European IFRS banking conference (June 2017) - EY

European IFRS banking conference Frankfurt 14 June 2017

Contents 1. Introduction

2

2. IASB update

3

3. IFRS 9: The final countdown

4

4. Multiple economic scenarios

5

5. IFRS 9 thematic review

6

6. IFRS 9 EBA regulatory update and impact study

8

7. Implications on the normative internal and economic internal perspective under ICAAP

9

8. IFRS 9: What do we expect on disclosures?

11

9. IFRS 9 classification and measurement survey findings

13

1. Introduction EY biannual European International Financial Reporting Standards (IFRS) banking conference on 14 June 2017 in Frankfurt was attended by representatives from 61 different banks across 16 countries, as well as representatives from standard-setters and industry bodies. The discussions revolved around the ongoing challenges arising from changes to accounting and regulatory rules affecting the banking industry. The event focused on IFRS 9 Financial Instruments with points of views from EY, banks, regulators and the International Accounting Standards Board (IASB), but also included a wider update on recent IASB developments. This document provides a high-level summary of insightful thoughts from discussions with leading specialists and peers across the European financial services industry, as well as the findings of real-time polls taken during the conference.

During the conference, a number of polling questions were asked of the audience. A selection of the responses is included in the respective sections of this publication.

We hope that you find the contents of this report useful in planning around the forthcoming changes.

European IFRS banking conference

| 2

2. IASB update Stephen Cooper, Board Member of the IASB, provided an update on the board’s activities that impact the banking industry. • Prepayment features with negative compensation — proposed amendments to IFRS 9 Constituents have raised concerns in response to the exposure draft about the contents of the basis for conclusions of the prepayment features. The board will redeliberate the basis for conclusions and aim to publish the final amended standard in October 2017. • Impairment webcast: expected life of revolving credit facilities Broadcast in May 2017, the webcast responds to a question received from those implementing IFRS 9 about the application of paragraph B5.5.40, which sets out the factors to consider when an entity determines the life expectancy of revolving facilities, such as credit cards. Link to the impairment webcast: www.ifrs.org/webcast/ ?webcastid=1145211 • Modification of financial liabilities In November 2016, the IFRS Interpretations Committee (IFRIC) discussed the submission relating to the recognition of gains or losses arising from modification or exchange of financial liabilities when the financial liabilities are not derecognised as a result of the modification. Stephen emphasised that these discussions only dealt with financial liabilities where IFRS 9 is already considered to be clear on the treatment for financial assets. While the IASB Staff proposed a final agenda decision confirming that the effective interest rate (EIR) of a modified liability will be kept constant and a catch-up adjustment recorded in profit or loss, this was rejected by the IFRIC and will be discussed by the board.

• Applying IFRS 9 to assets held for sale The IFRIC have discussed the application of the business model assessment and cash flow hedge accounting for assets held for sale from the perspective of the consolidated entity. The board will be discussing this further at an upcoming meeting. • Financial assets eligible for the fair value through other comprehensive income (FVOCI) presentation election IFRIC was clear on the fact that puttable financial assets as described in the submission do not meet the definition of an equity instrument and are therefore not eligible for the FVOCI presentation election for the holder. • Dynamic risk management The board has gone back to first principles to develop an accounting model that better reflects the dynamic risk management in the financial statements. The IASB is trying to better understand how banks approach this. The focus will be on the presentation of net interest margin. A second discussion paper is expected to be released in early 2018. • Financial instruments with characteristics of equity This is a project on the board’s research agenda, investigating: • The classification of liabilities and equity, and related disclosures • The presentation of gains and losses for both liabilities and equity It is expected that this will result in more financial instruments being classified as liabilities, but with more gains and losses being reported in other comprehensive income (OCI) instead of in profit and loss. A discussion paper is expected toward the end of 2017.

3 |


3. IFRS 9: The final countdown Hengameh Shikhi-Vijeh, Commerzbank, highlighted some of the significant challenges and complexities the bank has had to work through and shared some IFRS 9 programme priorities which have helped them navigate through a successful implementation. The audience was asked about when banks first started planning for IFRS 9.

