www.pwc.ie/banking
IFRS 9 Implementation
Challenges
22 October 2014
Agenda
1. Background to IFRS 9: The project and timetable for implementation
2. Classification and measurement
3. Overview of Expected credit losses in IFRS 9
4. Implementation Challenges
5. Conclusions
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 2
Background to IFRS 9: The project
and timetable for implementation
1
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 3
Effective date and transition
Overview
• The effective date will be for annual periods
starting on or after 1 January 2018.
• Retrospective application is required except:
- If on transition application requires
undue cost or effort, operational
simplifications are provided.
- No requirement to restate comparatives.
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 4
How well are banks positioned currently?
IFRS 9 - current status and emerging practice
IASB
EU / EFRAG
• IASB published IFRS 9 on
24 July 2014
• Endorsement process not yet
started
• IFRS 9 is mandatory from
1 January 2018
• EFRAG/EU are currently
constituting the respective bodies
• IFRS 9 needs to be applied in
entirety, except for the OCI
treatment of OCS of financial
liabilities in FVO
• Endorsement process not
expected to start before the end of
2014
• Early application is allowed
(endorsement required in the EU)
• Endorsement process of
comprehensive standards such as
IFRS 9 usually takes 12 months or
longer
Emerging Practice
• The level of effort to date has
been mixed. Most banks have
closely followed the
development of IFRS 9
• Many banks, particularly in
Germany, have already
conducted high-level impact
assessments on IFRS 9
Classification & Measurement
and ECL. Many banks are now
starting implementation
projects.
• Others are adopting a wait-andsee approach.
Having established an effective date for IFRS 9, banks are taking stock on the impact of IFRS 9 and
their approach to implementation
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 5
Classification and measurement
2
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 6
Classification and measurement of financial assets
Overview of three categories
Amortised cost
Fair value – OCI
Fair value – P&L
•
Hold to collect; and
•
•
•
Solely payments of
principal and interest.
Hold to collect and
sell; and
•
Solely payments of
principal and interest.
Amortised cost
FV-OCI
Residual category.
FV-PL
Key question is where these lines are drawn.
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 7
Why is classification & measurement important to
Expected Credit Loss determination?
• Classification under IFRS 9 for
investments in debt instruments is driven
by the entity’s business model for
managing financial assets and their
contractual cash flow characteristics.
• A financial asset is measured at
amortised cost if both of the following
criteria are met:
 The asset is held to collect its
contractual cash flows; and
 The asset’s contractual cash flows
represent ‘solely payments of
principal and interest’ (‘SPPI’)
Key issues impacting on ECL:
• Reclassifications of assets and/or
portfolios are highly likely to occur, as
the criterial for classification &
measurement are very different.
• A single entity can have more than one
business model for managing similar
financial instruments.
• For example, an entity can hold one
portfolio of mortgages in order to collect
contractual cash flows and another
portfolio of mortgages (with similar
characteristics) that it manages in order
to sell/or to realise fair value changes.
Classification changes, especially from AC to FVOCI or FVTPL will directly
impact on the determination ECL and thus impact regulatory capital.
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 8
Key challenges for IFRS 9 implementation
Challenges
• Definition of BM by senior management
• Selling decisions with impact on accounting
• Processes and systems required to document BM
and reasons for sales
• Use of existing BM documentation and portfolio
structures as starting point
• Informing SM about requirements and strategic
options (e.g. on transition date)
• SPPI assessment at instrument level
• Required information not available
• Business units to be included
• Improvement /implementation of systems
• Clustering & use of efficient questionnaires
• Training of business units
• High quality FV needed for (structured) loans
• FV needed for modified loans
• May result in P&L and Equity volatility
• Implementation of FV models for loans
• Improvement of existing IT systems
Transitional
impacts
• Availability of data on transition
• Determining opening position impacts
• FV may be needed for loans currently at
amortised cost
• Identify data gaps and capacity of existing IT
systems
• Deploy simulation tools to identify and quantify
impacts
• Develop, build and test FV models for loans
Disclosures
• Reconciliation between IAS 39 measurement and
new measurement categories under IFRS 9.
• Additional qualitative and quantitative
information is required to be disclosed.
• Need to communicate clearly to investor base.
• Mock up of disclosures
• Regular contact with regulators and investors
• Potential for national disclosures and / or
guidelines
Business model
C&M Considerations
Mitigation
Contractual
cash flows
Fair value
measurement
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 9
Overview of Expected credit losses in
IFRS 9
3
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 10
IFRS 9 Expected credit loss model
Scope
Overview
• Financial assets at amortised cost
• IFRS Expected loss model not same as
Regulatory EL model (i.e. not TTC).
