UK ALMA - ALMA - IFRS 9 Where to from here?...training and preparation and review of IFRS 9 Parts 1 & 2 final impact assessment results. Support to the client from a cross -functional

IFRS 9Where to from here?

1© 2015 KPMG, an Irish partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

“We also welcome the Financial Stability Forum recommendations on pro-cyclicality that address accounting issues. We have agreed that accounting standard setters should take action by the end of 2009 to...

■ strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information;

■ improve accounting standards for provisioning, off-balance sheet exposures and valuation uncertainty;

■ make significant progress towards a single set of high quality global accounting standards”

G-20 Summit Leader’s Statement2 April 2009

IFRS 9 – The beginning


IFRS Financial InstrumentsSummary

Key IASB projects

IFRS 9 Part 1: Classification and Measurement

■ New classification, measurement and presentation requirements based on ‘business model’ and ‘contractual cash flow characteristics of financial assets’.

■ The four IAS 39 classifications of financial assets will be eliminated. Only three classifications of financial assets under IFRS 9: Amortised cost, Fair value through other comprehensive income (FVOCI) and FVTPL.

■ Financial assets are measured at ‘amortised cost’ only if held within a business model whose objective is to collect contractual cash flows that are ‘solely payments of principal and interest’ (‘SPPI’).

■ Early application of the own credit risk requirements in IFRS 9 for financial liabilities measured under fair value option (i.e. presentation of fair value gains or losses due to changes in own credit risk in OCI), without having to early apply IFRS 9 in its entirety.

IFRS 9 Part 2:Expected Credit Losses

■ New impairment model – Concept of ‘expected credit loss’ to replace IAS 39’s incurred loss model.

■ The proposed expected loss uses a dual measurement approach: – Bucket 1: ‘12 months’ expected credit losses’ if an asset has not met the criteria for recognition of lifetime

expected losses; and– Bucket 2/3: ‘Lifetime expected credit losses’ would be recognised if there has been significant deterioration in

credit quality since initial recognition.

■ Extensive new disclosures – e.g. effects of deteriorations and improvements in credit quality, inputs, assumptions and estimation techniques.

IFRS 9 Part 3: Hedge Accounting

■ New general hedging model with closer integration to risk management and additional hedging strategies permitted for general hedge accounting with new potential qualifying hedged items and hedging instruments.

■ Elimination of 80-125% bright line for hedge effectiveness testing. Mandatory rebalancing of hedge relationship is required when hedged ratio is changed for risk management purposes.

■ Macro hedging is separate project from IFRS 9. Current IAS 39 macro hedge requirements are kept until macro hedge project is finalised.


IFRS Financial InstrumentsPhased approach to implementation

Phas

e

Scope and plan for a detailed impact assessment of the implications of IFRS 9 on specific portfolios and businesses.O

bjec

tive

Key

act

iviti

es

Setup overall IFRS 9 programme governance and have representation on the steering committee and programme board

Provide project management support as well as analyst support

Undertake detailed Classification & Measurement and Expected credit loss awareness training on impacted divisions and portfolios

Undertake deep-dive review of specific 'hotspot' areas where data might be unavailable and systems / processes may not be fit for purpose

Part I: Undertake business model and cash flow characteristic testing with input from the client

Part II: Identify key assumptions and methodologies, review and validate and undertake base and stressed scenario simulations

Part III: Undertake a feasibility study and review current hedging strategy and look for potential improvements

Phase I Scoping & planning

Phase IIImpact assessment

Undertake a deep dive assessment of IFRS 9 impacted portfolios within the divisions and gain an understanding of potential financial, business and operational impacts

Undertake high level IFRS 9 awareness training across the bank

Hold scoping/planning workshop meetings with the impacted divisions and functions

Undertake a high level review of current operating model and identify areas where systems, processes and data might be impacted by IFRS 9

Part I : Perform high level review of which portfolios and product types might be impacted by a change in classification and measurement

Part II : Identify key assumptions and methodologies, review and validate and undertake base and stressed scenario simulations

Part III : Discuss current hedging strategies and whether it is a viable option to move to IFRS 9; consider scoping and planning for a feasibility study

Phase IVImplementation

Provide ongoing project and programme management support as well as analyst support

Provide ongoing project and programme management support as well as analyst support

