Financial Accounting Advisory Services Implementing the new financial

instruments standard

IFRS 9, the new standard for financial instruments, was issued by the IASB in July 2014.

The IASB has established the Impairment Transition Group (ITG) to provide a discussion forum for IFRS 9 impairment implementation issues.

On 2 February 2015, the Basel Committee on Banking Supervision issued a Consultative Document outlining the supervisory expectations for sound credit risk practices associated with implementing and applying an expected credit loss accounting framework. The guidance notes that “internationally active banks and those banks more sophisticated in the business of lending” are expected to have the highest-quality implementation of an expected credit loss (ECL) accounting framework. For “less complex banks,” supervisors may determine a “proportionate approach” in implementing the guidance.

We can advise you in implementing the new standard in an effective and efficient way.

IFRS 9 Financial Instruments is the new standard that concludes all three phases of the International Accounting Standards Board’s (IASB) financial instruments accounting project, covering classification and measurement, impairment and hedge accounting.

Financial institutions, in particular banks but also insurers, will be particularly impacted by IFRS 9. With mandatory adoption in January 2018, and early application permitted, we expect to see financial institutions planning and initiating their transition projects in 2015. This provides up to two years for implementation and one year for a parallel run.

Currently working with entities that are assessing the impact of implementing the new standard, we understand that it requires considerable time and resources. Our experience with large, medium and small European financial institutions confirms that IFRS 9 has a considerable impact on data, systems, models, regulatory capital and KPIs. This impact has prompted financial institutions and other entities to plan their IFRS 9 implementation projects. We recommend that entities begin planning now to make best use of the lead time the IASB has allowed for preparers to implement the standard.

Implications of IFRS 9IFRS 9 brings together the classification and measurement, impairment and hedge accounting phases of the IASB’s project to replace IAS 39 Financial Instruments: Recognition and Measurement and all previous versions of IFRS 9.

The classification and measurement requirements of IFRS 9 replace the current measurement criteria of IAS 39 with the following three categories:

• ► Amortised cost

• ► Fair value through other comprehensive income

• ► Fair value through profit or loss

The impact of the new standard will vary depending on an entity’s business models, the composition of its portfolio and current accounting practice.

The IFRS 9 impairment requirements introduces an expected credit loss model, rather than the incurred loss model of IAS 39. This is expected to have a significant impact on financial institutions. The implementation of IFRS 9 will require a joint effort between finance and risk as impairment affects risk modelling, provision methodology and operating models. In addition, data, processes, systems and data warehouses will need to be reviewed on the basis of the new requirements. We expect loss allowances to be higher under IFRS 9 than they were under IAS 39. Also the fact that entities need to recognise a loss allowance for almost every asset which is then recalculated at each reporting date is likely to lead to greater volatility in impairment charges.

IFRS 9 outlines a hedge accounting approach that is based on the entity’s risk management activities. Hedge accounting under IFRS 9 is more principles-based than the current approach in IAS 39. An entity may choose to continue applying the requirements of IAS 39 for hedge accounting model until the IASB’s macro hedge accounting project, Accounting for Dynamic Risk Management, is complete.

Entities will need to consider how to:

• ► Evaluate the impact of IFRS 9 on the financial statements, as well as on models, data, systems, processes, controls and governance

• ► Analyse the extent to which it is possible to leverage existing models and systems for regulatory purposes

• ► Assess the impact on regulatory capital

• ► Make the required judgements introduced by the less extensive rules and the intrinsic nature of an expected loss model

• ► Consider whether it would be beneficial to adopt IFRS 9 fully, including hedge accounting

• ►Assess the interaction between the IFRS 9 requirements and wider regulatory challenges:

• ► Basel III

• ► CRR/CRD IV

• ► FINREP, COREP

• ► BCBS 239

• ► Asset Quality Review

• ► Stress testing

• ► Dodd-Frank and Volcker Rule

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• ► Asses the primary commercial, financial, regulatory and organizational challenges:

• ► During the transition period, entities need to communicate progress of the implementation to external stakeholders and be aware of what peer group companies are doing

• ► Product restructuring and reclassification will directly impact key ratios, regulatory capital and tax

• ► Current products and business models may need to be revised

• ► Extensive disclosures will require improved systems capability and data availability

• ► Changes to systems and processes may increase operational risk

How EY can help your implementation of IFRS 9

Why EY?

By leveraging our experience on IFRS 9 projects, we can:

• Advise you in implementing new IFRS 9 requirements using an established methodology

• ► Support and advise you in your design and implementation of models, processes, systems and control changes to capture the information necessary to apply the new rules

• ► Provide tailored training on the implications of the new requirements

• ► Support you in assessing the impact on regulatory capital and tax

• ► Provide comparisons with your peers to help determine the direction of your project

• ► Help you to better understand how the opportunities and challenges of IFRS 9 could impact your business, and enable you to make informed decisions about when and how to adopt

• ► Share market insights with you on current methodologies, peers’ views and options for next steps

We have a multidisciplinary team delivering accounting, risk, performance improvement, IT and transactions services tailored to your specific needs. Our services* are supported by materials, tools and enablers for classification and measurement and impairment:

• To help with assessing possible outcomes based on the IFRS 9 criteria

• To support in the classification of data

• ► The benefit for you:

• ► Eliminates the need for manual review of documentation

• ► Resolves data issues

• ► What will the output be:

• ► A report that flags indicators of fair value

• ► A report by type of instruments, fair value and booking entity

• To illustrate the amount of allowance required under the new IFRS 9 impairment requirements by:

• ► Performing simulations based on the final IFRS 9 standard and adapting the main features to your needs and portfolios easily

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• ► Adapting the probability of default (PD) matrix to the portfolio — use agency matrix if no other available

• ► Classifying according to PD level or delinquency status according to data available

• ► Running multiple scenarios at the same time to evaluate the key sensitive factors

• ► Setting different thresholds for transfer from 12 months’ expected credit losses to lifetime PD

For access to more EY thought leadership, please refer to our IFRS Developments and Applying IFRS series, available at ey.com/ifrs.

* Note: Certain of our services for an audit client and its affiliates may be more limited in order to comply with applicable independence standards. Please reach out to your EY contact for further information.

Contacts:Tara KenglaFinancial instruments standard implementationtkengla@uk.ey.com+ 44 20 7951 3054

Francesca Amatimaggio Financial instruments standard implementationfrancesca.amatimaggio@it.ey.com+ 39 3387857277