How much latitude will the court give a non-defaulting party under the GMRA and GMSLA?

FRJ
-
0
How much latitude will the court give a non-defaulting party under the GMRA and GMSLA?

 

By Alexandra Doucas

 

A recent case considers service of default notices (the Notices) and valuation of trades under a Global Master Repurchase Agreement (GMRA) and a Global Master Securities Lending Agreement (GMSLA) (toghether, the Agreements). The Agreements in LBI EHF v. Raiffeisen Zentralbank Österreich [2017] EWHC 522 were between LBI (formerly Landsbanki Islands hf) and RZB. RZB were the non-defaulting party. Both Agreements were in their 2000 editions. There were 11 open trades under the Agreements when LBI failed on 7 October 2008. On 8 October 2008, RZB served the Notices.

The judgment considers whether RZB: (i) served the Notices in accordance with the Agreements; and (ii) adopted an acceptable approach to valuation. The judgment supports RZB’s actions as the non-defaulting party on both issues. It should therefore be helpful to parties in similar positions. It would be unwise, however, to assume the court will always come to the aid of parties who do not clearly comply with the GMRA or GMSLA.

Issue one: avoid serving by fax

RZB attempted to serve the Notices by fax. The Agreements provided:

  • fax service was effected when the fax was received by a responsible employee of LBI;
  • the burden of proving this receipt was on RZB; and
  • producing a fax transmission report would not discharge this burden.

The judge was arguably generous to RZB in construing these service provisions. He agreed a “responsible employee” could be an employee tasked with collecting faxes, rather than with responsibility in relation to the transactions. This seems entirely reasonable, although the judge noted that Henderson on Derivatives seemed to suggest a different approach under the 1992 ISDA Master Agreement.

The judge was also prepared to accept on the balance of probabilities that:

  • the relevant RZB employee dialled LBI’s fax number exactly as the Agreements stated it;
  • LBI received the faxes in legible form; and
  • a responsible employee collected these faxes.

He did not accept that the fact LBI had searched for and been unable to find the faxes carried much weight, as he was not persuaded LBI had a reliable system for recording or storing faxes.

The judgment places little express emphasis on RZB’s burden of proving receipt, but arguably does reach a commercially reasonable solution. The judge’s comments on construing the Agreements’ service terms are of general relevance, but parties should be wary of serving by fax. Had LBI shown it had a methodical process for collecting and recording faxes, the decision might have gone against RZB.

Issue two: no need to panic if you cannot serve a default valuation notice in time?

It is tempting to answer “yes”. The Default Valuation Time for the trades was 15 October 2008. However, RZB seems only to have come to a final position on the relevant net value at the close of the trial (although the judgment does not indicate what information RZB had previously given LBI about its valuations).

The judge agreed RZB’s figures were a “rational, honest determination of fair market value as at 15 October 2008”. He referred to previous cases accepting that the question was what value RZB would have ascribed to the trades had it valued them as the Agreements required on 15 October 2008. The parties adduced expert evidence as to how the experts would have valued the trades and the “right method” for doing so. The judge did not find this helpful. As long as RZB acted rationally, it was not confined to any one valuation model.

Crucially, however, RZB was able to present coherent evidence as to how it assessed fair market value. The judgment is not carte blanche to ignore time requirements or adopt irrational or unsupported valuation methodologies.

Statement on the ISDA Credit Derivatives Determinations Committees and CDS auction processes

FRJ
-
0
Statement on the ISDA Credit Derivatives Determinations Committees and CDS auction processes

 

 

 

 

 

 

The International Organization of Securities Commissions (IOSCO) issued on 10 October 2017 this statement about the research of the IOSCO Task Force on OTC Derivatives Regulation (Task Force) regarding the functioning of the ISDA Credit Derivatives Determinations Committee (DC) and credit default swap (CDS) auction processes. IOSCO may perform further work in this area.

