REACTION time is a hugely variable thing.
According to medical text books, humans can respond in as little as 0.18 seconds to a stimulus. That’s less than the time required to blink an eye. But confront those same humans with a new accounting standard and that reaction time slows markedly – perhaps to as much as three years.
IFRS 9, the new accounting standard which aims to improve the reporting of credit losses linked to financial instruments and mortgages, is due to come into effect on 1 January 2018. Developed by the International Accounting Standards Board to replace IAS 39, the new standard should address concerns raised during the financial crisis when it became all too apparent that the incurred loss model inherent in the old standard contributed to the delayed reporting of credit losses. Having learned this lesson the hard way, the IAS’s new standard offers a forward-looking expected credit loss model.
The good news about IFRS 9 is that it should contribute to more robust financial reporting and the enhanced ability to project which way the numbers are going. The downside is that the new standard represents a fundamental change of approach and, as such, will mean that accounting systems and procedures will require substantial re-engineering.
A mortgage lender, for example, will need to be able to assess the potential for customers to default and the level of any resultant losses for each reporting period. This will necessitate expenditure on either modifying systems or purchasing new ones, and on staff training. These sums could be sizable, leaving firms to consider whether to implement their own solutions or to use the services of a third party such as one of the big accountants or a smaller specialist. And this is when the issue of reaction time starts to become an issue.
We may well be able to respond to a buzzer in less than a second, but faced with external factors that spell organisational change and expenditure, many businesses’ decision-making abilities slip into a much slower gear. But that deceleration is not necessarily due to indecision; it is the tactical consideration of whether to be an early adopter or a late adopter. It is a decision which tells us much about any given business’s commercial approach and its state of mind.
If you’re looking for a definitive answer to the question ‘Jump now or later?’, the world of the homily offers support for both approaches. But in some markets, firms have had their fingers burned repeatedly by being first in line. Take for example the Lloyd’s of London insurance market, which has seen wave after wave of new technology solutions and cross-market platforms designed to replace ‘the Victorian pipework’ of London’s insurance sector. To many players, it came as no surprise when the Kinnect initiative of the early-2000s ground to a halt that those firms who had been first to assist in the platform’s development were the ones who got their fingers burned. By contrast, those who had sat on the sidelines, watching and waiting, could nod sagely at the wisdom of their decision to remain spectators.
Solvency II is another external initiative that has divided the financial services industry – even nations – over the most effective approach. With just over half a year till its implementation, the early adopters are beginning to look increasingly comfortable while there’s a distinct whiff of panic in the air from the late adoption camp. Asset managers, who are not regulated by Solvency II but will need to supply their insurer investors with huge quantities of highly granular look-through data, are waking up to find that time really is running out.
The Association of Corporate Treasurers very neatly sums up the benefits of early adoption of IFRS 9 on its website, and there are indeed quantifiable benefits to moving sooner rather than later – but many businesses have learned, particularly where major pieces of international legislation are concerned, that things can change and the cost of possible solutions can fluctuate. So why jump at the first answer when many more may become available over time? Of course solution providers will encourage early adoption: they have a financial imperative to do so, which can make firms cynical about their claims.
Deloitte’s survey of banks last year found that around one-third of banks were yet to begin work on their IFRS 9 projects, citing the need for a final standard and clarity as necessities before data and models can be constructed. That makes sense; a sound argument for later adoption. But in the same study, most banks said it would take three years to implement IFRS 9. Even though the standard’s implantation is two-and-a-half years away, if the banks are to be believed, time is clearly starting to ebb away.
One thing that does tend to be forgotten in the pace-of-adoption debate is that there are immediate benefits to be realised as the standard gives risk managers, directors and finance directors a better understanding of the real downside risks embedded within their loan portfolios. This is something that directors ought to know in any event, both for reporting requirements but also to ensure that risks are identified, and risk management and mitigation strategies are adopted. Forward thinking lenders will have been carrying out a version of this analysis for some time, so it will not be entirely new to them.
Late adoption can be a sound business strategy, but increasingly the evidence around IFRS 9 suggests that the time to take action is now. Late adopters may argue otherwise, but the standard is well and truly set on its course. Waiting on the sidelines and observing is wise to a point; but stand too long and wisdom can rapidly turn into stubbornness in the face of compelling evidence. That time is fast approaching.
Tony Ward is president and chief executive of Clayton Euro Risk