Global Banking: Paradigm Shift IAS 39 (Opportunities & Challenges)

1. Global Banking: Paradigm ShiftIAS 39 (Opportunities & Challenges) Sanjeev Agrawal CFO, India & South Asia Standard Chartered Bank

2. Contents • IAS 39: Financial Instruments: Recognition & Measurement • Introduction to IAS/IFRS • Herald of a new era • Business Implications • Challenges • Summary

3. IAS/IFRS* : Major force in world accounting • Single set of high quality, global accounting standards • To increase transparency in financial reporting What is IAS ? • To enhance comparability of financial information • For local banks with global aspirations, exchange listing • More effective/consistent quality of compliance & audit Why IAS ? • Sole responsibility rests with IASB • Pronouncement aims to be country neutral Who develops IAS ? • Standards issued after Apr’01 designated as IFRS • Now Mandatory for “European Union” listed companies .. And since when ? * International Accounting Standards Board (IASB) International Financial Reporting Standards (IFRS)

4. Understanding IAS 39 - Herald of a new era Financial Instruments: Recognition & Measurement • Objective: Set accounting principles for recognition, measurement of financial assets/liabilities, rules (i.e. instruments/policies) for hedge accounting • First introduced in 2000 since undergone decisive changes • Latest promulgation of IASB. Also most deliberated, due to implications • Effective from Jan 1, 2005 • Intention to bring international GAAP similar to US GAAP • New concepts having far reaching implications on financial reporting • Broadly divided into following categories: Classification of assets/ liabilities De-recognition, securitization, factoring, etc Measurement principles, i.e. cost or fair value rule Derivative and hedge accounting Income recognition, effective interest, impairment

5. Understanding IAS 39 – through the maze..Financial Instruments: Recognition & Measurement On Balance Sheet Items: Off Balance sheet Items: Loans & receivables Derivatives (FX, FW, SWAP, OP) Consolidated Statement Debt / Equity instruments Commodity futures SCOPE & COVERAGE Cash & equivalents Financial Guarantee Debt / loan payables Loan commitment Exclusions (covered by other standards): Inventory Fixed Assets Disclosure Acctg. for own debt / equity

6. (..cont’d) Understanding IAS 39 Financial Instruments: Recognition & Measurement • An attempt to move international GAAP to relevant US GAAP • New classification categories: • Applicable for accounting periods beginning from Jan 1, 2005

7. Business ImplicationsFinancial Instruments: Recognition & Measurement • Strategic • Selection of “Fair Value” or “AFS”  Income or Equity volatility • Choice of “HTM” can throw up “liquidity management” issues • Tainting rules. Restricted usage of this category for 2 yrs Classification related • Products • Higher Impairment loss charge  Discounted future receivable • Acquisition Cost (DAC) and Yield Fees (YEF)  capitalized using Effective Interest method: Income Recognition • New (and logical) way of profitability analysis • Re-alignment of product features, fees, interest rate & cost • Systems requirements for transaction accounting * Direct Acquisition cost (DAC) Yield Enhancing Fees (YEF)

8. (..cont’d) Business ImplicationsFinancial Instruments: Recognition & Measurement • Conceptual rules • Derivatives to be stated in balance sheet at fair value • Satisfy hedge conditions & classification • Documentation of hedging relationships • Hedge effectiveness testing & documentation (80-125 rule) Derivatives & Hedge Accounting • Criterion & consequences • Transfer of control is not enough • Risk and rewards need to be transferred • Consequences : • On de-recognition, difference taken as “income” • On failed de-recognition, taken as collateralised borrowing * Financial asset de-recognition * Securitized portfolio will most likely stay in balance sheet as collateralised borrowing

9. Key changes in IAS 39IAS 39 vis-à-vis UK GAAP - Differentials A. Income related :

10. (.. cont’d) Key changes in IAS 39IAS 39 vis-à-vis UK GAAP - Differentials B. Classification related :

11. Challenges: Business & Regulatory Financial Instruments: Recognition & Measurement • Impact on strategy, policies, shareholder message; P/L volatility • Impact on products, clients and performance measurement • Communicating change without unsettling investors, regulators or rating agencies Business leadership • Maintain control as processes change (e.g. hedging , impairment) • Product valuation. Assets not previously revalued, will now do so • Hedging effectiveness: difficult to achieve and operationally manage Ops/product control • Regulatory capital – possible volatility due to greater use of ‘fair value’ • Impact on Credit risk processes and Basel II Risk & capital management

12. (..cont’d) Challenges: ImplementationFinancial Instruments: Recognition & Measurement • Vast scope and coverage • Educating users of financial statements, impact of policy changes • Changes to HO tax rules + local changes as countries move to IAS Finance/tax • Systems capacity/scale of change in multiple locations • Procedure and system for new hedge accounting rules • Impact on downstream users Technology • Information supporting remuneration policies • For many staff training, knowledge transfer will be essential • Possible manual workaround solutions in initial stages Human Resources

13. In Summary... What does IAS 39 mean to business Financial Operational • Change in revenue/cost recognition • Changes to Net Debt charge • Variance in customer Assets/Liability • New reconciliation process • Improved product programs • System changes Strategic • New business opportunities • Product strategy • Profitability models