Background of the research:

The Task Force’s research was based on a review of publicly available documents (such as the DC rules and auction terms published by ISDA, as well as published auction decisions) and select academic literature. The Task Force also considered confidential survey inputs from buy-side and sell-side market participants in various regions, as well as from ISDA and the Auction Administrators (IHS Markit and Creditex). This research allowed the Task Force to gain an understanding of the functioning and some of the potential limitations of the DC and CDS auction processes. The survey responses represent a range of market participants’ perspectives on the functioning of the DC and CDS auction processes and their views on potential avenues for improvement.

Recent Changes – Conflicts of Interest:

The Task Force notes that the current rule framework governing the DC and CDS auction processes includes provisions aiming to address potential conflicts of interest and guard against potential opportunistic behaviour, which include:

  • the balance between buy-side and sell-side participants in the DC together with the supermajority requirement;
  • the 2016 DC Rules Amendments[1] regarding the management of conflicts of interest;
  • the publication on the ISDA website of the vote of each participant;
  • the publication on the Creditex website of the dealers’ physical settlement requests, initial market submissions, and limit orders; and
  • the financial penalties for outlier submissions to an auction.

Recent Changes – Appointment of DC Secretary:

Another development affecting the DC and CDS auction processes is the recent appointment of ICE Benchmark Administration (IBA) as the DC secretary, which has not yet been finalised though the transition was expected to occur in mid-2017. IOSCO will continue to engage with the relevant participants in the DC and CDS auction processes to monitor on-going changes and their impact.

General Summary of Survey Responses:

The market participants’ survey responses do not suggest that they have identified a need for significant changes with respect to the composition and functioning of the DC or the management of conflicts of interest. However, the participants provided a number of suggestions for improvement that focused on the transparency of the process, including suggestions to increase disclosure of potential conflicts of interest, to create a panel of independent representatives to vote on material DC decisions, to clarify DC rules regarding governance and conduct, and to expand the participation to external observers. Some participants also made suggestions to potentially improve the external review process.

In general, responses to the survey questions regarding the functioning of the DC and CDS auction processes focused on the potential for increased buy-side participation, operational and rule adjustments to improve clarity of the process, and improvements to transparency, such as making internal policies of DC member firms publicly available to market participants to address key governance issues.

Next Steps:

This project was designed to give IOSCO a better understanding of the DC and CDS auction processes. Further work may be warranted to monitor recent changes to the DC and CDS auction processes and to consider any additional matters identified by IOSCO.

[1]    http://www2.isda.org/news/isda-determinations-committees-vote-to-change-dc-rules

Do foreign financial services providers need to register as external companies?

FRJ
-
0
Do foreign financial services providers need to register as external companies?

By Wayne Murray and Lebogang Maimane

The Financial Services Board (FSB) sent a letter dated 6 September 2017 to its registered foreign financial services providers (FSPs) advising them that it had come to the attention of the FSB that certain foreign FSPs conducting financial services related business in South Africa (also referred to as the Republic below in quoted legislation) are not registered as external companies in the country. According to the FSB, this registration is required in terms of s23 of the Companies Act, No 71 of 2008 (Companies Act).

The letter goes on to state that the FSB requires these foreign FSPs to confirm (by no later than 30 September 2017) whether or not they are compliant with s23 of the Companies Act. If not, the foreign FSPs must confirm that they have applied for registration as external companies or to provide reasons why they do not intend to register as external companies and reasons as to why they are of the view that they have complied with all applicable laws.

The Companies Act defines an external company as a “foreign company that is carrying on business, or non-profit activities, as the case may be, within the Republic, subject to s23(2)”. Section 23(2) further explains that:

A foreign company must be regarded as “conducting business, or non-profit activities, as the case may be, within the Republic” if that foreign company:

(a) is a party to one or more employment contracts within the Republic; or

(b) subject to subsection (2A), is engaging in a course of conduct, or has engaged in a course or pattern of activities within the Republic over a period of at least six months, such as would lead a person to reasonably conclude that the company intended to continually engage in business or non-profit activities within the Republic.

The Registrar of the FSB is of the view that:

The rendering of financial services (advice and/or intermediary services) by an FSP that is an external company constitutes or qualifies as “conducting business activities” as contemplated in s23 of the Companies Act. Further, given the indefinite nature of the authorisation granted to the FSP read with s11 of the FAIS Act, it is clear that the FSP intends to continually engage in business within the Republic.

