IFRS 9: Financial Instruments
Background
G20
Financial Stability Board
Financial Crisis Advisory Group
EC Endorsement
ARC meeting 11 November 2009
Endorsement decision deferred
EFRAG draft endorsement advice deferred at least to January 2010
Outcome
Endorsement delayed until at least 2010
EC may wait until the whole package of changes has been completed
• Endorsement 2011?
IASB Project Timetable
Project phase
Exposure draft
Finalisation
Classification and
measurement
July 2009
November 2009
Amortised cost and
impairment
October 2009
2010
Hedge accounting
Q1 2010
2010
Agenda
Scope
Classification and measurement
Embedded derivatives
Permitted options
Effective date and transition
Scope
Unchanged from IAS 39
References to IAS 39 for:
Impairment
Hedge accounting
Agenda
Scope
Classification and measurement
Embedded derivatives
Permitted options
Effective date and transition
Classification
Two measurement categories
Amortised cost
Fair value
IAS 39 categories eliminated
Held to maturity
Available for Sale
Loans and receivables
Amortised cost measurement
Determined on the basis of:
Business model
Contractual terms
Business model
As determined by key management personnel (IAS 24)
Not an instrument by instrument focus
Hold financial assets to collect contractual cash flows
Do not need to hold assets to maturity
Business model - examples
Hold investments to collect contractual cash flows
Can sell in particular circumstances
• No longer meets investment policy
• Insurer adjusts portfolio to match expected timing of payouts
• Entity needs to fund capital expenditure
Business model - examples
Business model is to purchase portfolios of financial assets
May or may not include financial assets with incurred losses
Seek to obtain payment of cash flows
Do not need to anticipate obtaining all contractual cash flows
Entity may also enter into interest rate swaps
Business model - examples
Business model is to originate loans and sell them
Loans sold to a securitisation vehicle that is consolidated
Consolidated entity business model
• Hold loans and collect contractual cash flows
• May qualify for amortised cost measurement
Individual entity business model
• Originate and sell loans
• Do not qualify for amortised cost measurement
Contractual terms for cash flows
Assess on an instrument by instrument basis
Principal
Interest
Specified dates
Interest represents consideration for
Time value of money
Credit risk
Foreign currency
Assess payments on the basis of currency in which the instrument is
denominated
Leverage
Amplifies variability of contractual cash flows
Leverage does not have economic characteristics of interest
Includes derivative contracts
• Option
• Forward
• Swap
Cannot qualify for measurement at amortised cost
Prepayment options
Debtor can prepay
Creditor can demand early repayment
Cash flows may be only principal and interest
Prepayment provision not contingent on future events except to protect
holder against
• Credit deterioration of the issuer
• Changes in taxation or law
• Change in control of issuer
Prepayment represents
• Capital
• Interest
• Compensation for early termination
Extension options
Can result in cash flows of
Principal
Interest on principal outstanding
Conditions
Not contingent on future events
Cash flows in extension period are only
• Principal
• Interest on principal outstanding
Changes in the timing or amount of cash flows
Can result in cash flows of
Principal
Interest on principal outstanding
Only if:
Variable interest rate – time value and credit risk only
Not contingent on future events except to protect holder against:
• Credit deterioration of the issuer
• Changes in taxation or law
• Change in control of issuer
Cash flows in extension period are only
• Principal
• Interest on principal outstanding
Cash flows of principal and interest on principal example
Bond with specified maturity date
Interest payments linked to inflation rate in currency of bond
Analysis
Contractual cash flows are payments of principal and interest on principal
Linkage to inflation rate resets time value to current level
What if linkage is to another variable (eg net income or equity index)?
Interest payments are not consideration for:
• Time value of money
• Credit risk of principal
Contractual interest payments inconsistent with market rates of interest
Cash flows of principal and interest on principal example
Variable rate bond
Borrower can choose one month or three month LIBOR on ongoing basis
Analysis
Key – does interest reflect
• Time value
• Credit risk
If able to choose one month LIBOR for three months
• If reset each month – yes
• If no reset – no
Term of instrument shorter than contractual interest rate
• Constant maturity bond with periodically reset five year rate
Cash flows of principal and interest on principal example
Bond with capped rate
Stated maturity date
Variable market rate with cap
Analysis
Fixed rate bond
Variable rate bond
Combination can qualify
Cash flows of principal and interest on principal –
examples that do not qualify
Convertible bond
Holder’s perspective
Principal and interest plus:
• Return linked to equity of issuer
Inverse floating rate loan
Interest is not consideration for time value
Cash flows of principal and interest on principal –
examples that do not qualify
Perpetual instrument
Holder can call and pay par plus accrued interest
Market rate of interest
Cash payment of interest – solvency test
No accrued interest on deferred amounts
Analysis
Potential to defer interest with lack of interest accrual disqualifies
Features that do not disqualify
Perpetual
Callable
Cash flows of principal and interest on principal –
examples that may not qualify
Full recourse loan
Secured by specified collateral
Analysis
Collateralisation does not affect classification
What if non recourse loan?