Document detailed business and technical requirements

Develop and design a governance framework

Undertake the build in a development environment, document the testing plan and undertake system tests and UAT

Rollout into Production

Phase VParallel Run

Run IFRS 9 in parallel with IAS 39 for a period of time to ensure that IFRS 9 will be operationally effective by the mandatory effective date

Provide ongoing technical accounting and systems support during the parallel run period

Provide reconciliation support and explain differences

Document a detailed plan to run both IAS 39 and IFRS 9 for a period of time (pre and (possibly) post-mandatory effective date) for comparatives and trending analysis

Document a draft framework for the IFRS 9 Target operating model, including governance and control frameworks

Design a detailed IFRS 9 Target operating model and validate with the client

Discuss and prepare results with the client

Phase IIIDesign

Design the IFRS 9 target operating model together with relevant governance and control frameworks


1. Q4 2014

2. Q1 2015

3. Q2 2015

4. Q3 2015

5. Beyond Q3 2015

0%

5%

10%

15%

20%

25%

30%

35%

12

34

5

8%

23%

34%

8%

28%

When do you expect your detailed design phase to be complete?


IFRS Financial InstrumentsWhat stage are Banks at?

Time Q4 2013 Q1 2014 Q3 2014 Q4 2014Q2 2014 Q1 2015

Client 3: Large European bank

Client 4: Large Irish bank

Client 5: Large Irish bank

Client 1: Large UK financial institution

Phase I complete

Detailed analysis and design / Implementation and sustainability

2015 - 2017

High level impact assessment of provisioning process

Scoping & planning (incl. high level impact assessment)

OverviewThe timeline below sets out where other financial institutions have got to in terms of progress with their IFRS 9 programme. We have also marked up where KPMG have been asked to support in the delivery of various parts of their IFRS 9 programmes and thus we have more detailed knowledge of these areas.

Key: Key milestone complete KPMG involvement Activity timeline

Identifying scope and planning requirements for C&M and ECL (including programme management support, contractual cash flow characteristic testing, credit loss simulations, training and preparation and review of IFRS 9 Parts 1 & 2 final impact assessment results.

Support to the client from a cross-functional group. The scope would cover determination of definition of changes in credit quality and movements between IFRS 9 buckets, calculation of losses, interaction between IFRS 9 and other ECL calculations, implementation, expected accounting treatment for transition to the new standard and gap analysis to identify key areas of future focus.

Detailed impact assessment

Phase I complete

Phase I complete

Client 2: Large global bank

Phase I completeDetailed analysis and design

Review modelling methodologyReview Target Operating Model and

governance framework

Implementation and sustainability

Where you are now

Scoping & planning (incl. high level impact assessment)


What has been your biggest challenge/concern?

1. Data Management

2. Governance/Finance Risk Alignment

3. Lack of Timely Interpretation/Guidance

4. Resources

0%

5%

10%

15%

20%

25%

30%

35%

12

34

30%

19% 19%

32%


How much additional effort do you expect at each reporting date under IFRS 9?

1. Less than 25%

2. 25-50%

3. More than 50%

0%

10%

20%

30%

40%

50%

60%

12

3

39%

53%

8%


IFRS Financial InstrumentsKey views in the Market

Overview

Over the last few months, we have become increasingly engaged in discussions with industry groups, regulators and analysts, with extensive conversations around the implementation challenges of IFRS 9 and impairment. In recent months market activity has ramped-up significantly as a number of large banks are working towards having their impairment design completed by Q2-Q3 2015 and hence we have become increasingly immersed in this space.

KPMG continues to liaise with Supervisory Risk Specialists on IFRS 9. We have held Big 4 meetings with the PRA and the ECB in Q4 2014 and Q1 2015 and briefed the CBI in September 2014.

Given the experience of regulators on stress testing and Asset Quality Reviews regulators are interested in the implications more generally on data quality and how that links to provisioning;

The PRA are active participants in the BBA working group on IFRS 9 implementation (driven by the accounting policy team rather than the supervisory risk specialists) and appear to be adopting a fairly conservative and prudent initial stance towards some of the more technical accounting interpretations and judgmental areas.

FSB continues to question when banks might have a view on the proposed impact so these can be disclosed to the market early.

