IFRS 9 classification helping you see more than the tip of the iceberg

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1 IFRS 9 classification helping you see more than the tip of the iceberg EY IFRS 9 Classification Engine ICE a ing IFRS 9 classification easie aste o e e i le an o e elia le EY s IFRS 9 Classification Engine 1

2 In order to help you deal with the continuous regulatory and accounting changes in the financial services industry, we created a dedicated Financial Accounting Advisory Services (FAAS) group within EY EMEIA FSO (Financial Services Organisation). We advise financial institutions on new accounting and regulatory standards in banking, insurance and wealth management. Our teams provide insights on matters related to financial accounting and its impact on accounting and reporting processes, systems and controls. Our FAAS group combines technical accounting knowledge with insights from our Assurance, Advisory, Transactions, and Tax departments. Our experienced people are on top of current market developments in the European and global financial services industry, addressing the most challenging needs of our clients. Our goal is to be the one-stopshop for CFO s. In particular, we have knowledgeable consultants in IFRS, Transaction Accounting, Operating Model Simplification, Integrated Risk and Finance Reporting, Solvency II, AnaCredit, Basel III and other requirements mandated by supervising bodies and regulators. We have major experience in IFRS 9, and our teams across the EMEIA region have successfully provided complete IFRS 9 projects for a significant number of financial institutions. For IFRS 9 classification and measurement, EY possesses extensive experience in providing tailored tools to its clients. Introduction In July 2014, the International Accounting Standards Board (IASB) issued the final version of IFRS 9 Financial Instruments, bringing together the classification and measurement, impairments, and hedge accounting aspects of this IASB project to replace IAS 39 Financial Instruments: Recognition and Measurement. The new standard, IFRS 9, is effective for annual periods beginning on or after 1 January 2018 for all entities, except for certain insurance entities that are eligible for temporary exemption. These insurance entities can defer the implementation of IFRS 9 until the mandatory date of the upcoming new insurance contracts standard, IFRS 17 (or 2021 if sooner). Why EY? We are well prepared to assist all financial services companies. Regardless of whether you are well advanced with your IFRS 9 project, or still anticipating a large effort, we can help you to successfully cross the finish line in time. The classification of financial instruments under IFRS 9 is based on the entity s business model for managing the financial assets, but is also based on the nature of their contractual cash flows. EY has developed the tools needed to facilitate a successful execution of IFRS 9: Our business model checklist supports a rigorous and structured approach to determining whether cash flows are generated from holding the financial assets, selling the financial assets or both. EY ICE tool offers an automated classification tool for instruments with identifiers (ISIN, CUSIP). This tool has repeatedly demonstrated its value during our client engagements throughout the globe. EY ICE tool has benefited from the rich input that our clients and our senior leadership have provided during its development and is continuously updated. In order to analyse more complex loans and contractually linked instruments that are not eligible for automated classification, we offer a text data mining tool, which generates an assessment of the instruments risk of failing the contractual cash flow (SPPI - Solely payments of principal and interest) test. The results of this assessment can then be used as a basis for further classification using our SPPI checklist. This checklist examines all essential instrument features that are relevant for classification. 2 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 3

3 Key aspects of the IFRS 9 classification for financial assets This chart provides an overview of the required assessments and resulting outcomes for IFRS 9 classification and measurement. Debt (including hybrid contracts) Derivatives Contractual cash flow characteristics test (at instrument level) Equity P a s s F a i l F a i l F a i l Business model (BM) assessment (at an aggregate level) Held for trading? (1) Hold-to-collect contractual cash flows (2) BM with objective that results in collecting contractual cash flows and selling financial assets Neither (1) nor (2) Conditional fair value option (FVO) elected? FVOCI option elected? F CI Fai al e t o g t e Co e ensi e Inco e F Fai al e t o g ofit o oss Amortised cost FVOCI* (with recycling) FVTPL** FVOCI (no recycling) 4 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 5

