Circular D1/3427: Aspects of the Euro Transition from Solvency and Accounting Perspectives

COMMISSION BANCAIRE ET FINANCIERE Prudential Supervision of Credit Institutions 99 Louise Avenue, B-1050 Brussels phone +32(2)535.22.11 - fax +32(2)535.24.96 December 8, 1998

CIRCULAR LETTER D1/3427 TO CREDIT INSTITUTIONS

Madam, Sir,

Subject: Aspects of the Euro Transition from Solvency and Accounting Perspectives

The entry into force of the third phase of the EMU and the introduction of the euro on January 1, 1999, require adaptations to banking legislation on certain points, but also raise several interpretative issues.

Regarding the adaptation of banking legislation, the Law of October 30, 1998, relating to the euro 1, modified, among other things, the Law of March 22, 1993, relating to the status and supervision of credit institutions, and the Law of April 6, 1995, relating to secondary markets, the status of investment firms and their supervision, and intermediaries and investment advisors. Royal Decrees dated November 26, 1998, adapted the Royal Decrees of September 23, 1992, relating to the annual accounts and consolidated accounts of credit institutions, as well as to the information to be published by branches of foreign credit institutions 2. In the meantime, the Commission has also adapted the schema of periodic information to be communicated by credit institutions concerning their financial situation (the "Schema A") in view of the entry into force of the third phase 3. To be complete, it must be noted that the Commission's Decree of December 5, 1995, concerning the regulation relating to the own funds of credit institutions, does not need to be adapted at this time.

The introduction of the euro also poses several interpretative problems regarding solvency and accounting regulations.

Regarding the application of solvency regulations, the Commission examined whether, in calculating their capital requirements - particularly for interest rate risk arising from the trading book and for foreign exchange risk - credit institutions could already take into account, before January 1, 1999, the decision taken last May according to which the conversion rates for the euro, to be fixed on January 1, 1999, would be calculated based on the bilateral pivot rates currently in force within the exchange rate mechanism of the European Monetary System, for currencies participating in the euro.

The Commission considers that such anticipation is not advisable, for several reasons: the euro is only introduced on January 1, 1999, annual accounts cannot be drawn up anticipating the aforementioned conversion rates (see in this regard the opinion of the Accounting Standards Commission), and in the financial statement and the supplementary description tables of Schema A, currencies participating in the euro must, until December 31, 1998 inclusive, be considered as distinct currencies and be subject to separate reporting.

Consequently, credit institutions must, until December 31, 1998 inclusive, consider currencies participating in the euro as distinct currencies and treat them accordingly for the application of capital regulations. Correlation and offsetting between participating currencies are accepted only within the limits imposed in the past by the Commission on individual credit institutions 4.

However, if a credit institution presents a capital deficiency on December 31, 1998, the Commission will take into account, when assessing this deficiency and determining the remedial measures to be taken, the possible positive impact that the transition to the euro will have on the solvency of the credit institution.

Several credit institutions also publish, in their annual report, their capital ratio at the end of the fiscal year. Contrary to what applies for reporting to the Commission, institutions may, if they wish, anticipate the introduction of the euro for the calculation of their ratio published on December 31, 1998. In this case, they must also publish the numerical impact of this anticipation on their capital ratio 5.

In its Bulletins No. 37 of January 1997 and No. 42 of February 1998, the Accounting Standards Commission published various opinions regarding the accounting law aspects related to the transition to the euro. As the issue is in principle similar in general accounting law and banking accounting law, the opinions of the Accounting Standards Commission apply by analogy to credit institutions. These institutions must therefore draw up their annual accounts in accordance with these opinions.

However, a specific interpretative problem arises regarding Article 36bis of the aforementioned Royal Decree of September 23, 1992, relating to the annual accounts of credit institutions. The Commission has defined the framework within which it authorizes derogations from this article for the valuation of certain interest rate forward transactions (see on this subject the Annual Reports 1993-1994, p. 40, and 1994-1995, p. 43). Regarding interest rate forward transactions concluded within the framework of "asset & liability management," the Commission makes a distinction between activity in Belgian francs and that in foreign currencies. Upon the transition to the euro, the derogatory regime provided for interest rate forward transactions concluded within the framework of ALM management and recorded in the balance sheet in BEF will apply, from January 1, 1999, to the balance sheet drawn up in euros.

A copy of this letter is sent to your or your statutory auditors.

Please accept, Madam, Sir, the expression of my distinguished sentiments.

The President, J.-L. Duplat.

1 Belgian Monitor of November 10, 1998. 2 Belgian Monitor of December 1, 1998. 3 See circulars D1 97/2 and D1 98/3 of the Banking and Financial Commission of June 5, 1997 and November 23, 1998.

4 See in particular Article 73 of the capital regulation. 5 In accordance with international recommendations advocating greater transparency in the annual report of credit institutions.