The Basel Accounting Experts Group issued a consultation paper on IFRS 9, which sets out supervisory expectations on the practices and accounting under Expected Credit Loss models, and to require a high quality, robust and consistent implementation of ECL accounting requirements by internationally active banks for lending exposures. Key elements include:

Creating a robust framework for developing ECL estimates for lending exposures that fully considers forward-looking information and macroeconomic factorsCollective and individual assessments of ECLsAssessment of significant increases in credit riskPractical expedients/simplifications

We provided a briefing of UK bank analysts on IFRS 9 both the technical background and the interpretation challenges. They were particularly focused on: Approach to disclosure of transitional impacts Volatility How preparers may try to ‘game’ the system Capital impacts

The purpose of the meeting was to discuss eight key challenge areas: Use of forward looking assumptions and macroeconomic factors Grouping of loans into portfolios Treatment of modified and forborne loans

International Banking

Federation’s Accounting W.G

Morgan Stanley Analysts

Basel Committee / Accounting

Experts Group

IASB’sITG

Supervisory Regulators

Individual ITG members made the following observations:

Larger banks, especially in Europe, are more advanced than smaller banks in analysing IFRS 9 and planning for transition, with some hoping to move to systems design in H2 2015. Banks face major challenges in collecting and managing data and modifying and designing models and systems. The earlier that implementation issues are discussed, the more ability there will be for preparers to build the results of that discussion into systems design. Critical constraints on transition activities include scarcity of skilled resource and competing systems change projects (e.g. regulatory change).

Banks and other stakeholders are forming local implementation discussion groups in Canada, China and South Africa.

Modelling approaches Adjustments to historical averages Role of regulators in setting accounting guidance IASB’s transition resource group


IASB Transition resource group

■ Reflects the fundamental change in accounting

■ Members are subject matter experts from audit firms and preparers and three IASB members

■ Representatives of the Basel Accounting Expert Group and IOSCO are observers

■ Meetings will be public

■ The group will not publish authoritative guidance but refer issues as needed to the IASB or Interpretations Committee

■ Webpage to submit issues

■ Level of questions to date has been low – IASB has requested more questions ASAP

■ Established to respond to questions to support implementation of impairment in the period leading up to 2018 mandatory date

Strategic and operational considerations for banks

11© 2015 KPMG, an Irish partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved

Strategic Considerations

2

43

Volatility in the P&L going forward

Possible implications on regulatory capital

Governance and controls, including Finance and Risk operating model

Early key decisions, including interaction with other in-flight programmes

1


Three possible impacts

High level implications of IFRS 9 on regulatory capital

Classification &

measurement

Expected credit losses

IRB portfolios: the impact on capital would be driven by the regulator’s stance on aggregation for the excess EL and the need to separate defaulted and non-defaulted asset portfolios. Depending on where the excess EL arises the potential impact could be significant as excess provisions may only be added back into Tier 2, subject to Irish Central Bank agreement.

Standardised portfolios: the impact would be significant as the capital requirement relief is dwarfed by the reduction in CET1.

Due to the ‘cliff effect’ on provision rates when assets transition to lifetime expected losses, provision charges could escalate very rapidly in times of stress exceeding the offset for excess expected loss for IRB portfolios.

Firms that are advanced in their work in classification and measurement are starting to see a larger than expected proportion of assets moving from amortised cost to either FVOCI or FVTPL. (e.g. particularly those with embedded derivatives)

If interest rates were to rise, it would negatively affect the FV of these instruments and this would impact Common Equity Tier 1 (CET1) under CRD4.


Three possible impacts

In light of the guidance expected by Basel and other regulators, the range of possible impacts to regulatory capital is wide and depends the firm’s portfolio structure.

High level implications of IFRS9 on regulatory capital (cont.)

Tax

Irish revenue have not yet provided a view on IFRS 9

Under the existing tax code, only ‘specific provisions’ can be deducted in full. Under IFRS 9, the test will likely remain on proving that expected losses are specific provisions.

Operational Considerations


Data is an issue – especially when sourcing from non-finance systems

Operational Considerations

2

43

Lack of resources – people and budget

Timeliness of interpretations and guidance Communications – it’s not just an

accounting project

1


Survey Results - Budgets

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

<£20m£20-50m

£50-100m£100+

45%

30%

8%

17%

■ Determining a budget is challenging whilst uncertainty exists around resourcing, governance and timelines.

