T1 - Implementación NIIF 9 Instituciones Financieras - Rafael Rodríguez

Implementing IFRS 9 Financial Instruments– Financial Institutions

Contents 1. IFRS 9 - Overview

Fundamental changes call for careful planning

2. Classification and measurement – Facts 3. Classification and measurement – Impacts 4. Impairment – Facts 5. Impairment – Impacts 6. Next steps

Overview – IFRS 9 Financial Instruments In summary

Bottom line

The IASB has now issued the completed version of IFRS 9 Financial Instruments (‘IFRS 9’ or the ‘standard’), which substantially brings to a close the challenging project launched in 2008 to replace IAS 39 Financial Instruments: Recognition and Measurement.

Version

What’s included?

Retained from IAS 39

IFRS 9 (2009)

New requirements for the classification and measurement of financial assets and financial liabilities.

Requirements for recognition and derecognition of financial instruments with only minor amendments.

IFRS 9 (2013)

New requirements for general hedge accounting.1

IFRS 9 (Complete standard)

Amendments to classification and measurement requirements for financial assets published in IFRS 9 (2009) and IFRS 9 (2010).

New impairment model based on expected credit losses.

Larger and more volatile bad debt provisions are likely.

Companies need to start planning for transition, to understand the time, resources and changes to systems and processes needed .

IAS 39 has been revised in stages as follows.

IFRS 9 (2010)

The standard could have a major impact across an organisation – particularly for financial institutions.

No convergence with The FASB had launched a similar project to revise accounting for financial US GAAP instruments but decided to continue in a different direction to the IASB.

As a result, companies applying both US GAAP and IFRS in their financial reporting will be required to implement different guidance – which could pose a significant operational challenge.

Effective date and transition The standard will be effective for annual periods beginning on or after 1 January 2018, and will be applied retrospectively with some exemptions.

Early adoption is permitted. ●

The completed standard also amends IFRS 7 Financial Instruments: Disclosures to introduce new or amended disclosures.

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Restating comparatives is not required, and permitted only if information is available without use of hindsight.

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Fact sheet – Classification and measurement Overview

Key sectors impacted

● Financial asset classification based on: – contractual cash flow characteristics; and – objective of business model in which assets are managed. ● IAS 39 principles for financial liabilities retained subject to new ‘own credit’ presentation for liabilities designated at fair value through profit or loss.

Financial asset classification

● The new standard may have a significant impact on the classification and measurement of: - financial assets held by banks – e.g. those held to meet various liquidity needs; and - financial assets held by insurance companies to fund their insurance liabilities or to match the duration of their longer-term insurance liabilities. ● The impact on corporates will often be limited, although investment portfolios will be affected.

SPPI assessment

IFRS 9 has three primary measurement categories for financial ● The assessment is linked to the concept of a basic lending arrangement. assets. ● ‘Principal’ is the fair value of the financial asset at Amortised cost initial recognition. ● Assets that meet the following criteria: ● ‘Interest’ consists of consideration for the time - contractual terms give rise, on specified dates, to cash value of money, credit risk, other basic lending flows that are solely payments of principal and interest risks (e.g. liquidity risk) and costs (e.g. (the ‘SPPI criterion’); and administrative costs) as well as a profit margin.

- held in a business model whose objective is to hold ● The standard has specific guidance on: them in order to collect contractual cash flows.

- regulated interest rates; Fair value through other comprehensive income (FVOCI) - modified time value of money; ● Assets that meet the SPPI criterion and are held in a - de minimis or non-genuine contractual cash business model whose objective is achieved by both collecting contractual cash flows and selling financial flow characteristics; and assets.

- other contractual provisions that change the ● Non-trading equity instruments for which fair value changes timing or amount of contractual cash flows. are irrevocably elected to be presented in OCI. ● There is no separation of embedded derivatives from financial asset hosts.

Fair value through profit or loss (FVTPL) ● Assets irrevocably designated as at FVTPL to reduce accounting mismatches. ● All other financial assets.

Reclassification between categories is only permitted if the business model objective has changed. © 2014 KPMG IFRG Limited, a UK company limited by guarantee and a member firm of the KPMG network of independent member firms with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved

Business model assessment ● Determined based on how groups of financial assets are managed together to achieve a particular business objective – i.e. not at the individual instrument level. ● Business model is a matter of fact that can be assessed by considering all relevant evidence available including sales activity, business performance evaluation, risk management and how business managers are compensated.

Financial liability ● Financial liabilities are measured at amortised cost, measurement with some exceptions that include liabilities held for trading or designated at FVTPL. ● Reclassifications between categories are not permitted. ● In general, for liabilities designated as at FVTPL: - a change in fair value that is attributable to changes in credit risk is presented in OCI; and - any other change in fair value is presented in profit or loss.

