International Financial Reporting Standard (IFRS) 9 Financial Instruments is the new accounting standard that will eventually replace International Accounting Standard (IAS) 39 Financial Instruments: Recognition and Measurement on Jan. 1, 2018. This standard is regarded as the most significant accounting development for banks today because it will (1) introduce fundamental changes to financial reporting for financial instruments; and, (2) require significant changes to a bank’s operational processes and risk management practices. The final standard was issued by the International Accounting Standards Board (IASB) in July 2014 and contains the new requirements for classification and measurement (C&M) of financial instruments, impairment and hedge accounting.
Under the C&M requirements of IFRS 9, financial assets are to be measured either at amortized cost, fair value through profit or loss (FVTPL) or fair value through other comprehensive income (FVOCI) based on both their contractual cash flow characteristics and the entity’s business model for managing the financial assets. For impairment, IFRS 9 introduced a forward-looking “Expected Credit Loss” (ECL) model which will require entities to recognize either a 12-month or Lifetime ECL depending on the extent of deterioration of the financial asset’s credit quality since initial recognition. Lastly, a new hedge accounting model was introduced with the aim to provide a better link between an entity’s risk management activities and accounting. These new requirements are expected to have far-reaching impact such that globally, banks are already gearing up for an efficient and successful implementation.
To assess the current “state of readiness” of banks in implementing their IFRS 9 conversion programs, EY Global conducted its second global IFRS 9 survey in September 2016. Participated in by a total of 36 top tier IFRS-reporting banks, including 14 Global Systemically Important Banks (G-SIBs), from 13 countries worldwide, some of the survey findings are as follows:
- Many participants have made significant progress in their impairment programs with most prioritizing the impairment modeling, data and systems work streams of their programs. Of the respondents, 64% indicated that they have shifted from the design phase into the build phase of the modeling work stream. For data and systems, 39% and 33%, respectively, also indicated having shifted into the build phase of these work streams.
- With regard to C&M, there have been some developments although at a slower pace than impairment. This is consistent with the view of less complexity associated with the C&M requirements compared with the impairment requirements. About 58% and 67% of the participants are still in the advanced design phase for the “Business model” assessment and “Solely payment of principal and interest” testing, respectively, of their C&M programs.
- Due to the perceived minimal benefit to banks of applying the general hedge accounting requirements (given their strategy to hedge on a portfolio basis), only 14% of the participants are planning to adopt the IFRS 9 hedge accounting requirements. They are waiting for developments in the IASB’s macro hedge accounting project and are therefore, not extensively investing in this area.
- In relation to governance and coordination, there is a clear trend (64%) among the participants for the impairment program to be governed jointly by both Finance and Risk, while the C&M and hedge accounting programs are led mainly by Finance. Moreover, because of the intricacies involved in the end-to-end business as usual (BAU) processes of IFRS 9, banks recognize the need for interaction of the Finance and Risk functions with other functional units of the banks such as operations and IT.
- To be able to assess the reliability of the reporting systems and new IFRS 9 models, a parallel run of IAS 39 and IFRS 9 figures is necessary. Based on the survey, 64% of respondents expressed that they will be able to generate impairment numbers by the end of 2016. Only 31% of the participants expect to start a full parallel run of IAS 39 and IFRS 9 numbers, including C&M numbers, in the first quarter of 2017. Meanwhile, 19% and 25% have to delay their full parallel run to the second quarter and third quarter of 2017, respectively, while the remaining 25% are either planning to do the parallel run in the fourth quarter or are still undecided on the timing of the parallel run.
- The participants have prepared a very wide range of budgets (from less than €2m million to more than€125 million, with some undisclosed) for their IFRS 9 programs. It is evident from the survey results that the cost is not linearly related to the size of the bank but depends on the level of complexity of solutions implemented. In terms of work streams, impairment is still anticipated to be costlier to implement.
- Of the respondents, 47% and 25% plan to disclose their first quantitative impact assessment in 2017 and 2018, respectively, while the remaining 28% are still undecided on the timing of their public disclosure.
For the banking industry, successful IFRS 9 implementation is expected to be very challenging because of the time, effort and resources required for this potentially highly complex and expensive exercise. Given this, global banks have started early and are planning out well their implementation programs to ensure that they reap the benefits of their investment in this initiative.
IFRS 9 conversion is not just a simple accounting exercise as its impact will cut across the entire organization of a bank. There will be a great deal of dependencies between IFRS 9 processes and the existing processes within a bank. Thus, implementation programs should be comprehensive, involving not just the finance function but also other units, such as risk, operations, compliance and IT. Transition will also require high-quality project management and conversion methodology to ensure optimal results.
At this point, banks should already have a clear understanding of the requirements of IFRS 9 and its potential business implications. Management and Audit Committees should be proactive in providing strong governance for a robust IFRS 9 implementation. Given that over two years have passed since the issuance of the final version of IFRS 9, banks can no longer claim that a poorly implemented IFRS 9 program is due to lack of knowledge on the requirements, planning and preparation. For banks that have not started with their implementation initiatives, time is already of the essence.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.
Redgienald G. Radam is a Senior Director of SGV & Co.