, the relevant activity will be the management of defaults so that whoever has the capacity to manage defaults will have the power to direct the relevant activities of the investee, and this regardless of whether any default has occurred or not.

Rights that protect against fundamental changes in the activities of the invested entity, such as changes in the credit quality of a borrower, or that apply in exceptional situations, such as defaults, do not themselves constitute power over the investee. However, not all rights that apply in exceptional circumstances, or depend on exceptional events, are protective, for example, when such rights are exercised over the relevant activities of the investee.

4 bis. When voting rights do not constitute the determining factor for the direction of the relevant activities of the invested entity, the analysis of control shall take into consideration the following factors:

a) Purpose and design of the invested entity: The entity shall consider the purpose and design of the invested entity to identify its relevant activities, the manner in which decisions regarding said relevant activities are made, who has the capacity to direct them, and who benefits. If the investee was designed as a mechanism to eliminate certain risks from the balance sheet of the entity, or another in the group, the entity shall consider the risk to which it is exposed, the risk transferred, and whether it has been exposed to part or all of those risks. If the entity was involved in the design of the invested entity, it shall consider this fact to the extent that it may indicate that it had incentives to obtain rights resulting in the capacity to direct the relevant activities of the investee.

b) Rights that grant power: Power over an entity arises from rights. In certain circumstances, it may be difficult to determine if rights are sufficient to grant the power to direct relevant activities unilaterally. To this end, the entity shall take into account contractual agreements regarding what is provided in the previous letter a) and the degree of involvement in the creation of the investee, as well as what is provided in section 4 of this rule regarding situations where it is difficult to determine if rights are sufficient to give power to an entity over another entity.

Additionally, the possible existence of elements that may suggest the existence of a special relationship with the investee, beyond a passive participation, which in combination with other rights may be indicators of power over the investee, such as financial dependence of the entity or that this guarantees the obligations of the investee, shall be considered.

4 ter. Exposure, or rights, to variable returns of the investee implies that the returns the entity obtains from the investee must be able to vary as a consequence of its performance and not be fixed. This exposure may proceed, among others, from:

i) Rights from financial instruments issued by the subsidiary that give rise to returns, such as dividends or interest, and changes in the value of the participation.

ii) Remuneration for administering the assets and liabilities of the investee.

iii) Remuneration and exposure to losses for having provided financial or credit support to the investee.

iv) Returns from combining operational functions with the investee to achieve economies of scale, cost savings, or improve the value of the entity's assets.

4 quater. The linkage between power and returns may indicate an agent or principal status when making decisions. In this sense, an agent is a party primarily engaged to act in the name and for the benefit of third parties, called "principals". Rights delegated to an agent shall be considered as its own. When returns are obtained by virtue of the agent status, there is no control when decisions are made. Determining agent status requires an evaluation of relevant factors, such as the scope of authority to make decisions, rights retained by other parties, or exposure to variability of returns from other participations in the investee.

The amount of remuneration and its variability related to the returns of the investee must be considered to identify the action as agent or principal, so that the greater they are, the higher the probability of being principal. In this sense, it shall also be considered whether the remuneration is supported by a contract with clauses and amounts usual and appropriate for the provision of similar services, the existence of rights of revocation without justified cause, or having provided guarantees regarding the performance of the investee."

3. In the fourteenth rule, at the end of section 2 a new paragraph is added, and another at the end of section 3, with the following texts:

"2. [...] The entity shall take these data unadjusted unless:

a) it holds a large number of similar assets or liabilities (but not identical), which are valued at their observable fair value in an active market but not immediately accessible for each of the assets and liabilities individually, as might occur in certain situations with sovereign debt instruments;

b) the quoted price in an active market does not represent fair value at the valuation date, such as when significant events occur after market close;

c) the price must be adjusted for specific factors of the element, such as the existence of restrictions on an entity preventing the sale of an asset for legal reasons.

In these cases, if the fair value data obtained from the market is adjusted, the fair value shall be classified in a lower level of the fair value hierarchy referred to in the sixtieth rule."

"3. [...] 'When a group of financial assets and liabilities is managed on the basis of its net exposure to market or credit risks and the management reports it as such, the entity may estimate the fair value of its net exposure. This exception does not concern the presentation of financial statements, that is, individual assets and liabilities must appear separately in the financial statements, and it must be applied consistently period to period.'"