• Financial assets (debt instruments) at
FVOCI
• Loan commitments
• Financial guarantee contracts
• Lease receivables and trade receivables
or contract assets
• Modified financial assets
• Responsive to changes in information
that impact credit expectations.
• It is inappropriate to recognise full
lifetime expected credit losses on initial
recognition of financial instruments,
except for the simplified approach for
trade and lease receivables.
• Significant increase in credit risk leads to
recognition of lifetime losses.
• IFRS 9 EL model is data intensive.
• Convergence between US GAAP and
IFRS has not been achieved.
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 11
Expected credit losses
General model
Change in credit quality since initial recognition
Recognition of expected credit losses
12 month expected
credit losses
Lifetime expected
credit losses
Lifetime expected
credit losses
Effective interest on gross
carrying amount
Effective interest on amortised
cost carrying amount
(i.e. net of credit allowance)
Interest revenue
Effective interest on gross
carrying amount
Stage 1
Performing
(Initial recognition*)
Stage 2
Underperforming
(Assets with significant
increase in credit risk since
initial recognition*)
Stage 3
Non-performing
(Credit impaired assets)
*Except for purchased or originated credit impaired assets
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 12
Expected credit losses
General model
Definitions
12-month
expected credit
losses
Are a portion of the lifetime expected credit losses and represent
the amount of expected credit losses that result from default
events that are possible within 12 months after the reporting date.
Lifetime
expected credit
losses
The expected credit losses that result from all possible default
events over the life of the financial instrument.
Credit loss
The difference between all principal and interest cash flows that
are due to an entity in accordance with the contract and all the
cash flows the entity expects to receive discounted at the
original EIR.
Expected credit
losses
The weighted average of credit losses.
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 13
Expected credit losses
General model
Expected credit losses
Financial assets
ECL represent a probability-weighted estimate of the difference over the remaining life of
the financial instrument, between:
Present value of cash
flows according to
contract

Present value of cash
flows the entity
expects to receive
Undrawn loan commitments
ECL represent a probability-weighted estimate of the difference over the remaining life of
the financial instrument, between:
Present value of cash
flows if holder draws
down
IFRS 9 Implementation Challenges
PwC

Present value of cash
flows the entity
expects to receive if
drawn down
22 October 2014
Slide 14
Expected credit losses
General model
Assessment of a significant increase in credit risk
Variation
between
reporting date
and initial
recognition
Maximum
credit risk for a
portfolio
IFRS 9 Implementation Challenges
PwC
Absolute
probabilities are
not sufficient
12 months
unless lifetime
assessment is
necessary
Probability of
Default
(‘PD’)
Counterparty
assessment
22 October 2014
Slide 15
Expected credit losses
General model
Expected credit losses
• An entity’s estimate of expected credit losses must
reflect:
– the best available information.
– an unbiased and probability-weighted estimate of
cash flows associated with a range of possible
outcomes (including at least the possibility that a
credit loss occurs and the possibility that no credit
loss occurs).
– the time value of money.
• Various approaches can be used.
• An entity should apply a default definition that is
consistent with internal credit risk management purposes
and take into account qualitative indicators of default
when appropriate.
90 days past
due
rebuttable
presumption
However…
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 16
Expected credit losses
General model
Information to take into account for assessment of increased credit risk
Changes in
external market
indicators
Changes in
business
Changes in
internal price
indicators
Changes in credit
ratings
Other qualitative
inputs
Changes in
operating results
30 days past
due
rebuttable
presumption
However….
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 17
Expected credit losses
General model
Regulatory PD vs IFRS 9 PD
IFRS 9 PD
Regulatory PD
Through the cycle
(‘TTC’)
IFRS 9 Implementation Challenges
PwC
Hard to reconcile both!
Point in time
(‘PiT’)
22 October 2014
Slide 18
Expected credit losses
General model
Discount rate and operational simplifications
Discount rate for calculating the expected credit losses
• Effective interest rate or an approximation thereof.
Operational simplifications
• Low credit risk: the loss allowance for financial instruments that are deemed low credit
risk at the reporting date would continue to be recognised at 12-month ECL.
Simplified approach for lease and trade receivables
• For trade receivables or contract assets that do not contain a significant financing
component: Relief from calculating 12-month ECL and to assess when a significant
increase in credit risk occurred. Lifetime ECL throughout the trade receivable’s life.
• For lease receivables and trade receivables or contract assets that contain a significant
financing component: Accounting policy choice to apply simplified approach to
measure loss allowance at lifetime ECL on initial recognition.
