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IFRS 9 and Basel III
Marc Buklis MBA CFA
Managing Director, Consulting and Deals
PricewaterhouseCoopers LLP
June 10, 2015
IFRS 9 - Basel III
1
June 2015
Agenda and Introduction
Regulatory Initiatives - Timeline
IFRS 9 Key Highlights
OSFI and BCBS Guidance
IFRS 9 and Capital - Integration
Questions and Follow up
Marc E. Buklis, Managing Director, Consulting and Deals, PricewaterhouseCoopers LLP
Mr. Buklis is a Managing Director with PwC's Canadian consulting practice, with a specialization in risk, compliance and technology. Marc has nearly 20 years' experience working with financial institutions on regulatory initiatives for capital, liquidity and compliance. Marc has worked with large banking organizations in Canada, the United State and Australia to understand regulatory requirements and to implement solutions fit to each client's needs. Mr. Buklis speaks regularly on regulatory risk, compliance and technology implementation matters. Mr. Buklis has an MBA from the Joseph L. Rotman School at the University of Toronto (1998) and a BA in Economics from the University of Toronto (1993). He is a CFA Charterholder.
This presentation has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this presentation without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this presentation, and, to the extent permitted by law, PwC does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this presentation or for any decision based on it.
© 2015 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details.
IFRS 9 - Basel III
2
June 2015
Regulatory Initiatives - Timeline
December 2017
BCBS 239 – DSIB Deadline
January 2013
Basel III Capital Reporting
July 2014
Final Standard – IFRS 9
November 2017
Effective Date – IFRS 9 DSIB
January 2015
LCR Reporting
NCCF Reporting
January 2016
BCBS 239 – GSIB Deadline
3
June 2015 IFRS 9 - Basel III
IFRS 9 Key Highlights
IFRS 9
Impairment ‘Expected credit loss
model’
Hedge accounting Classification
and measurement
5
June 2015 IFRS 9 - Basel III
IFRS 9 Classification and Measurement: Equity Instruments
Cost exemption for unquoted equity removed.
6
IFRS 9 - Basel III
Is the equity instrument held for trading?
Has the entity elected fair value through OCI?
Fair value through OCI with no recycling and no
impairment
Fair value through profit or loss
Yes
No
Yes
No
June 2015
Amortised cost FV-OCI
IFRS 9 Classification and Measurement: Debt Instruments
Fair value through
P&L
Do contractual cash flows represent solely payments of principal and interest?
Does the company apply the fair value option to eliminate an accounting mismatch?
Yes
Yes
No
No
No
No
Yes
No
Yes
Yes
IFRS 9 - Basel III
7
Is objective of the entity’s business model to hold the financial assets to collect contractual cash flows?
Is the financial asset held to achieve an objective by both collecting contractual cash flows and selling financial assets?
June 2015
Documenting the business model (incl
sales)
IFRS 9 Classification and Measurement Key Judgements and Implementation Issues
No separation of embedded derivatives
FVPL is the residual category
Contractually linked
instruments
Liquidity portfolios
Reclassification of assets rare
Investments in equities – FVPL
vs FVOCI?
June 2015 IFRS 9 - Basel III
8
IFRS 9 Impairment – General Model
9
Effective interest on gross carrying amount
12 month expected credit losses
Recognition of expected credit losses
Interest revenue
Change in credit quality since initial recognition
Stage 1 Stage 2 Stage 3
Performing (Initial recognition*)
Underperforming (Assets with significant
increase in credit risk since initial recognition*)
Non-performing (Credit impaired assets)
Effective interest on gross carrying amount
Lifetime expected credit losses
Effective interest on amortised cost carrying amount
(i.e. net of credit allowance)
Lifetime expected credit losses
*Except for purchased or originated credit impaired assets IFRS 9 - Basel III June 2015
IFRS 9 impairment guidance will apply to financial assets at amortised cost, financial assets (debt) at FVOCI, loan commitments, financial guarantee contracts, lease / trade receivables and modified financial assets
IFRS 9 Impairment General model – significant increase in credit risk Key Judgements and Implementation Issues
10
Top down versus bottom
up
Level of segmentation /granularity
Mapping internal and
external credit grades
Basel PDs vs IFRS 9 PDs
IFRS 9 - Basel III June 2015
IFRS 9 Impairment General model – significant increase in credit risk Key Judgements and Implementation Issues
11
Regulatory PD IFRS 9 PD
Through the cycle
(‘TTC’)
Point in time (‘PiT’)
Hard to reconcile!