45% 40% 35% 30% 25%

42.9%

20% 15% 10% 5%

26.2% 16.6%

14.3%

0% 2013

2014

2015

2016

Hengameh provided an overview of the challenges Commerzbank’s IFRS 9 implementation project had faced:

Hengameh discussed the priorities of the IFRS 9 implementation programme

• T he need to integrate finance and risk data and process flows, which creates a complex systems landscape

• Maintaining a tightly defined programme scope using integrated planning and introducing a hard deadline for any potential scope increases

• Understanding and dealing with the interplay between IFRS 9 and FINREP • Designing and building a solution that adequately caters to subsidiaries and branches whilst providing a degree of flexibility

• Early engagement and education with the business to promote awareness and create clearly defined programme roles and ownership • Taking a structured assessment in defining the transitional approach by analysing several alternatives and against predefined criteria • Defining the end-to-end process at an early stage in the programme to help understand the scope, implications for the business and to inform process ownership


| 4

4. Multiple economic scenarios Mark Gregory and Tony Clifford of EY talked about some of the key considerations and challenges in developing and applying multiple economic scenarios for reporting expected credit losses (ECL) under IFRS 9. Tony’s key messages included:

Mark’s key messages included:

• Incorporation of multiple economic scenarios (MES) in the calculation of ECLs continues to be very challenging, primarily because of the lack of data, not only to frame and weigh possible economic futures, but also to estimate the consequent losses.

• Banks will need to understand the correlations and economic dynamics between parameters to ensure that assumptions are applied consistently across portfolios and jurisdictions.

• There are a range of approaches being considered and different forecast outcomes reflecting, in part, the different sensitivity to non-linearity of different portfolios. The effect of MES is expected to be greatest for:

• To avoid creating overly pessimistic results, scenarios should factor in any governmental actions, such as policy responses, which could dampen the effects of an adverse economic environment.

• Where the risk of default is linked to commodity or property prices

• Informing users about MES forecasts, without confusing them with excessive information, is challenging. One possibility would be to provide information on the base case scenario without going into details about how the alternative scenarios were calculated and quantifying the effect of using MES.

• Exposures collateralised by assets whose values are volatile or correlated with probabilities of default, such as mortgages

We expect our full survey with the MES results to be available in August 2017.

• Exposures in volatile economies

• The EY 2017 impairment survey results showed that nearly half of the responders who had a view expected more than a 5% uplift in their ECL as a result of the incorporation of MES.

ECL uplift on base case

30%

36%

17%

17%

0%–5% 5%–10% 10%–20% Don’t yet know

5 |


5. IFRS 9 thematic review Patrick Amis, European Central Bank (ECB) discussed the ECB’s approach to the IFRS 9 thematic review, preliminary observations and reflected on some of the prudential implications. • Key areas of focus for the thematic review were consistency with the regulatory framework and the importance of judgement in implementing IFRS 9.

Whilst the focus so far has been on impairment, the ECB will not • lose sight of the effects of classification and measurement, and the interplay with governance and risk management.

The audience was asked whether they felt IFRS 9 would be more pro-cyclical than IAS 39.

90% 80% 70% 60% 50%

84.7%

40% 30% 20% 10%

8.5%

6.8%

0% How could I know?

For sure

Difference won’t be material

The audience was asked to what degree they expected their bank to be ready for 1 January 2018.

45% 40% 35% 30% 25%

46.9%

20%

32.8%

15% 10% 5%

15.6%

4.7%

0% Yes, fully

Yes, barely

Not in general

Yes, but in a diverse manner


| 6

• Findings of the thematic review suggest that many banks need to make significant enhancements to their documentation in respect of the initial classification and measurement assessment and ongoing governance framework, as well as the methodologies for the calculation of expected credit losses. • Patrick expressed concerns that the reliance on only quantitative indicators might result in late transfers to stage 2 and that qualitative indicators could be used as well. • Banks need to clarify the interaction between forbearance and stage 2 classification.

• T he findings of the IFRS 9 thematic review outcome will be included in the supervisory review and evaluation process in the sub-category internal governance and risk management. • Patrick mentioned that a third of the queried banks are significantly behind in their IFRS 9 implementation readiness. • Patrick stated that the ECB’s initial preference was for a static (rather than the dynamic) approach with respect to FTA prudential filters, as this is seen as more conducive to transparency and comparability.