■ New processes and controls (e.g. SOx controls) will be required as areas such as credit risk modelling processes are brought into the financial reporting framework. This explains the significant additional cost of ‘controls’.

Expected budget for IFRS 9 Programme

Key credit considerations


IFRS Financial InstrumentsExpected Credit Loss Framework - Approach

Scope of changes

■ The proposed ECL model uses a dual measurement approach depending on the extent of credit deterioration since initial recognition:

− Stage 1: ‘12 months’ expected credit losses’ if the credit risk has NOT increased significantly since initial recognition; and

− Stage 2/3: ‘Lifetime expected credit losses’ would be recognised if the credit risk has increased significantly since initial recognition

■ Extensive new disclosures – e.g. effects of deteriorations and improvements in credit quality and the critical judgements made in measuring the ECL accounts.

Gross basis

■ No significant deterioration in credit quality

■ 12 month expected credit losses are expected credit losses that result from default events on the financial instruments that are possible within the 12 months after the end of the reporting period.

■ They are a portion of the lifetime expected credit losses, and therefore are neither: (a) the lifetime expected credit losses on financial instruments that are expected to default in the next months nor (b) the cash shortfalls that are predicted over the next 12 months

Net basis

■ Significant deterioration in credit quality

■ Change relates to probability of default rather than changes in LGD

■ Rebuttable presumption that the criterion for lifetime expected credit losses is met if payment are more than 30 days past due

■ Credit-impaired financial assets (includes purchased and originated credit-impaired)

■ Interest is calculated on amortised cost (i.e. net of loss allowance). Consistent with the amount IAS 39 requirement for all financial assets and financial liabilities

■ Interest is calculated by applying the EDR to the gross carrying amount (i.e. before the loss allowance)

Bucket 1Performing

Bucket 2Underperforming

Bucket 3Non-performing

TransferIf the credit risk on the financial asset has increased significantly since initial recognition

Move backIf transfer conditions above is

no longer met

Change in credit quality since initial recognition


IFRS 9: Financial InstrumentsSignificant Credit Deterioration : PD Threshold Method

■ Asset quality and bucket allocation are largely disconnected. This is inconsistent with the PD-based risk management view.

– Bucket 1 contains loans from all risk classes except ‘credit-impaired’ loans.

– Loans with identical PDs can be in buckets 1 and 2.

– Loans in bucket 1 may have higher PD than loans in bucket 2.

■ The model is symmetrical: Once transfer criteria are no longer fulfilled, loans are transfered back to bucket 1.

■ 12-month expected credit losses would be recognised for all newly originated or purchased instruments except credit impaired, which go to bucket 3.

DefaultInvestment Grade Non Investment Grade

At0 At1

Dt0 Dt1

Et0

Et1

Xt0

Xt1Loan X at the end of the first period (t1)

Loan X at origination (t0)

Bucket 1

Bucket 2

Bucket 3Lifetime EL Notion

1yr EL Notion

Ct0

Definition ‘Credit-impaired’

Ct1

Bt1

PD-Threshold(Non-investment grade)

Bt0

PD

‘Assets with low credit risk’

Asset Quality and Bucket Allocations are largely disconnected

Ft1Ft0

Significant deterioration

Insignificant deterioration


IFRS 9: Financial InstrumentsExample of a portfolio to be simulated

0

1000

2000

3000

4000

5000

6000

1 2 3 4 5 6 7 8 9 10 11 12

Rating Distribution

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

1 2 3 4 5 6 7 8 9 10 11 12

Probability of Default: All Grades

■ Assuming a distinction between Investment/Non-Investment grade between grades 4/5, approximately 40% of the portfolio is a candidate for bucket 2

■ The original rating is required to determine the initial bucket allocation

■ Analysing the portfolio based on a variety of parameters gives an indication of the transition effects and the need for determining original ratings

Comments


IFRS 9: Financial InstrumentsResults of a portfolio to be simulated (1/2)

Significant Deterioration based on a 3-Notch Downgrade


All DealsVolume Allowance

Bucket 1 19,043,607,705 118,636,521Bucket 2 3,956,392,295 481,160,960Total 23,000,000,000 599,797,481 0