IFRS 9 - Basel III June 2015
IFRS 9 Hedge Accounting What has NOT changed?
Basic hedge accounting models
retained (i.e. FVH, CFH & NIH)
Hedge accounting is optional
Detailed rules on eligible hedged items
and hedging instruments
Documentation still needed
Derivatives still at fair value
Ineffectiveness recognized in P&L
IFRS 9 - Basel III
12
June 2015
13
80-125% effectiveness threshold is removed
IFRS 9 qualifying criteria
1. Formal designation and documentation
2. Only eligible hedging instruments and hedged
items
3. Meets the hedge effectiveness requirements
3.1 Economic relationship between hedged item and hedging instrument gives rise to offset
3.2 Effect of credit risk does not dominate the value changes
3.3 Hedge ratio results from the quantity of hedged item hedged and hedging item used to hedge
IFRS 9 - Basel III
IFRS 9 Hedge Accounting Qualifying for hedge accounting
June 2015
OSFI and BCBS Guidance
• OSFI and BCBS continue to develop their guidance.
• OSFI (January 2015) has advised financial institutions to NOT early adopt IFRS 9 except for DSIB’s, due to the expected significant impact.
• OSFI continues to monitor IFRS 9 acceptance and guidance with other jurisdictions and BCBS.
• BCBS Guidance on Accounting for Expected Credit Losses (2015) is currently in draft – and was issued for comment by April 30.1
• The document provides separate guidance on expected credit losses, expected credit losses and capital and IFRS 9 adoption.
• BCBS guidance outlines 11 principles, of which 3 relate to supervisory evaluation of credit risk practices, expected credit losses and capital adequacy. Effectively, capital adequacy rests on credit and accounting processes:
• Principle 9: Banking supervisors should periodically evaluate the effectiveness of a bank’s credit risk practices.
• Principle 10: Banking supervisors should be satisfied that the methods employed by a bank to determine allowances produce a robust measurement of expected credit losses under the applicable accounting framework.
• Principle 11: Banking supervisors should consider a bank’s credit risk practices when assessing a bank’s capital adequacy.
1 BCBS Consultative Document, Guidance on Accounting for Expected Credit Losses, 2015, page 1.
IFRS 9 - Basel III
15
June 2015
OSFI and BCBS Guidance - Continued
Topic Draft BCBS Discussion
Calculation of 12-
month loss
estimates
• Banks should adopt an active approach to assessing 12-month ECL, with changes
identified on a timely basis
• BCBS defines / clarifies 12-month ECL as not the expected 1-year loss, but the expected
lifetime loss due to default within 1 year – PD is 1-year PD while LGD is lifetime LGD.
• Where a move to lifetime expected loss (LEL) occurs, the change in probability is to be
considered.
• In formulating estimates of ECL, all reasonably available factors, including macroeconomic
factors, should be included.
• 12-month ECL estimates should be updated for each reporting period.
Definition of default • IFRS 9 does not directly define default but requires that it be defined consistently with that
used for internal credit procedures, with a rebuttable presumption that default is not later
than 90 days past due.
• BCBS expects the definition to reflect both qualitative criteria for identifying credit
deterioration (‘unlikeliness to pay”) AND an objective indicator of material delinquency (90
days, as in IFRS 9).
Grouping for
collective allowances
• Collective or individual assessments are allowed; where collective allowances are allowed,
exposures in the group must share similar credit risk characteristics.
