December 2014 Issue
This past July saw the International Accounting Standards Board (IASB) unveil the final piece of the IFRS 9 jigsaw puzzle, while C-suites throughout the financial sector collectively sighed at the thought of yet another accountancy standard.
The new standard, which replaces IAS 39, will have a major impact on institutions that have financial instruments on their balance sheets, although the largest impact is likely to be on banks and non-banking lending institutions with significant changes to accounting and reporting taking place.
With a complex transition period ahead, and the deadline for financial institutions to be compliant set for 1 January 2018, the new standard needs to be on the boardroom agenda now, not further down the line when it’s too late to get houses in order.
IFRS-what?
For non-accountants, IFRS 9 is the culmination of five years’ work – triggered by concerns over the impact of IAS 39 following the global financial crisis – and is intended to enable financial institutions to present a more accurate picture of their accounts.
The standard will change the way in which banks and other financial institutions account for loan losses on their balance sheets, aiming to impose a more forward-thinking view regarding expected losses.
IFRS 9 will introduce specific changes to the classification, measurement and impairment assessment requirements for financial instruments. The most notable change is the way in which financial institutions will have to account for loan losses on their balance sheets, with them now being required to recognise losses that have already happened, as well as those that are expected.
Although the deadline isn’t until 1 January 2018, the reality is that the changes need to be in place at least a year before in order for them to reflect the impact on opening balances. This gives companies only two years to overhaul their systems.
Planning ahead
While it may seem obvious, planning for IFRS 9 should begin as soon as possible. Otherwise, it may be seen as yet another regulatory headache for financial services firms and be pushed down the priority list.
Until such time that institutions begin the planning process, they will not have a full understanding of the changes they will need to make to existing systems and processes, staffing requirements, as well as the cost implications and the time it will take. The length of the IFRS 9 implementation process will depend on the size of the financial institution’s book, existing systems, nature of products, use of hedge accounting and the entity’s credit risk measurement systems.
As for how long it will take, it is generally accepted that a lead time of two to three years is required to be fully compliant with the expected loss model, including Credit Value Adjustment (CVA) and Credit Value Adjustment Value at Risk (CVA VaR) measurements.
Additionally, new rules for hedge accounting are expected to take financial institutions somewhere between one to two years to implement. Some institutions already have sophisticated risk management systems with economic hedge information already available, while others may need to enhance systems and documentation to be fully compliant.
The road to compliance
Although it’s clear that it could well take a couple of years to get a firm up to speed with IFRS 9, many may ask why financial institutions should start preparing now, rather than in January 2016. The answer: the complexity of the implementation process.
Businesses should keep any impact on existing systems, resourcing and regulatory capital under the Basel III framework front of mind throughout the process and ensure that a gap analysis of systems and requirements is undertaken for IAS 39 versus IFRS 9 implementation. Firms also need to determine the measurement differences between IFRS 9 Basel III as there are a number of items, such as debit value adjustment (DVA), which are not admissible for Basel III capital adequacy purposes. Additionally, profit and loss volatility has implications for debt covenants, which are another important planning aspect for businesses making and receiving loan funding. Costs to implement IFRS 9 will also vary from business to business, but this has clear budget significance over the next three to five years.
All firms should be aware that the requirement to model expected losses over the life of the loan asset will mean forecasting macroeconomic factors – for example, economic recessions, inflation, amongst others – as well as probabilities of default over a lengthy period of time. This will involve actuarial estimation to be able to determine expected losses – something which firms should tackle as early as possible to assess the impact on their businesses.
Mid-sized and small financial institutions should look at all the elements involved in expected loss model calculation. In addition to the actuarial estimation required, other elements to be aware of include the move from the probability of incurred losses to the probability of expected losses, and the implementation of systems to provide emergence period information on an expected loss basis.
Finally, there will also be significant IT and resourcing investment needed to comply with the new rules, as well as granular level data requirements and the additional costs of integrating accounting, IT and risk functions in order to accurately monitor and report losses.
Ready or not?
Ready or not, IFRS 9 is coming. From 1 January 2018, should a firm not be compliant with IFRS 9, they will be unable to insert an unreserved statement of compliance with IFRS. This would mean that financial reporting will not be transparent, and no business wants a qualification of opinion in the audit report. On the flip side, there is no penalty for firms that become compliant ahead of the implementation deadline – a benefit for those who are ahead of the pack.
The implications of IFRS 9 are not to be underestimated. Businesses affected by the new standard should, if they have not already done so, start the planning process now. The earlier the start, the better prepared firms will be for when IFRS 9 heralds a new era of long-term forecasting for financial institutions.
Leigh Wormald is a partner at BDO LLP. She can be contacted on +44 (0)20 3219 4063 or by email: leigh.wormald@bdo.co.uk.
© Financier Worldwide
BY
Leigh Wormald
BDO LLP