10,000,000,000

20,000,000,000

Volume0

250,000,000

500,000,000

750,000,000

Allowance



10,000,000,000

20,000,000,000

Volume0

250,000,000

500,000,000

750,000,000

Allowance

■ Assuming a definition of significant deterioration based on a 2-notch downgrade instead of 3 notches shifts approximately EUR 1.5 billion from bucket 1 to bucket 2

■ The corresponding changes in measurement in each bucket yields a change of approximately EUR 75 Million in allowance amount


IFRS 9: Financial InstrumentsResults of a portfolio to be simulated (2/2)

Significant Deterioration based only on the PD-Threshold



10,000,000,000

20,000,000,000

Volume0

250,000,000

500,000,000

750,000,000

Allowance




10,000,000,000

20,000,000,000

Volume0

250,000,000

500,000,000

750,000,000

Allowance

■ The changes from a between 2/1 notches are similar to 3/2 notches in volume (EUR 1.8 billion) and allowance (EUR 80 million)

■ Using only the PD-threshold (practical expediency at initial implementation) results in drastic changes in bucket allocation and allowance amount. The key drivers are the assets just over the threshold


IFRS 9: Financial InstrumentsChallenges – An Irish Perspective

■ Should the IFRS 9 implementation build off existing capital models (where they exist), use existing provisioning models (where sufficiently well developed) or follow a ground up approach?

■ Is there scope for rationalisation of the model universe? How many existing models can be consolidated given the proliferation of models that will result from IFRS 9 (e.g. 12 month PD, lifetime PD, 12 month LGD, lifetime LGD)?

■ How flexible should the model parameters to be? Will we seek a model build which will allow sensitivity analysis to be run on the fly?

■ How will behavioural maturity for revolving credit facilities such as credit cards/overdrafts be determined?

Modelling Approach

From our observations on engagements we have undertaken in the past six months with Irish domestic banks, we highlight below some of the issues currently being thought through by the IFRS 9 programme teams in respect of the impairment part of IFRS 9

■ Immediate need to begin capturing data which will be required under IFRS 9 but is not currently gathered in a systemised manner by the bank (e.g. credit grade at origination).

■ Implementation of a programme to obtain such data for pre-existing loans which will remain on the balance sheet at 1 January 2018.

■ Is forbearance data complete and accurate? Do loans which have been placed into forbearance remain in low PD grades even after emerging from a probation period?

■ How will the bank address gaps in data fields or other data quality issues (e.g. effective interest rate, maturity date)?

■ Do we have a starting point for grade migration matrices which we can use to develop PDs through time?

■ Is collateral allocated on a one-to-one basis, many-to-one or one-to-many basis (for modelling LGD term structure)?

■ Is there sufficient data to EAD in the future? How will amortising loans be treated? What types of profile are exhibited (e.g. annuity, linear, bullet)? Is there a significant portfolio of loans with capital repayment holidays, or partial amortisation features with a bullet repayment of a portion of principal?

Data

■ Expectation for regulator to seek disclosure of quantitative impact of IFRS 9 in 2016 ICAAPs.

■ Will the IFRS 9 impact be likely to lead to a shortfall in capital?

Regulatory

■ What is the internal capacity to resource the programme? How much of the implementation will need to be outsourced to external advisors?

■ Consideration of the following:– 30 days past due backstop– Loans in active forbearance– Number of “notches” downgrade on internal PD grading scale– “Catch all” non-origination grade PD grade

■ How will the Basel Committee’s GAECL paper, if finalised in current form, impact the transfer criteria being considered (e.g. relative % change in PD versus x number of notches down a scale)?

Transfer criteria

People

Key classification considerations


IFRS 9 Classification and MeasurementOverview

IFRS 9 introduces 2 steps approach in determining classification of financial assets: assessment of contractual cash flows (CCF) and business model. Equity instruments will be measured at FVTPL unless an initial election is made to measure them at FVOCI.

FVTPL

Financial assets – debt instruments

FVOCI Amortised cost

Cash flows that are solely payments of principal and interest?

Economic relationship between principal and interest modified?

Modification results in cash flows that could be more than insignificantly

different from a benchmark?

Business model: Objective to hold to collect contractual

cash flows?

Business model:Managed both to collect contractual

cash flows and for sale?

Fair value option

Yes

Yes

Yes

YesNo

Yes

No

No

No


Key features Description

The relationship between the passage of time and the interest rate are imperfect – examples include: the interest rate is periodically reset but the frequency of that reset does not match the tenor of the interest rate; Interest rate is periodically reset to an average of particular short-term and long-term rates.

