IFRS 9 The Road to Success - PARKER...

UK Financial Services Practice

IFRS 9 – The Road to Success 2014

1

Strictly Confidential

Contents

| IFRS 9 – The Road to Success

01 IFRS 9 and the Regulatory Journey 2

02 More than an Accounting Programme 3

03 Where are the Major Challenges? 4

04 Guiding You to Success 7

05 Why Parker Fitzgerald 9

06 IFRS 9 Advisory and Delivery Team 10

A1 Impairment Methodology of IFRS 9 11

A2 Office Locations and Contact Details 12

2


IFRS 9 and the Regulatory Journey

In July 2009, the International Accounting Standards Board

(IASB) made a move to simplify the accounting rules for

recognising and measuring financial instruments.

It wanted to reduce complexity, harmonise with US GAAP

and respond to the needs of the industry…

The step was part of efforts to address issues that arose

during the financial crisis, such as loan-loss provisioning.

The IASB decided to replace the International Accounting

Standard (IAS) 39 with the International Financial Reporting

Standard (IFRS) 9.

The final standard was published in July 2014 with an

effective date of 1 January 2018. However, it is likely that the

market will expect a certain level of disclosure of impairment

on an expected loss basis prior to the effective date.

Most banks and other financial institutions estimate they will

need three years to implement the standard, due to the

significant impact that IFRS 9 will have on existing business

processes, technology systems and infrastructure.

“The planning work has established that for

banks the complexity and cost of the IFRS

9 implementation is likely to be second only

to the Basel II implementation, and broadly

equivalent to the entire first time adoption of

IFRSs in 2005”.

“There are many reasons for this [3 year

implementation] period including the size

and complexity of the necessary changes to

systems and processes, the volume of data

required by the model, the limited pool of

skilled resources required for the

implementation available in the market, the

need for guidance to develop on the

interaction with regulatory capital

requirements and the need to inform market

expectations of the accounting, regulatory

capital and business impacts in advance of

the final standard coming into force”.

Parker Fitzgerald helps Financial

Institutions transition to the new standard

with advisors who possess in-depth

knowledge of the strategic and

operational challenges arising from

IFRS 9.

Our teams have years of experience

transforming the Risk and Finance

functions of the world’s leading Financial

Institutions and have an in-depth

understanding of the associated

business processes.

Our relevant experience, the calibre of

our consultants and our tailored IFRS 9

delivery methodology means we are

the delivery partner of choice.

| IFRS 9 – The Road to Success | Section One

This paper outlines the changes that will result from

the transition to IFRS 9 and how Parker Fitzgerald

can help you be successful with that journey…

British Banker’s Association letter to

the IASB on 5 November 2013

3


More than an Accounting Programme

The implementation of IFRS 9

is taking place in three

phases:

1. Classification and Measurement

2. Impairment Methodology

3. Hedge Accounting

The deepening integration of the key

finance related functions, from

strategy and planning, through to

Risk, Finance and Treasury means

that IFRS 9 will have a widespread

impact across the business.

The primary impact on your overall

business model and financial

reporting functions will, however, arise

from the changes to the Impairment

Methodology.

Adoption of the IFRS 9 Impairment

Methodology is an area of

specialisation for our Risk

Practice – and where we believe

we can help you change to become

more successful.

Adopting IFRS 9 requires banks to change the way they offset assets and liabilities,

calculate impairments and account for hedging.

The International Accounting Standards Board (IASB) released a new standard for financial instruments, IFRS 9,

replacing IAS 39. Coupled with the two existing, relevant standards for the financial instruments (IFRS 7 and IAS

32), these standards now fulfil all aspects of accounting requirements for financial instruments.

| IFRS 9 – The Road to Success | Section Two

Classification and

Measurement

Based on the business model

and supported by the cash flow

characteristics, financial

instruments are classified and

measured via amortized cost or

fair value.

Impairment

Methodology

Changes from an incurred loss

basis to forward looking

provisioning based on expected

losses (i.e. expected cash flow

assessment).

Hedge

Accounting

Alignment between accounting

and risk department. Risk

strategy has to be adjusted to

the hedge accounting standard.

1 2 3In scope of proposition

4


Where are the Major Challenges?

| IFRS 9 – The Road to Success | Section Three

Why Start Now?

Transitioning successfully from IAS

39 to IFRS9 will take a minimum of

24 months. More complex Financial

Institutions should allow for a

minimum of 36 months.