4 D D EY IFRS 9 classification methodology and related tools Portfolios A E Y h a s developed a wide range of tools for efficient IFRS 9 classification, covering all aspects of the required assessment. Business model testing e siness o el e ects o a o t olio o assets is anage to ac ie e siness o ecti es et e ol ing t e financial assets selling t e assets o ot anage ent nee s to se g ent to assess t e siness o el ta ing all acto s an acti ities into acco nt S ficient e i ence is e i e in o e to eac t e ig t concl sions ic n e lines t e nee o a st ct e a oac EY ill g i e t e entit t o g t e assess ent oce e an assist anage ent in co e ing e as ects SPPI testing Business model testing Hold to collect portfolios Identified portfolios for further analysis Automated Hold and sell portfolios Cont act all lin e inst ents o loans Other portfolios Pre-work for manual testing Among them is the EY ICE tool, which performs automated classification of portfolios consisting of securities with an ISIN or CUSIP. Fo a e t inst ent to ass t e cont act al cas o s c a acte istic test an e s se entl eas e at a o tise cost o ai al e t o g ot e co e ensi e inco e t e entit st ete ine et e cont act al cas o s a e solel a ents o inci al an inte est ence t e assess ent is also e e e to as t e S I test n inst ent asses t e S I test i it oes not int o ce is s o olatilit t at a e inconsistent it a asic len ing a ange ent e S I testing t icall in ol es a ai a o nt o eso ces an an entities n e esti ate t e e o ts e i e EY S I testing tools ill acilitate t is ocess ile s stantiall e cing t e ti e an costs elate to t is o The following chapters will describe four tools in more detail: SPPI testing ISIN list High (priority 1) Detailed assessment Cluster based on similar characteristics Assess reclassification risk Medium (priority 2) Validate assumptions Obtain sample Low (priority 3) Validate assumptions A B C Business model checklist Automated classification EY ICE Text data mining S P P I checklist B Automated classification EY ICE tool C Text data mining Completion of SPPI testing Manual SPPI checklist lso no n as sec itisations 6 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 7

5 A Business model checklist What to expect Purpose IFRS 9 e i es t e siness o el assess ent to e ase on t e acts an ci c stances t at e ist on t e ate o a o tion o t e stan a siness o el c ec list o i es t e necessa s o t to e o t is assess ent an el s to n a el i o tant in o ation ega ing o financial assets a e anage t e entit s t e siness o el assess ent is an a ea o t e stan a e i ing consi e a le g ent it is i e ati e t at entities se a st ct e a oac Requirements In o e to e a le to el o e o l nee to con ct inte ie s it t e ele ant contacts in o o ganisation ese a e o essionals o no t e financial inst ents an a e a ital so ce o in o ation o e o ing t e assess ent e c ec list incl es an anal sis o e e o ance in icato s t e entit ses to assess e o ance an o e ie o siness o ecti es an a antitati e anal sis o sales le els How it works e tool consists o a fille o t etaile o oc ent it an E cel ase te late e e e en co lete t e c ec list itsel is t e o t t Key features stan a ise estion list contin o sl a a te on t e asis o o e e ience o ot e o ects is o i e e o t t satisfies t e oc entation e i e ents i ose t e stan a 8 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 9

6 What to expect B Automated classification EY ICE Purpose Fo t e S I testing o inst ents it an i entifie ISI C SI EY esents EY ICE tool IFRS 9 Classification Engine o tool o a to ate classification It can e se to elia l an acc atel anal se inst ents on t e asis o e c a acte istics e tool et ie es a et ata an acc atel classifies t e inst ents sing an IFRS 9 ase ecision t ee algo it Requirements n i entifie is nee e o eac inst ent ISI C SI etc How it works e tool et ie es a et ata o ata o i e s on t e asis o t e i entifie o g t e se o a ecision t ee algo it t at is ilt on IFRS 9 inci les it acc atel classifies financial inst ents significantl e cing t e eso ce e i e ents co a e to an al classification e tool classifies t e inst ents sing an IFRS 9 ase ecision t ee algo it co ining IFRS 9 inci les it EY inte etations t at a e ase on o ast a et e e ience In icato s o t e ai al e a e agge an t e tool gi es a ig l etaile o t t incl ing is als an an a it t ail Fast: The data extraction and classification report generation is done within a few hours. Easy: The only input needed is a list of ISIN (or CUSIP) codes, then the tool produces an excel file indicating the classification conclusion and the reasons for it. Reliable: The tool is validated by our senior leadership and used for many Financial Institutions in the world. The results and related documentation include a detailed audit trail. 1 0 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 1 1

7 Key features EY ICE tool significantly reduces required classification efforts, offers a consistent approach and improves accuracy. S I testing e o e it EY ICE tool t icall es lts in a o t olio co e age o a o t 9 t ot e e enefits a ise as ell sing t is tool e can Signi icantl e ce t e e i e e o t o S I testing gi en t e ig eg ee o a to ation e t e sa e consistent a oac o e e inancial inst ent o i e etails on t e classi ication ocess o eac inst ent it e e ence to t e stan a For all of the ISINs that were not classified by the tool, we have a database of financial instruments that have been assessed manually by EY. Clients typically achieve a portfolio coverage of 90% when using the tool. Why is this tool special? etaile o t t an a it t ail incl ing ationale o classi ication In se since an contin o sl ate ig l le i le le engine Fle i ilit ega ing in t classi ication o an i enti ie s o te ata o i e s 1 2 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 1 3

8 What to expect Purpose is tool is se in o e to e o an assess ent o t e financial inst ents is o ailing t e cont act al cas o S I test e tool can e se o an inst ent it a te t cont act is incl es cont act all lin e inst ents asset ac e sec ities loans an o tgage cont acts Requirements Fo cont act all lin e inst ents t e e ing e o an also no n as e ing Ci c la o os ect s is nee e Fo loans an o tgages t e cont act is e i e How it works C e tool e o s a e o sea c sing a le icon o e o s Eac e o as an associate is eig t e e o le icon is i e ent o loans an C Is E ten ing t e le icon is an ite ati e ocess Text data mining 1 4 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 1 5

