IFRS updates and challenges for banks in the UK - EY€¦ · IFRS updates and challenges for banks...

IFRS updates and challenges for banks in the UKLondonJuly 2016

EY’s UK IFRS banking conference summaryEY’s UK IFRS banking conference on 1 July 2016 drew more than 110 representatives from 40 different banks, as well as standard-setters and industry bodies. The discussions revolved around the ongoing challenges arising from the changes to accounting and regulatory rules affecting the banking industry.

The focus of the event was the impairment requirements of IFRS 9 Financial Instruments, with particular focus on:

Market perspectives

A panel session on issues such as progress of IFRS 9 programmes and multiple scenarios

Financial Reporting regulation (FINREP)

The impact of IFRS 9 on ratings

As the conference was held shortly after the referendum to leave the EU (European Union), some of the wider implications of the decision were considered and there was

2 | IFRS updates and challenges for banks in the UK: July 2016

1 International Financial Reporting Standard, IFRS 9 Financial Instruments, July 2014, paragraph 5.5.17 (a)..

In addition, there were sessions discussing:

Prudential developments

Revenue from Contracts with Customers

Introduction to IFRS 16 Leases

Update on emerging XVA topics

This document provides a high-level summary of insightful thoughts from discussions with leading specialists and peers

real-time polls taken during the conference.

for managing the forthcoming changes.

Key considerationsSome of the key considerations of this paper include: IFRS 9

alternative views on IFRS 9 from market participants; an update

result might impact IFRS 9; results of the EY EDTF benchmark report; and how the new IFRS 16 Leases standard will impact balance sheets.

InsuranceThe International Accounting Standards Board (IASB or Board)

2016, although it will not be effective before 2020, i.e., two years after IFRS 9. The Board intends to permit most insurers to defer the application of IFRS 9, but this deferral will generally not be available for the consolidated accounts for banks with insurance subsidiaries.

IFRS 9 endorsement

2016 to endorse IFRS 9. European members of parliament (MPs)

Q4. However, French bancassurers may raise objections, and endorsement is not a foregone conclusion.

Key developments for IFRS 9 impairmentRegulatory capital implications: these have still not been raised. There appears to be a desire amongst regulators for symmetry, so that capital doesn’t depend on the accounting framework. However, it is not clear how this would be done.

Big and uncertain events (EU referendum result): The Transition Resource Group for Impairment of Financial Instruments (ITG) calls for a good faith estimate to be made, whilst the Basel Guidance on

say that “In certain circumstances, information relevant to the assessment and measurement of credit risk may not be reasonable and supportable … However … these circumstances would be

nature, but it is not clear whether regulators would agree.

Multiple scenarios:

that is determined by evaluating a range of possible outcomes.1

linear relationship between the different forward-looking scenarios and their associated credit losses, using a single forward-looking economic scenario would not meet this objective.’

implementation of IFRS 9

The emerging consensus so far is that it is better to develop coherent scenarios than to model each driver in isolation

European banking conference.

She stressed that the ITG did not say that an entity must:

Use probability of default (PD)

Use three scenarios

Always use multiple scenarios

What it did say was that an entity should:

of possible losses

Be subject to what is reasonable and supportable and available without undue cost or effort

3IFRS updates and challenges for banks in the UK: July 2016 |

2

other risk management models.

incorporating non-linearity into their loss allowances:

2 — this avoids having to specify scenarios or assign probabilities, but there are hidden

quality of the relationship between the scenarios and the associated losses

Several probability-weighted scenarios — these are transparent, but you need to be able to specify the scenarios and their weightings, and the associated losses

Base case and a suitably weighted stressed scenario — this is transparent and uses data that is already used for risk management. However, you need to assign an appropriate weighting, which will not be stable over time, to the stressed scenario

Revolving credit facilities: At the December ITG, it was agreed that:

An entity should consider credit risk management actions that:

Will mitigate credit risk (actions that do not mitigate credit risk, such as the reinstatement of previously curtailed credit limits, should not be considered)

but only if the normal business practice is to take credit risk mitigation actions as part of this process.

Application by simpler banks:not say that it addresses only internationally active banks, and the European Banking Authority (EBA) is turning it into law for European credit institutions. However, the principles may be applied proportionately, commensurate with the size,

and assessment of what is proportionate (and therefore the use

additional requirements.

Market perspectives on IFRS 9Nimesh Verma, Bank Advisory, BNP Paribas, provided a stimulating discussion from a market perspective.

