No. 206: Accounting for Equity Instruments: Does IFRS 9 Deter Gains-Trading or Long-Term Investments?

IFRS 9 significantly changed the accounting for equity instruments measured at fair value through other comprehensive income (OCI), most notably by eliminating the recycling of unrealized fair value gains and losses into net income upon realization. Under the new rules, banks must either recognize all fair value changes in the profit and loss (P&L) statement or exclude them entirely. The reform sparked political controversy grounded in the academic debate about the impact of accounting standards on real investments by firms. While standard-setters aimed to curtail incentives for gains trading and opportunistic earnings management, critics argued that the lack of recycling would discourage long-term equity holdings, harming sustainable investment. Using global data on IFRS 9 adoption by banks, this study examines whether and how the rules for gains realization impact banks’ equity investments. We present three main findings. First, banks’ equity investments did decline overall, particularly those previously classified as fair value through OCI. Second, the decline was most pronounced among banks with a record of gains trading and earnings management, and for instruments most suited to these practices. Third, banks’ long-term equity investments shrank barely, if at all. Overall, our findings suggest that rules on the realization of unrealized gains matter for banks’ investment decisions. However, the investment change is attributable to equity securities that were primarily used for gains trading and not held for strategic long-term objectives. This latter purported outcome rather served as a convenient political excuse to oppose accounting rules that constrain opportunistic earnings management.