• Patrick noted there was a ‘wait and see’ approach relating to disclosures. The audience was asked for their views on how transitional arrangements should be calculated for the regulatory capital purposes. 45% 40% 35% 30% 25% 20%

39.3%

46.4%

15% 10% 5%

14.3%

0% What are you talking about?

7 |


Static for sure

Dynamic of course!

6. IFRS 9 EBA regulatory update and impact study Delphine Reymondon, European Banking Authority (EBA), gave an overview of the work which has been carried out to date by the EBA in respect of the introduction of IFRS 9 and highlighted some of the initiatives and areas of focus for the EBA in the future. The following is a summary of the highlights: • The second impact assessment will be published at the end of June. Delphine summarised some of the main messages to be drawn, related, in particular, to the state of implementation, parallel runs, main challenges, alignment with prudential requirements, use of scenarios and practical expedients, and the estimated volatility of provisions. • With respect to the transition arrangements for the effect of IFRS 9 impairment on capital requirements, Delphine noted the EBA’s preference for a ‘static’ approach. It is simpler to understand and apply, and achieves a better balance between simplicity and prudence. Also, disclosure of the full effect will be key whatever transition approach is chosen. • Delphine also reminded the audience of other initiatives by the EBA, such as:

• She closed by listing some future initiatives, such as: • IFRS 9 to be incorporated into the 2018 stress-test methodology — guidance will be communicated to banks before it is issued • A post-implementation review of effectiveness of the EBA guidelines on ECLs • Monitoring of implementation issues to understand the effects of different methodologies, models, scenarios, etc. • Monitoring of the interaction between accounting and regulatory capital impacts • Long-term assessment of the impact of IFRS 9 on volatility of own funds

• The guidelines on expected credit losses • Guidelines on communication between competent authorities and auditors • Implementation of technical standard supervisory reporting changes related to IFRS 9


| 8

7. Implications on the normative internal and economic internal perspective under ICAAP Thomas Werner from Deutsche Bank discussed the interaction between IFRS 9 ECL and the regulatory treatment of accounting provisions with specific focus on the implications of IFRS 9 on ICAAP from both normative internal and economic internal perspectives. With the IFRS 9 go-live date approaching, there has been an increase in focus from regulators and supervisors on the implications of ECL on regulatory capital. His presentation focused on further substantiating some of the high-level arguments raised by the industry in the consultation process, with specific attention to the long-term treatment of the IFRS 9 impact on the regulatory requirements, which are still to be finalised by regulators. The following is a summary of the key points made during presentation: • Cycle sensitiveness The overall expectation from the industry is an increase in regulatory capital volatility, although offsetting effects exist in the accounting framework.

• Horizon Because of the recognition of lifetime ECL for Stage 2 assets, there is an expectation of shifts from expected loss (EL) shortfalls to EL surpluses for internal rating-based approach (IRBA) banks. This is asymmetric because an EL surplus does not count toward common equity tier 1 (CET1) capital under the current regulatory treatment. • Forward-looking information Thomas noted that forward-looking information introduces a potentially complex interaction with regulatory requirements and various buffers. • Solutions The first potential solution could be to introduce a symmetric treatment of EL shortfall and EL surplus, i.e., the amount of EL surplus to be added back to CET1 capital. An alternative solution could be to adjust the IRBA risk-weighted assets (RWA) formula.

The audience was asked for their views on the long-term regulatory treatment of accounting provisions. 60% 50% 40% 30%

59.6%

20%

34.0%

10%

6.4%

0% Very urgent, should be completed before IFRS 9 goes live in 2018

9 |


Relatively urgent, should be completed between 2018 and 2020 (when US ECL goes live)

Not urgent, can be completed after 2020

The audience was asked for their views on what is the best expected loss framework going forward given the new IFRS 9 regime for bank steering purposes. 50% 45% 40% 35% 30% 25%

48.7 %

20% 15% 10% 5%

27.0%

8.1%

16.2%

0% Basel framework ‘through-thecycle’

‘Point-in-time’ (risk sensitive)

Hybrid

I don’t know

The audience was asked for their expectation on the change in regulatory capital volatility under IFRS 9. 80% 70% 60% 50% 40%

80.8%

30% 20% 10%

1.9%

0% Increase

Decrease

11.5%

5.8% No change

I don’t know

The audience was asked for their views on expected changes in banks’ portfolio management and pricing strategy under IFRS 9. 45% 40% 35% 30% 25%

