New and revised Standards -Applying IFRS 9 Presentation by: CPA Stephen Obock December 2017

Transcription

1 New and revised Standards -Applying IFRS 9 Presentation by: CPA Stephen Obock December 2017 Uphold public interest

2 IFRS 9 What are the key changes? What are the transition requirements?

3 Presentation agenda Introduction Classification and measurement Impairment credit losses Effect on Kenyan financial sector Disclosures Transition Q&A

4 Introduction The new financial instruments standard will be a momentous accounting change for banks and financial sector. Implementation of IFRS 9 s forward-looking requirements may be challenging and will involve a high degree of judgment. Need for impact assessments & implementation plan to have been completed by now. IFRS 9 is applicable for periods beginning on or after 1 January Q publications should be in compliance status

5 Introduction summary of IFRS 9 will affect expected changes Credit losses Classification and measurement Disclosures Reported credit losses are expected to increase and become more volatile under the new expected credit loss model. The number and complexity of judgments is also expected to increase. How financial assets are classified becomes more judgmental and may affect how capital resources and requirements are calculated. Extensive new disclosures are required system and controls changes will be necessary to capture the required data.

6 Classification and measurement Similar categories: IFRS 9 IAS 39 FVTPL Amortised cost FVOCI FVTPL Loans and receivables/htm* AFS* *Significant changes in criteria for classifying assets. FVTPL Fair value through profit or loss FVOCI Fair value through other comprehensive income HTM Held to maturity AFS Available for sale

7 IFRS 9 Equity and derivative financial asset classification No separation of embedded derivatives Derivative Equity Instrument Yes Yes No Held for trading? No OCI option elected? Yes In separate financial statements, investments in subsidiaries normally carried at cost in accordance with IAS 27 FVTPL FVOCI IFRS 9 removes the exception that allowed certain equity investments (and linked derivatives) to be measured at cost Irrevocable Changes in fair value presented in OCI Dividends generally recognised in P&L No reclassification of gains and losses into P&L on disposal and no impairment recognised in P&L

8 FVOCI election for equity instruments An equity instrument is an contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities (IAS 32) Specific instruments for which this election is NOT available: Investment entities Investments in subsidiaries that are accounted for at FVTPL Venture capital organisations or mutual funds Investments in associates and joint ventures at FVTPL

9 IFRS 9 Debt instruments classification Debt instrument No Are the asset s contractual cash flows solely payments of principal and interest (SPPI)? Is the business model s objective to hold to collect contractual cash flows? Yes FVTPL No Is the business model s objective both to collect contractual cash flows and to sell? Yes No Yes FVOCI Amortised cost

10 The SPPI criterion Cash flows represent, on specified dates, solely payments of principal and interest on the principal amount outstanding Consistent with a basic lending arrangement Definition Principal Interest Fair value of financial asset on initial recognition Consideration for: the time value of money; and credit risk associated with the principal amount Can also include consideration for: other basic lending risks (such as liquidity risk) and costs (such as administrative costs); and a profit margin

11 Impairment the new model Past events Expected loss model + + Current conditions + Forecast of future economic conditions WHAT S NEW?

12 Impairment - high level overview Existing Basel models are a starting point for implementation EL = PD x LGD x EAD Expected loss is a statistical measure used to reflect expectations of future losses based on historical data The three primary components are derived based on observation, empirical evidence and expert judgment The objective is to quantify loss expectations over a 12 month forecast Probability of default for an asset or class of assets over the next year PD represents an average expectation over the course of an entire business cycle (through-the-cycle) as opposed to specific current expectations (point-in-time) Loss given default based on losses resulting from defaults over the next 12 months Ideally the LGD will be separated for secured and unsecured portions of an exposure LGD is a prudent parameter based on an assumed downturn in the economic conditions Exposure at default represents the amount a financial institution stands to lose in the event of a default event For a 12 month horizon, the EAD is defined as the current exposure without considering payments Undrawn commitments are factored in using statistical probabilities of drawing Changes to existing models are necessary to comply with lifetime expected credit loss (LECL) requirements

