IFRS 9 – What is involved and what are the implications for Internal Audit?

​Alana Sainsbury 10 November 2016

Agenda

• Introductions
• IFRS 9: what is changing?
• What are the implications for Internal Audit?
• Questions and next steps

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What is IFRS 9?

• IFRS 9 Financial Instruments is effective from 1 January 2018 and replaces IAS
39
• IFRS 9 Financial Instruments sets out the recognition and measurement
requirements for financial instruments. There are three phases to IFRS 9 and the
impact on Impairment is deemed to be the most complex with the introduction of
requirements to incorporate forward-looking information and macroeconomic
factors.

​ The three phases:

• classification and measurement

• Impairment
• Hedge accounting

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What is IFRS 9?
The three phrases
IFRS 9 Three Phases

Classification & Measurement Impairment Hedge Accounting Nov 2009

C&M of
Assets
• Requirements for impairment of financial assets Standard
• Three measurement
based on12-month and Lifetime Expected Losses
categories for financial assets • General hedge accounting Oct 2010
(12-month EL and LEL) replacing the current
driven by the entity’s’ model designed to more closely C&M of
Incurred Loss (IL) approach under IAS 39
business models for reflect risk management Liabilities
Standard
managing financial assets and
• Increased eligibility of hedged
the contractual cash flow Change in credit risk since initial items and hedging instruments Jan 2011
characteristics of those assets recognition First
are: • No retrospective hedge Impairment
Final Standard

Stage 1 Stage 2 Stage 3 effectiveness test ED

− Fair Value
Initial recognition Significant Credit impaired • Prospective hedge effectiveness Nov 2012
− Amortised Cost
(unless increase in credit test (80-125%) replaced with a Limited
changes to
− Fair value through other purchased/originat risk but not credit principles based test of amongst the C&M
comprehensive income ed credit-impaired) impaired others, “economic relationship” proposed
(FVOCI) for certain assets
Allowance recognised • Entities currently reporting
• For financial liabilities under IFRS will have an Mar 2013
LEL Second
designated at fair value 12-Month EL accounting policy choice to Impairment
through profit or loss, changes continue to apply IAS 39 hedge ED
in own credit will be recorded Interest revenue accounting until the macro
in other comprehensive hedging project is finalised. Nov 2013
Gross basis Net basis General Hedge
income. Accounting
standard

• Determination of business • Contractual versus behavioural maturity • The IASB is exploring a new
models; to hold, to sell or way to account for dynamic risk Feb 2014
Current Hot Topics

• Use of practical expedients such as “low credit risk”

both management of open portfolios Proposed
and the “More than 30 days past due rebuttable
(‘macro hedging activities’). effective
• Consideration of whether presumption” Date 2018
contractual cash flows are
• Use of forward looking information and Jul 2014
“solely payments of principal
incorporation of multiple forecast and Standard on
and interest”.
macroeconomic scenarios impairment &
Amendments
• Portfolio vs individual asset assessment of to C&M of
assets
significant deterioration

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IFRS 9 Overview
IFRS 9 Business Wide Impact
​Whilst IFRS 9 can be seen as an accounting policy change, it creates business-wide challenges for
organisations. IFRS 9 has a direct, quantifiable impact on provisions feeding into the P&L but it also has a
perhaps indirect but material impact on a wide range of factors contributing to shareholder value.
IFRS 9 Business-wide Impact

Risk and Finance

operating model
efficiency Risk
Basel Pricing adjusted
• People Revenue
III • Processes pricing
Growth
• Data & systems
• Policies
• Models Operating Portfolio and
• MI & Reporting product mix
Margin
COREP Products
FINREP P&L impact of and Market
IFRS 9 volume position
provisioning, relative
including on- IFRS 9 to peers
going volatility

Disclosures
Balance sheet impact and market
of IFRS 9 discipline
provisioning, Reputation
Capital
including step
External
change upon
audit
introduction
Pillar 2B
Basel 3 Tier 1
capital
and Tier 2 External
planning
capital rating,
buffer for
instruments reflecting
Pillar 1 and 2A drawn
and leverage increased P&L
capital down in
ratio volatility
requirements a stress

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IFRS 9 timeline and implementation challenges

2014 H1 2015 H2 2015 H1 2016 H2 2016 H1 2017 H2 2017 2018

Build and Testing Implementation and Parallel Stabilisation &

Impact Phase Design Phase
Phase Run Improvement

Given the scale and complexity of the changes required by IFRS 9, the short
Timeline implementation timeframe leading up to the 2018 mandatory effective date means
that it is a large high risk project for many banks.