9 Key features Text data mining tool The challenge CLIs (securitisations) Our automated tool creates a user-friendly classification output and highlights instruments that need further analysis. Our text data mining tool offers you a very efficient way of dealing with vast volumes of text: e c ent engine can assess a cont act it a o t one illion c a acte s in secon s e tool can ocess a ataset o an n e ing o cont acts in a o t secon s enc a e It can anage t e o lation o cont acts it total si e in n e one o nteste EY ICE tool and text data mining EY ICE tool Is it practicable to look through to the underlying pool of instruments? Does the tranche have cash flows that are solely payments of principal and interest? ese es lts can e i o e it aste a a e Text data mining tool Does the underlying pool have instruments with cash flows that are solely payments of principal and interest? The lexicon in our tool has been developed over years of experience and has the functionality to assess contracts in different languages. e o t t o t e tool ig lig ts t e inst ents t at nee t e anal sis Text data mining tool Do all other instruments in the underlying pool reduce cash flow variability or align the cash flows of the tranches with the cash flows of the underlying pool? Ris at i s o s is o F classification it in is catego ies Ris class o ces c ets o inst ents t at a e t e in estigate as necessa sing t e S I c ec list Credit risk tranche vs. pool test* Is the credit risk of the tranche equal to or lower than the credit risk of the underlying pool of instruments? Text data mining tool Can instruments in the underlying pool change after initial recognition, in a way the pool does not meet the conditions above? EY c eate a e icate et o olog o e ficient t anc e s ool testing on t e asis o t e in t o e te nal a et ata an c e it ating o i e s P a s s S P P I F a i l S P P I 1 6 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 1 7

10 D What to expect Purpose e EY IFRS 9 S I c ec list o i es a co lete an eas to n e stan g i ance to con ct t e an al S I classification Requirements cont act te s eet o a o ct esc i tion s eci ing in etail all t e c a acte istics o t e financial inst ent How it works etaile E cel ase ac o ena le oc ent is se E e estion can e ans e e it a si le es o no ile acco anie it t e ele ant co ents an e i ence en co lete t e c ec list itsel is t e o t t S P P I checklist Key benefits S ita le o all assets incl ing C Is Co e s e e i o tant iss e esc i e in t e stan a Consi e s co leteness an e ce tions Eas to n e stan it e lanations an e a les t t gi en as a clea ass o ail ase on e e ele ant S I c ite ion 1 8 EY s IFRS 9 Classification Engine EY s IFRS 9 Classification Engine 1 9

11 Your EY contacts For more information and an approach tailored to your needs, please contact our IFRS 9 team. EY EMEIA contacts Tara Kengla E ail t engla e co one Dragutin Patrnogic ag tin at nogic e e co one 9 Belgium Emmanuel Villaire e an el illai e e e co one France Celine Molinari E ail celine olina i e co one 9 Germany Thimo Worthmann E ail t i o o t ann e e co one 9 9 Italy Francesca Amatimaggio ancesca a ati aggio it e co one 9 Netherlands Sander de Ruiter san e e ite nl e co one 9 99 Spain Randolf Niedermeyer an ol nie e e e es e co one 9 United Kingdom Yolaine Kermarrec E ail e a ec e co one 9 E Y A s s u r a n c e T a x T r a n s a c t i o n s A d v i s o r y A b o u t E Y E Y i s a g l o b a l l e a d e r i n a s s u r a n c e, t a x, t r a n s a c t i o n a n d a d v i s o r y s e r v i c e s. T h e i n s i g h t s a n d q u build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organisation, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organisation, please visit ey.com. EY is a leader in serving the financial services industry We understand the importance of asking great questions. It s how you innovate, transform and achieve a better working world. One that benefits our clients, our people and our communities. Finance fuels our lives. other sector can touch so many people or shape so many futures. That s why globally we employ 26,000 people who focus on financial services and nothing else. Our connected financial services teams are dedicated to providing assurance, tax, transaction and advisory services to the banking and capital markets, insurance, and wealth and asset management sectors. It s our global connectivity and local knowledge that ensures we deliver the insights and quality services to help build trust and confidence in the capital markets and in economies the world over. By connecting people with the right mix of knowledge and insight, we are able to ask great questions. The better the question. The better the answer. The better the world works EYGM Limited - All Rights Reserved - EYG no Gbl - ED ne is ate ial as een e a e o gene al in o ational oses onl an is not inten e to e elie on as acco nting ta o ot e o essional a ice lease e e to o a iso s o s ecific a ice 2 0 EY s IFRS 9 Classification Engine