13 Default not IFRS 9 ECL General model defined Significant increase in credit risk (credit deterioration) since initial recognition 12-month expected loss EIR on gross amount (excl loss allowance) Impairment recognition Lifetime expected loss Interest revenue recognition EIR on gross amount (excl loss allowance) Lifetime expected loss EIR on amortised cost (net of loss allowance) Stage 1 Performing The Good EIR: Effective interest rate Stage 2 Under-Performing The Bad Stage 3 Non-Performing The Ugly 12-month ECLs are the portion of lifetime expected credit losses that represents losses resulting from default events that are possible within 12 months Lifetime ECLs are the expected credit losses that result from all possible default events over the expected life of a financial instrument

14 Impairment Model General model (cont d) Impairment recognition Credit quality deterioration since initial recognition Transfer of individual assets when: No longer Investment Grade and Significant increase in PD since origination Transfer of individual assets from stage 2 to stage 3 when impairment triggers are observed 12-month ECL Lifetime ECL Lifetime ECL Stage 1 Performing Stage 2 Under-Performing Stage 3 Non-Performing

15 Impairment Model General model (cont d) Impairment recognition Credit quality deterioration since initial recognition 12-month ECL Lifetime ECL Lifetime ECL Stage 1 Performing Stage 2 Under-Performing Stage 3 Non-Performing Transfer of individual assets back to stage 1 when criteria above are no longer met (symmetric model) Transfer of individual assets back to stage 2 when asset has recovered from default*

16 IAS 39 versus IFRS IAS 39 versus IFRS 9 Comparison Parameter Expected Loss (EL) or Incurred Loss (IL) Emergence Period (EP) Exposure At Default (EAD) Probability of Default (PD) Loss Given Default (LGD) IAS 39 Incurred Loss Model *Provisioning factors applied to respective arrears buckets or: IL = EAD PD LGD EP EP attempts to strip out the incurred portion from expected loss. Includes the assets carrying value at reporting date. No adjustment for future exposure. Point-In-Time (PIT) PD or a roll rate approach. Usually done using a 1 year outcome period and adjusting for incurred loss via the EP. Point-In-Time (PIT) LGD. It should reflect expectations in terms of recovery cash flows due to credit cycle effects. IFRS 9 Expected Loss model EL = EAD PD LGD Not applied Includes credit conversion factors (CCF s) for unutilised facilities. 12m PD (to estimate 12m EL for performing assets) Lifetime PD (to estimate lifetime EL for underperforming and default assets) Lifetime LGD should be considered through the life of the assets.

17 IAS 39 IFRS 9 Practical example Example of IAS 39 vs IFRS 9 Illustration 5 year loan The table below provides an overview of the PD and EAD assumptions: PD EaD EL 1 Yr 2.5% K K Yr 2.4% K K Yr 2.4% K K Yr 2.3% K K Yr 2.3% K K 1.36 Total K LGD is assumed to be 30% through out the life of the loan, and the emergence period is 3 months (i.e. 25% EP adjustment). Scenario 1: Performing Loan is up-to-date, and there is no indictors suggesting that the loan is under- performing IAS 39 classified as general provision incurred but not expected As per the example above IAS39 provision is K7.50*25% = K1.88 IFRS 9 classified as bucket 1: 12 month expected loss As per the example above IFRS 9 provision is K7.50 Scenario 2: Under-performing Loan is not in arrears but there are indicators suggesting the loan is underperforming IAS 39- classified as general provision incurred but not reported As per the example above IAS39 provision is K7.50*25% = K1.88 IFRS 9 classified as bucket 2: Life time expected loss As per the example above IFRS 9 provision is K21.78 Scenario 3: Under-performing Summary The provision estimate under IFRS 9 is expected to be higher than the requirements under IAS 39. For this example, the main reasons for the higher loss allowance under IFRS 9 are due to: Incurred vs. expected loss estimate; and Lifetime EL for underperforming loans (bucket 2). Loan is in arrears (under performing ) but not in default IAS 39 classified as general provision special mention As per the example above IAS39 provision is K7.50 IFRS 9 classified as bucket 2: Life time expected loss As per the example above IFRS 9 provision is K21.78