IFRS 9 is one of several major and simultaneous drivers of change in the banking industry. Nimesh pointed to the big picture and highlighted some of the challenges:

form in 20 years’

Various initiatives are driving an increase in capital

of advanced internal ratings-based (IRB) approaches, Fundamental Review of the Trading Book (FRTB) and new operational risk rules

Some of the negative consequences of IFRS 9 include the increase in provisions and earnings volatility, the impact on

increased use of judgement and estimates, administrative

IFRS 9 is more volatile and pro-cyclical by design. In Nimesh’s view, judgements that are best made by the prudential supervisor, who has an interest in managing stability, are being left to banks to model and auditors to validate

What are investors saying?

realistic values’

be higher’

any longer’

and regulators — as well as the banks themselves — to hire people who understand the risk models’

effects of IFRS 9, such as increasing use of fair value approaches and risk transfer structures

“ Judgements that are best made by the Prudential supervisor, who has an interest in managing stability, are being left to banks to model and auditors to validate.”


Panel sessionYolaine Kermarrec, EY, moderated a panel session of industry representatives to discuss implementation issues relating to the impairment requirements of IFRS 9. The panel included:

Dan Hensel, TSB Bank

Ben Perry, Nationwide Building Society (NBS)

ProgressPanellists were asked where they were on the project, and about their main achievements and challenges:

All of the represented banks are in the process of building their

The design of the target operating model under IFRS 9 is in the preliminary stages and is increasingly becoming a point of focus for the IFRS 9 programmes

Key challenges shared by the panellists include how to design a pragmatic and meaningful multiple-scenario approach,

models, and compliance with the new disclosure requirements

Multiple scenariosMultiple scenarios have been a major focus of the banks in the past

All banks agreed that the requirement for a multiple-scenario

similar modelled approach to incorporate forward-looking

They pointed out that, whilst this approach may not necessarily be precise, it is without bias

The other two banks plan to set the base case scenario in

add a discrete number of scenarios; the process of sourcing additional scenarios and their probability weight had not been designed yet

Investor relations and disclosures All banks agreed that they would need to have more

before they are in a position to disclose the quantitative impact assessment of IFRS 9 publicly

All banks are planning to disclose this impact during 2017, although which quarter has not been decided yet

One panellist stated that they would disclose the impact as late as possible, depending on what is required from regulators

Applying the staging assessment Three panellists plan to use a variation of PDs for stage

allocation

lists for their corporate portfolios as a secondary trigger

Management overlay may still be required for a few portfolios

Impact on the way the business is run

on origination (e.g., wider time horizon and more granularity), which may affect both product pricing and risk appetite

The impact on capital remains uncertain pending the upcoming regulation. However, panellists tended to think it would increase capital requirements

impact on the way mortgages are designed and the sale of these products.

Another bank has added a separate work stream on the second order effects of IFRS 9 to its implementation programme and

as forecasting and stress testing

The challenge is not to create too many unintended consequences from implementing IFRS 9

Other

and risk

been greater co-operation between the departments as a result of working together towards a common goal

Financial reporting regulation in the world of IFRS 9

and the Prudential Regulation Authority’s (PRA) regulatory reporting, as it relates to changes due to IFRS 9.

The EBA’s 2016–17 areas of focusThe EBA has stated that the focus will be on proportionality,

performing loan status update is likely to lead to more detailed data requests than FINREP non-performing and forborne

potential quantitative impact study (QIS), which could be more intensive. A second IFRS 9 QIS will be performed closer to the


3 In order to provide a uniform implementation of the ITS on Supervisory Reporting, the data items included in the ITS have been translated into a Data Point Model (DPM). The DPM is a structured representation of the data, identifying all the business concepts and its relations, as well as validation rules. It contains all the relevant technical

https://www.eba.europa.eu/regulation-and-policy/supervisory-reporting/implementing-technical-standard-on-supervisory-reporting-data-point-model-

Activity No progress Making progress Complete

Impact assessment 50% 33% 17%

Data requirements 75% 17%

24%

76%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Yes No

Have you performed an impact assessment of the new IFRS 9 templates?

Results are from real-time polls taken during the conference.

The impact of IFRS 9 on FINREP

proposing amendments to the Implementing Technical Standards (ITS) on supervisory reporting with regard to FINREP for IFRS reporters (FINREP IFRS 9).

IFRS 9 and IFRS 7 requirements.

3

by the EBA during 4Q16. We do not anticipate major changes to the draft ITS.

Most institutions have indicated that they cannot afford to wait

requirements and have begun to perform an assessment to understand the impact of the draft templates.

