Royal Decree amending the Royal Decree of 23 September 1992 on the annual accounts of credit institutions, investment firms and management companies of collective investment undertakings

FEDERAL PUBLIC SERVICE FINANCES [C − 2021/32562] 29 AUGUST 2021. — Royal Decree amending the Royal Decree of 23 September 1992 on the annual accounts of credit institutions, investment firms and management companies of collective investment undertakings

REPORT TO THE KING

Sire,

The Royal Decree submitted to Your signature for approval aims to amend the Royal Decree of 23 September 1992 on the annual accounts of credit institutions, investment firms and management companies of collective investment undertakings (hereinafter referred to as the "Royal Decree of 23 September 1992").

The proposed amendments relate to the accounting of hedging operations for interest rate risk carried out by credit institutions. This matter is governed by Article 36bis of the Royal Decree of 23 September 1992.

Since 1993, the Banking and Finance Commission (hereinafter "the BFC"), as the then-prudential supervisor, granted individual derogations from Article 36bis to institutions that requested them, enabling them to apply a specific alternative accounting method for (in particular) interest rate swap transactions (macro-hedging) entered into within the framework of ALM (Assets and Liabilities Management) management. The policy followed by the BFC in this area was described in its annual reports for 1992-1993 and 1993-1994. This system of individual derogations was continued from 2011 by the National Bank of Belgium, which became the prudential supervisor at that time. In 2014, the National Bank of Belgium strengthened the framework for this derogation scheme through a standard letter of 18 November 2014 (supplemented by a standard letter of 29 December 2015). This 2014 standard letter provided for the maintenance of derogations permitted before that date, but only until 31 December 2021 (grandfathering - later extended to 2022).

For derogations granted after the publication of the 2014 standard letter, stricter conditions were imposed, particularly regarding effectiveness testing of the hedging, for which the National Bank of Belgium introduced targeted references to the international accounting standard IAS 39, Financial Instruments. Furthermore, the National Bank of Belgium limited the derogations to hedging operations that reduce interest rate risk (within the framework of ALM) and to intra-group hedging operations for interest rate risk entered into as part of a securitization carried out within the framework of liquidity risk management with a vehicle consolidated by the credit institution. In the meantime, the aforementioned IAS 39 has been replaced by the international accounting standard IFRS 9 (Financial Instruments), which, however, offers the possibility to continue applying the provisions of IAS 39 relating to hedge accounting. In this regard, reference should be made to the version of IAS 39 approved by the European Commission for application in Europe (with "carve out").

This draft decree aims to enshrine by regulation the accounting practice developed under the derogations granted by the prudential supervisor and to regulate various technical issues that have emerged in the meantime, particularly in the event of ineffectiveness of the hedging operations concluded in this specific framework. The accounting principles adopted should ensure overall consistency (so that the annual accounts give a true and fair view of the hedging operations processed) and enable institutions to apply hedging strategies driven solely by the economic objective of limiting interest rate risk and not by any accounting arbitrage. Although there are significant differences between the proposed accounting system and the IFRS standards applied for consolidated accounts, the new provisions regarding the treatment of voluntary or involuntary termination cases should limit the differences that can be identified at the level of the income statement with the IFRS standards regarding the treatment of such cases. It is precisely for this reason that, when future cash flows are hedged, these must initially be highly probable to qualify the hedging operation in the accounts (see IAS 39, 88.c), while the accounting treatment specific to hedging instruments can then be maintained as long as these future flows remain probable (see IAS 39, 101.c).

The hedging operations referred to here reflect the ALM management of the institution with regard to its exposure to interest rate risk. Unlike the micro-hedging operations referred to in Article 36bis, § 1, these operations relate to: (a) a homogeneous or non-homogeneous set of hedged items (for example, with regard to maturity or interest rate characteristics); (b) which evolves over time (for example, by including new loans and removing other loans repaid before maturity); (c) and for which the hedging operations also evolve (not necessarily qualified as such in the books from the beginning).

The special nature of these hedging operations led the supervisor to allow an adapted accounting method, which differs from the methods referred to in §§ 2 and 3 of Article 36bis. Thus, the hedging derivatives for these operations are recorded among off-balance sheet rights and obligations at their notional amounts. Consequently, positive and/or negative changes in the market value of these macro-hedging instruments are not recognized in the income statement (as provided for in § 2 of Article 36bis) or in a suspense account (as provided for in § 3 of the same article). The receivables, payables, and interest expenses or income resulting from these hedging instruments continue to be accounted for in accordance with the other provisions of the Royal Decree of 1992 (this concerns in particular accrued interest, option premiums, or margin calls paid by the institution). Thanks to this approach, an accounting treatment symmetrical to that of the hedged instruments can be applied to hedging instruments; in this way, a more accurate accounting picture of the underlying economic reality can be provided. The draft decree submitted to Your signature for approval formalizes this specific accounting practice for the hedging operations described above by including a new provision in Article 36bis.