Whilst IFRS 9 remains in draft form,

the IASB has provided guidance on

most major areas of the new standard

and methodology.

An early understanding of impacts on

the portfolio is critical to ensuring the

right type of mitigating action e.g.

Credit and recovery strategy, is

adjusted before the standard

becomes effective.

There are several synergies between

IFRS 9 and other regulatory initiatives

such as CRD IV and EMIR that

should be considered to ensure the

investment and associated

technology strategy is appropriately

leveraged.

New Impairment

Methodology

is a significant departure

from IAS39, focussing on

a forward assessment of

asset quality and

changes to the

composition of impaired

assets over time.

Demanding and

additional disclosure

requirements are

aimed at increasing

transparency and

understanding drivers

for impaired assets.

Delivering IFRS 9

to the standard required

will be costly, complex,

and will impact all areas

of the Finance and Risk

reporting teams,

processes and

infrastructure in most

institutions.

Extensive period of

Impact Assessment and

Parallel Run (2 years) will

be needed to mitigate

implementation risk and

ensure adequate definition

and management of the

business impacts...and will

be costly.

Complexity, scale and

length of the

implementation are

significant challenges.

Maintaining momentum and

rigour is key for success.

Heavy IT/Technical

components should be

prioritised and front loaded

whenever possible to

mitigate potential future

delays due to competing

regulatory priorities. On-boarding

of skilled resources

required for

implementation will pose

a significant challenge

as there will be a limited

pool and high concurrent

demand from all

institutions.

IMPLEMENTATION FINANCIAL IMPACTS EXPLAIN

5




Product Design and Pricing

• Product managers need to ensure that

products are either redesigned and/or repriced

to remain viable post IFRS 9

Technology and Operations

• Consistent use of data sources across

business functions

• Further driver for process integration

Finance

• Reliable forecasts based on agreed

assumption which are back tested for margin

of error

• Greater need to reconcile pillar 3 and financial

disclosure

Risk Management

• Accounting and risk management functions

will further benefit from integration

• The modelling of EL (historic & prospective) is

the key unifying factor

Treasury

• The potential increase in P&L volatility

requires Treasury to manage capital and

liquidity dynamically

CAN YOU AFFORD IT?

Transition to IFRS 9 may result in a shortage

of capital. This would require pre-emptively

raising further Capital or reducing Risk

CAN YOU EXPLAIN IT?

IFRS 9 will lead to increasing P&L volatility

– in turn requiring clear explanation for

investors, ratings agency and the Board

CAN YOU DELIVER IT?

A proven approach, specialist modelling

skills, appropriate data and senior sponsorship

are required to deliver this complex

programme predictably

Governance and Disclosure

• Programme Sponsor (typically the CFO) will

need to explain the strategic impacts of IFRS

9 to the Board

• Need for further detailed disclosure in order

for investors to understand the P&L volatility

IFRS 9

6




Impact barometer

1. Scale: Barometer of magnitude of change expected as a result of the implementation of the new standard

2. Volatility: Barometer of current certainty around delivery and design assumptions

Description of high level impacts

B/S

Reporting

Data

Infrastructure

Models

Methodology

P&L

Volatility2Scale1

Key:

Low Medium High

IFRS 9 introduces greater volatility through the economic cycle, as the majority of losses through any downturn

are recognised upfront. Firms may see an increase in the impairment charge and provision requirement, which is also

recognised 1-2 years earlier in the cycle.

Significant changes to methodology moving from incurred to expected losses. Requirement to identify criterion

indicative of significant credit risk deterioration and reflecting changes in expected losses due to forward looking

economic, policy and regulatory changes.

Leveraging existing models will be complex. Basel II Advanced Internal Rating Based (AIRB) Banks will seek to

maximise the use of their existing models, governance and validation process, on the basis that adjustments will

be needed for IFRS 9.

Infrastructure will need to be provisioned and scaled to ensure it is able to run the existing IAS 39 and IFRS 9

models concurrently. This may require investment in technology capacity and partitioning to ensure model runs

perform in line with expectation from key user groups.

IFRS 9 introduces the need for additional data to support both methodology and disclosure requirements. Data

architectures will need to be adapted to include modified assets and other data to support life-time expected loss

and probability of default.

Reporting teams will face significant challenges primarily driven by the need to understand drivers of impaired

assets and risk measures at lower level of granularity to current standard IAS39. The increased volume and

granularity of disclosure requirements are likely to be a major cost driver.

