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IFRS 9 - Implementation challenges
Transcript of IFRS 9 - Implementation challenges
Page 3
Introduction to IFRS 9 (1)
What do you need to know about IFRS 9 in relation to the classification and measurement
► The objective of the IFRS 9 is to set out the requirements for recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items.
► Financial assets are measured at amortized cost, FVPL or FVOCI.
► The new FVOCI measurement category has different treatment for debt and equity instruments. In case of equity securities, unlike debt instruments, gains and losses in OCI are not recycled upon sale and there is no impairment accounting.
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Introduction to IFRS 9 (2)
What do you need to know about IFRS 9 in relation to the classification and measurement
► The classification of debt assets depends on two principle-based assessments:
► the entity’s business model for managing the financial asset, and
► the financial asset’s contractual cash flow characteristics.
► Apart from the ‘own credit risk’ requirements, classification and measurement of financial liabilities is unchanged from existing requirements of IAS 39.
► The rules for embedded derivatives treatment for financial assets are changed as are the rules for reclassifications, while derecognition rules remain widely unchanged.
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Introduction to IFRS 9 (3)
What do you need to know about IFRS 9 in relation to impairment
► The impairment requirements in IFRS 9 are based on an expected credit loss model
► The expected credit loss model applies to all debt assets recorded at amortized costs or at fair value through other comprehensive income
► Entities are required to recognize either 12-month or lifetime expected credit losses
► The measurement of expected credit losses should reflect a probability-weighted outcome, the time value of money and reasonable and supportable information that is available without undue cost or effort
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Classification of financial assets IAS 39 Reminder
Category Main use
Fair value through profit or loss
All derivatives (outside designated hedges)
Other items intended to be actively traded
Any item designated as such (at inception) that meets certain criteria
Held-to-maturity Debt assets with determinable payments and fixed maturity date acquired to be held to maturity
Loans and receivables
Conventional loan assets that are not quoted in an active market (originated or acquired), trade receivables
Available-for-sale
All financial assets not fitting into the definition of any of the above
May also designate as AFS
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Financial instruments at FV through P&L IAS 39 Reminder
► A financial asset (or financial liability) at fair value through profit or loss is one that is either: ► Held for trading (by definition) Or ► Designated at initial recognition (so-called ‘fair value option’)
► A financial instrument shall be classified as held for trading if it is: ► Acquired or incurred principally for the purpose of selling or
repurchasing it in the near term ► Part of a portfolio of identified financial instruments that are
managed together and for which there is evidence of a recent actual pattern of short-term profit-taking
Or ► A derivative (except for designated and effective hedging
instruments)
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IFRS 9 classification and measurement model
IFRS 9 defines 3 categories:
► Amortised cost: if the contractual cash flows characteristics represent solely payments of principal and interest AND the asset or portfolio has a ‘held to collect’ business model
E.g. Plain vanilla debt securities including hybrid contracts
► Fair value through other comprehensive income: for assets that: - Pass the ‘contractual cash flow characteristics’ test; and - Are managed in a ‘hold and sell’ business model Debt instruments including loans (some AFS in IAS 39)
► Fair value through profit or loss: residual category
E.g. Derivatives, equity, structured instruments, contractually linked instruments
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The proposed revised classification and measurement model of financial assets
Debt (including hybrid contracts)
“Characteristics” test (at instrument level)
“Business model” test (at an aggregated level)
Conditional FVO elected?
Fail
Pass
No
Amortised cost
FVTPL FVOCI
(with recycling)
Hold to collect contractual cash flows
Neither (1)
nor (2)
Both (a) to hold to collect contractual cash flows; and (b) to sell
1 3 2
No
Yes
Derivatives Equity
Held for trading?
FVOCI option elected ?
