IFRS 9 Moving Forward 2015
Contents Page 1. Overview on IFRS 9 Standard 3 2. IFRS 9 Impairment Methodology (vs. IAS 39) 4 3. How Does it Impact you? 5 4. What are the Major Challenges? 7 5. What are the implementation Timelines? 8 6. How Athena can help? 9 7. Contact Details 10 Page 2
Overview on IFRS 9 Standard 1 In 2014 the IASB published a significant change to the standard in the form of IFRS 9, replacing IAS 39 guidelines. There are three main phases with the major change in the impairment recognition where earlier it was all based on trigger events, now you must make provision for current exposure and expected lifetime losses in your portfolio(s). Classification and Measurement Impairment Hedge Accounting Financial instruments are classified and measured via amortized cost (or fair value) using corporate model and cash flow characteristics. Moving from incurred loss approach to the expected losses approach based on forward looking information Merging standards between risk and accounting department in order to align the risk strategy with the accounting standard. In-scope In-scope Separate Project What trigged this, the 2008 financial crisis? A number of financial institutions globally were found to have delayed recognition of credit losses on loans, identifying a weakness in the old standard and forcing change from IAS 39 to IFRS 9. The new standard has brought with it lots of debate, not least how the new standard will interact with the Basel III accord and Capital levels. Also what is lifetime for each product? Fixed term loans, credit cards, mortgages, overdrafts and the many new and innovative offerings coming from across the industry all need to be modelled through to ensure that adequate provisions are made but also that your business remains competitive verses another institutions interpretation. The new IFRS9 standard will considerably increase the workload across various functional groups, especially in Finance and Risk. Adoption of the IFRS 9 Impairment Expected Credit Loss Methodology is an area of expertise for our Analytics department. Athena Consultancy brings an experience in the impairment modelling of both unsecured and secured retail portfolios, which can be tailored to the organization requirements. Using our experience, gained over numerous years of forecasting expected credit losses and dealing with regulatory change, we can help institutions to accelerate the implementation of IFRS 9 before the mandatory effective date of 1st January 2018. Page 3
IFRS 9 Impairment Methodology 2 Replacing IAS 39 with IFRS 9 will materially impact the institution s financials, the maximum impact being the impairment calculations. For impairment modelling, IFRS 9 requires a 12-month expected credit loss to be recognised on day 1. Thereafter, an entity should assess whether the credit risk of a product has significantly increased since initial recognition or not. If credit risk increased significantly then recognize lifetime expected credit losses. Treatment/Accounting Standard IAS 39 IFRS 9 Stage 1 - At Initial Recognition No Recognition 12 Month Expected Credit Loss VS. IAS 39 Stage 2 - Significant Increase in Credit Risk No Recognition Lifetime Expected Credit Loss Stage 3 - Credit Impaired Lifetime Expected Credit Loss Lifetime Expected Credit Loss IFRS 9 expected loss model segment the Loans and Loan commitments that are not measured at fair value through profit or loss into three stages. Stage 1: Performing assets not subject to significant increase in credit risk since initial recognition recognise 12 months of expected losses. Stage 2: Assets where the credit risk of the assets has increased (or credit quality deteriorates) significantly and the resulting credit quality is below investment grade full lifetime expected credit losses would be recognised. Stage 3: Assets where the credit quality of the asset has deteriorated to the point that credit losses are incurred or the asset is credit-impaired full lifetime expected credit losses would be recognised. Page 4
How Does it Impact it you? 3 Implementing IFRS 9 to the standard required will be an expensive, composite and will have a business wide impact on multiple departments; Finance, Risk, Technology Infrastructure and Engines. Complexity and extent of the IFRS 9 implementation will be the significant challenge. Managing Stakeholder expectations and intra-department coordination will prove to be a major test. Skilled resources required for the successful implementation can prove to be a challenge due to the inadequate talent pool and high parallel demand from all other institutions. Tapping on to the existing resources and training new ones will prove to be a key to success. Data and IT platforms will be critical for the Impairment modelling and implementation. Extensive coordination would be required within departments to lessen potential future delays due to the implementation of other regulatory requirements like Basel IRB. Detailed disclosure requirements are meant to increase the transparency to the investors, regulators and other stakeholders, and help to understand the important drivers for impaired assets. Dry/Parallel run of 1 year will be required to provide buffer for resolving issues before the standard goes live for generating the comparatives and provisions. IFRS 9 new impairment approach is a major departure from the previous standard. This will prove to be the major challenge to make the models forward looking and capture the movement from Stage 1 to Stage 2. Implementation Requisite Reporting & Disclosures Financial Effect Is it too late? Understanding of the impacts on the portfolio is critical to ensuring the right adjustments are made in the business (product pricing) and reporting before IFRS 9 goes Live. Successful implementation of IFRS 9 will take 24 months to 48 months depending on the complexity of the financial institutions. Existing risk models in the institution can be leveraged for IFRS 9 implementation but the detailed impact analysis would be required to map the existing processes and formulate the roadmap for IFRS 9 implementation. Page 5