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Impact sheet – Classification and measurement Significant judgements to be made ● The business model approach will require judgement to ensure that financial assets are classified in the right category. ● Judgement may be required in determining whether the SPPI criterion is met. ● If the time value of money is modified – for example where the interest rate resets every month to a oneyear rate – then determining whether the SPPI criterion is met may require a quantitative assessment.

This will require an entity to: – identify the characteristics of a benchmark instrument in which the time value of money is not modified; – identify reasonably possible scenarios; and – determine whether there could be a significant difference between: – the undiscounted contractual cash flows of the financial asset being assessed; and – the undiscounted cash flows of the benchmark instrument.

Possible changes in volatility in profit or loss and equity

Regulatory capital requirements may be impacted

● The standard may have a significant impact on the way financial assets are classified and measured, resulting in changes in the volatility in profit or loss and equity. ● The type and degree of change will depend on the nature of an entity’s financial instruments and how they are managed.

● For banks and other financial institutions that have to comply with the Basel capital requirements or other national capital adequacy requirements, many asset measures used to calculate regulatory capital resources and requirements are based on the entity’s financial statements.

● Early application of the own credit requirements for financial liabilities would help to reduce volatility in profit or loss sooner than the effective date of the standard.

● The way in which an entity classifies financial assets could therefore affect the way its capital resources and requirements are calculated.

● To understand the potential implications for volatility in profit or loss and equity, entities will need to :

Extra resources may be needed for transition

– assess the business models of existing financial assets as part of the transition effort; and – plan to assess the classification of new transactions under IFRS 9.

● Entities that have already applied, or are planning to early apply, IFRS 9 (2009) and/or IFRS 9 (2010) may have to re-engineer the conversion process to take into account the requirements of the final standard.

● Banks and other financial institutions may need to enhance systems and processes to separately analyse credit risk of financial liabilities designated as at FVTPL.

THE BOTTOM LINE The standard could have a major impact across an organisation – particularly for financial institutions.

Different drivers of volatility in profit or loss and equity could impact your future results.

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Begin your business model and solely P&I assessments and plan to assess both existing contracts and those you expect to enter into before 2018.

Fact Sheet – Impairment Overview

Key sectors impacted

● ‘Expected credit loss’ model to replace IAS 39’s ‘incurred loss’ model. ● Applies to: debt assets (including both loans and securities, and lease and trade receivables) measured at amortised cost or FVOCI; contract assets; certain financial guarantees; and loan commitments. Not applicable to equity investments. ● Dual measurement approach: 12-month expected credit losses or lifetime expected credit losses. ● Simplified approach for certain trade and lease receivables and contract assets. ● Interest income recognised using effective interest rate. ● Special rules for assets that are credit-impaired on initial recognition.

Dual measurement approach 12-month expected credit losses ● Defined as the portion of lifetime expected credit losses that represent the expected credit losses that result from those default events on the financial instrument that are possible within the 12 months after the reporting date. ● Recognised for all instruments unless criterion for lifetime expected credit losses is met. ● Impairment trigger no longer required before impairment allowance is recognised.

Lifetime expected credit losses ● Defined as expected credit losses that result from all possible default events over life of financial instrument. ● Recognised if credit risk on instrument has increased significantly since initial recognition. ● Conditions for recognising lifetime expected credit losses may be assumed not to be met if credit risk is low – e.g. for investmentgrade assets.

● Banks are likely to see a significant impact – far-reaching implications are expected for credit systems and processes. ● Insurance companies should expect a substantial impact – there is no simplification for debt instruments measured at FVOCI. ● For leasing companies, the extent of the impact will depend on the type of leases and the impairment approach elected. ● Corporates will see a limited impact for trade receivables. ● All sectors will be affected by extensive new disclosure requirements.

Special rules for certain assets Trade and lease receivables and contract assets ● Trade receivables or contract assets that do not contain a significant financing component will always carry a loss allowance equal to lifetime expected credit losses. ● For trade receivables or contract assets that contain a significant financing component and lease receivables, an entity can elect either to: − apply the general approach; or − recognise lifetime expected credit losses at all times. ● Assets that are credit-impaired on initial recognition ● The effective interest rate is calculated at initial recognition using estimated future cash flows – net of lifetime expected credit losses. ● Subsequent changes in lifetime expected credit losses are recognised in profit or loss, and as a corresponding allowance balance.

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Disclosures ● ●

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Disclosures Extensive qualitative and quantitative disclosures, generally by class of financial instruments, including: description of credit risk management practices – including how an entity determined whether credit risk has increased significantly; explanation of inputs, assumptions and techniques used when applying the impairment requirements; reconciliation of loss allowance and explanation of significant changes in the gross carrying amount; and information on modified assets and on collateral.

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Impact Sheet – Impairment

Significant increase in the number and complexity of judgements ● Judgement is required to assess future credit losses for all exposures. ● The model relies on robust estimates of: − expected credit losses; and − the point at which there is a significant increase in credit risk since initial recognition of an asset. ● For making those estimates, companies will need to decide how key terms such as ‘significant increase’ and ‘default’ will be defined in the context of their instruments. ● The measurement of expected losses should reflect: − reasonable and supportable information that is available without undue cost or effort about past events, and current conditions; and − reasonable and supportable forecasts of future economic conditions. ● The standard: − does not prescribe a method to calculate expected credit losses; and − acknowledges that methods used may vary based on facts and circumstances.