Yes
No
No
Yes
FVOCI
(no recycling)
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“Business model” test: hold to collect
► Hold assets to collect contractual cash flows
► Consider sales frequency, value, timing and reason and expectation about future (judgment)
► Matter of fact and not an assertion. Refer to actual portfolio management. Evidence includes:
► How is performance evaluated
► How are risks managed
► How are managers compensated
► Not the same as held to maturity, can meet the test if sales do occur or are expected to occur due to:
► Increase in credit risk
► Manage credit concentration risk
► Infrequent and significant in value
► Frequent and insignificant in value
► Irrespective if imposed by a third party or entity’s discretion
► Close to maturity and proceeds close to contractual cash flows
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“Business model” test: hold to collect
► The entity does not hold its receivables to collect cash
flows, it actually sells them. Consequently the business
model is not “hold to collet”.
► The entity should classify such receivables as fair value
thought profit or loss.
An entity has a past practice of factoring its receivables, such that the significant risks and rewards are transferred from the entity, resulting in the original receivables being derecognised from the statement of financial position. Is the business model “hold to collect”? How should the receivables be classified?
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“Business model” test: hold to collect
► The entity’s business model might still be “hold to collet”
as the receivables are not derecognised.
► Classification depends on the “Contractual characteristics”
test – will most probably be passed.
Same scenario as in previous example but this time the significant risks and rewards of the receivables are not transferred from the entity, and the receivables do not qualify for derecognition. Is the business model “hold to collect”? How should the receivables be classified?
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“Business model” test: both to collect and sell
► Hold assets both to collect cash flows and to sell
► For example:
► Manage everyday liquidity needs
► Involves greater frequency and value of sales (as compared to ‘hold to collect’), however no threshold
► The same as ‘Not held for trading’?
► Implementation considerations:
► Change in business model?
► Business model on first time application
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FVOCI category – debt investments
► Fair Value through Other Comprehensive Income measurement will apply to a portfolio where the entity’s primary objective is both:
► (1) To hold to collect contractual cash flows, and
► (2) To sell financial assets
► As compared to AfS in IAS 39:
► Only financial assets with contractual cash flows that are solely principal and interest would qualify for FVOCI
► Not a free choice nor a residual category
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FVOCI category – ED Example
► A non-financial entity anticipates a capital expenditure in a few years.
► The entity invests its excess cash in financial assets in order to fund the expenditure when the need arises.
► The entity’s objective for managing the financial assets is to maximise the return on those financial assets.
► Accordingly, the entity will sell financial assets and re-invest the cash in financial assets with a higher yield when an opportunity arises.
► The managers responsible for the portfolio are remunerated based on the return generated by the financial assets.
Page 17
FVOCI mechanics – debt investments treatment
► Interest income will be recognised using the EIR method
► Impairment losses / reversals will be recognised in profit or loss in a similar manner as for assets measured at amortised cost
► Net cumulative fair value gains or losses (except for impairment and foreign currency) are recognised in other comprehensive income
► then recycled to profit or loss only upon derecognition (parallel AfS in IAS 39)
Page 19
Impairment under IAS 39 Reminder
► Impairment losses are required to be recognised in profit
or loss if there is objective evidence that a ‘loss event’
has occurred, and that loss event has an impact on the
estimated future cash flows of the financial asset or group
of financial assets that can be reliably estimated.
► Includes observable data
► Excludes losses expected on future events
► An entity shall assess, at the end of each reporting period,
whether there is any objective evidence that a financial
asset or group of financial assets is impaired.
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► Examples of loss events:
► significant financial difficulty of issuer
► a breach of contract such as failure to make interest/principal
payments
► high probability of bankruptcy or other financial reorganization
► for economic or legal reasons relating to borrower’s financial
difficulty, lender grants concessions that the lender would not
otherwise consider
► historical pattern or observable data indicating a measurable
decrease in estimated cash flows from a group of financial
assets since initial recognition, although decrease cannot be
identified with individual assets
IAS 39 requirements for loans and receivables
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Main consequences of the IAS 39 model
► Overstatement of interest revenue before trigger event;
► Loss recognition too late;
► Pro-cyclical effect;
► Does not reflect the underlying economic substance of
transactions.
