ifrs 9 what is involved and what are the implications for ... · ifrs 9 – what is involved and...

IFRS 9 – What is involved and what are the implications for Internal Audit?

Alana Sainsbury 10 November 2016

2

Agenda

• Introductions

• IFRS 9: what is changing?

• What are the implications for Internal Audit?

• Questions and next steps

© 2016 Deloitte LLP. All rights reserved.

3


What is IFRS 9?

• IFRS 9 Financial Instruments is effective from 1 January 2018 and replaces IAS 39

• IFRS 9 Financial Instruments sets out the recognition and measurement requirements for financial instruments. There are three phases to IFRS 9 and the impact on Impairment is deemed to be the most complex with the introduction of requirements to incorporate forward-looking information and macroeconomic factors.

The three phases: • classification and measurement • Impairment • Hedge accounting

4

Stage 3 Stage 2 Stage 1

Initial recognition (unless

purchased/originated credit-impaired)

Significant increase in credit risk but not credit

impaired

Credit impaired

Change in credit risk since initial recognition

12-Month EL LEL

Gross basis Net basis

Allowance recognised

Interest revenue

What is IFRS 9?

The three phrases

Impairment

• Three measurement categories for financial assets driven by the entity’s’ business models for managing financial assets and the contractual cash flow characteristics of those assets are:

− Fair Value

− Amortised Cost

− Fair value through other comprehensive income (FVOCI) for certain assets

• For financial liabilities designated at fair value through profit or loss, changes in own credit will be recorded in other comprehensive income.

Fin

al Sta

ndard

Curr

ent

Hot

Topic

s

• Determination of business models; to hold, to sell or both

• Consideration of whether contractual cash flows are “solely payments of principal and interest”.

• Requirements for impairment of financial assets based on12-month and Lifetime Expected Losses (12-month EL and LEL) replacing the current Incurred Loss (IL) approach under IAS 39

• Contractual versus behavioural maturity

• Use of practical expedients such as “low credit risk” and the “More than 30 days past due rebuttable presumption”

• Use of forward looking information and incorporation of multiple forecast and macroeconomic scenarios

• Portfolio vs individual asset assessment of significant deterioration

• General hedge accounting model designed to more closely reflect risk management

• Increased eligibility of hedged items and hedging instruments

• No retrospective hedge effectiveness test

• Prospective hedge effectiveness test (80-125%) replaced with a principles based test of amongst others, “economic relationship”

• Entities currently reporting under IFRS will have an accounting policy choice to continue to apply IAS 39 hedge accounting until the macro hedging project is finalised.

• The IASB is exploring a new way to account for dynamic risk management of open portfolios (‘macro hedging activities’).

Nov 2009 C&M of Assets Standard

C&M of Liabilities Standard

First Impairment ED

Limited changes to the C&M proposed

Second Impairment ED

General Hedge Accounting standard

Proposed effective Date 2018

Oct 2010

Jan 2011

Nov 2012

Mar 2013

Nov 2013

Feb 2014

Jul 2014

Standard on impairment & Amendments to C&M of assets

Classification & Measurement Hedge Accounting

IFRS 9 Three Phases


5

IFRS 9 Overview

IFRS 9 Business Wide Impact

Whilst IFRS 9 can be seen as an accounting policy change, it creates business-wide challenges for organisations. IFRS 9 has a direct, quantifiable impact on provisions feeding into the P&L but it also has a perhaps indirect but material impact on a wide range of factors contributing to shareholder value.

IFRS 9 Business-wide Impact

Basel III

COREP FINREP

Risk adjusted pricing

Risk and Finance operating model efficiency • People • Processes • Data & systems • Policies • Models • MI & Reporting

Pillar 1 and 2A capital

requirements

Pillar 2B capital

planning buffer for

drawn down in a stress

Basel 3 Tier 1 and Tier 2 capital instruments and leverage ratio

P&L impact of IFRS 9 provisioning, including on-going volatility

Portfolio and product mix

External rating,

reflecting increased P&L

volatility

Market position relative to peers

External audit

Balance sheet impact of IFRS 9 provisioning, including step change upon introduction

Products and

volume

Pricing

Disclosures and market

discipline

Revenue Growth

Operating Margin

Reputation Capital

IFRS 9


6


IFRS 9 timeline and implementation challenges

Given the scale and complexity of the changes required by IFRS 9, the short implementation timeframe leading up to the 2018 mandatory effective date means that it is a large high risk project for many banks.

