International Financial Reporting Standard 9 (IFRS 9)

Transcription

1 International Financial Reporting Standard 9 (IFRS 9) KnowCo s solution for IFRS 9 responds to all requirements of the Standard applicable to non-complex institutions, from governance, classification and measurement of assets and off-balance sheet exposures, to impairments and regulatory reporting. In consultation with KnowCo personnel, client firms transpose their data and rules into the solution to calculate Expected Credit Loss (ECL) and generate the required regulatory returns and data for disclosure and MI. Overview The International Accounting Standards Board has developed IFRS 9 to address the shortcomings of the incumbent IAS 39 standard, which exacerbated the financial crisis by curbing institutions ability to fully anticipate and absorb future credit losses. From 01/01/2018 institutions accounting under IFRS standards will once again be able to fully provide for ECLs, but strict principles-based rules are intended to prevent the use of provisions to mitigate income volatility. The changes are radical and important, because they will ultimately affect financial institutions P&L and capital, notwithstanding transitional provisions under discussion, aimed at lessening the cliff effect. So, each firm s adoption of the new standard must be subject to rigorous governance disciplines. KnowCo Limited, All Rights Reserved 1

2 Governance Firms must make determinations and judgment calls, which will need to Be documented as policy (and consequently given effect by supporting process and assurance mechanisms) Be subject to review, annually or more often if exposure profiles change Evidence sanction by the Board (or the Board Audit Committee) and Withstand scrutiny by auditors and supervisors (see Latest Updates: IFRS9 Policy and Interpretation at ) To be compliant with IFRS 9, firms will need to analyse their business lines and their related business objectives according to the new classification rules, in order to determine the treatment of expected losses. This applies to virtually all types of financial assets and off-balance sheet exposures. Objective of Impairment Requirements The objective of the impairment requirements is to recognise lifetime expected credit losses for all exposures for which there has been a significant increase in credit risk since initial recognition - whether assessed on an individual or collective basis - considering all reasonable and supportable information, including that which is forward-looking. So, at least as frequently as each reporting date, firms must assess whether the credit risk on an exposure or group of homogenous exposures has increased significantly, since origination. Expected Credit Loss Calculation Institutions may initially set ECL parameters at business model (portfolio/product) level. These parameters are applied at the account level to calculate the ECL. Users can also change these values for an account before calculating the ECL, giving a reason for the change: KnowCo Limited, All Rights Reserved 2

3 When information that is more forward-looking than past due status (either on an individual or a portfolio/business-line basis) is not available without undue cost or effort, a firm may use past due status alone to determine whether there have been significant increases in credit risk since initial recognition. Caution: EU institutions should be aware that the EBA IFRS9 guidelines say credit institutions should avoid using it [the 30+ days past due 'rebuttable presumption'] as a primary indicator of transfer to lifetime ECL. So you should have other indicators of significant increase in credit risk documented in your credit risk management policies and procedures. Credit Impairment The IFRS9 3-stage approach is based on the change in ECL since origination. Exposures may move through the three stages if and as credit quality changes: Stage 1 includes financial instruments that have not had a significant increase in credit risk since initial recognition, or that have inherent low credit risk. For these exposures, 12-month ECL is recognized - the expected result from the default rate predicted as most likely in the forthcoming year. Interest revenue is calculated at the effective interest rate on the carrying amount of the exposure, without reduction for ECL. Stage 2 includes exposures that have had a significant increase in credit risk since initial recognition. For these exposures, Lifetime ECL is recognized, but interest revenue is still calculated on the gross carrying amount. Lifetime ECL is the expected credit loss for the life of the exposure - the weighted average credit losses with the deemed probability of default (PD) as the weight, discounted to present value at the EIR. KnowCo Limited, All Rights Reserved 3