Benchmark test is required: to compare the difference between the undiscounted contractual cash flows with modified time value of money

feature and the undiscounted cash flows if the time value of money element was not modified (the benchmark cash flows);

If the difference is significant, the SPPI criterion is not met,

IFRS 9 Classification and MeasurementSPPI test – Other general key features to look out for and challenges

Modified time value of money

Non-standard interest rate Inverse floating rate and interest indexed to debtor’s performance (e.g. net income) are examples of non-

standard interest rate that are non-SPPI. However financial assets with negative interest rate may meet SPPI.

Prepayment options

Contractual terms that allow the issuer or the holder to prepay before maturity. Prepayment option is consistent with SPPI if: prepayment amount substantially represents unpaid amounts of principal and interest on the principal

amount outstanding - may include reasonable additional compensation for early termination; fair value of the prepayment feature is insignificant when initially recognised; and the nature of any contingent event has been assessed for SPPI – e.g. an interest rate that is reset to a

higher rate if the debtor misses payments is more likely to be in line with SSPI than an interest reset triggered by a specified equity index reaching a particular level.

Extension options

Contractual terms that allow the issuer or the holder to extend the term of financial asset. Extension optionmeets SPPI if:• the terms of the extension option result in contractual cash flows during the extension period that are SPPI –

which may include reasonable additional compensation for extension of the contract; and • the nature of any contingent event has been assessed (as above).

The table below sets out a number of other key indicators when the asset may need to be measured at Fair Value through Profit or Loss.


IFRS 9 Classification and MeasurementBusiness Model assessment – key considerations

■ An entity may have more than one business model.

■ A portfolio of financial assets may be sub-divided into multiple business models.

■ Management’s intention is determined at a higher level of aggregation rather than instrument by instrument basis.

■ Business model is a matter of fact and is typically observable through activities undertaken.

Held-to-collect model:

No need to hold assets until maturity, sales can occur :

■ Due to an increase in credit risk

■ Infrequent (even if significant)

■ Insignificant individually and in aggregate (even if frequent)

■ Close to maturity with proceeds approximate the collection of remaining cash flows

Relevant and objective evidence:■ Management’s stated business objectives,

documented investment policies and the operation of those policies.

■ KPIs used to evaluate and report performance of the business.

■ How the management of the business are compensated.

■ Risks affecting the performance and how they are managed.

■ An entity may have more than one business model.

■ A portfolio of financial assets may be sub-divided into multiple business models.

■ Management’s intention is determined at a higher level of aggregation rather than instrument by instrument basis.

■ Business model is a matter of fact and is typically observable through activities undertaken.

Held-to-collect model:No need to hold assets until maturity, sales can occur :

■ Due to an increase in credit risk

■ Infrequent (even if significant)

■ Insignificant individually and in aggregate (even if frequent)

■ Close to maturity with proceeds approximate the collection of remaining cash flows


IFRS 9 Classification and MeasurementBusiness Model assessment – Key Challenges

Portfolio performance measurement

If management reporting and KPIs on the performance of the portfolio are fair value related, this may be an indicator of a business model that is not held to collect.

Management report and review that focus on the credit quality of the instruments and contractual returns are consistent with the held-to-collect business model.

Investment strategy

Key challenges Description

If the investment strategy focuses on realising gains on fair value changes or realising cash flows through sale rather than earning contractual interest, this may indicate that the business model is not held-to-collect.

Judgement is needed to assess the impact of sales

activity

Reasons for sales

An increase in the frequency or value of sales in a particular period is not necessarily inconsistent with a held-to-collect model if an entity can explain the reasons for sales and why those sales do not reflect a change in the objective for the business model. Example of sales in business model assessment:

Held-to-collect: Sales in stress case scenario Sales due to a decline in credit quality that no longer meets the credit criteria in the entity’s documented

investment policy.Held to collect and sell: Sales to meet everyday liquidity needs Sale of low-yielding assets and re-investment in higher yielding assets to maximise return Sale of assets and re-investment to better match the duration of its liabilities Significant sales due to regulatory requirement to demonstrate asset liquidity.