Without commenting on the correctness of the view of the FSB Registrar, we recommend that foreign FSPs rendering financial services in South Africa voluntarily apply to the South African Companies and Intellectual Property Commission (CIPC) to be registered as external companies if they have not already done so.

Key requirements for a foreign company to consider before making the application to the CIPC are its registered address in South Africa and a local representative resident in South Africa. In a 2012 practice note, the CIPC confirmed that an external company’s chosen address should not be one chosen only for its convenience. The registered address must be the address from which the external company conducts its administrative business and can accept service of legal documents and process. That being said, the process for foreign companies to register as external companies in South Africa is not a complex or particularly lengthy one.

It is important to note that in instances of non-compliance with s23, the CIPC may send a compliance notice to a company that has not registered as an external company, calling for it to comply within 20 business days with the provisions of s23. If the company fails to comply within the prescribed period, the CIPC may issue a notice requiring the company to cease carrying on its business of activities within South Africa. Continuation of business activities by a company that has been barred from doing so, may result in such company being prosecuted for an offence or being liable to pay an administrative penalty (not greater than 10% of the company’s annual turnover).

Once foreign FSPs have successfully registered as external companies, they will need to ensure that they continue to comply with all laws affecting companies in South Africa including the Companies Act and the South African common law.

Australian Regulator Consults on Proposed Regulatory Regime Regarding Financial Benchmarks

FRJ
-
0
Australian Regulator Consults on Proposed Regulatory Regime Regarding Financial Benchmarks

 

       By Gary DeWaal

The Australian Securities and Investments Commission sought feedback on potential new rules for administering a financial benchmark regulatory regime. The new regime is based on the IOSCO Principles for Financial Benchmarks issued in July 2013 (click here to access) and is designed to facilitate equivalence assessments under overseas regimes. ASIC will accept comments through August 21.

Interested parties can approach the CIPC to request a Compliance Notice against directors’ breach of Companies Act

FRJ
-
0
Interested parties can approach the CIPC to request a Compliance Notice against directors’ breach of Companies Act

PJ Veldhuizen, CEO of Gillan and Veldhuizen

Many people don’t realise that we have the right and ability as interested parties to approach the Companies and Intellectual Properties Commission (CIPC) if we suspect that a company is being conducted recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose. This right was demonstrated recently in the case of, Dudu Myeni (South African Airways). An interested party, who elected to remain anonymous, approached the CIPC requesting that they investigate and issue a Compliance Notice against Myeni for trading in circumstances that did not align with her fiduciary duties as a director.

PJ Veldhuizen of Gillan and Veldhuizen Incorporated says that it is surprising how many people are unaware of the option made available by the CIPC to request a compliance notice. “Most people avoid any encounter when they feel that a company has been compromised by actions of directors or directorship. What we are not aware of is that we don’t have to approach a court, at a ridiculous cost; the CIPC will investigate and issue a compliance notice as a service.”

According to section 169/170/171 of The Companies Act:

‘Interested parties’ include, but are not necessarily limited to  shareholders, creditors, employees and fellow-directors. Veldhuizen adds that the process is a simple one which can be done anonymously with the appropriate forms downloaded from the CIPC website. For example, “If you are a creditor of a company that you suspect is unable to honour its payments to you, instead of proceeding with lengthy and costly court applications, you have the ability to cause an investigation via the CIPC.”

A compliance notice may require the person to whom it is addressed to:

  • cease, correct or reverse any action in contravention of the Companies Act;
  • take any action required by the Companies Act;
  • restore assets or their value to a company or any other person;
  • provide a community service, in the case of a notice issued by the Commission; or
  • take any other steps reasonably related to the contravention and designed to rectify its effect.

On the other hand, companies or directors who are issued with a compliance notice against them can request that it be reviewed by the Companies Tribunal who will determine whether the CIPC was correct or whether the notice should be amended or scrapped. Once the notice has been issued, the affected party may request a review by The Companies Tribunal, sitting either as a panel of 1 or 3, who will determine whether the CIPC was right or alternatively they can review, amend or scrap the decision.