Early disclosure to the EBA and perhaps to the market means that reliable
information about IFRS 9 impact will be needed before the first IFRS 9 accounts
Early disclosure
are published further squeezing banks’ decision making process and
implementation timeline.
Regulatory and Significant regulatory and market focus will drive interpretation of key aspects of
industry the rules, implementation standards and best practices with knock on effects for
developments banks’ IFRS 9 implementation project.

Design and build of ECL models is underway although model developments are
posing new technical challenges with variances in solutions appearing across the
Modelling
industry, due to differing interpretations of compliance and target level of
sophistication as well as size.

The large number of stakeholders, business functions and jurisdictions impacted

Governance poses a significant project management challenge. Strong governance and
ownership of project streams are therefore critical to the success of the project.

The lack of resources means that securing the right resources in each jurisdiction
Resources
within the required timeframe is a key implementation challenge.
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Impairment

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IFRS 9 Impairment model - Scope

IFRS 9 requires the same expected loss model to apply to the following:

• Financial assets measured at amortised cost;

• Financial assets mandatorily measured at FVTOCI;
• Loan commitments when there is a present obligation to extend credit
(excluding loans measured at FVTPL);
• Financial guarantee contracts (excluding those measured at FVTPL);
• Lease receivables within the scope of IAS 17/IFRS 16; and
• Contract assets within the scope of IFRS 15 Revenue from Contracts with
Customers.

Credit losses are required to be measured through a loss allowance at

an amount equal to:

• 12-month expected credit losses (expected credit losses that result from
those default events on the financial instrument that are possible within 12
months after the reporting date); or
• Lifetime expected credit losses (expected credit losses that result from all
possible default events over the life of the financial instrument).

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Impairment
General model

Change in credit risk since initial recognition

Significant Objective
increase evidence of
in credit risk? impairment?

STAGE 1 STAGE 2 STAGE 3

12-month Lifetime Lifetime

Loss expected expected
expected
allowance credit losses credit losses credit losses

Apply
​
effective Gross carrying Gross carrying Net carrying
amount amount amount
interest rate
to …

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Assessment of a significant increase in credit risk
​A significant increase in credit risk is defined as a significant increase in the probability of a default
occurring since initial recognition:

Low
Relative
credit risk
assessment
exception

Significant
Assessment increase
Collective of increase normally
basis in credit occurs before
risk credit-
impairment

‘30 days past Forward-

due’ looking
rebuttable information
presumption

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Reasonable, supportable information—factors to consider

Measurement of expected credit losses

• Expected value • Time value of money
• Contractual period • Cash shortfalls
• Collective assessment • Reasonable and supportable information

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What are the implications
for Internal Audit?

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Governance and internal control considerations
Given the size of the potential impact combined with the complexity and subjectivity of the
requirements, there is a risk of material bias associated with financial statements lines affected by IFRS
9 which will have a knock on impact on key financial and regulatory metrics which means that ECL must
be determined in a well governed environment.

An effective governance and control

Need framework before, during and after transition in these three areas
to understand
transition
are key for IFRS 9 implementation: impact due
to potential upfront
capital impact and
market reaction
Data quality • Management will need additional credit risk information that may not be available
or was not previously required to be used for financial reporting purposes.
and • Appropriate governance and controls will be required for these sizeable additional
availability data sets used for the estimation of ECL.

• Management must develop methodologies and models which will require

significant expertise and judgement in order to deliver probability weighted and
Methodologies unbiased estimates of ECL on an ongoing basis.
and modelling • Ensuring that models are not a ‘black box’ and that ECL outcomes can be
understood and articulated will be a significant challenge and will require robust
governance and control at each level of the organisation.

• Banks will need to produce their IFRS 9 numbers and related disclosures within a
short timeframe, thus systems and processes that banks build will need to be
Systems and sufficiently automated and streamlined to deliver reliable results.
processes • Strong governance and controls will be key and the cost associated with achieving
all of these objectives are likely to be significant both in terms of direct spend as
well as management time before, during and after transition.

