IFRS 9 – Impairments The Pain Points…

François Masquelier, Chairman ATEL

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Less is often more in finance and the best is enemy of the good

• A lot has been said about IFRS 9 and Hedge Accounting (HA) part

• However, there is also some provisions regarding ECL impairment, which shall impact mainly banks and financial institutions

• But it may also impact Corp’s on A/R’s

• This part of new standard deserves to be contemplated and impacts to be assessed prior to implement IFRS 9

• IASB completed final element of its comprehensive response to GFC with publication of IFRS 9 Financial Instruments

• Reminder: IFRS 9 includes (1) logical model for classification and measurement, (2) substantially-reformed approach to HA and (3) single forward-looking ‘expected loss’ impairment model (vs. “incurred loss” current backward-looking based on credit provision) idea would be to impair earlier

• Should be effective for annual periods beginning on or after 1 January 2018

• It may be tougher than initially thought…

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IFRS 9 Expected Credit Losses (ECL) Impairments - Introduction

• During GFC delayed recognition of credit losses on loans and other financial instruments was identified as a weakness in current standards

• Existing model (i.e. “incurred loss” model) delays recognition of credit losses until there is evidence of a credit loss event

• Therefore, it was recommended to IASB exploring alternatives solutions

• Major objective: to provide users with more useful information about an entity’s ECL on financial assets and its commitment to extend credit

• Company will not wait for a credit event to occur before recognizing credit losses

• Eventually, preparers will welcome removal of a source of complexity by applying the same model of impairment to all financial instruments

• One of major changes of IFRS 9 is concept of “expected losses”

• IASB wanted to bring its standard closer to B3/CRDIV (BIS bank regulations)

• However, changes in credit risk could generate changes in ECL allowances and hence P&L volatility

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Why IASB decided to address impairmentof A/R’s?

• IASB decided to opt for a 3-stage approach for impairment, which is based on changes in credit quality since initial recognition

• When (1) credit risk is stable or “performing assets”, (2) when there is a significant increase in credit risk or “underperforming assets” and (3) when an impairment event occurs or “non-performing assets”(cfr. former IAS 39).

• For corporates with less sophisticated credit risk management systems, simplification needs to be adopted

• For A/R’s or contract assets without significant financing components, a simplified 2 stage model is possible

• Corp’s will also have increasing QUAL and QUANT disclosures about credit risks

• QUAL disclosures: e.g. need to formulate policies and procedures

• QUANT disclosures: e.g. main ones are about reconciliation of loss allowance by instrument and of gross carrying amounts by class of instrument; max. exposure to credit risk excluding collateral; nature and quality of collateral and changes in quality; quant information about collateral and credit enhancements; significant concentrations of credit risk per sector, region, issuer,…

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3-Stage Approach…

• To implement ECL model mainly on trade receivables• Current provisioning approach is decentralized at BU level• The more than 90 day past due A/R’s should be impaired unless it is justified• Major difficulty with this provision matrix is collection of historical data on default over

number of years, per subsidiary• Stock of credit loss allowances is expected to significantly increase (i.e. 10 to 50% of current

stock of provisions)• Consistent methodology required for homogeneous principle-based approach • New approach forward-looking information required• Before, changes in creditworthiness of debtors were only recognized until such a credit loss

event occurs, typically payment default• From now, “significant” deterioration in credit quality will generate a loss to be booked

into P&L• Ensure a more timely recognition of the ECL• Entity’s estimates of ECL and credit risk are inherently subjective• Despite work of both Boards on convergence, ECL model adopted diverge with US • Significant amount of time to be compliant • Corp’s seem to pay for banks failures during GFC

“Good debts become bad when you do not care to make it pay”

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Forward-Looking Approach – Principle-Based

Thank you!

François Masquelier, Chairman ATEL

Twitter: @FrancoisMasquel

Blog: https://mytreasurer.wordpress.com

LinkedIn: ATEL group