 

 

SEC Finds Initial Coin Offerings Can be Securities

FRJ
-
0
SEC Finds Initial Coin Offerings Can be Securities

By Stephen M. Quinlivan

The SEC issued an investigative report cautioning market participants that offers and sales of digital assets by “virtual” organizations are subject to the requirements of the federal securities laws. Such offers and sales, conducted by organizations using distributed ledger or blockchain technology, have been referred to, among other things, as “Initial Coin Offerings” or “Token Sales.” Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.

The SEC’s Report of Investigation found that tokens offered and sold by a “virtual” organization known as “The DAO” were securities. The DAO sold tokens representing interests in its enterprise to investors in exchange for payment with virtual currency. Investors could hold these tokens as an investment with certain voting and ownership rights or could sell them on web-based secondary market platforms. Based on the facts and circumstances of this offering, the Commission, as explained in the report, determined that the DAO tokens are securities.

The DAO’s intended purpose was to “To blaze a new path in business for the betterment of its members, existing simultaneously nowhere and everywhere and operating solely with the steadfast iron will of unstoppable code.”

Because the tokens were found to be securities, offers and sales of the tokens were therefore subject to the federal securities laws. The report confirms that:

  • Issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies.
  • Those participating in unregistered offerings also may be liable for violations of the securities laws.
  • Securities exchanges providing for trading in these securities must register unless they are exempt.

The SEC’s report stemmed from an inquiry that the agency’s Enforcement Division launched into whether The DAO and associated entities and individuals violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for “Ether,” a virtual currency. The DAO has been described as a “crowdfunding contract” but it would not have met the requirements of the Regulation Crowdfunding exemption because, among other things, it was not a broker-dealer or a funding portal registered with the SEC and the Financial Industry Regulatory Authority.

In light of the facts and circumstances, the SEC decided not to bring charges in this instance, or make findings of violations in the report, but rather to caution the industry and market participants: the federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology.

The death of share buy-backs?

FRJ
-
0

      By Emil Brincker

Share buy-backs have become very popular over the last few years in circumstances where a taxpayer intended to dispose of his shareholding in a company. This was especially the case to the extent that the seller is also a company. The reason is that, should one consider the definition of a dividend in s1 of the Income Tax Act, No 58 of 1962 (Act), the proceeds from a share buy-back will be deemed to be a dividend to the extent that it is not funded out of so-called share capital or contributed tax capital (CTC). To the extent that the seller is a company, such dividend would also not be subject to dividends tax at the rate of 20% given the fact that a dividend to a resident company is exempt from dividends tax. Instead of thus paying capital gains tax (CGT) at normal company rates of 22,4%, the seller effectively divested itself of the shares in the target company and in the process received an exempt dividend.

Ironically, non-resident shareholders and individual shareholders did not opt for the share buy-back alternative given the fact that:

  • a non-resident shareholder is more often than not, not subject to CGT given the fact that the proceeds will not be taxable in South Africa unless one is dealing with a so-called property rich company;
  • an individual pays CGT at the rate of 18% compared to the 20% dividend withholding tax that would arise had the individual received a dividend; and
  • billions of Rand of transactions have been entered into in this manner on the basis that any conceivable reason was advanced to enter into a share buy-back arrangement as opposed to an outright sale of shares. It must be noted, however, that in both instances securities transfer tax at the rate of 0,25% would be payable.

The legislature acts

In terms of the Draft Taxation Laws Amendment Bill, 2017 (Bill) drastic anti-avoidance measures are introduced. The current anti-avoidance provisions were limited to a scenario where there was a share buy-back linked with a subscription of shares by the purchaser of the target company. In other words, it only applied to very limited circumstances. The new anti-avoidance measures which will apply with reference to disposals on or after 19 July 2017 are aimed to take into account the following:

  • variations to the share buy-back structure pursuant to which sellers avoided income tax or CGT on the outright sale of shares;
  • the limited scope of the current anti-avoidance provisions that only focused on debt funding advanced or guaranteed by a prospective purchaser or a connected person in relation to the prospective purchaser to fund the share buy-back; and
  • the limited scope of the dividend stripping rules in the sense that they only applied to a scenario where a seller held more than 50% of the shares in the target company.