.

The impact on regulatory capital will attract much attention. For many organisations, the introduction of IFRS 9

will lead to an increase in provisions that could reduce core tier 1 regulatory capital under Basel III.

.

7


Guiding You to Success

Parker Fitzgerald – Specialist IFRS 9 Services

We have an experienced team of IFRS adoption, credit risk, and change practitioners that can assist clients assess the strategic and operational impacts of

IFRS 9 on their organisations and deliver the necessary change across the enterprise.

| IFRS 9 – The Road to Success | Section Four

SERVICE

OFFERING

Service Focus

• Initiation and structuring

of programme,

including definition of

governance and

articulation of overall

delivery strategy

• Establishment of

programme work

streams, deliverable

maps, supporting

delivery plans and

resourcing estimates

Service Focus

• Structured assessment

of business and

technology impacts

across the Risk,

Finance and

Technology functions

• Understanding of key

drivers and sensitivities

impacting impairment

forecasts and level of

provisions within the

portfolio

Service Focus

• Interpretation and

definition of impairment

methodology and

associated model build

activities, including

adaptation of existing

AIRB rating models

• Preparation of suitable

strategies for portfolios

where no models are

available

Service Focus

• Definition of strategic

architecture and

technology

requirements across

core Risk and Finance

platforms

• Identification and

implementation of

required changes to

underlying technology

infrastructure and

application architecture

Service Focus

• Re-definition of key

reporting processes

and controls to

accommodate new

basis for impairment

projections and

underlying assumptions

• Design and

development of

bespoke end-user

solutions to enable the

reporting process and

“Audit ready” control

framework

We have developed a

number of accelerators

to ensure maximum

control and

predictability throughout

each stage of the

IFRS 9 implementation.

Implementation Roadmap

Resource Estimation

Business Case Preparation

In-Flight Programme Review

Impairment Methodology

Financial Statements

Credit Strategy

Control Framework

Methodology Definition

Model Inventory Analysis

Model Augmentation

Model Validation

Architecture Definition

Vendor Selection

Application Integration

Test Execution

Reporting Requirements

Operating Model Design

EUC Remediation

Reconciliation

Reporting and

Disclosures

Programme

Mobilisation

Impact

Assessment

Model

Development

Technology

Delivery

8


Guiding You to Success

IFRS 9 Implementation Roadmap

Plan highlights

2.5 year minimum implementation

window is required for standard IFRS

9 delivery (complex banks should

allow for 3 years).

Significant delivery effort and inter-

dependencies between Risk, Finance

and Technology. Programme

Governance models must reflect this

to ensure effective delivery.

Extensive impact assessment and

parallel run (or dry run) period

required in order to gain comfort with

IFRS 9 impacts as well as end-to-end

process change.

Onerous data provisioning and build

activities should be expedited where

there is a greater level of certainty

over end state design.

Close coordination amongst work

streams and BAU functions is key

due to significant inter-dependencies,

and programme construct could

change rapidly.

| IFRS 9 – The Road to Success | Section Four

2014 2015 2016 2017

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Key

Mile

sto

nes

Pro

gra

mm

e

Managem

ent

Meth

odolo

gy

Model

Build

Ris

kF

inance

IT

Standard Published

Refresh/Build ne Modelling logic

(tactical infrastructure)

IT Engagement

Strategy Defined

Gap Analysis

• Data

• Methodology

• Disclosure

requirements

Requirements

• General Ledger / COA

• Reporting & Disclosures

• Analysis

Build

• Chart of Accounts

• Disclosures

• SoX

Adoption o

fta

rget pro

cesses

and r

evis

ed r

esponsib

ilities

acro

ss r

isk a

nd fin

ance

Architecture Strategy

• Data Architecture

• Model Functionality

• Delivery Model

Data Provisioning

• Modelling

• Parallel Run

• Disclosure requirements

IT Mobilisation and

plan interlock

Build (Infrastructure

and EUC environment) System Testing

GO LIVE

Calibration of

Requirements

IMPACT ASSESSMENT

Model Integration• Strategic architecture • Model construction • Code deployment

Design • Reporting Architecture• Reporting Processes • Control Framework

Test

• Provisions

• Controls

• Disclosures

Model Validation • Model Calibration• Model Governance• Sign-off

Re-engineering of Business Processes & Operating Model

Audit Opinion

• Methodology

• Interpretation

Methodology Definition

• Transition Criteria

• Lifetime Expected Loss

• Forward Looking

Frequent instances of internal reporting

External Investor Awareness Senior Management Awareness

and Remediation

DRY RUN

Standard Adopted

(2016 B/S)

•Governance

•Delivery Strategy

•Implementation Roadmap

Programme

Mobilisation

9


Why Parker Fitzgerald

| IFRS 9 – The Road to Success | Section Five

Why Parker

Fitzgerald?