• Grouping of exposures should be modified and updated when new information emerges to
show that credit characteristics have changed.
• Grouping should not be used to mask changes in credit quality or to mask the weak credit
quality of some exposures included in the group.
IFRS 9 - Basel III
16
June 2015
• In addition to the principles, BCBS provides specific draft commentary on several IFRS issues
OSFI and BCBS Guidance - Continued
Topic Draft BCBS Discussion
Assessment of
increases in credit
risk since inception
• Impairment calculations must estimate changes in credit quality since inception of the loan:
loan pricing includes credit quality at inception but changes since inception will not be.
• Impairment calculations for financial reporting are an important part of credit risk
management – and the two should thus be integrated.
• Calculations will require both historical and forward looking data. Banks will need systems
capable of consistently handling and systematically assessing the large amounts of
information required and to measure LEL, along with strong governance and controls.
• Banks will need to provide clear policy definitions of what constitutes worsening credit.
• Banks will need to have a clear view – backed by analysis – of the linkages from
macroeconomic factors to credit risk.
Modified /
Renegotiated
Transactions
• BCBS believes that modifications or renegotiations can mask increases in credit risk,
resulting in underestimation of ECL or delayed move to LEL measurement.
• Where renegotiation has been undertaken, banks must be able to demonstrate whether the
renegotiated asset has ‘improved or restored’ the ability to collect interest and principal –
and reflect credit losses accordingly.
Use of Practical
Expedients
• BCBS believes practical expedients in IFRS 9 are inappropriate for large banks
• For example:, and 30-days past due presumption.
• The allowance to limit the information search for measuring ECL, ‘without undo cost
and effort’: Banks should search thoroughly.
• The ‘low credit risk’ exposures exemption from assessment of significant increase in
credit risk since inception: Banks to use this only in exceptional circumstances.
• The 30-days past due presumption: credit risk should be assessed BEFORE
delinquency.
IFRS 9 - Basel III
17
June 2015
• In addition to the principles, BCBS provides specific draft commentary on several IFRS issues
IFRS 9 and Basel III Capital – Integration Points
Impairment ‘Expected credit
loss model’
Hedge accounting
Classification and
measurement
19
June 2015 IFRS 9 - Basel III
Definition and Components of
Capital
Credit Risk - Standardised
Market Risk
Credit Risk - IRB
Credit Risk - Securitisation
Counterparty Credit and
Netting
Operational Risk
Basel III – as with Basel II before it – on principle sits on the foundation of each Bank’s prudential credit risk policies and procedures.
IFRS 9 and existing Basel III implementations will thus interact, with IFRS forming part of the foundation.
Specifically, IFRS 9 and Basel III will also interact around provisions, calculation of Expected Credit Loss and Parameters, Valuation and Netting.
In addition to Capital, other regulatory reporting – such as LCR – also draws on financial reporting classification and impairment.
Transition to IFRS 9 will involve assessment of these interactions and the changes necessary.
OCI vs P&L Adjustment and Capital
Provisions
ECL and Parameters
Valuations
Netting and Definitions
IFRS 9 Basel III
IFRS 9 and High Level Business Functional Model - Impact
Products
Front Office
Middle Office
Back Office
Firm Wide Supporting Services
Equities Bonds Commo-
dities Currencies Derivatives
Corporate Finance
Sales & Trading
Research Client
Relationship Management
Product Development
Order/Trade Matching
Trade Allocations &
Bookings
Trade Desk Support
Trade Enrichment
Trade Affirmation
Trade Confirmation
Counterparty Netting
Client On-boarding
Front/Back Office Reconciliation
Compliances & Regulatory
Requirements
Client Services
Fin
an
ce
Treasury Accounting Management
Reporting Regulatory & Tax
Reporting Budgeting & Forecasting
Product Control
Pre-settlement Reconciliation
Clearance & Settlement
Post Settlement Reconciliation
Collateral Management & Allocation
Margin Management
Asset Servicing
Reference Data Mgmt.