How Does it Impact you? 3 Implementation of IFRS 9 impairment models will have a significant business-wide impact on the multiple stakeholders, where there will be a direct impact on the impairment provisioning which feeds into P&L and secondary but substantial impact on the others covering product pricing, implementation platforms, and considerable increase in workload of multiple departments (especially risk, finance and treasury). Also, assigning the accounts to different stages and providing historical information for disclosures is a new challenge that is not possible in legacy systems and requires an extended data platform. Given the implications of IFRS 9 financial reporting, finance department will be the main stakeholder. But, the risk department will also be the major stakeholder given its part in the credit-impairment calculation. IFRS 9 Risk Finance & Treasury Business & Product Data & Technology Development of new expected Credit loss impairment models Preparing policies and documentation for the models Developing Controls around the process (Monitoring, Validation, Governance, MI and reporting) Increase in P&L volatility would require optimally managing capital and liquidity Reconciliation with the Basel (Pillar 3) and other financial disclosures Cost of funding Modifying risk based pricing to make sure it remains viable post IFRS 9 implementation Change in profitability and product mix Change in strategy and score cut-offs accordingly Evolution of Information systems and databases in order to develop, implement and collect new data for the impairment models Consistent use of data sources across various business functions Reinforce data quality and management Page 6
What are the Major Challenges 4 IFRS 9 impairment standards will bring about several significant changes to the way provisioning is done into the institutions. Impairment models will not only be forward looking but will also capture the lifetime expected losses. There are a number of possible approaches to develop these models but the big difference to deliver it successfully is to tailor it to the organization and respective portfolios. In addition, technical resource constraints are considered as one of the major challenges in IFRS 9 implementation. New Impairment Approach & Existing Risk Model Moving from Incurred loss approach to the expected loss approach would result in the development of sophisticated statistical models which will be forward looking Leveraging existing models like Basel II AIRB models will be difficult as the adjustments will be needed to align it to the IFRS 9 requirements (through the cycle vs. point in time, lifetime vs. 1 year probability of default, conservatism margins, etc.) Data & Information Technology Data quality and incomplete data history is going to prove challenging in the segmentation and development of a robust forward-looking expected loss model Investment in IT will be needed for the implementation of impairment models and generating data for reporting and disclosure requirements Volatility in P&L & Stakeholder management Disclosures & Regulatory Capital Volatility in P&L will increase through the economic cycle due to the introduction of IFRS 9, where the recognition of loss would substantially increase even before the downturn period is recognized Stakeholder management will be important as IFRS 9 impacts the largest number of stakeholders; investors, finance, risk, IT, product, regulatory reporting, etc. Controls and reporting has been identified as a significant challenge in implementing IFRS 9, especially capturing significant increase in credit risk and reconciliation between several financial disclosures and IFRS 9. For several organizations, introduction of IFRS 9 will impact the regulatory capital by increasing the provisions, which is a deduction from core tier 1 regulatory capital under Basel III Page 7
What are the Implementation Timelines? 5 The magnitude of impact of IFRS 9 impairment models roll-out will depend on the several factors but the most important of all is to manage key stakeholders expectations and timely inform them of the financial impact and expected workload in terms of key design choices including model methodology and Stage 2 and Stage 3 cut-offs. 2015 2016 2017 Phase 1 - Evaluation Phase 2 - Development Phase 3 Implementation & Dry Run Planning Costing Governance Business Model Study Stakeholder Management Gap Analysis Data and Existing Models Type of Models and Data Requirement completed Data Architecture Study IT Engagement and Strategy Defined Model Development, Validation and Sign-off Policy Review and Sign-off Reporting and Disclosures Requirements Control/Monitoring/Govern ance Framework System Testing and Implementation IFRS go-live Dry Run for Generating Comparatives Testing Provisions, Controls and Disclosures External Investor Awareness IFRS 9 Effective Date Page 8
How Athena can help? 6 Gap Assessment Impairment Modelling IT requirements /Dry Run Reporting & Disclosure DELIVERY OFFERING Athena have extensive experience of Impairment modelling, where we can help the organization to roll-out IFRS 9 Impairment models tailored to their needs. 1. Initiation and structuring of programme 2. Providing a training session on the implications of the new proposed standards (vs. Current IAS 39) 3. Gap analysis on Data, Methodology and Disclosure requirements 4. Preparing an inventory of all risk models available for the new standard 5. Preparing the essential modifications to be made to the Basel 2 models in order to meet the new standard (TTC vs. PD for PD, lifetime vs. 12 months PD, neutralization of conservatism margins) 1. Development and Validation of methodology and models covering the following 2. Transition Criteria (from Stage 1 to Stage 2) 3. Lifetime Expected Losses 4. Forward Looking 5. Formulation of policies, controls, monitoring and governance process for the new standard 1. Identifying the IT requirements for the implementation 2. Implementing the models for parallel run 1. Identifying modifications to entity data collection and reporting processes for local and group reporting 2. Redefining the key reporting practices and controls to accommodate the new impairment projections 3. Designing the enduser solution for reporting purpose, management information, audits and regulatory requirements Page 9
Contact Details 7 1. Identifying the IT requirements for the implementation We have practitioners in the methodology, creating the correct 2. data Implementing sets needed the and building all the supporting models now. If you are interested in our services we would models be for parallel very pleased to meet with run you and discuss any aspect of the IFRS9. You can contact us me Chris Kneen on +44 7807 817322 and ckneen@athenacmrs.com. Alternatively, you can contact: Mark Murton: mmurton@athenacmrsconsultancy.com Rahul Choudhary: rchoudhary@athenacmrsanalytics.com Page 10
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