IFRS 9 does not include ‘bright lines’ for assessing the impact of sales activity but requires an entity to consider: the significance and frequency of sales activity (both current and prior periods); its expectations about future sales activity; and whether sales activity and the collection of contractual cash flows are each integral or incidental to the

business model. Held-to-collect - Sales are incidental to the objective of the model and are infrequent or insignificant in value.Held to collect and sell - Sales are integral to the objective of the model.


IFRS 9 Classification and MeasurementBusiness Model assessment – Key Challenges (cont.)

Data needed for analysis of historical sales

Certain assets that are funded or intended to be funded via securitisation (e.g. mortgage and credit card assets) may need to be fair valued going forward in originator’s accounts depending on whether derecognition criteria are met.

From the consolidated group’s perspective, these assets are held in a held-to-collect business model. However the originating entity has an objective of realising cash flows by selling these assets to the

securitisation vehicle, so for the purposes of its separate financial statements, it would not be considered to be a held-to-collect model.

Key Challenges Description

Reclassification of financial assets

Reclassification is required if the objective of the entity’s business model for managing those financial assets changes. Such change is expected to ‘very infrequent’ and has to be significant to the entity’s operations and demonstrable to external parties.

Not a change in business model – financial assets transferred between parts of an entity with different business models; or the intention for particular assets changes due to changes in market conditions.

Management compensation How management of the business are compensated, for instance, whether the compensation is based on the fair value of the assets managed or on the contractual cash flows collected.

Credit risk management The use of CDS to actively manage and transfer credit risk is not consistent with a held to collect business

model. Within the held to collect portfolio, the use of CDS for managing significant credit risk may result in FVTPL

measurement of the loan portfolio.

Securitisation activities

Analysis of past sales are required to provide evidence as to how the stated objective of holding the financial assets is achieved and how cash flows are realised.

Accordingly, entities may not have readily available historic data on the frequency, significance of sales (volume, value, timing) and the associated reasons for such sales, and collecting it may require huge effort.

Business model is not determined solely by current and historical objectives and activities undertaken. Future expected strategy such as strategic intention to sell (e.g. securitisation), targeted sales within pre-defined range will impact business model assessment.

Prospective view

Risk Implications


Group vs. Division Assumptions

Complexity

■ Design authority requirements

■ Policy interpretation consistency

■ Audit trail/'bible' of assumptions

■ Suitable impact quantification

Complexity vs. senior managementunderstanding

Degree of centralisation allowed/required –balancing consistency and efficiency/ ownership

Matters to consider

Have the risks arising from devolution been adequately considered?

Is there a robust mechanism to capture all assumptions?

What has been done to get senior management up to speed (training etc)?

Making it work: Linking credit risk and accounting processes

Key issues to consider There are no hard and fast rules related to the design of the model.

However, regardless of the final model design there are common design considerations that will have to be addressed.Use of regulatory models

Leverage existing infrastructure vs modifications


Types of models■ 1 year EL (PD, LGD, EAD)■ Lifetime EL (Models for term

structure; behavioural maturity; economic overlay)

Potential segmentation for Retail mortgages:

■ First mortgages■ Second

mortgages■ Fixed/variable■ .....etc

Models to determine significant credit deterioration

■ Principles of modelling start with portfolio segmentation.

■ Key requirements are:

– Appropriateness of data used in development with what the model will be used for.

– Sufficiency of data to build robust models.

■ Sheer volume of potential models is daunting.

Matters to consider

Has the firm appropriately segmented the portfolio?

Has it looked at population stability?

Has the firm used a statistical model to determine significant credit deterioration? How do we test that it is appropriate?

Making it work: Linking credit risk and accounting processes


Concluding remarks

■ A key complexity comes from making people with different skills sets work together

■ IFRS 9 clearly goes beyond accounting and affects business models

■ Do not assume 2018 as go-live date; pressure for earlier indications

■ Allow flexibility to benchmark

■ Allow flexibility for regulatory intervention / guidance

■ If you refer to it as “ the new world of provisions” it might be heard louder!

■ Key organisational challenges, starting with sponsorship/approval

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Ian NelsonPartner, KPMG Ireland

Tel: + 353 (1) 410 1989Mobile:+ 353 (87) 744 1989 [email protected]

Documents

UK ALMA - ALMA - IFRS 9 Where to from here?...training and preparation and review of IFRS 9 Parts 1 & 2 final impact assessment results. Support to the client from a cross -functional