To ensure that the accounting treatment is consistent with the basic approach described above, it is also necessary to clarify the regime applicable when the hedging proves to be ineffective or when the hedging is terminated voluntarily or involuntarily (for example, in the event of transfer or de-designation of the hedging instruments). The approach proposed in the draft decree consists of, when these events occur, determining the market value of the relevant hedging instruments and (in the event of transfer, if this market value constitutes a hedging result) recognizing this residual value in a suspense account. This suspense account is then recognized in the income statement symmetrically with the hedged items (amortization). In this case, the amortization period in the income statement of the suspense account is the shorter of the remaining originally established maturity of the hedging and the remaining maturity of the hedged items. In this regard, only the remaining effective maturity of the hedged items may be taken into account. This means that institutions must establish monitoring procedures to verify that the hedged assets are effectively on the balance sheet and that the established amortization period in the income statement is consistent with these assets. Furthermore, the hedging instruments remaining on the balance sheet must be prospectively (from the date of termination or the date on which ineffectiveness is determined) accounted for at market value using the method of § 2 of Article 36bis.

To ensure a robust application of the new provisions of Article 36bis, the present draft decree charges the National Bank of Belgium with establishing by circular the manner of application of the principles set out above. The choice of the circular as the instrument to implement these principles is motivated by the concern to be able to update technically quickly to take into account the continuous development of banking practices and international standards.

The implementation and monitoring of hedging operations within the framework of ALM management and their correct accounting representation are particularly complex and require that institutions have robust internal governance, whether regarding decision-making processes, management methodology, control tools, or documentation of operations. These governance requirements formed an important part of the conditions imposed by the National Bank of Belgium for obtaining derogations from Article 36bis. To ensure continuity in this regard and to address the prudential concerns that these operations inevitably raise, the application of the new accounting provisions must be subject to a series of strict conditions and to the prior authorization of the National Bank of Belgium. The National Bank of Belgium will have to indicate in a circular how these conditions must be applied and which procedures must be followed to obtain the aforementioned authorization, which may be withdrawn or suspended if the National Bank of Belgium identifies an infringement within the framework of its prudential supervision.

Given the special nature of the accounting principles applicable to the operations in question, particularly the fact that derivatives are kept off-balance sheet during the hedging period, it is important that additional information be provided to the readers of the annual accounts regarding the policy the institution follows in this regard and regarding latent profits and losses on the hedging instruments used. The draft decree amends several provisions regarding the notes to the annual accounts for this purpose.

It is proposed that the accounting principles established in this draft decree enter into force immediately and be declared applicable to the current financial year. This means that the derogations previously granted by the National Bank of Belgium remain valid for a sufficient period to enable the institutions concerned to obtain the aforementioned authorization (based on a simplified file if the institution already meets all the conditions mentioned in the standard letter of the National Bank of Belgium of 2014). Thus, it is determined that the derogations from Article 36bis granted on an individual basis prior to the entry into force of this decree remain valid until 31 December 2022. The institutions concerned that wish to obtain the authorization of the National Bank of Belgium after that date must submit a file within the period to be established by the National Bank of Belgium.

Article-by-article discussion

Article 1. This article aims to introduce a new § 1bis in Article 36bis of the Royal Decree, dedicated to operations intended for the general and dynamic macro-hedging of interest rate risk and relating to homogeneous or non-homogeneous sets (and by extension hedging operations related to securitization operations) which were previously only permitted if the prudential supervisor had granted an individual derogation. This article also specifies the conditions that these operations must meet to be able to be accounted for according to the same system as the hedged items, which is described in the new § 4 of Article 36bis. Finally, this article aims to adapt §§ 2 and 3 of Article 36bis to take into account the new provisions introduced as mentioned above.

Art. 2. This article requires no comment.

Art. 3. This article amends the provisions regarding the notes to the annual accounts to include the new data that must be communicated by institutions applying the new § 4.

Art. 4. This article relates to the date of entry into force of the Royal Decree and contains the accompanying transitional measures for institutions that have already obtained an individual derogation from the National Bank of Belgium.