EY is supporting some organisations with its impact assessment and data requirements. Industry talk would suggest that a number of large institutions have made no progress to date.

different reporting requirements and timings depending on size

information to full FINREP. It’s important to remember that the EBA has not yet released information relating to the impact of IFRS 9 on these returns.

Future PRA plans, consultation papers and the supervisory approach to IFRS 9

statements, forecast capital data and IFRS 9 requirements — sets out the PRA’s proposals on future reporting of balance sheet,

FSA forms which have been static for a period. This will assist in

the potential reporting requirements of IFRS 9, and is relevant


measurementMaria Nordgren, Deutsche Bank, discussed some of the practical

Maria highlighted some of the lessons learned from Deutsche Bank’s IFRS 9 programme:

For SPPI (solely payments of principal and interest) testing, when deciding whether to go with a top-down or a bottom-up (detailed contract review) approach, consistency with the audit methodology is encouraged. SPPI testing should be happening now, as problematic areas will require engagement with

When performing the business model assessment, the relationship between the fundamental review of trading book (FRTB) regulation and IFRS 9 should be considered, as the link between regulatory and accounting rules is closer than before

IFRS 9 will require new processes and controls to be put in place:

Assessment of new assets in line with IFRS 9 SPPI rules, e.g., new product approval processes may need to be amended

models when new management centres are set up or altered

Sales monitoring processes and controls for hold-to-collect

These changes should be communicated and syndicated early to affected stakeholders.

Bank in its IFRS 9 programme.

Two-way break clauses — it was found that, in certain instances,

borrower terminates the loan early, the bank will pay the fair value

also allows for payment to the bank by the borrower in case of early termination.

— for instance, products bundled with insurance offerings. These may pass the SPPI test,

credit risk.

Interest rate and tenor mismatches — for instance, a 12-month loan with an interest rate that resets every quarter based on a

some instruments will fail.

Bank ratings and impact of IFRS 9 on analysis

Simon Ainsworth, Moody’s, provided an update on the impact of IFRS 9 on ratings.

Moody’s key message is that the impact of the implementation of IFRS 9 on reported capital numbers is uncertain, and introduces

are unlikely to be impacted. Moody’s ratings are forward-looking opinions and judgement based, which do not automatically respond to accounting changes. Therefore, iterations to accounting standards should have no direct impact on ratings.

statements as, whilst it introduces subjectivity going forwards on

standard (IAS 39), it provides more information, which will better inform their ratings.

The impact of IFRS 9 on regulatory capital remains a key area of

impact baseline credit assessments and instrument ratings if the introduction of IFRS 9 resulted in a real change in the likelihood of bank failure or coupon suspension. However, a wide scale impact seems inconsistent with the banking authority’s position that bank capital requirements are now broadly stable.

should not see a wholesale shift in ratings as no change in credit standing has occurred.”


The UK and the EU: working through uncertainty after the EU referendum result

latest impacts of the decision by the UK to leave the EU.

The uncertainty is set to continue as we wait to see what position that the UK’s new prime minister (PM) proposes to take in terms

is worth noting that the EU referendum vote was advisory only.

formal process around leaving the EU and the style it should take.

Possible questions over the UK’s withdrawal from the EU include:

Does the Government consult Parliament on the withdrawal process?

recognise the outcome of the vote?

Do any court cases threaten the Government’s ability to

“ Retaining access to the single market in goods and

services, whilst restricting free movement and European

jurisdiction within the UK, are likely to be at the core of

negotiations.”

Following a vote to leave, the UK could consider the following ways of legal withdrawal from the EUWithdrawal under Article 50 of the Treaty of Lisbon

The UK would immediately give two years’ notice of its

would be negotiated. The decision to leave does not require agreement of the other member states, which cannot block or delay beyond the two-year period.

The EU treaties would cease to apply to the UK on the entry into force of a withdrawal agreement or, if no new agreement is concluded, after two years (unless there is mutual agreement

Negotiate before withdrawal

The UK Government may use the vote to leave as a mandate

negotiations left undetermined.

The UK may then trigger Article 50 once talks have concluded to validate the agreement. This may lead to demands for a second UK referendum on the negotiated deal.


considerations

Impact on EU-adopted IFRSThe application of EU-adopted IFRS is enshrined in the UK

a change to the act itself. Even where an entity is not subject to Article 4 of the IAS Regulation, it can elect to prepare company

with IFRS.

incurred losses as a result of the referendum, and companies could incur a loss provision for these debtors. There may be a

(e.g., real estate and property developers).