Timeline

Significant regulatory and market focus will drive interpretation of key aspects of the rules, implementation standards and best practices with knock on effects for banks’ IFRS 9 implementation project.

Regulatory and industry developments

Early disclosure to the EBA and perhaps to the market means that reliable information about IFRS 9 impact will be needed before the first IFRS 9 accounts are published further squeezing banks’ decision making process and implementation timeline.

Early disclosure

The large number of stakeholders, business functions and jurisdictions impacted poses a significant project management challenge. Strong governance and ownership of project streams are therefore critical to the success of the project.

Governance

The lack of resources means that securing the right resources in each jurisdiction within the required timeframe is a key implementation challenge.

Resources

Design and build of ECL models is underway although model developments are posing new technical challenges with variances in solutions appearing across the industry, due to differing interpretations of compliance and target level of sophistication as well as size.

Modelling

2014 H1 2015 H2 2015 H1 2016 H2 2016 H1 2017 H2 2017 2018

Impact Phase Design Phase Build and Testing

Phase Implementation and Parallel

Run Stabilisation & Improvement

7

Impairment

8

IFRS 9 requires the same expected loss model to apply to the following: • Financial assets measured at amortised cost; • Financial assets mandatorily measured at FVTOCI; • Loan commitments when there is a present obligation to extend credit

(excluding loans measured at FVTPL); • Financial guarantee contracts (excluding those measured at FVTPL); • Lease receivables within the scope of IAS 17/IFRS 16; and • Contract assets within the scope of IFRS 15 Revenue from Contracts with

Customers.

IFRS 9 Impairment model - Scope

Credit losses are required to be measured through a loss allowance at an amount equal to: • 12-month expected credit losses (expected credit losses that result from

those default events on the financial instrument that are possible within 12 months after the reporting date); or

• Lifetime expected credit losses (expected credit losses that result from all possible default events over the life of the financial instrument).


9

Impairment

General model

Change in credit risk since initial recognition

Lifetime expected

credit losses

Gross carrying amount

STAGE 2

Lifetime expected

credit losses

Net carrying amount

STAGE 3

Significant increase

in credit risk?

12-month expected

credit losses

Gross carrying amount

STAGE 1

Objective evidence of impairment?

Loss allowance

Apply effective

interest rate to …


10

Assessment of a significant increase in credit risk

Assessment of increase

in credit risk

Low credit risk exception

Collective basis

Relative assessment

Significant increase normally

occurs before credit-

impairment

Forward-looking

information

‘30 days past due’

rebuttable presumption

A significant increase in credit risk is defined as a significant increase in the probability of a default occurring since initial recognition:


11

Reasonable, supportable information—factors to consider

Measurement of expected credit losses

• Expected value • Time value of money

• Contractual period • Cash shortfalls

• Collective assessment • Reasonable and supportable information


12

What are the implications for Internal Audit?

13

Need to understand transition impact due to potential upfront capital impact and market reaction

Governance and internal control considerations

Given the size of the potential impact combined with the complexity and subjectivity of the requirements, there is a risk of material bias associated with financial statements lines affected by IFRS 9 which will have a knock on impact on key financial and regulatory metrics which means that ECL must be determined in a well governed environment. An effective governance and control framework before, during and after transition in these three areas are key for IFRS 9 implementation:

• Management will need additional credit risk information that may not be available or was not previously required to be used for financial reporting purposes.

• Appropriate governance and controls will be required for these sizeable additional data sets used for the estimation of ECL.

Data quality and

availability

• Management must develop methodologies and models which will require significant expertise and judgement in order to deliver probability weighted and unbiased estimates of ECL on an ongoing basis.

• Ensuring that models are not a ‘black box’ and that ECL outcomes can be understood and articulated will be a significant challenge and will require robust governance and control at each level of the organisation.

Methodologies and modelling

• Banks will need to produce their IFRS 9 numbers and related disclosures within a short timeframe, thus systems and processes that banks build will need to be sufficiently automated and streamlined to deliver reliable results.

• Strong governance and controls will be key and the cost associated with achieving all of these objectives are likely to be significant both in terms of direct spend as well as management time before, during and after transition.

