Financial instruments an update on replacing IAS 39 28 January 2014 Financial Reporting Faculty
Introduction Marianne Mau Technical Manager, Financial Reporting Faculty
Introduction Tony Clifford Senior Technical Partner EY Eddy James Technical Manager Financial Reporting Faculty
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Contents Overview & timeline Hedging Classification & measurement Impairment of financial assets
Financial instruments OVERVIEW & TIMELINE
Timeline for IASB financial instruments projects 2009 2010 2011 2012 2013 H1 2013 H2 2014 H1 Effective date IFRS 9 (replacement of IAS 39) Classification and measurement IFRS ED IFRS Impairment ED SD ED IFRS Hedge accounting ED RD IFRS No sooner than 2017 Accounting for macro hedging DP? Other related pronouncements Fair value measurements (IFRS 13) IFRS 2013 Offsetting disclosures (amendments to IFRS 7) IFRS 2013 Offsetting criteria (amendments to IAS 32) IFRS 2014 Novation of derivatives and continuation of hedge accounting (amendments to IAS 39 and IFRS 9) Conceptual framework (comment period closed 14 January 2014) IFRS 2014 DP R? Note DP: discussion paper SD: supplementary document ED: exposure draft RD: review draft IFRS: final standard
Effective date Mandatory effective date IFRS 9 s mandatory effective date is left open pending the finalisation of the impairment and classification and measurement requirements Early application IFRS 9 s own credit requirements available before the completed version of IFRS 9 is issued The above two amendments are available following the publication of IFRS 9 (2013) which also adds the hedge accounting chapter to IFRS 9
Financial instruments HEDGING
Hedging Objective To represent in the financial statements the effect of an entity s risk management activities Key changes Focus shifts from hedging items to hedging risks Should result in more risks being eligible hedged items More economic hedging strategies should qualify for hedge accounting Change in effectiveness assessment
Major changes from IAS 39 (1) More eligible hedged items: Groups of items (including net positions) Layers of groups of items Combinations of exposures and derivatives eg, if hedge FX risk later than, say, commodity risk Components, including for non-financial items eg, contractual: inflation component of sales contract eg, non-contractual: crude oil component of expected fuel oil purchases Less rules-based effectiveness assessment No bright line requirements
The hedge accounting model Define risk management (RM) strategy and objective Identify eligible hedged item(s) and eligible hedging instrument(s) To avoid ineffectiveness, the ratio may have to differ from the one used in RM No Yes Yes 1) Is there an economic relationship between hedged item and hedging instrument? Yes 2) Does effect of credit risk dominate fair value changes? No Base hedge ratio on the actual quantities used for risk management 3) Does hedge ratio reflect an imbalance that would create hedge ineffectiveness? No Formal designation and documentation
Major changes from IAS 39 (2) Rebalancing to adjust hedge ratio without de-designating/redesignating the hedge Equity instruments at FVOCI can be eligible hedged items - Even ineffectiveness is recorded in OCI Time value of options, forward element of forward contracts and foreign currency basis can be accounted for as costs of hedging - Fair value changes recorded in OCI - Recycled to p&l either over time or when transaction is recorded in p&l
Major changes from IAS 39 (3) Fair value option for hedges of credit risk using credit derivatives Fair value option for own use contracts Disclosure of risk management strategy and effect that hedge accounting has on the financial statements Accounting policy choice to continue to apply IAS 39 for all hedge accounting until macro hedging project complete (but new disclosures apply)
Macro hedging Decoupled from IFRS 9 project and DP expected in Q1 2014 The portfolio revaluation approach Revaluation of all assets and liabilities in a portfolio for changes in the managed risk (eg, a benchmark interest rate) Change in revaluation is accounted for in profit or loss Change in fair value of risk management instruments (derivatives) is accounted for in profit or loss Revaluation adjustments are presented together with the fair value changes of the risk management instruments as a net revaluation result
Poll 1 - Will more of your risk management activities qualify for hedge accounting once IFRS 9 is effective?
Financial instruments CLASSIFICATION & MEASUREMENT
Financial assets original IFRS 9 model Contractual cash flow characteristics + Business model test Amortised cost Fair value option Accounting mismatches only All other instruments Equities, derivatives & some hybrid contracts Fair value through P&L Option to take gains & losses to OCI for equities No recycling No bifurcation Reclassification required where business model changes
Financial assets proposed new model Contractual cash flow characteristics + Business model test Hold to collect Hold to collect and sell Amortised cost Fair value through OCI Fair value option Accounting mismatches only All other instruments Equities, derivatives & some hybrid contracts Fair value through P&L Option to take gains & losses to OCI for equities No recycling No bifurcation Reclassification required where business model changes
Examples Amortised cost Straightforward loans and bonds where the objective is holding to collect Includes those with features such as interest rate caps and most prepayment options Fair value through OCI Portfolios where straightforward debt instruments are bought and sold more frequently but that are nonetheless managed on a yield basis Equities if election taken to take gains & losses to OCI Fair value through P&L Debt instruments where the objective is to sell before maturity Hybrid debt instruments with complex features eg, equity or commodity linked interest rates All other equities Derivatives
Financial instruments IMPAIRMENT OF FINANCIAL ASSETS
Impairment of financial assets Strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information G20 Declaration on strengthening the financial system April 2009
From incurred loss to expected loss Incurred loss model Currently used by IAS 39 Credit losses are recognised only if an event has occurred that has a negative effect on future cash flows & that effect can be reliably estimated An entity is not permitted to consider the effects of future expected losses Expected loss model Will be used by IFRS 9 Requires an entity to make an ongoing assessment of expected credit losses Requires earlier recognition of credit losses in many cases
Expected loss model but how? IASB proposals November 2009 Too theoretical Too difficult to apply in practice FASB proposals May 2010 More practical Too conservative Joint proposals January 2011 Combined elements of IASB & FASB proposals No clear conceptual basis
Expected loss model latest proposals No significant deterioration in credit quality since originated or purchased 12 months expected losses Effective interest on gross carrying amount Stage 1: Performing Stage 2: Under-performing Credit quality has deteriorated significantly from that at origination or purchase Lifetime expected losses Effective interest on gross carrying amount Credit quality has deteriorated to the point that credit losses are incurred or the asset is creditimpaired Lifetime expected losses Effective interest on net carrying amount Stage 3: Impaired
Agreeing to disagree FASB Recognise expected lifetime credit losses upfront IASB Recognise expected lifetime credit losses only if a loan has suffered deterioration in credit quality
Expected loss model latest proposals Financial assets credit impaired on initial recognition Includes both originated and purchased creditimpaired assets Use credit adjusted effective interest rate No day 1 allowance balance No day 1 impairment loss recognised Allowance balance represents changes in lifetime loss expectations Trade receivables without a significant financing component Allowance is always lifetime expected losses Practical expedient to enable entities to calculate losses using certain current practices eg, group receivables by age and applying historical loss rates
Poll 2 - Which is the best model for recognising impairment?
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Questions Tony Clifford Senior Technical Partner EY Eddy James Technical Manager Financial Reporting Faculty Topics covered today Overview & timeline Hedging Classification & measurement Impairment of financial assets
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