Engagement Model

Clients are able to draw-down from highly specialised resources

at each stage of the implementation lifecycle from one of the

largest and most experienced teams of risk and change

practitioners in the industry.

Our dynamic resourcing model minimises idle activity periods,

ensuring all resources are fully utilised throughout the end-to-

end delivery.

Delivery Track Record

Parker Fitzgerald are experts in the delivery of large scale and

complex risk programmes and have extensive experience in

assisting firms’ responses to the strategic and operational

challenges posed by IFRS 9.

The firm has developed a specific IFRS 9 delivery methodology

and a unique set of accelerators to increase predictability and

decrease execution risk.

Industry Insight

We have a unique understanding of the inter-relationship

between IFRS 9 and other major reporting challenges

facing the industry today (e.g. EMIR, COREP), in addition

to those posed by emerging regulation.

This allows us to consider the future impacts of new

financial regulation and emerging themes in risk

management on key design decisions helping minimise the

frequency firms augment their underlying architecture and

reduce the associated investment spend.

Expert Knowledge

Parker Fitzgerald are market leaders in all areas of financial

risk measurement and modelling. This includes credit risk,

loss forecasting, econometric and stochastic analysis.

The firm has extensive experience in the design, build and

validation of both capital and impairment models to support

Retail and Wholesale product sets.

Consulting Team Experience

Our consultants have an average of 15 years relevant industry

experience gained at the world's leading Financial Institutions. Their

experience, combined with an unparalleled understanding of the

transformation lifecycle, ensures the team is effective from Day 1.

Appreciating that every client is different, we do not believe in

standard industry answers but deliver solutions tailored to our

clients’ organisational profiles.

10


Strategic Programme Delivery

Financial Services Partner specialising in the delivery of Risk and Finance Transformation initiatives for leading Banking and Insurance groups.

Significant expertise in the mobilisation and management of complex, multi-year, investment programmes in direct response to new regulation and International Financial Reporting Standards (IFRS), including the re-design of client operating models, and the leadership of firm-wide cultural reform across a variety of client organisations.

Deep insight into the strategic and operational challenges faced by firms as a result of IFRS 9 and the inter-relationship with other major reporting initiatives.

Risk Advisory Services

Senior Risk Director specialising in the development of risk exposure measurement for Retail and Commercial Banking clients, including Lifetime Expected Loss and Stage Transfer Criteria for IFRS9.

He is an experience practitioner in all aspects of credit risk and regulatory reporting with an unparelled insight into, and experience in, the production of risk management information, in particular those relating to RWA, large exposure, NPL and impairment forecasting.

Significant expertise in delivering the risk management infrastructure (policies, processes and data) to support advanced credit risk analysis.

Risk Technology Services

Financial Services Partner specialising in the development of technology strategy to create market leading risk management, measurement and reporting capabilities for complex Financial Institutions.

Experienced in all aspects of the risk transformation lifecycle, with particular expertise in design and delivery of capital and impairment engines, stress testing architectures and Basel II A-IRB ratings systems to support global banking groups and capital market clients.

Member of the firm’s UK innovation council focusing on key developments and evolving technology trends within Financial Services.


Senior Quantitative Analyst specialising in the design and development of advanced risk measurement techniques, predictive and econometric analytics.

Experienced in the design and development of Basel II PD PiT and TTC models for both Retail and Commercial Banking clients in addition to LGD and EAD models across a variety of asset classes and product types.

Extensive experience in scorecard model development, model validation, statistical analysis and assurance of derived outcomes; with particular expertise in Risk Weighted Asset (RWA) and impairment forecasting, deconstruction, trend analysis and back testing.

IFRS 9 Advisory and Delivery Team

[email protected]

[email protected]

[email protected]

[email protected]

| IFRS 9 – The Road to Success | Section Six

Dunia ReverterPartner

Simon WilsonDirector

Andrew CortisPartner

Olivier Baixas Senior Manager


Heidi is a Senior Risk Management Practitioner and Quantitative Analyst

with over 15 years’ experience working with leading financial institutions to

implement advanced credit risk measurement and management techniques

and strategies to achieve Basel II AIRB compliance.