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From IAS 39 to IFRS 9 Impairment
Good book
(no impairment)
IAS 39
Method A
Impaired
Specific allowances
Lifetime EL
Impaired
Specific allowances
Lifetime EL
IFRS 9
Receivables
Stage 1
Method B
IBNR
provisions
‘Emergence
Period’ length
expected loss
No change
expected
Expected
increase of
impairments
Receivables
12M EL Impairment allowance
Exposures without significant
deterioration since initial
recognition
Lifetime EL Impairment
allowance
Exposures with significant
deterioration since initial
recognition
Significant
deterioration ► Key
methodological
analysis
► Choice of
indicator
► Calibration
Example based on common impairment approaches under IAS 39:
After
Good Book
IBNR
provisions
‘Emergence
Period’ length
expected loss Stage 2
Stage 3
Before
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IFRS 9 Impairment model General approach
Change in credit risk since initial recognition Improvement Deterioration
Loss
allowance (updated
at each
reporting date)
Lifetime
expected
credit losses
criterion
12-month
expected
credit losses
Lifetime
expected
credit losses
Lifetime
expected
credit losses
Credit risk has increased significantly since initial
recognition (individual or collective basis)
Stage 1 Stage 2 Stage 3
Start here
(with exceptions)
Credit-impaired
Similar to IBNR
under IAS39,
however impact
from lengthening
of “emergence
period”
Similar to incurred loss
under IAS39
Includes projections
Scope extract: Loans and receivables, FVOCI
Calculation
approach
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Overview of approach for assessing significant deterioration in credit risk
Assessment on a
collective basis
30 days past due
(DPD) ‘backstop’
Set transfer
threshold by
determining
maximum
initial credit risk
‘Low’ credit risk
– equivalent to
‘investment
grade’
Use change in 12-
month risk as
approximation for
change in lifetime
risk
Assessing
significant
increases
in credit
risk
Assessment at
counterparty
level
► No specific or mechanistic approach is
imposed by the standard
► The appropriate approach will vary
depending on the level of sophistication of
entities, the financial instruments and the
availability of data
► Transfer to Stage 2 when “significant increase in credit risk of financial instrument since initial recognition”
Based on reasonable and supportable
information at the reporting date about:
► Past events
► Current conditions
► Forecasts of future economic conditions
Indicators of deterioration in risk of default General approach – simplifications and
presumptions for assessing deterioration
A B
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Significant deterioration Use of delinquency & 30 Days Past Due presumption
► If reasonable and supportable forward looking
information is available without undue cost or effort, an
entity cannot rely solely on past due information ► Days past dues are lagging indicators
► More leading indicators must be used (e.g.: macroeconomic, industry etc.)
► There is a rebuttable presumption that the credit risk
has increased significantly since initial recognition
when contractual payments are more than 30 days
past due ► It is presumed to be the latest point at which lifetime expected credit losses
should be recognised even when using forward-looking information
► An entity can rebut this presumption but in practice it will be difficult
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Simplifications to the general model
IFRS 15 contract assets or
trade receivables with no
significant financing component
(including contracts ≤ 1 year)
IFRS 15 contract assets or
trade receivables with a
significant financing component
Lease receivables
Other financial assets
measured at amortised cost
Other financial assets
measured at FVOCI
Specific approach
• initially measured using credit-
adjusted Effective Interest Rate
• loss allowance recognised at
change in lifetime EL
Simplified approach
• initial and subsequent
loss allowance at lifetime
expected credit losses
General 3-stage model
• initial loss allowance at 12M
expected credit losses
• lifetime expected credit
losses recognised when
credit risk deteriorates
significantly (and is not low)
Purchased or originated credit-
impaired financial assets
Ac
co
un
tin
g P
oli
cy
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Application roadmap
No
Recognise lifetime expected credit losses
Yes
Is the asset purchased or originated credit-impaired?
