Studies

Studies
PDEX: APPROPRIATE FOR IAS/PAS 19 VALUATION Lyndon F. Fadri, FASP, ASA (Last year, a major auditing firm prescribed the use of ZeroCoupon Bond rates published by Bloomberg even if the rates were incredibly high. According to the firm, the reason is that PDEX rates (commonly used by most actuaries) are not appropriate for use because government bonds are couponpaying and therefore, do not conform to the IAS / PAS 19 provision that the rates should be reflective of the timing of cash flows of the retirement obligation, retirement benefits being commonly payable in lump sum.
This has prompted the Actuarial Society of the Philippines (ASP) through its Employee Benefit Committee to submit its position to the Interpretations Committee of the Accounting Standards Council. The author submitted a position paper to the ASP Employee Benefits Committee which has the same substance as this one.)
I am of the position that the reference rates published by the Philippine Dealing Exchange Corporation (PDEX) are appropriate for use as discount rates for IAS / PAS 19 purposes. PDEX rates, used appropriately, can satisfy the IAS / PAS 19 provision that the currency and term of the government bond should be consistent with the currency and estimated term of the postemployment benefit obligations.
It should be noted that the standards prescribed the use of government bond rates where there is no deep corporate bond market. As I see it, it is not acceptable for IAS / PAS 19 to use rates that may not be reliable either because of the thin trading or a derivation of rates because there simply were no available figures for certain terms of maturity.
Yes, I agree that PDEX rates may not exactly be reflective of the timing of cash flows of the retirement obligation. However, following the principle implied in requiring a deep market to qualify as reference for the discount rates, there is no deep market of zerocoupon bonds here in the Philippines, hence we should stick to the PDEX rates.
Granting that the yields of couponpaying bonds are not acceptable, we can only approximate the equivalent yields of zerobonds from the yields of couponpaying bonds. The problem is there are many methods of approximation and there are various assumptions that could be employed. Thus, there are numerous different resulting rates even if the same approximation method is used. Some methods are enumerated below.
One method is setting the zerobond rate equal to the couponpaying bond rate. This method is probably the most acceptable method here in the country, particularly for the bankers. In my interview with some of them, they say that the actual difference in the price of zerobonds and couponpaying bonds depend on liquidity requirements and interest rate outlooks. Changes in these factors can drive zerobond rates either higher or lower than the couponpaying bond rates. On the average though, the zerobond rates should be close to couponpaying bond rates.
Below are actual transactions published by PDEX that tend to support the premise that zerobond yields are not consistently lower than couponpaying bond yields and conversely:
As mentioned above, there are many other valid methods of approximation. To enumerate some:
Below are sample approximated rates using the different methods.
In carrying out these methods, inputs and assumptions have to be made. There are effectively infinite assumptions and input variations, all of which will produce varying results.
In summary, PDEX rates should be accepted as a valid reference rates in setting the discount rate because there is no deep market of zerocoupon bonds. Granting that we really need to use zerocoupon bond rates, equating the zerobond yield with the couponpaying bond yield is a valid method. It is simple and applied without need for complicated calculations and further assumption. It should be noted that IAS / PAS 19 does not prescribe nor disqualify a particular method (again, most probably because discount rates should be based on actual market yields and not from derived or approximated rates).
Actually, given the infinite number of possible approximated zerobond rates, insisting on using derived zerocoupon bond rates defeats the implied objective of accounting standards to enhance uniformity and comparability of financial statements. 