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 19
Expected credit losses
Disclosures
Quantitative
Qualitative
Reconciliation of
opening to closing
amounts of loss
allowance showing
key drivers of
change
Write off, recovers
and modifications
Inputs,
assumptions and
estimation
techniques for
estimating ECL
Write off policies,
modification
policies and
collateral
Reconciliation of
opening to closing
amounts of gross
carrying amounts
showing key drivers
of change
Gross carrying
amounts per credit
risk grade
Inputs, assumptions
and estimation
techniques to
determine
significant increases
in credit risk and
default
Inputs, assumptions
and techniques to
determine credit
impaired
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 20
Implementation Challenges
4
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 21
Impairment: Implementation challenges
Components
Portfolio
segmentation
Transfer
criteria
Maturity
Expected loss
modeling
Forward
looking data
Implementation challenges
• Determine segmentation criteria.
• Consider existing models and data availability for various portfolios
• Criteria for low credit risk
• Definition of trigger events
• Significant deterioration in credit
• Contractual term Vs behavioral
• Consideration of prepayments and others
• Determination of models for 12 month and lifetime expected loss
• Discount rate
• Economic overlay
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 22
Impairment: Key considerations
Governance
Technical analysis and
interpretation
Lack of comparability /
benchmarks
Modelling assumptions/inputs,
validation and outputs
Views of regulators
Disclosures
Others
Controls considerations
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 23
Impairment : Models to be developed
Portfolio coverage (by model)
Expected loss – 12 months EL,
lifetime EL
Significant deterioration of credit
Important questions
• Has the entity appropriately segmented its portfolios?
• How is it determined that the various models are appropriate?
• How strong is the model governance framework?
• Is there a consistent basis for model development, validation and documentation?
• Is there an appropriate benchmark?
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 24
Impairment : Level of modelling
3
Advanced
3
Advanced approach
• Robust models to incorporate forecasts of
macroeconomic conditions used to adjust loss curves.
• Loss curves exist for PD, LGD and EAD and are updated
both by internal and external data
2
1
Specific issues
Intermediate
• Challenging to explain to senior management and
investors
• Consistence roll out of economic scenarios
• Significant overheads
Basic
1 Basic approach (?)
• A simplified approach to ECL by using management
judgment to determine provision rates
Specific issues
• How to evaluate that management judgment is
accurate and correlated to historical data
• Is it acceptable under the standards and with the
regulators ?
IFRS 9 Implementation Challenges
PwC
2
Intermediate approach (?)
•
•
•
•
Model PD using simple statistical averages.
LGD assumptions are flat
Loss curves are generated using external benchmarks
Economic forecasts included as a management overlay
Specific issues
• Substantiate economic overlays
• Insufficient details in development of PD
22 October 2014
Slide 25
Impairment : Leveraging existing credit infrastructure
Banks will consider leveraging existing infrastructure
- Improves efficiency and minimise rework
- Align with regulatory model
- Leverage internal control framework
Transfer criteria
• Significant deterioration
Specific issues and audit concerns
• What is considered as significant credit deterioration ?
• How can you demonstrate consistency?
• What are the controls over application of significant
deterioration?
Term structures
• Development of lifetime EL, term
structure for PD, LGD and correlation
Economic overlays
• Consider economic forecasts based
on past events, current conditions
and reasonable forecasts of future
events
IFRS 9 Implementation Challenges
PwC
• How to model life time PD and LGD leveraging on
existing regulatory and credit models?
• How to perform back testing with limited availability of
data ?
• How to determine what economic overlays to be applied
?
• How do you judge and evidence the “right economic
conditions” and forecasts of the future?
22 October 2014
Slide 26
Default ('PD')
Default ('LGD')
Loss Given
Probability of
Impairment - Leveraging existing Basel methodologies
IFRS 9
Basel III
• PD estimated over 12-month horizon for Stage 1;
Lifetime loss calculation for Stages 2 and 3
• PD estimates are ‘point-in-time’ measures
• Definition of default - may adopt regulatory definitions
• Considers forward looking estimates at balance sheet
date
• 12-month PD estimation
• PD estimates is mostly based on ‘through-thecycle’ measures
• Regulatory overrides
• Routine use of stress testing and scenario
analysis to calibrate
IFRS 9
Basel III
• Current LGD
• Discount rate should be at effective interest rate
• Collateral valuation and disclosures for financial
instruments with inherent objective evidence of
impairment.
• Downturn LGD estimates
• Consideration of certain costs and LGD floors
• Discount rate based upon weighted average
cost of capital or risk-free rate
• Treatment of collateral is subject to detailed
rules, haircuts etc
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 27
Impairment – Data requirements
Key considerations
•
Identify the new data requirements
How has firm developed processes to collate data
from the other systems?