Operationalising the new requirements may be challenging ● Expanded data/calculation requirements may include: − estimates of 12-month expected credit losses; − estimates of lifetime expected credit losses; and − data to show whether significant increase in credit risk has occurred or reversed.

Equity, covenants and regulatory capital may be affected − Initial application may result in a large negative impact on equity for banks and, potentially, insurers and other financial services companies.

The regulatory capital of banks may also be impacted. ● This is because equity will reflect not only incurred credit losses but also expected credit losses. ● The impact on an entity will be substantially influenced by: − the size and nature of its financial instrument holdings and their classification; − the judgements that it has made in applying the IAS 39 requirements; and − the judgements that it makes under the new model.

Banks with less sophisticated credit systems may have difficulty implementing the new requirements ● They may currently lack the data or systems to perform the expected credit loss calculations. ● They may have little previous internal expertise in developing expected loss models.

KPIs will be affected for banks and similar entities ● Credit risk is at the heart of a bank’s business, so transition to the expected loss model is likely to have a significant impact on key performance indicators. ● The standard is likely to introduce new volatility in financial statements because: − credit losses will be recognised for all financial assets in the scope of the model – rather than only for those assets for which losses have been incurred; − external data used as inputs may be volatile – e.g. ratings, credit spreads and predictions about future conditions; and − any move from a 12-month expected credit loss measurement to a lifetime expected credit loss measurement may result in a big change in the corresponding allowance.

Disclosure requirements are extensive ● Sourcing the additional information required could be a complex and time-consuming process that will have an impact on resources and systems.

THE BOTTOM LINE Credit risk is at the heart of a bank’s business, so the standard is likely to have a significant impact on banks and similar institutions. © 2014 KPMG IFRG Limited, a UK company limited by guarantee and a member firm of the KPMG network of independent member firms with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved

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Larger and more volatile bad debt provisions are likely.

Implementation could be challenging, with far-reaching implications for banks’ credit systems and processes, including interaction with the regulatory requirements.

Next steps – IFRS 9 Financial Instruments

Consider the impact on your business from an accounting, tax and regulatory perspective, as well as the impact on your systems and processes, business and people.

Here are some of the impacts that we envisage.

Accounting, tax and reporting ● ●

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Perform a comprehensive review of all financial assets, to ensure that they are appropriately classified and measured.

Decide how the expected credit loss model will be applied to different financial assets, and how key terms such as ‘significant increase’ and ‘default’ will be defined in the context of the financial assets held.

Develop appropriate impairment methodologies and controls to ensure that judgement is exercised properly and consistently and is supported by appropriate evidence.

Put in place processes to collect additional data required.

Perform a test run on the calculations that will be needed.

Assess the impact on regulatory capital and tax requirements.

Update accounting policy manuals.

Identify additional disclosure requirements.

Systems and processes Upgrade accounting systems to ensure that they can capture fair value, amortised cost and any other information needed for classification and measurement. ● Decide which systems and processes need to be changed to collect new data and perform new calculations. ● Consider whether any data or calculations used for regulatory purposes – e.g. Basel III – may be used, and what adjustments are necessary. ● Evaluate the changes needed to key internal controls over financial and regulatory reporting. ● Perform a dry run of data collection processes, to help ensure the integrity of source data. ● Develop a transition plan for parallel runs, including reconciliations. ● Establish contingencies for data collection needs. ●

Business ● ● ● ● ● ● ● ●

Assess the risks affecting business models and how their performance is evaluated.

Evaluate the impact of accounting change on management compensation metrics, and performance targets and measures.

Perform a comprehensive review of contractual terms.

Assess the impact on KPIs and internal management reporting.

Factor new expected credit loss requirements into stress testing.

Assess the impact of accounting change on general business issues – e.g. contractual terms, risk management practices, treasury practices etc.

Budget for necessary changes to people, processes and systems.

Develop communication plans to minimise surprises for stakeholders.

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Set up a project team with representatives from credit, accounting, tax, regulatory and IT teams, and with an appropriate governance structure. ● Develop and execute training plans for employees across functions and locations.

Ensure that the project provides realistic timescales and accountabilities.

Assess how changes to processes may impact the way in which work is performed, including how teams are structured.

Identify whether there is a need for additional staff with appropriate expertise, or a need to engage external help.

Revise performance evaluation targets and measures, and communicate them to affected personnel.

Embed knowledge – build a dry run into the adoption plan to test staff understanding. ●

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People and change

Rafael Rodríguez Partner – KPMG Colombia

This content was originally developed by KPMG International Standards Group. KPMG International Standards Group is part of KPMG IFRG Limited.

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