18 Effect on the financial sector 1. Increase in credit losses & complexity for preparers IFRS 9 uses a dual measurement approach; 12-month ECLs for assets that have not suffered a significant increase in credit risk since initial recognition and lifetime ECLs for those that have. The expected credit losses (ECLs) model require robust estimates of ELCs and establishing when significant changes in credit risk occur. Its more complex and has impact on systems and controls.

19 Effect on the financial sector 2. Capital requirements & KPIs Equity, regulatory capital and KPIs may be significantly affected as they will reflect ECLs as well as incurred credit losses. Volatility will also increase as external data, such as ratings, credit spreads and predictions about future conditions, will be assessed in the calculation of ECLs.

20 Effect on the financial sector 3. Time and effort to implement Less than 1 months remain until IFRS 9 s effective date. Implementation programmes may be large, complex and expensive, so management, BACs, Boards need to be super-active now.

21 Effect on the financial sector 4. Potential impact on availability of credit Lenders are expected to tighten credit policies. The impact of IFRS 9 and the Interest capping regulation potentially restricts lending to high risk clients and institutions may look for safer investments in government securities.

22 Disclosures -IFRS 7 Scope Classes of financial instruments and level of disclosure Initial application of IFRS 9 Significance of financial instruments for financial position and performance Nature and extent of risks arising from financial instruments Statement of financial position Other Qualitative Quantitative Statement of Comprehensive Income Credit Risk Liquidity Risk Market Risk Significant changes

23 Reclassifications (ii) Remeasurements (iii) Initial application Financial Asset Class: Amortised Cost IAS39 carrying amount closing balance (i) IFRS 9 carrying amount opening balance (iv) = (i) + (ii) + (iii) Retained earnings effect opening balance (v) = (iii) From available for sale (IAS 39) From at FVTPL (IAS 39) - elected, required or revoked by choice To FVTOCI (IFRS 9) To FVTOCI (IFRS 9) - elected or required Total change to Amortised cost

24 Gross carrying amount reconciliation Trade receivables: Gross Carrying Amount 12-month expected credit losses Lifetime expected credit losses Totals Opening balance Changes: - Transfers due to change in credit risk - New financial assets originated/ purchased - Write-offs - Derecognition - Modification - Other Closing balance

25 Loss allowance reconciliation Loss Allowance per Financial Asset Class: Trade receivables 12-month ECL Significant increase in credit risk Lifetime ECL Credit impaired Simplified approach Totals Opening balance x x x x x - Transfers due to change in credit risk - New financial assets originated/ purchased - Write-offs - Derecognition - Modification - Other Closing balance x x x x x Total undiscounted expected credit losses at initial recognition x

26 Effective date and transition Effective date Timeline 1 Jan Jan 2018 Application of IFRS 9 Previous versions of IFRS 9 Early application Possible to continue to apply Complete version of IFRS 9 Issued in July 2014 Early application Mandatory Application of a part of IFRS 9 Only applying own credit requirements IFRS 9 except for hedge accounting Early application Election to continue IAS 39 s hedge accounting requirements

27 Retrospective application & restatement An entity shall apply IFRS 9 retrospectively in accordance with IAS 8 Accounting Policies, Change in Estimates and Errors Except if certain assessments are impracticable 1 Jan Jan 2018 Restate Not restate Retrospective application in opening RE at the beginning of the earliest prior period presented Retrospective application in opening RE in reporting period including DIA

28 Interactive Session