The proposal

The proposal contained in the Bill is aimed at a scenario where the shares are both held as trading stock as well as on capital account. Essentially the proposal is that dividends that are received within 18 months of the disposal, must be added to the proceeds and thus are subject to CGT or income tax, as the case may be. The dividends are thus not exempt from tax. However, at least there will not be an additional dividends tax that will apply.

The following circumstances must exist before the anti-avoidance rules will apply:

  • the seller must be a resident company. In other words, if one is dealing with a non-resident shareholder, the aim is that it will receive a dividend which is subject to dividends tax at the rate of 20% or such other rate as may be applicable in terms of the relevant treaty. If one had extended the anti-avoidance rules to a non-resident shareholder, it would effectively have meant that the non-resident shareholder would not pay any tax given the fact that it is not liable to tax on the proceeds of the sale of shares in a company unless the company is a property rich company;
  • the seller (together with connected persons in relation to the seller) must hold at least 50% of the equity shares or voting rights in the target company or at least 20% of the equity shares or voting rights in the target company if no other person holds the majority of the equity shares or voting rights. In other words, the scope is now much wider as the anti-avoidance rules could also be applicable if one holds 20% of the shares in the target company and nobody holds the majority of the equity shares (ie more than 50%);
  •  a dividend is received or accrues within 18 months prior to the disposal of the shares in the target company or is received or accrues, regardless of the time of the receipt or accrual, by reason of or in consequence of the disposal of the target company shares. In other words, even if one receives a dividend subsequently and it is linked to the overall disposal, the dividend will still be added to proceeds.

It is important to appreciate that there is no longer a focus on the way in which the dividend is funded or whether there is also a subscription for shares. The only test now is whether one has received an exempt dividend within an 18-month period, in which event the dividend will be added to proceeds.

Given the fact that the amendment applies with effect from 19 July 2017, agreements that may have been entered into prior to this date but have not become unconditional, will also be covered by the anti-avoidance provisions. The reason is that a disposal is understood to be an agreement which is unconditional or an agreement the suspensive conditions of which have been fulfilled. Taxpayers will thus have to consider their agreements urgently so as not to fall foul of the proposals.

It should be appreciated that comments are still awaited in respect of the proposals. National Treasury can expect to be flooded with comments on this provision, even though taxpayers have been warned about this potential abuse for a number of years.

It should be appreciated that, even in its current format, the proposal has limited application. The reason is that, to the extent that one is dealing with a minority shareholder, a buy-back can still be implemented. It is only if one holds more than 50% of the shares in the target company or more than 20% if no other person holds the majority of the equity shares, that the proposal will become applicable.

The perils of introducing tax “legislation by press release”

FRJ
-
0
The perils of introducing tax “legislation by press release”

 

Arnaaz Camay, Senior Executive: Tax, Baker McKenzie Johannesburg

 

Earlier this year, the South African Minister of Finance announced in the Budget Speech that the dividends tax rate would be increased from 15% to 20% with effect from the date of the announcement thereof on 22 February 2017. More recently, in the 2017 draft Taxation Laws Amendment Bill (TLAB) published by National Treasury, new tax proposals related inter alia to share subscription and repurchase transactions were announced to come into effect on the date of publication of the TLAB on 19 July 2017. The practice of effecting de facto legal amendments announced by press release, draft legislation or regulations immediately upon the announcement or the publication date thereof, notwithstanding that such amendments are not yet formally promulgated, is censoriously referred to as “legislation by press release”.

The rationale advanced by National Treasury for this practice in the TLAB and the general premise upon which such practice is based is usually to eliminate an “unintended benefit” or “loophole” and to prevent a so-called “announcement effect” whereby taxpayers take preventative action as soon as they become aware of future changes in legislation. In other circumstances, the justification for this practice may be to correct “technical errors” in legislation or to “clarify” existing legislation to reflect the original intent.