Account Administration
Fails Management
Customer Report Distribution
Regulatory & Compliance
Management
Customer Billing
Adminis-tration
Legal & Compliance
Internal Audit
Human Resources
Facilities Support
Business Continuity Planning
Technology
Risk Mgmt
FO Risk Management
Credit Risk Management
Market Risk Management
Risk Model Management
Scenario Analysis
Op
er
ati
on
s
1
2
3
Processes for creation and trading of financial instruments are typically broken into
• The front office, which interacts with clients;
• The middle office, which provides key analytical and financial support for transactions;
• The back office, which processes settlements and maintains the books and records of the firm
IFRS 9 will have impacts at each level, as shown in blue.
20
June 2015 IFRS 9 - Basel III
Outlined below are key functions that are typically involved in transacting financial products. Transition to IFRS 9 will need to contemplate relationships across this spectrum.
IFRS 9 Compared to Capital Systems Additional data elements required to support classification:
Valuation methods and income treatment
Stage of impairment
Hedge classification – including aggregate positions
Revised treatment for liquidity buffer may impact capital
Increase in reported capital due to changes to expected loss
New disclosures
Potential for new types of hedging strategies
Revised engine capability and processes for valuation
Revised calculation for impairment and expected loss
Calculation of results for new disclosures
•Addition of new data elements and rules to data governance processes
•Reinforce integration of risk and finance data governance. Data Governance
21
June 2015 IFRS 9 - Basel III
Scenario Generation
MarketCredit
LiquiditySensitivity
Stress
Risk and Capital Calculation
Credit ExposureCredit Capital
CVA
Position Data
MarketData
Static Reference Data
ScenarioToolset
Capital or Risk Engine
Data Landing and Transformation:
Data Landing / Consolidation
Data TransformationData quality and
completeness
Parameter Estimation
PDLGDEADEE
Margin Period of Risk
EstimationTool
Source Data Extracts
Market Data Source / Services
Data Storage Users – Risk and Front Office
Credit Risk Reporting
Credit / Regulatory Reporting
Impairment Financial Reporting
Control: Source Consolidation or
Reconciliation
Control: Consistency of Tranformation
Control: Results Reconciliaion
Need for sharing resources trained in credit calculation – or expansion of team
IFRS 9 and Capital – Summary and Implementation Considerations
Operating Model
•IFRS 9 will require the capture of additional data – required to classify credit risk and stage of impairment, hedging characteristics and pricing. •IFRS 9 will thus impact operational processes and systems from deal capture, deal valuation, settlement and risk management.
Expected Loss and Capital
• The particular needs of expected loss and impairment calculations – for data and analytical systems - resemble the needs that drive centralized capital and liquidity risk calculations.
• Banks that do not have appropriate systems – and parameter generation – will need to build or acquire this capability.
• Large banks that have appropriate capital processes and systems will need to consider how to leverage them, possibly with multiple sets of parameters – or how to explain the differences.
Governance
• IFRS 9 will involve new data, attributes and disclosures.
• For all new data feeding the disclosures, plus any new ‘critical data elements’ that will ink to existing credit and capital reports, Banks will need to consider all appropriate governance as per BCBS 239: data ownership and stewardship, understanding of data lineage, rules and quality, etc.
IFRS 9 - Basel III
22
June 2015
Questions and Follow Up Thank you for your time today. For further information, please contact: Marc Buklis, Managing Director, Consulting and Deals PricewaterhouseCoopers LLP [email protected] +1-416-728-0639 or +1-416-687-8611
This presentation has been prepared for general guidance on matters of interest only, and
does not constitute professional advice. You should not act upon the information contained in
this presentation without obtaining specific professional advice. No representation or warranty
(express or implied) is given as to the accuracy or completeness of the information contained
in this presentation, and, to the extent permitted by law, PwC does not accept or assume any
liability, responsibility or duty of care for any consequences of you or anyone else acting, or
refraining to act, in reliance on the information contained in this presentation or for any decision
based on it.
© 2015 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its
member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for
further details..