42.0%

20% 15%

32.0%

10%

14.0%

5%

12.0%

0% Yes, because cost of doing business is higher under IFRS 9 and this cost increase should be partly transferred via pricing

Yes, but for other reasons than answer 1

No, because the underlying risk profile of clients or transactions is unchanged under IFRS 9 compared with IAS 39

No, but for other reasons than answer 2


| 10

8. IFRS 9: What do we expect on disclosures? Tara Kengla, EY, discussed what was disclosed in 2016, and what to expect for the rest of 2017 and upon transition in 2018. • With respect to 2016, EY performed a desktop survey against the Enhanced Disclosure Task Force (EDTF) recommendations and noted that disclosures progressed in 2016. However, the extent and details diverged across banks. The disclosures were still heavily focused on the changes and new accounting requirements under IFRS 9. Many disclosed that they would not make a quantitative impact disclosure until it’s practicable to provide reliable estimates, which will be no later than in the 2017 annual accounts. One bank wrote that further validation and testing needed to be done until a reliable estimate could be provided.

• In terms of what to expect in 2017 relating to quantitative disclosures, EY showed some preliminary results from their upcoming 2017 IFRS 9 survey. This showed that only 16 banks expect to disclose a quantitative impact before the year-end 2017 financial statements are published. This is unchanged from the 2016 EY survey, except that a number of banks changed their answer from undecided to disclosure some time in 2018.

Period when the quantitative disclosure is expected to be available (number of respondents). 23

25 20 15

11 8

10

5 5

2

0 Already disclosed

11 |


During Q3

During Q4

During 2018

Undecided

Tara asked the audience where they expect their bank to provide first time quantitative impact disclosures. 50% 45% 40% 35% 30%

52.0%

25% 20% 15% 10%

28.0%

6.0%

5%

14.0%

0% In the interim IFRS financial statements

Outside the interim financial statements in the front-end section

• With respect to year-end 2017, EY expects the extent and granularity of information will continue to be diverse. Banks will provide continued updates on the implementation status and maybe more information on assumptions used.

Analysts’ presentation

Will only be disclosed in the year-end financial statements or in 2018

In terms of the quantitative impact, banks may disclose the effect of the IFRS 9 phases separately. They may also provide further details on the quantitative impact if they have already disclosed the effect.

The audience was asked whether they expect to comply with the EDTF recommendations on pre-transition disclosures as of year-end 2017. 35% 30% 25% 20%

32.5%

15%

23.3%

10% 5%

11.6%

9.3%

9.3%

Only to comply where there is overlap with existing IAS 8 requirements

Haven’t decided yet

14.0%

0% Yes, expect to comply with all, where material

Yes, expect to comply with most, where material

Only expect to comply with some, where material

• It is important that banks also start to plan their first disclosures about transition in 2018 and consider: • If they will adopt the full IAS 8 requirements in the first interim report • How much details to include on the changes in classification categories and provisions as compared with under IAS 39, along with the related detail on the stage allocations • If they will provide a separate document to provide more details on the changes upon the move to IFRS 9

EDTF compliance is not a priority

• Ahead of adoption of IFRS 9, there is a lot to plan and consider with respect to disclosures of the impact. At the same time companies are planning the transition disclosures early in 2018, not to mention the ongoing extensive IFRS 7 disclosures required from an annual basis starting from year-end 2018. Some of the most challenging disclosures are expected to be the sensitivity disclosures, rating and vintage details, movement tables by class, and the new hedge accounting disclosures.


| 12

9. IFRS 9 classification and measurement survey findings Francesca Amatimaggio of EY presented some of the results of the EY IFRS 9 Classification and Measurement (C&M) bank survey which was conducted in 2017. Overall state of readiness • Some participants are finalising their implementation of both the business model and solely payments of principal and interest (SPPI) testing, although others are late in their preparation process.

cash flow test methodology for SPPI testing. • The majority of banks have developed an internal tool in order to perform the SPPI test, either purchasing the data from an external provider or leveraging their internal databases.