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How can Internal Audit support the transition?
Programme Review
​Some firms are delivering their own programme but are reaching out to external specialists to assess
whether their programme is effective to avoid compliance risk and delivery failure

​ Potential IA Actions

• Pre-Project Assurance – IA can provide assurance whether a PMO has sufficient

capabilities to deliver the IFRS 9 transformation programme including reviews of governance,
MI, project tracking tools – all in line with best practice
• Real-time in-flight project assurance – During the project, IA can provide continuous
assurance as to whether the IFRS 9 project transformation programme is going to deliver the
required capabilities and statutory requirements, within budget and within deadlines
• Post-Project assurance – IA can conduct post-implementation audits to review controls in
place to determine their adequacy, effectiveness and efficiency to independently evaluate the
firm’s readiness for IFRS 9 on Day 1 and beyond

​ Example Assessment Output

Use of Model IFRS 9 Process & ECL Flows

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How can Internal Audit support the transition? (continued)
Governance & Controls Framework
​IFRS 9 will put increased pressure on the existing governance and controls frameworks across the
impairment process

​ Potential IA Actions

• Governance – IA can provide assurance whether changes in a firm’s governance due to

IFRS 9 regarding the provisioning process will result in outcomes consistent with stakeholder
expectations, including regulators
• Policy – IA can review whether a firm’s policies and procedures adequately document its
internal credit risk assessment and credit risk models
• Control frameworks – IA can provide assurance over the adequacy and effectiveness over
back testing so key drivers have been captured and calibrated accurately. In addition, IA can
examine whether the impairment process adequately embeds experienced credit judgement
including robust documentation evidencing of challenge

​ Example Assessment Output

PMO Heatmaps & Governance Findings

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How can Internal Audit support the transition? (continued)
Data & IT Architecture
​IFRS 9 will impact across different layers of the IT infrastructure

​ Potential IA Actions

• Source systems – IA can provide assurance whether source systems can satisfactorily
record historic, current and forward looking data sets which are required for modelling and
impairment calculation data flow - this is often a challenge for mature banks
• Credit risk calculators – IA can provide assurance over the adequacy of the development
and testing regime on fundamental changes in the calculation logic and platform used
• Disclosure systems – IA can provide assurance whether existing systems have adequate
“Extract, Transform and Load” capabilities to provide for IFRS 9 requirements with sufficient
granularity to provide insight on trends & variances and credit & collateral quality migration
analysis
• New/upgraded systems – IA can provide assurance whether the project plans to
implement upgrades (or entire new systems) are adequate to deliver the required system
changes and will meet IFRS 9 requirements within deadlines & budget

​ Example Assessment Output

Data & IT Infrastructure Heatmaps

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How can Internal Audit support the transition? (continued)
Timeline
2014 H1 2015 H2 2015 H1 2016 H2 2016 H1 2017 H2 2017 2018

Build and Testing Implementation and Parallel Stabilisation &

Impact Phase Design Phase
Phase Run Improvement

In the Parallel Run

During the Design & Build and Testing
Phase, IA can
Phases, IA can conduct project programme
conduct an audit to
audits.
examine whether
In your firm's Design & Build and Testing Phases, the Parallel Run is
the focus will be on delivering to budget and time designed and
in accordance with the approved Design phase operating
methodology. effectively.
IA can conduct pre-project and in-flight project In your firm’s Parallel
assurance audits to gain assurance over whether Run phase, the focus
the project will meet its commitments to should be on refining
stakeholders your firm’s operating
model.
In the Implementation Phase, IA can IA can conduct
conduct project programme audits along reviews of roles and
with IFRS 9 Day 1 readiness audits. responsibilities,
In your firm’s Implementation Phase, the focus expected credit loss
should be on embedding your IFRS 9 solution calculation processes,
throughout Parallel Run and Transition. IA can application of
conduct in-flight and post-project assurance experienced credit
audits along with IFRS 9 Day 1 readiness audits judgement and
to identify gaps in controls and efficiency control frameworks &
improvements. policies.
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Questions and next steps

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