4. At the end of section 8 of the twenty-second rule, a new paragraph is added with the following wording:

"When at the inception of a transaction the price differs from its fair value, the difference shall be recorded:

a) immediately in the profit and loss account when it concerns financial instruments of level 1 and 2 of the fair value hierarchy referred to in the sixtieth rule, or

b) as an adjustment of fair value and amortized over the life of the instrument when it concerns financial instruments of level 3 based on changes in factors, including time, that market participants would consider when valuing the instrument."

5. In the thirty-fifth rule, letters B.3 and C are given a new wording, which shall be drafted as follows:

"B.3. Defined benefit plans.

7. The accounting treatment of defined benefit plans will imply for the entity at least annually:

a) Consider its legal obligations according to the formal terms of the plan, in addition to implicit obligations derived from practices that, although not formalized, are usually followed.

b) Calculate the present value of legal and implicit obligations at the date to which the financial statements refer, which will be performed by a qualified actuary.

c) Deduct from the present value of the obligations the fair value of the plan assets, at the date to which the financial statements refer. Plan assets are understood to be those with which obligations will be settled directly, including insurance policies, if they meet the following conditions:

i) They are not owned by the entity, but by a third party legally separate and without the character of a related party, as defined in section 1, except letter h), of the sixty-second rule.

ii) They are only available to pay or fund employee remuneration, not being available for the creditors of the entity, even in the event of insolvency.

iii) They cannot return to the entity unless the assets remaining in the plan are sufficient to meet all obligations of the plan, or of the entity, related to employee benefits; or when the assets return to the entity to reimburse it for employee benefits already paid by it.

iv) In the case where the assets are held by an entity (or fund) for post-employment benefits for employees, such as a pension fund, they cannot be non-transferable financial instruments issued by the entity.

d) Register the amount obtained in the previous letter c) whenever it is positive as a provision for defined benefit pension funds.

e) Register the amount obtained in the previous letter c) whenever it is negative as "other assets". The entity shall value the registered asset by choosing the lower value between the following two:

i) The amount obtained in letter c), in absolute value.

ii) The present value of cash flows available to the entity, in the form of refunds from the plan or reductions in future contributions to it.

f) Recognize all changes in the provision registered according to letter d) [or asset according to letter c)] when they occur, in the following manner:

i) In the profit and loss account: the cost of services rendered by employees, both corresponding to the current period and to previous periods not recognized therein, the net interest on the provision (asset), as well as the gain or loss that occurs at the time of settlement. When these amounts are to be part of the cost of an asset according to the twenty-sixth, twenty-seventh, and twenty-eighth rules, these amounts shall be additionally recorded as "other operating income".

ii) In the statement of changes in equity: new valuations of the provision (asset), resulting from actuarial gains or losses, the return on plan assets that have not been included in the net interest on the provision (asset), as well as variations in the present value of the asset resulting from changes in the present value of cash flows available to the entity, which are not included in the net interest on the provision (asset). The amounts recognized in the statement of changes in equity shall not be reclassified to the profit and loss account in a subsequent period.

7 bis. The net interest on the registered provision (or, where applicable, on the asset) is obtained by multiplying the interest rate used in the estimation of the present value of the obligations determined at the beginning of the annual reporting period by the amount of these, taking into account any change that occurs in their value. Net interest comprises interest income from plan assets, interest cost for the provision, and interest resulting from valuing, where applicable, plan assets at the present value of cash flows available to the entity, in the form of refunds from the plan or reductions in future contributions to it.

8. The projected unit credit method, which considers each year of service as generating an additional unit of right to benefits and values each unit separately, shall be used in the determination of:

a) Present value of defined benefit obligations.

b) Cost of services rendered by employees in the period.

c) Past service cost, where applicable, as defined in section 12 of this rule.

9. Benefits to be received by employees in the future shall be allocated in the periods in which they render services to the entity, as established by the terms of the plan. However, if services rendered by an employee in subsequent years entitle them to a significantly higher level of benefits than they have achieved in previous years, the benefit the employee will receive in the future shall be allocated linearly in the time interval comprised between:

a) The date from which the service rendered entitles them to receive the benefit according to the plan, regardless of whether the benefits are conditioned on future services.

b) The date at which subsequent services to be rendered do not generate the right to receive additional significant amounts of the benefit according to the plan, except for possible future salary increases.

10. When adopting actuarial assumptions, it shall be taken into consideration that:

a) They are unbiased, resulting neither imprudent nor excessively conservative.

b) They are compatible with each other, reflecting the economic relationships existing between factors such as inflation, salary increase rates, asset returns, and discount rates.

c) If they are financial hypotheses, that is, hypotheses related to aspects such as the time value of money, future salary and benefit levels, they shall be based on market expectations at the date to which the financial statements refer.