The introduction of “legislation by press release” appears to be a growing practice of National Treasury, and whilst the legal powers of Parliament extend to giving effect to retrospective tax legislation proposals, as confirmed in the recent Pienaar Brothers case (Pienaar Brothers (Pty) Ltd v Commissioner for the South African Revenue Service and Another), the practice does not fulfil the fundamental tax principle of “certainty”. The guiding principles of good tax policy issued by the American Institute of Certified Public Accountants in 2001, articulates this principle well:

“certainty is important to the US tax system because it helps to improve compliance with the rules and to increase respect for the system. Certainty generally comes from care statutes as well as from timely and understandable administrative guidance that is readily available to taxpayers”

“The tax system should not impede or reduce the productive capacity of the economy. The tax system should neither discourage nor hinder national economic goals, such as economic growth, capital formation, international competitiveness. The principle of economic growth and efficiency is achieved by a tax system that is aligned with the economic principles and goals of the jurisdiction imping the tax”

Introducing “legislation by press release” places taxpayers in an impossible position as they expected to proceed on the basis that these changes will become law, effective as of the announcement date, yet taxpayers do not know if they can rely, with certainty, on the introduction of the proposed amendments nor do they know what final form such amendments will take, as generally, the draft legislation undergoes various changes before being finally promulgated by Parliament.

The major uncertainty created by this increasing prevalent practice by National Treasury, may however, be a significant deterrent for doing business in the country, as was found in the case concerning Vodafone’s acquisition of Hutchinson Telecom operations in India(Vodafone International Holdings B.V. v Union of India and Another). In this case, retrospective amendments made to the Finance Act were described as “clarificatory” by the Indian revenue authorities, seemingly for the removal of doubt but this action resulted in major controversy with substantial repercussions for the country. A Government Expert Committee set up to examine the controversy noted:

“retrospective application of tax law should occur in exceptional or rarest of rare cases, and with particular objectives: first, to correct apparent mistakes/anomalies in the statutes; second, to apply to matters that are genuinely clarificatory in nature, i.e. to remove technical defects, particularly in procedure, which have vitiated the substantive law; or, third, to “protect” the tax base from highly abusive tax planning schemes that have the main purpose of avoiding tax, without economic substance, but not to “expand” the tax base”

Furthermore, in 2013, the World Bank downgraded India in the index of investment friendliness from 131 in 2011 to 134, falling below countries like Uganda, Ethiopia and Yemen, whilst its neighbours like Sri Lanka fared much better. Another government committee, established to examine this decline, notably made the following comment on the issue of retrospective taxation:

“retrospective taxation has the undesirable effect of creating major uncertainties in the business environments and constituting a significant disincentive for persons wishing to do business in India. While the legal powers of a Government extend to giving retrospective effect to taxation proposals, it might not pass the test of certainty and continuity. This is a major area where improvements should be attempted sooner rather than later…”

The experience in India, clearly demonstrates the wide-reaching risks of introducing retrospective tax legislation for developing economies who are dependent on maintaining investor confidence. Being in a similar position, National Treasury should be mindful that this practice does not become so predominant so as to affect investor confidence but instead should assist Government by providing for certainty in its future tax policies to assist in attracting investors and developing national economic goals.

Australia stepping closer to open banking

FRJ
-
0

By Jim Bulling and Michelle Chasser

 

 

The Australian Treasury has announced an independent review into open banking in Australia. Open banking will require banks to share product and customer data with customers and third parties with the consent of the customer. The Government previously announced that the open banking regime would be introduced in 2018 to help customers seek more suitable products and increase competition.

The review will make recommendations on the most appropriate data sharing model, and regulatory and implementation frameworks as well as include an examination of:

  • the scope of data sets to be shared;
  • parties who will be required to share, and be provided with, the data sets;
  • data transfer mechanisms;
  • issues and risks such as customer usability and trust, security of data, liability, privacy safeguard requirements and enforcement of customer rights;
  • costs of implementation.

