By Jeroen Van Doorsselaere, Director, Business Development, Global Finance and Performance.
On the road to IFRS 9 implementation, the Transition Resource Group for Impairment of Financial Instruments (ITG) was founded as a discussion forum to provide support for stakeholders on implementation issues arising on the new impairment requirements following the issue of IFRS 9 Financial Instruments. At the end of last year this group had an extensive and, it appears, productive meeting addressing various topics around impairment. Some important findings are included in the below:
- The first finding was around the definition of what is meant by forward-looking information in a multi scenario context. Firstly, it was confirmed that IFRS 9 does require a multi scenario approach and that the sources for macro-economic or forecasted figures should not be based on a single scenario but a probability weighted scenario. Only taking the main economist scenario for forecasting into account will not be sufficient unless it is a probably weighted outcome of different expectations. However, it is not necessary to identify every scenario and it is advised not to select unlikely scenarios within this analysis. Furthermore, the IASB still expects at least one scenario included that is expecting to default, even if historically or presently there is no indication that a default will occur.
- The second issue that was raised was regarding expected lifetime of financial contracts. Within the standard it is clearly mentioned that the expected time a financial asset is exposed to credit risk and not longer than the contractual lifetime can be taken into account with the exception of contracts that can go beyond the contractual lifetime as consequence of their nature such as guarantees and commitments.
This also means that for these off-balance sheet items one should take the lifetime of the assets which is not offset by any credit enhancements or mitigations itself, even if this is beyond the contractual lifetime. It seems that identifying the expected lifetime is somehow one of the most difficult nuts to crack for preparers. The start date of the expected lifetime should be seen as the reporting date which was formerly stated by IFRS 9, whilst the end date is really dependent on the nature of the financial assets, which raises more questions. For example several issues were raised how to solve the many practical difficulties in the case of more complex financial contracts such as revolving credit facilities, credit cards and credit lines. One such difficulty that was discussed was that despite the fact that a credit card can be stopped with a one day notice period, in practice this only happens at a certain moment in time (e.g. 60 days). As a result, preparers should take into account potential cash outflows for the next 60 days for the calculation of expected credit losses. So it seems that the expected period should be used rather than the legal period.
- The third issue that was handled relates to credit enhancements, such as underlying guarantees, collateral and insurance contracts. In principle the enhancements that can be taken into account should be part of the contractual terms and not recognized by the entity separately. The ITG has concluded that the confusion lies more in the fact that there are two types of enhancements. There are enhancements which are measured and administrated as part of the P&L such as a credit default swaps. And there are enhancements which will adjust the cash flows of a contract but do not contribute to P&L adjustments as they reside off balance until triggered. The first group should be excluded as this would encounter double counting in the P&L while the second group should be included in the expectations, as they are part of the cash flows that an entity is expected to receive.
Postponement of narrow scope amendments
Meanwhile, it's also worth noting that the IASB decided to not amend the narrow scope adjustments proposed on IAS 28 and IFRS 10 regarding investment entities. The major reason for this was because while the IASB was making adjustments for these investment entities by excluding them from the consolidation requirements, it also decided that these amendments should be put in a broader changes framework. It has been decided that these narrow scope amendments no longer need to be finished by 2016 but will have a mandatory application when a broader review of these standards become effective. This would avoid the need for financial institutions to update their process twice in a short time frame as other amendments to the standard will be needed.
Current insurance standard amended
Finally, the IASB has decided to make amendments in the IFRS 4 standard to enable insurers to delay the implementation effects of IFRS 9 and bridge several difficulties that have arisen from not matching effective dates within the new insurer standards. In principle it will add amendments for the existing standards giving insurance companies a disadvantage of having to deal with volatility in their balance sheet between the two effective dates. To address this this amendment to be effective when IFRS 9 becomes effective in 2018; insurance companies are offered two alternative options. The overlay approach and the deferral approach.
- The overlay approach will still need the application of IFRS 9 and by consequence the implementation of the IFRS 9, but it will defer any P&L effect for insurance contracts due to the IFRS 9 implementation and park them in retained earnings until the new IFRS for insurance is released.
- The deferral approach will defer the implementation of IFRS 9 but no later than 2021, meaning that insurance companies will not need to apply IFRS 9 at all.
The "big if" in this respect lies within the fact that this is for insurance companies and not for universal banks or banks which also have an insurance business. This means that a lot of banks with an insurance business will not be in scope for this exemption. For pure insurance firms, however, this will indeed be a relief.
The latest ITG statement will no doubt clarify several items in terms of financial institutions, preparations of IFRS 9 standards onto their portfolios. However it seems that for quite some financial institutions the way to be fully IFRS 9 compliant is still far from its goal. The ITG hope to ease the functional impracticalities and speed up this process. After all IFRS 9 is principle-based and the way the principles are interpreted are up to the financial institutions and their auditors to state which makes the IFRS 9 implementation process not only a system implementation but also a policy writing process. The road to 2018 is maybe closer than expected.