4 Stage 3 includes exposures that have objective evidence of impairment at the reporting date. For these exposures, lifetime ECL is recognized but interest revenue is calculated, at the EIR, on the net carrying amount (i.e. net of ECL and any write-off). Important Note: Note the difference between ECL status and Impairment status not a direct relationship. Impairment relates to counterparties and groups of financially interdependent counterparties, whereas ECL is applied at account level. You may have little or no ECL in respect of a heavily-impaired counterparty (strong collateralisation) and significant ECL in exposures at Stage 1 impairment (high-risk, uncollateralised products). Write-Off and Recovery The solution captures all write-offs and any subsequent recoveries, for accounting, MI and FINREP reporting purposes. Write-off is a derecognition event and the carrying amount of the asset is therefore reduced by the amount of the write-off. As ever, the reason for the intervention and the ID of the person making the change are both captured Regulatory Reporting In the EU there is mandatory FINREP reporting. The UK PRA has specified 6 quarterly FINREP reports for even the smallest institutions (assets under 5bn) which the KnowCo solution produces. KnowCo s IFRS 9 solution The KnowCo IFRS 9 solution is built upon its mature stress testing engine KST which captures data at a cash flow level of granularity. It then applies the business rules that determine IFRS9 exposure classification and measurement, impairment and reporting values. These are calculated using expected loss parameters and then present-valued at the Effective Interest Rate, which is calculated taking into account attributable fees and costs. The place where IFRS9 lives, in your firm Our solution provides the essential infrastructure and functionality required by IFRS9 for any firm: the place where data is stored (potentially large volumes, over long periods), where the Effective Interest Rate is calculated into which the 12-month and Lifetime probabilities of default, and the loss-given-default, credit conversion factor and exposure-at-default percentages are fed, in order to be able to calculate expected credit losses, KnowCo Limited, All Rights Reserved 4

5 where nominal ECL values are present-valued at the EIR to give discounted values for accounting and reporting purposes. where parameters are set for automatic movement between impairment stages, according to each institution s own business rules, where portfolio-level Impairment Stage and ECL can be overridden, for individual counterparties and accounts respectively (by those authorised to do so), where the regulatory reporting categorisation (for e.g. FINREP 5.1 as below) is set and maintained, from which regulatory returns and internal MI are produced. In the screenshot above you can see FINREP 5.1 Loans and advances other than held for trading generated, together with a drill-down version of the same report for detailed analysis. The drill-down is to account level (bottom-right). K-IFRS9 is completely transparent to end-users. Practical Answers In the course of building the solution we have addressed the many practical and operational issues which will arise for all firms in complying with what is in essence a high-level, principles-based Standard long on what to do, but short on how to do it. For example, we ve built-in standard functionality such as Stage 3 impairment at 60+ days past due, but we ve parameterised those functionalities, so that users can flex them to align with whatever their policy might be. Once ECL calculations are completed, disclosures and reporting can be produced in accordance with the required FINREP (or other) returns, with annual disclosure and internal management information reports also available. KnowCo Limited, All Rights Reserved 5

6 All source data, together with retained results data, is stored in the solution s rich database, located on the client institution s servers. Our IFRS9 database is loaded automatically by K-ETL (extract, transform and load) code written by KnowCo developers for each client, according to the data sources provided and the data mapping agreed between KnowCo and the institution. KnowCo consultants work with each client firm to configure the solution. The history of changes, and what, why and who did them, are stored in the system and can be viewed for each portfolio, account number, client or counterparty. Why KnowCo s IFRS 9 solution? A proven, robust platform housed on your servers Business Model classification according to each firm s business lines Automated data loading, eliminating spreadsheet risk Automated determination of Effective Interest Rate Automated ECL calculation and present-valuing at general (business line) and specific (account) level, according to each client s business rules Manual override to individual impairment levels and ECL All overrides must carry a justification before the system will record them. A full access/activity log is kept. KnowCo Limited, All Rights Reserved 6

7 This screenshot shows the system capturing a partial write-off (for reporting purposes you need to distinguish between partial and total write-offs). All such actions are available to authorised users only and in every instance a reason for the action is captured otherwise the operation can t be completed Captures all history to track and report changes and trends in ECL per portfolio, via MI and all required regulatory reports such as FINREP Both system and MI highly configurable-to-client Deep domain expertise, aimed at total compliance Support for policy, process and assurance alongside a complete technical solution. Authorised users can change, at individual account level, any or all of 12-month PD, Lifetime PD and Exposure at Default, Credit Conversion Factor (off-balance sheet exposures) and Loss Given Default the factors which drive Expected Credit Losses. Again a reason must be captured, and a full history is maintained in the database Call to Action Since we established KnowCo 7 years ago, we have supported almost 40 institutions in successfully meeting regulatory challenges of all kinds. Contact us now for an informal, confidential discussion about your own IFRS 9 project, and how we can help. Please visit for more IFRS 9 resource or contact Paul Ashton, Director, at paul.ashton@knowco.co.uk or call him on +44 (0) KnowCo Limited, All Rights Reserved 7