Lender entitled to repayment only from specific assets or cash flows
• ‘look through’ to specific assets to determine characteristics
Subordinated instruments
May still have contractual cash flows
Principal
Interest on principal outstanding
Conditions:
Issuer’s non payment is breach of covenant
Holder has right to unpaid amounts even if issuer bankrupt
• Unsecured trade receivable when debtor has collateralised loans
‘Waterfall’ structures
Example
SPE purchases a portfolio of mortgage receivables
Finance raised through issue of tranches of debt
Tranches have subordination ranking for payment
Cash flows of principal and interest on principal if:
Contractual terms of the tranche itself qualify
Underlying pool of financial instruments have specified characteristics
Credit risk of tranche is equal to or lower than average
If cannot ‘look through’
Fair value measurement
‘Waterfall’ structures
Underlying pool of financial instruments
Some required to have cash flows of principal and interest on principal
May also have:
Instruments that change the cash flow variability
• Interest rate swap that changes rate on underlying assets from floating
to fixed
Instruments that align cash flows of tranches and underlying instruments
• Foreign exchange contract
Reclassification and ‘tainting’
Reclassification
Required on change of business model
• ‘Very infrequent’
Not changes
• Changes in intentions (even if significant market changes)
• Temporary disappearance of market
• Transfer of financial assets between existing business models
IAS 39 HTM ‘tainting’ eliminated
Reclassification
Examples
Entity has portfolio of commercial loans – intention to sell in short term
• Acquires a company that manages commercial loans
• Portfolio of commercial loans no longer for sale
Financial services firm
• Decision to close retail mortgage business
• No new business accepted
• Existing loan portfolio now actively marketed for sale
Measurement
Initial recognition
Fair value
Add transaction costs if amortised cost
Subsequent measurement
Definition of amortised cost in appendix
Reference to IAS 39 for impairment of assets at amortised cost, fair value
measurement and hedge accounting
Agenda
Scope
Classification and measurement
Embedded derivatives
Permitted options
Effective date and transition
Embedded derivatives
Financial host asset (within scope)?
Yes: no separation
Does the instrument as a whole give rise to payments of principal and
interest?
Yes – amortised cost, no – fair value of entire instrument
No: apply existing IAS 39 rules
Potential separation
Financial liability, financial asset (outside scope of IFRS 9), and nonfinancial asset host contracts
Existing guidance for embedded derivatives retained
Agenda
Scope
Classification and measurement
Embedded derivatives
Permitted options
Effective date and transition
Fair value option
Election available to designate at FVTPL
Initial recognition and irrevocable
Eliminates/substantially reduces an accounting mismatch
Other IAS 39 options obsolete
Managed on a fair value basis
Embedded derivatives
Equity instruments
Do not have cash flows that are solely principal and interest
Fair value measurement
Optional recognition in OCI
Not held for trading
Irrevocable election on initial recognition of each investment
All changes in fair value in OCI
No recycling to income statement
Dividends recognised in profit or loss
Agenda
Scope
Classification and measurement
Embedded derivatives
Permitted options
Effective date and transition
Effective date
Periods beginning 1 January 2013
Linked to effective date for impairment and hedge accounting
Early adoption permitted for December 2009 year ends
Transition
Retrospective application with exceptions
IAS 8 applies
Date of initial application
Date on which the requirements of the new standard are first
applied
Date of initial application
Any date between:
Date of issue of IFRS 9; and
Before 1 January 2011
Beginning of first reporting period if adopt on/after 1
January 2011
If date of initial application not beginning of a reporting
period:
Disclose that fact and reasons for using that date
Transition - exceptions
Assessment of whether hold to collect contractual cash flows
Date of initial application
Retrospective application
Designation as at FVTPL – applies to financial assets AND liabilities
Circumstances as at date of initial application
Retrospective application of FV
Previous optional designation as at FVTPL
May revoke based on facts/circumstances
Required to revoke if eligibility criteria not met
Based on facts at date of initial application
Transition - exceptions
Hybrid contracts that are required to be at fair value, if fair
value not determined in prior periods
Measure at sum of fair value of components
Measure at fair value in entirety at date of initial application
Treatment of differences in fair value of components and
whole
Opening retained earnings (if apply at start of reporting period)
Profit or loss (if apply during reporting period)
Designation of equity instruments as at FVTOCI
Optional if not held for trading
Assessment at date of initial application
Retrospective application
Transition - exceptions
Hedge accounting
Apply IAS 39 hedge cessation rules if no longer qualify
Instruments previously measured at fair value that are
restated to amortised cost
If impracticable to apply effective interest rate method,
amortised cost and impairment based on previous period end
fair values
Fair value at date of initial application is deemed amortised cost
Transition - exceptions
Unquoted equity instruments measured at cost under IAS 39
Remeasure to fair value at date of initial application
Difference between fair value and previous carrying amount to
opening retained earnings
Interim financial reports
Comparatives not required to be restated if impracticable (IAS
8)
Transition - exceptions
Comparative information – annual financial statements
Adopt in reporting period beginning before 1 January 2012
Not required to restate comparatives
Differences between previous carrying amount and fair value on
initial application recognised in opening retained earnings
Adopt in reporting period beginning on/after 1 January 2012
Restate comparatives
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