•
Which systems will the data come
from - existing finance reporting
systems and others?
Has finance engaged with other business unit to
understand the data impact?
•
•
Data sourcing from different
systems may not be subject to same
level of controls and governance
Identification of appropriate data
from right systems
Has the firm determined the level of automation
required to produce the required disclosures in the
financial statements ?
Has the firm considered the controls over systems
typically outside the statutory audit ?
How to develop process to maintain and update
the newly required qualitative/assumption
disclosures ?
How comfortable is the firm with the completeness
and accuracy of loan level data?
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 28
Impairment - Control and governance considerations
Business
model
• Business models reflect the impact of the IFRS 9
Systems
• Alignment of risk and finance systems?
• ECL models feedback into other strategic processes (e.g. capital management, pricing, stress
testing, etc).
• Remapping of lines and accounts within the general and sub ledgers
• Common chart of accounts and data definitions across all parts of the business.
Data quality
• Single data source at required granularity, with full drill down capability and validation of data
• Frequent testing and maintenance of new data models
• Automation of data controls
Process
• Fully defined processes for identifying the provisions and how they relate to the business units,
product pricing and strategy.
• New credit risk monitoring processes to incorporate system solution to the generation of
accounting information.
Controls and
Governance
• Circulation of management reports in a timely manner
• Governance and controls over areas not currently subject to statutory audit (e.g. Risk and
regulatory data)
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 29
Conclusions
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 30
Key challenges for IFRS 9 implementation
•
•
•
•
Affected
functions
• IFRS 9 impacts the whole group: Group
Finance, Risk, GTO, regional finance,
legal entities, business units (CB&S, GTB,
PBC, AWM, NCOU), senior management
• Early inclusion of all potentially affected
functions
• Clear responsibilities, communication
and understanding of impacts
Interactions
with other
projects
• Technical overlaps (e.g. with FinRep,
BCBS239, CRD IV, IT projects)
• Potential resource conflicts
• Unaligned project time lines
• Identification of all technical and content
overlaps
• Integrated project set up
• Early decisions on interdependencies and
leverage
Data
• Availability and collection of data
• Data definitions
• Control and assurance environment
• Early data gap and quality analysis
• Ability to leverage existing data and
processes
Capital impacts
• IFRS 9 impacts the accounting and
regulatory capital
• Simulations and strategic policy and
business choices
• IFRS 9 phrases certain requirements
more clearly than IAS 39 (e.g.
modifications)
• IFRS 9 implementation could be used to
solve issues existing under IAS 39
• Identification of requirements and
chances to improve accounting
• Solving overlaps with other requirements
(e.g. forbearance, post AQR topics)
• Manage “scope creep”
IFRS 9 Implementation Challenges
PwC
• Full transparency of external and internal
factors to be able to make the right
decisions
• Project governance
• Budgeting & timing (target application date)
• Communication and presentation of strategy
Strategic
decisions
IAS 39
burdens
Quality of implementation
Systems and data landscape
Resources and timing
Materiality
Mitigation
Project set up
Overall
Challenges
22 October 2014
Slide 31
Key lessons learned from on-going engagements
with our clients
Lessons learned from the implementation projects completed to date:
•
Simulation of the quantitative impacts is complex but necessary. The data required to run a fully
compliant IFRS 9 EL model is considerable. PwC have experience of running our diagnostic Simulation Tool in over
35 banks of different environmental complexity with varying levels of available data.
•
The transfer between buckets is highly judgmental. Banks need to develop practical policies and guidelines
to inform these judgements.
•
Identification of data gaps is critical. The EL model is data intensive. Early effort is needed to identify data
gaps and then consider practical solutions to collect and control the necessary data;
•
IFRS 9 impacts are pervasive. IFRS 9 impacts on lending, underwriting and pricing, accounting and reporting,
capital and return on equity.
•
Potential to release synergies and efficiencies. It may be possible to leverage existing credit risk
methodologies and processes to comply with IFRS 9 requirements without incurring undue cost or effort.
•
Implementation needs to be controlled. PwC has in-depth IFRS 9 project management experience and skills,
including role allocation and issue resolution experience. We can help you ensure implementation is controlled and
achieved in an orderly and efficient manner.
•
IFRS 9 is of strategic importance. The strategic impacts of IFRS 9 can be considerable and therefore it is
important to understand the impact on the banks business and plan potential responses.
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 32
Questions?
IFRS 9 Implementation Challenges
PwC
22 October 2014
Slide 33
Thank you for your attention
John Kelly
Senior Manager,
Banking & Capital Markets
T: +353 (1) 792 8903
M: +353 (87) 244 0162
john.j.kelly@ie.pwc.com
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