• Banks are still debating topics, such as the identification of thresholds for ‘significant sales’ for the business model assessment, as well as the adoption of a specific benchmark

Status of Implementation (number of banks in each phase) 25

Impact assessment

Design-early stage

Design-advanced stage

Implementation phase

Complete

No response

20 15 10 5 0 Business model assessment

SPPI testing

SPPI assessment and testing • P roducts for which a more extensive and detailed SPPI testing is required include non-recourse assets and products with no interest rates. • S ome respondents are discussing with peers and external auditors their SPPI interpretations: for instance, banks have not finalised yet the application of ‘de minimis’ and ‘not genuine’ concepts, which represent significant areas of judgement.

Policy

Operating model and control framework

Data and systems

Frequency of cited causes for contractual terms failing SPPI (frequency increase as datapoint is further from the centre) Leveraged coupon, inverse floater or structured coupon formula

Contractually linked instruments

Failed benchmark cash flow test

Instruments with no additional interests on deferred amounts

Prepayment features and extension feature

Investments in funds

Non-viability contingency provision (or bail-in instruments)

13 |


Equity features Non-recourse assets

Business model test • The most common approach to set the ‘significance’ threshold for ‘held to collect’ assets is based on the amount of the assets expected to be sold as compared with the total amount of the portfolio.

38%

Identification of a significance threshold for sale of held to collect assets 20%

• The destination of the liquidity portfolio (HQLA) is still under discussion. Some banks are considering a split of the portfolio, with participants intending to use a ‘held to collect and sell’ and held to collect combination. A significant number of banks, on the other hand, state that the portfolio is held to collect and sell (and thus measured as FVOCI). • The majority of banks that state that they hold loans and receivables with a potential “originate to sell or to distribute” business model (mainly for syndicated loans) are considering a FVPL measurement for the to-be syndicated portion.

38%

Yes No Not decided

42%

10% 20%

4% 48%

Yes No Not decided

38%

Liquidity portfolio business model

10%

FVOCI and AC FVOCI FVTPL and AC FVTPL

4% 48% 38%

FVOCI and AC FVOCI FVTPL and AC FVTPL

Governance • Most banks had not decided how to validate and authorise the origination of new products on the basis of the new IFRS 9 Classification and Measurement requirements.

42%

20%

58% 22%

Impact on the process related to the credit committee

20%

• For those banks who plan to involve their credit committees when developing new products, the most common adjustments will be to:

Yes No Not decided yet

58% 22%

1. Include the test outcome in the documentation 2. Develop specific consultation procedures in order to prevent products failing the SPPI test for the banking book. • We observed that the ongoing assessment of the new classifications requires the input of multiple stakeholders, as shown in the graph. The complete EY IFRS 9 Classification and Measurement survey will be published in August 2017.

Yes No Not decided yet

Functions involved in the Classification and Measurement assessment following transition Middle office

18

Risk management

15

Front office

14

Not decided yet

13

Finance and accounting Others

8 4

We hope to welcome you to our next European IFRS banking conference in November 2017 in London, UK.


| 14

In addition to your normal contacts, see below a list of EY IFRS 9 professionals. Tony Clifford Partner, Ernst & Young LLP

Tara Kengla Partner, Ernst & Young LLP

Laure Guégan Partner, Ernst & Young et Associes

T: +44 20 7951 2250 E: [email protected]

T: +44 20 7951 3054 E: [email protected] @TaraKengla_EY

T: +33 1 46 93 63 58 E: [email protected]

Michiel van der Lof Partner, Ernst & Young Accountants LLP T: +31 88 40 71030 E: [email protected] Dr. Jana Währisch Partner, Ernst & Young GmbH T: +49 6169 996 23072 E: [email protected] Mark Gregory Partner, Ernst & Young LLP

Fabio Fabiani Partner, Ernst & Young LLP T: +44 20 7783 0816 E: [email protected]

T: +44 20 7951 3213 E: [email protected] @YolaineK

Francesca Amatimaggio Partner, EY S.p.A.

Andrew Beaumont Senior Manager, Ernst & Young LLP

T: +39 02722122035 E: [email protected]

T: +44 20 7980 9296 E: [email protected]

T: +44 20 7951 5890 E: [email protected] @MarkGregoryEY

EY | Assurance | Tax | Transactions | Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. © 2017 EYGM Limited. All Rights Reserved. EYG no. 04240-174Gbl ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.

ey.com/fsbanking

Yolaine Kermarrec Partner, Ernst & Young LLP

European IFRS banking conference (June 2017) - EY

Recommend Documents