The review is also required to have regard to the Productivity Commission’s final report on Data Availability and Use which was published in May 2017 to which the Government is yet to respond. The report recommended creating a new Data Sharing and Release Act which:

  • gives individuals and SMEs a new comprehensive right to:
    • view, request edits or corrections, and be advised of the trade to third parties of consumer data held on them similar to current rights under the Privacy Act; and
    • have a machine-readable copy of their consumer data provided either to them or directly to a nominated third party;
  • implements a structure for data sharing and release that would allow access arrangements to be dialled up or down according to the different risks associated with different types of data and uses.

Other jurisdictions such as the UK and the EU have already introduced open banking regulations which will come into effect from January 2018.

 

A lawyer talks accounting: International Financial Reporting Standards (IFRS) 17 insurance contracts

FRJ
-
0
A lawyer talks accounting: International Financial Reporting Standards (IFRS) 17 insurance contracts

By Charl Williams, Director at CDH and Denise Durand, Associate at CDH

The global set of accounting standards known as International Financial Reporting Standards (IFRS) is broadly used and supported in multiple jurisdictions by various organisations such as the International Monetary Fund, the World Bank and the JSE Limited to mention but a few. Section 29(5)(b) of the Companies Act, No 71 of 2008 (Act) specifically prescribes that public companies must adopt IFRS, which places all insurance companies within the ambit of this section.

This is due to the fact that insurance companies are either registered public companies or are considered to be public companies under the provisions of the Short-term Insurance Act, No 53 of 1998 and the Long-term Insurance Act, No 52 of 1998 and are required to comply with financial reporting standards applicable to public companies. Furthermore, Regulation 27 published under the Act provides financial reporting frameworks for different companies. Most companies are required to adhere to IFRS. The ultimate purpose of financial reporting is to provide the most accurate financial position of an entity and its state of affairs.

The International Accounting Standards Board (IASB) recently published the latest standard for the insurance industry, IFRS 17 Insurance Contracts (IFRS 17) which will be effective for financial years starting on 1 January 2021. An insurance contract is defined in the standard as:

A contract under which one party (the issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.

Since insurance contracts are reliant on numerous assumptions and contingencies, profit and loss is difficult to quantify for many insurers. In addition, some insurance contracts regularly pay out savings to policyholders regardless of whether the insured event occurs. These factors pose challenges for measuring insurance contracts for accounting purposes and reporting on their financial performance.

At the core of financial reporting is the ability for information to be comparable across various entities and jurisdictions in order to attract investors and assess risk exposure and profitability. The purpose of IFRS17 is to standardise insurance company reporting frameworks across the globe and increase their consistency, comparability and transparency. In contrast, the previous insurance standard IFRS 4, relied on a myriad of national accounting standards. IFRS 4 also fell short in that it did not reflect a complete view of an entity’s underlying financial position. Consequently, IFRS 4 did not effectively mitigate the potential investors’ risk of obtaining a fair and true view of the company’s financial position and skewed decision making as the analysis of company financials became quite complex and varied.

Some notable changes introduced by IFRS 17:

  • the standard creates a consistent accounting framework for insurance contracts within the same group and between other insurance companies;
  • companies will be required to provide information about current and future profitability arising from insurance contracts as well as estimates used to measure insurance contracts; and
  • the value of insurance contracts will be measured at current value and to reflect estimated future payments to settle incurred claims on a discounted basis. Furthermore, entities will be required to calculate and disclose an explicit risk margin or adjustment in the measurement of insurance contracts.

The introduction of a new standard always brings a risk of non-compliance. When the standard comes into force, failure to comply with these standards inter alia may also result in companies being in breach of their contractual obligations. The responsibility of compliance cannot be fully delegated to the auditors of the company since Principle 5 of the King IV Code on Corporate Governance places a responsibility on boards of directors to set the approach and direction of reporting:

The governing body should ensure that reports issued by the organisation enable stakeholders to make informed assessments of the organisation’s performance, and its short, medium and long-term prospects.

To mitigate the risks of non-compliance, companies should take the ensuing changes seriously by considering the possible interplay regarding other relevant accounting standards and performing in-depth financial and business impact assessments. Taking such steps may ensure that the full impact of compliance is understood and that processes are put in place to meet the implementation deadline.

1...697071...74Page 70 of 74