Fair value: markets have been active, so it is not possible to argue

of fair value.

Provisions:greater uncertainty may require an increase in the discount rate.

Derivatives and hedge accounting: market volatility could impact the hedge effectiveness of certain hedge accounting relationships.

Goodwill:there has been a downward revision of long-term growth rates for

Pensions:result of share price reduction on the asset side and a reduction of the discount rate on the liabilities side.

Going concern: there may be instances where going concerns should be reassessed for certain businesses.

Deferred tax assets:

Disclosures: businesses will need to consider certain disclosures

related mitigation, Viability statement disclosures, Estimation uncertainties, Impairment of assets and provisions, Goodwill and

on liquidity and capital management and Events after the balance sheet date.

Prudential developmentsVivek Kavdikar, EY, presented on prudential developments and liquidity supervision.

Capital impact of IFRS 9

banks using the standardised approach4 in calculating risk-weighted assets (RWAs) than those using an IRB approach

current IFRS impairment accounting rules — including incurred

IFRS 9 Stage 1 impairments, and also in Stage 2 — which could

general credit risk adjustments

All of the RWA calculation methodologies for standardised approaches are being revised (implementation dates are

The introduction of the internal ratings-based approach (IRB)

potentially disclosable RWA calculations under standardised rules. The IRB will not be abandoned, but used for internal measurement

given the dependence of standardised RWA calculations on

data, drive IRB)

4

http://www.bis.org/bcbs/publ/d347.htm

“ Leaving the EU does not have an impact on the implementation of IFRS 9”

Unilateral withdrawal

The UK could repeal domestic legislation, the 1972 European

for UK-EU relations.

This option may damage the UK’s chances of settling a trade

Retaining access to the single market in goods and services, whilst restricting free movement and European jurisdiction within the UK, are likely to be at the core of negotiations.


within the EU, with three pillars:

Minimum requirements — short-term liquidity

liquidity requirements — net stable funding ratio — (NSFR).

Granular and more frequent reporting — additional liquidity

intraday reporting, have become applicable from 1Q16. The purpose of these is to make new, more detailed disclosures about banks’ liquidity sources and uses, and identify possible sources of funding pressures

Governance and framework — the internal liquidity

measurement and monitoring of liquidity should be in place by 31 October 2016

Securitisation The revised Basel III securitisation framework represents a

of approaches

One of the stated aims is to provide a robust framework for what is a key source of funding within the EU

September 2015, is a package of two legislative proposals:

Regulation that will apply to all securitisations, covering due diligence, risk retention and transparency rules, together with the criteria for simple, transparent and standardised (STS) securitisations

EDTF benchmark, including ECL disclosuresFabio Fabiani and Marek Walendowski, both EY, presented on the Enhanced Disclosure Task Force (EDTF) benchmark of various banks.

During 2015, the EDTF recommendations were supplemented with additional considerations and application guidance relating

recommendations were developed for global systemically important banks (G-SIBs), but smaller banks and the subsidiaries

recommendations. Regulators, including the PRA, have strongly encouraged the implementation, and we are observing increased

EY EDTF benchmark reportSince 2014, EY has conducted an independent benchmark on the status of implementation of the EDTF recommendations.

the implementation progress and possible areas for further

original EDTF recommendations, as well as the additional elements

the EDTF 2014 and 2015 progress reports.

Benchmark results for 2016 Whilst the recent benchmark shows an overall increase in the level of compliance, there is still room for improvement, particularly in the areas of:

Risk governance

Market risk

Achieving full implementation will require further effort and

regulatory and accounting changes.


RegionRisk type General Risk governance Capital

Recommendation 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Uni

ted

Kin

gdom

Bank 1

Bank 2

Bank 3

Bank 4

Bank 5

Bank 6

Bank 9

Con

tine

ntal

Eur

ope

Bank 10

Bank 11

Bank 12

Bank 13

Bank 14

Bank 15

Bank 16

Bank 17

Recommendation fully met Recommendation met, minor enhancements possible

the level of detail provided. Most banks included information about the new accounting standard and provided a high-level

requirements embedded in the standard, and provided qualitative indication of how they will be assessed.

Benchmark results for 2016 by detailed recommendation:

0

5

10

15

20

25

30

35

40

14

Implement allrecommendations

24

Implement mostrecommendations

20

Implement somerecommendations

4

Implement fewrecommendations

37

Not applicable

To what extent do you expect to implement the EDTF ECL disclosure recommendations in your 2016 annual report and accounts?



