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Slow and steady wins the IFRS 9 race

IN July 2014, the International Accounting Standards Board (IASB) unveiled the final piece of the IFRS 9 jigsaw puzzle.

IFRS 9 is the culmination of five years’ work triggered by concerns following the global financial crisis about the current financial instruments standard, IAS 39. The new standard is intended to enable financial institutions to present a more accurate picture of their accounts. IFRS 9 will help banks to align their financial accounting with the risk management framework. It will have a major impact on all institutions that have financial instruments on their balance sheets and will involve significant changes to accounting and reporting.

With a complex transition period ahead and the deadline for mandatory compliance set for 1 January 2018, financial services firms need to start thinking about the new standard now, not down the line when it’ll be too late to get their house in order.

Three years and counting

The length of the IFRS 9 implementation process will depend on a variety of factors, ranging from the size of a financial institution’s lending book, the capability and specifications of systems producing Basel III related numbers as well as credit risk measurement systems, for instance.

Coupled with the current regulatory pressures placed on financial institutions at both a national and international level, IFRS 9 may seem like yet another regulatory headache that is not a high priority.

But until the planning process begins, firms operating in the financial sector will not have a full understanding of the changes needed to existing systems and processes. An impact assessment is the first step for any firm, to find out the lie of land. From this they will be able to gauge not only the changes that need to be made, but also the potential cost implications, resource requirements and the time it will likely take.

A thorough a gap analysis of systems and requirements for IAS 39 vs IFRS 9 implementation should also be conducted during this period to identify the measurement issues, develop updated documentation and source data for additional disclosures.

Following the various assessments, companies should spend the next 12 months looking to comply with the expected loss model including Credit Value Adjustment (CVA) and Credit Value Adjustment Value at Risk (CVA VaR) measurements.

Emerging practices such as funding value adjustment (FVA) also needs to be taken into account. Firms need to determine the measurement differences under IFRS 9 vs Basel III as there a number of items, such as debit value adjustment (DVA), which are not permissible in determining capital adequacy in line with Basel III.

These early indications of the impact that the new standard will have on a firm financially are vital to ensure the firm’s ongoing compliance with debt covenants and planning regulatory capital.

Two years and counting

Under the new rules, hedge accounting will be linked to the entity’s risk management framework, which will help financial institutions by aligning the hedging strategies used with financial reporting which should result in more meaningful disclosure to the users of financial statements

It is widely accepted that the implementation of IFRS 9 rules on hedge accounting is expected to take between one and two years to implement. Some financial institutions already have sophisticated risk management systems where economic hedge information is available, while others may need to enhance systems and documentation to be fully compliant.

Banks who are intending to designate (a) risk components of non-financial items, (b) aggregate exposures, or (c) net positions; should start thinking about developing hedge accounting documentation aligned with IFRS 9 requirements of hedge accounting. Entities, particularly banks, should consider including provisions for re-balancing the hedge to achieve hedge effectiveness to avoid de-recognition issues.

Firms should be looking to finalise the agreement process with stakeholders in terms of interpreting effects of applying IFRS 9.‎

One year and counting

By this stage, with only a year to go, the majority of the actual implementation process should have already been completed in order to reflect the impact on opening balances. These final 12 months should be spent fine tuning the implementation of the standard.

A project of this size will inevitably have teething problems, but with a substantial portion of the implementation process having taken place over the previous two years, financial institutions should have some flexibility to test and tweak the new processes.

2017 should be the year to dry run the pro-forma financial statements so that come 1 anuary 2018, banks and financial institutions can be confident that they are fully compliant and that the systems are working as they should.

Firms should also use this time to get the statutory auditors to review the classification and measurement basis, hedge accounting documentation and approach to measure loan loss provision developed by the financial institutions as well as data source for developing the required disclosures. This will enable smooth audit process for 2018 year end.

1 January 2018

From January 2018, financial institutions will need to be fully compliant with IFRS 9 in order to insert an unreserved statement of compliance with IFRS in the financial statements. The implications of IFRS 9 are not to be underestimated. Although the deadline is three years out, which means that there is a reasonable timeframe to implement, given the complexities, those businesses that are affected by the new standard should, if they have not already done so, start the planning process without delay.

Dan Taylor is financial services partner at BDO

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  • A reader

    What do DVA and CVA have to do with the expected loss impairment model? DVA and CVA refer to fair value adjustment changes, and are linked to IFRS 13, not IFRS 9.