Systems and processes


14

Some firms are delivering their own programme but are reaching out to external specialists to assess whether their programme is effective to avoid compliance risk and delivery failure

Potential IA Actions

• Pre-Project Assurance – IA can provide assurance whether a PMO has sufficient capabilities to deliver the IFRS 9 transformation programme including reviews of governance, MI, project tracking tools – all in line with best practice

• Real-time in-flight project assurance – During the project, IA can provide continuous assurance as to whether the IFRS 9 project transformation programme is going to deliver the required capabilities and statutory requirements, within budget and within deadlines

• Post-Project assurance – IA can conduct post-implementation audits to review controls in place to determine their adequacy, effectiveness and efficiency to independently evaluate the firm’s readiness for IFRS 9 on Day 1 and beyond

How can Internal Audit support the transition?

Programme Review

Use of Model IFRS 9 Process & ECL Flows

Example Assessment Output


15

IFRS 9 will put increased pressure on the existing governance and controls frameworks across the impairment process


• Governance – IA can provide assurance whether changes in a firm’s governance due to IFRS 9 regarding the provisioning process will result in outcomes consistent with stakeholder expectations, including regulators

• Policy – IA can review whether a firm’s policies and procedures adequately document its internal credit risk assessment and credit risk models

• Control frameworks – IA can provide assurance over the adequacy and effectiveness over back testing so key drivers have been captured and calibrated accurately. In addition, IA can examine whether the impairment process adequately embeds experienced credit judgement including robust documentation evidencing of challenge

How can Internal Audit support the transition? (continued)

Governance & Controls Framework

PMO Heatmaps & Governance Findings



16

IFRS 9 will impact across different layers of the IT infrastructure


• Source systems – IA can provide assurance whether source systems can satisfactorily record historic, current and forward looking data sets which are required for modelling and impairment calculation data flow - this is often a challenge for mature banks

• Credit risk calculators – IA can provide assurance over the adequacy of the development and testing regime on fundamental changes in the calculation logic and platform used

• Disclosure systems – IA can provide assurance whether existing systems have adequate “Extract, Transform and Load” capabilities to provide for IFRS 9 requirements with sufficient granularity to provide insight on trends & variances and credit & collateral quality migration analysis

• New/upgraded systems – IA can provide assurance whether the project plans to implement upgrades (or entire new systems) are adequate to deliver the required system changes and will meet IFRS 9 requirements within deadlines & budget


Data & IT Architecture


Data & IT Infrastructure Heatmaps


17



2014 H1 2015 H2 2015 H1 2016 H2 2016 H1 2017 H2 2017 2018

Impact Phase Design Phase Build and Testing

Phase Implementation and Parallel

Run Stabilisation & Improvement

During the Design & Build and Testing Phases, IA can conduct project programme audits.

In your firm's Design & Build and Testing Phases, the focus will be on delivering to budget and time in accordance with the approved Design phase methodology.

IA can conduct pre-project and in-flight project assurance audits to gain assurance over whether the project will meet its commitments to stakeholders

In the Implementation Phase, IA can conduct project programme audits along with IFRS 9 Day 1 readiness audits.

In your firm’s Implementation Phase, the focus should be on embedding your IFRS 9 solution throughout Parallel Run and Transition. IA can conduct in-flight and post-project assurance audits along with IFRS 9 Day 1 readiness audits to identify gaps in controls and efficiency improvements.

In the Parallel Run Phase, IA can conduct an audit to examine whether the Parallel Run is designed and operating effectively.

In your firm’s Parallel Run phase, the focus should be on refining your firm’s operating model.

IA can conduct reviews of roles and responsibilities, expected credit loss calculation processes, application of experienced credit judgement and control frameworks & policies.

Timeline

18

Questions and next steps


Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.co.uk/about for a detailed description of the legal structure of DTTL and its member firms. Deloitte LLP is the United Kingdom member firm of DTTL. This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of the principles set out will depend upon the particular circumstances involved and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of this publication. Deloitte LLP would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication. © 2016 Deloitte LLP. All rights reserved. Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at 2 New Street Square, London EC4A 3BZ, United Kingdom. Tel: +44 (0) 20 7936 3000 Fax: +44 (0) 20 7583 1198.

ifrs 9 what is involved and what are the implications for ... · ifrs 9 – what is involved and...

Documents