Liquidity and funding Market risk Credit risk Other risk

15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32

Recommendation met (considering phased-in approach) Recommendation partly met

Recommendation met but enhancements required

Recommendation met but enhancements required

# Recommendation Implementation timeline

United Kingdom Continental Europe

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

2a Describe general concepts

2015–163

5b implementation strategy

8 framework

2bDescribe key concepts and credit risk modelling techniques

2016–17*4

Impact of allowance for credit losses on regulatory ratios

5aGovernance, process,

methodology

12 capital planning

26 Quantitative assessment 2017*

*Recommendations included for reference, as they are due for implementation starting from 2016.


IFRS 15 for banks — lessons learned and industry challengesFabio Fabiani, EY, presented an overview of the new revenue recognition standard, IFRS 15 Revenue from Contracts with Customers,learned and industry challenges.

The key differences from the current standards are:

New structured approach introduced to recognise revenue

disclosures, business processes and internal controls. In order to establish whether there will be an impact, banks will have to run an

and outcome, including any judgement applied.

From a commercial perspective, a detailed assessment of material contracts will help identify changes in time to inform future contract negotiations.

Some of the key areas for banks to consider when assessing the impacts from IFRS 15 include:

Multiple performance obligations — preparers should assess all performance obligations, which may include any implicit

Credit card interchange and reward programmes — preparers will have to determine who the customer should be (the cardholder or the merchant) by analysing all the facts in the contracts

Trade execution for customer orders — preparers should

the trade date or on the settlement date

Investment research and soft-dollar arrangements — preparers should consider whether multiple contracts with the same customer should be combined

Securities underwriting — preparers should assess if there are other performance obligations within the contract (e.g.,

whether revenue is recorded on the trade or settlement dates

Insurance intermediary commissions — preparers should analyse any future revenue to be earned from performance

Costs

lead to changes compared with the previous standards

Disclosure requirements with new quantitative and qualitative disclosures required on areas such as:

Disaggregation of revenue

Methods, inputs and assumptions

0%

5%

10%

15%

20%

25%

30%

35%

40%36%

Diagnostic

0%

Systemenablement

23%

Design

12%

Implementation

15%

Testing

13%

Not started

How advanced are you in your IFRS 15 project?



IFRS 16: leases make their way onto the balance sheetMarek Walendowski, EY, presented an overview of the new leases standard and discussed its implications.

IFRS 16 Leasesaccounting and will be effective for periods beginning on or after

to the lease accounting model for lessees who will be required to recognise most of the leased assets on their balance sheet.

previous standard.

Key implications of the new standardCapital requirements:treatment of right-of-use assets in regulatory reporting. The ability to show leased assets within property, plant and equipment

that for PPE, rather than the 100% capital deduction required for intangible assets.

P&L volatility:

years. Additional volatility may arise from the introduction of a

Data:support all disclosures and measurement requirements, and allow documentation of management estimates and assumptions.

Processes: More robust processes may have to be put in place to identify the lease and non-lease components of contracts, as they

Income tax: continues to be based upon current accounting concepts.

liabilities would also be affected.

Sale and leaseback: Sale and leaseback transactions will no longer

Impact on customers:

Early engagement may be key to sustaining business relationships.


How advanced is your IFRS 16 project?

0%

5%

10%

15%

20%

25%

30%

35%

40%

35%

Started

27%

Planned for 2016

12%

Planned for 2017

27%

No plans


Update on emerging XVA topics, including margin valuation adjustmentsRhys Taylor, EY, presented on some of the XVA elements (credit, debt, margin, funding and liquidity value adjustments — known as

Margin valuation adjustments (MVAs): Banks are increasingly pricing the funding cost of the initial

margin into derivative valuations

Initial margin funding costs are typically consistent with those used in establishing funding valuation adjustment (FVA),

source and term structure of the spread used

in fair value this year due to regulatory changes. However, the deferral of those changes in Europe has meant MVAs are likely to be a 2017 fair value consideration for the majority of banks

Capital valuation adjustments (KVAs):

The application of KVA in derivative pricing continues to vary

measurement techniques, degrees of sophistication in modelling technology and other commercial factors

It appears more likely that a KVA-based adjustment will form part of prudent value before it becomes part of fair value


Tony Clifford

E: [email protected]

Fabio Fabiani


John Cole


Catriona Early


Rhys Taylor


Yolaine Kermarrec


Vivek Kavdikar


Marek Walendowski


Tiana Gulan


Andrew Pilgrim


Calvin More


Jonathan Chesebrough


Contacts

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