She began her career at Halifax, Bank of Scotland and has since worked at

Cheltenham & Gloucester and Lloyds Banking Group, where she was

senior advisor on the Secured Capital & Impairment programme within

Retail Credit Risk. Heidi has a deep understanding of retail banking with

particular expertise in retail mortgages and associated credit risk

management methodologies.

Heidi holds a doctorate in Applied Statistics & Maths Modelling from the

University of Salford.Heidi KharbhihSenior Advisor


Joao is a Senior Manager within Parker Fitzgerald’s Risk Advisory Services

practice. Joao has over 10 years experience as a credit risk modeller,

having developed and validated impairment, PD, LGD and EAD models for

major banks, including LBG and Barclays.

Joao has worked across a wide range of retail and wholesale portfolios,

including mortgages, private banking and corporates, and has significant

experience with regards to regulatory expectations around these topics.

He has provided credit risk consultancy to several leading institutions,

including Citibank, RBS and AIB.

Joao holds an MSc in Applied Statistics and Stochastic Modelling from

Birkbeck College and a BSc in Mathematics Applied to Economics and

Management from the Technical University of Lisbon.

João FigueiredoSenior Manager

[email protected] [email protected]

11


Impairment Methodology of IFRS 9

Phase II: Impairment Methodology

The standard introduces a forward-looking provisioning methodology based on

expected losses and seeks to ascribe the risk connected to the assets as accurately

as possible. It replaces the simple Incurred Loss Model used in IAS 39.

This paradigm shift in methodology will impact how Financial Institutions measure

risk provisions. The accounting function will more closely align with risk

management, due to a sea change in data requirements and a more complex profit

& loss management process.

A three-bucket approach will replace the current concept of a “good” and a “bad”

book. For Phase II, products must be classified into the three buckets, based on the

credit quality calculated at either account or portfolio level.

All assets whose credit risk has not significantly increased since origination (except

bank-acquired assets that were already impaired) are classified in Stage 1. These

assets will calculate impairment on a 12-month Expected Loss basis and interest will

be accounted for on a gross basis.

Where an asset’s credit quality has materially deteriorated relative to origination but

not defaulted, it will be moved into Stage 2. Stage 2 impairment is calculated on

lifetime expected losses and interest accounted for on a gross basis.

Where individual accounts have objective evidence of impairment, they will be

classified as Stage 3. The impairment will be calculated on lifetime expected losses

and interest accounted for on a net basis.

Once the credit assets have been allocated into Stages, Firms are then required to

look forward, using forecasts that include multiple realistic scenarios with a

combination of market and internal drivers, to model the impact these will have on

the allocation between stages and recalculate impairment accordingly.

Following public consultation, the final standard was published in July 2014 with an

effective date of 1 January 2018. However, it is likely that the market will expect a

certain level of disclosure of impairment on an expected loss basis prior to the

effective date.

The three-bucket approach of IFRS9

| IFRS 9 – The Road to Success | Appendix 1

Based on past and current information Based on forward looking information

Will the credit risk increase significantly

from initial recognition?

STAGE 1

• Portfolio/account based

• 12-month Expected Losses

• No observable deterioration in

credit quality

STAGE 2

• Portfolio/account based

• Remaining lifetime expected losses

• Account/portfolio credit quality has

deteriorated relative to origination

• Specific assets in danger of default

have not yet been identified

STAGE 3

• Credit risk has increased

significantly since initial recognition

and there is objective evidence of

impairment

• Single instruments based

• Remaining lifetime expected losses

Has the credit risk increased

significantly since initial recognition?

Yes

No

Yes

No

12


Office Locations and Contact Details

| IFRS 9 – The Road to Success | Appendix 2 | v1.2

NEW YORKThe Seagram Building

375 Park Avenue

New York,

NY 10152, US

+1 212 634 7478

LONDONHeron Tower

110 Bishopsgate

LONDON

EC2N 4AY, UK

+44 207 100 7575

AMSTERDAMWTC Amsterdam

H / Tower

Zuidplein 36

1077 VX, Netherlands

+31 20 799 7969

SINGAPORELevel 30

Six Battery Road

049909

Singapore

+65 6725 6376

www.parkerfitzgerald.com

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Registration number: 06362018. © 2014

Registered office: Heron Tower, 110 Bishopsgate, LONDON EC2N 4AY

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