Is the simplified approach applicable?
Does the instrument have low credit risk?
Has there been a significant increase in credit risk?
No
No
Yes
Calculate credit-adjusted effective interest rate and
recognise a loss allowance for changes in lifetime expected
credit losses
Is the low credit risk simplification applied?
Recognise 12-month expected credit losses
Yes
Yes
No
Yes No
Is the instrument credit impaired?
Calculate interest on gross carrying amount
Calculate interest on net carrying amount
And
Yes
No
And
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Measurement of ECL – Key Features
► Measurement of Expected Credit Loss (ECL) must reflect
► Unbiased and probability-weighted amount that is determined by
evaluating a range of possible outcomes,
► the time value of money,
► reasonable and supportable information, that is available without
undue cost or effort at the reporting date, about past events, current
conditions and forecasts of future economic conditions
► It must be directionally consistent with changes in related
observable data from period to period (such as changes in
unemployment rates, property prices, commodity prices, payment
status etc.).
► ECL is the probability-weighted estimate of the present
value of all cash shortfalls over the expected life of the
instrument
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Expected credit losses for trade receivables
► Results in a day-1 loss ► However initial recognition of financial assets remains at fair value
► Impact limited when trade receivables are short term
► Practically for trade receivables without a financing
component (i.e.: maturities of less than 12 months – refer
to IFRS 15) the lifetime expected credit loss is equivalent
to the 12 months expected credit loss
► Discounting generally not required, however closely
analyse restructuring operations.
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Practical expedients – Provision matrix
► A manufacturer has a portfolio of trade receivables of RON30
million in 20X1. It operates only in Romania.
► The customer base consists of a large number of small
clients and the trade receivables are categorised by common
risk characteristics that are representative of the customers’
abilities to pay all amounts due in accordance with the
contractual terms.
► The trade receivables do not have a significant financing
component in accordance with IFRS 15 Revenue from
Contracts with Customers.
► In accordance with IFRS 9 the loss allowance for such trade
receivables is always measured at an amount equal to lifetime
time expected credit losses.
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Practical expedients – Provision matrix
► To determine the expected credit losses for the portfolio, the
entity uses a provision matrix.
► The provision matrix is based on its historical observed
default rates over the expected life of the trade receivables
and is adjusted for forward-looking estimates.
► At every reporting date the historical observed default rates are
updated and changes in the forward-looking estimates are
analysed.
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Considerations for using provision matrix
► An entity that applies provision matrixes should consider:
► Segmentation of trade receivable portfolio, e.g.:
► Corporate vs. Individual
► Large entities vs. Medium and Small entities
► Recurring client vs. New clients
► Geography
► Length of historical loss experience considered,
► Adjustment of historical loss experience to incorporate
current and forward looking conditions, e.g.:
► Unemployment rates,
► Industry trends,
► GDP.
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Significant impact expected
► Expected increase in total provisions (e.g.: 19% to 49% increase for UK
banks)
► The impact on individual receivables portfolios can vary significantly
depending also on the type of portfolio and magnitude of currently
impaired receivables
Direct impact on provision levels
Risk of inducing significant
volatility in provision levels
► The new IFRS 9 can increase volatility in impairment figures which is
then translated to volatility in income statement and equity
► Generally the sources of this volatility can be the application of forward
looking models with the use of macro-economic forecasts and the nature
of the indicators used to determine transfer to Lifetime Expected Loss
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Hedge accounting and the project on dynamic risk management: the status quo
Status quo is preserved in transition requirements intended life: until
the project on accounting for dynamic risk management is finished
Accounting policy choice
IFRS 9 hedge accounting
model
‘IFRS 9
macro CFH’
‘Macro
FVH’
IAS 39 hedge accounting
model
‘Macro
FVH’
‘IAS 39
macro CFH’
Default
outcome
Retention of IAS 39
for hedge accounting
Scope exception
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