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Financial Accounting Advisory Services Implementing the new financial instruments standard April 2015

Financial Accounting Advisory Services

Implementing the new financial instruments standard 3 How EY can support you 13 About EY 17 Contacts 19

Appendix A. Credentials 20

Agenda


Implementing the new financial instruments standard


► The International Accounting Standards Board (IASB) issued the final version of IFRS 9 Financial Instruments, concluding the three phases of the financial instruments accounting project covering: ► Classification and measurement ► Impairment ► Hedge accounting

► Accounting for dynamic risk management (macro hedging) is not included and forms a separate project.

► IFRS 9 is effective for annual periods beginning on or after 1 January 2018, with early adoption permitted.

► However, within the EU, endorsement is still pending. Early adoption will be permitted only once endorsement occurs.

IFRS 9 The background


IFRS 9 Overview of the changes

IFRS 9 Overview

► Replaces the current measurement criteria in IAS 39 Financial Instruments: Recognition and Measurement with the following three measurement categories: amortised cost, fair value through other comprehensive income, and fair value through profit or loss.

► The impact of IFRS 9 will vary depending on an entity’s business models, the composition of its portfolio and current accounting practice.

Classification and measurement

► The IASB proposes an expected loss model rather than the incurred loss model under IAS 39.

► The implementation of IFRS 9 will require a joint effort between finance and risk as impairment affects risk modelling, provision methodology and operating models.

Impairment

► Outlines a hedge accounting approach that is based on the entity’s risk management activities. It is more principles-based than the current approach in IAS 39.

► An entity may choose to continue applying the requirements for IAS 39 for hedge accounting model until the IASB’s macro hedge accounting project, Accounting for Dynamic Risk Management, is complete.

Hedge accounting


Entities will need to consider how to: ► Evaluate the impact of IFRS 9 on the financial statements, as well as

on models, data, systems, processes, controls and governance ► Analyse the extent to which it is possible to leverage existing models

and systems for regulatory purposes ► Assess the impact on regulatory capital ► Make the required judgements introduced by the less extensive rules

and the intrinsic nature of an expected loss model ► Assess interaction between the IFRS 9 requirements and wider

regulatory challenges ► Assess the main commercial, financial, regulatory and organisational

challenges

IFRS 9 Overview of the changes (continued)


IFRS 9 Key industry challenges

Systems and data

IFRS 9

Effectiveness

Efficiency Control

The new accounting and regulatory environment has forced banks to face new challenges that affect the operating models of banks, as well as processes, systems and data.



Areas of challenge Activities

Financial and capital impact

► It is generally expected that the new IFRS 9 requirements will result in a reduction in banks’ regulatory capital. However, there are complex ongoing interactions between the impairment and capital requirements in relation to credit losses.

► There is also the possibility of higher and less manageable P&L volatility arising from the impairment line.

► Given the focus on integrated balance sheet forecasting, provision and capital forecasting will continue to converge. Forecasting of provisions has received less industry attention and is a key area for enhancement.

► An assessment of the IFRS 9 impairment impacts needs to include the implications on banks’ regulatory capital.

► P&L volatility arising from the impairment line should be calculated while analysing the simulation.

► Enhancement of the forecasting of provisions is expected.

Key areas of judgement

► The need to incorporate forward-looking information (for example, how changes in macro factors will affect losses) consistently will require considerable judgement.

► “Significant” deterioration will require careful definition and industry benchmarking.

► Local regulators may look to apply guidance in key judgemental areas.

► Define the design principles and the interpretation of the key areas of judgement of the standard in advance to ensure the right information is gathered and stored.

► Based on the interpretation of key definitions, the credit monitoring and other internal processes could change.

► Systems would need to capture the changes of data and processes.



Areas of challenge Activities

Processes and controls

► IFRS 9 drives a more prescribed, consistent and standardised impairment calculation.

► An analysis of required operating model changes should be made as the model may need to change.

Systems

► Impairment affects risk modelling, provision methodology and operating models.

► In addition, the impact on data, processes, systems and data warehouses will need to be reviewed on the basis of the new requirements.

► Systems and data warehouses will need to be reviewed on the basis of the new requirements.

► Requirements for consistency and reconciliation between risk and finance (e.g., exposure at default (EAD) to balance sheet at a granular level) are likely to be higher. Consideration needs to be given to other reporting, including COREP, FINREP and Pillar 3.

► Data coverage and quality is likely to need testing to a high level.

Data

► A process for risk and finance data reconciliation has to be considered.

► Linkages with other financial reporting requirements (i.e., COREP, FINREP should be assessed.

Resources

► Finance, risk and reporting will need to work closely together, absorbing many of the same scarce resources.

► Significant operational and operating model changes are likely.

► A strong governance process over the entire IFRS 9 project is necessary.

► The governance process should be agreed upon before implementation.


IFRS 9, in combination with the regulatory requirements listed below, may create a major impact on your business model and the underlying resources, processes, systems and data. Linkages between current requirements and internal projects can represent a challenge if not approached with an organised road map to implementation in 2018.

IFRS 9 Interaction with other regulatory requirements

Basel III (capital, liquidity), Basel Committee on Banking Supervision (BCBS 239)

Basel III ECB FED/IRS Comprehensive assessment including balance sheet assessment, asset quality review and stress testing

Dodd-Frank/Volcker Rule, FATCA

(Ext

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tal f

acto

rs

(Clie

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com

petit

ors,

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)

Capital Equity and capital

requirements (RWA)

Liquidity Liquidity and funding

Performance Integration of internal and

external reporting

Bank management/business model Impact on business model and management as well as simulation

Credit, liquidity, market risks FINREP/COREP

CRR/CRD IV (single rulebook), EU driven initiatives (e.g., forbearance and non-performing exposures), enhanced disclosure task force disclosures

EBA/EU Commission IFRS 9, IFRS 7 Financial Instruments: Disclosures, IFRS 13 Fair Value Measurement

IASB

Resources Processes Systems and data

Impa

ct


Below are the main activities we can advise you in when implementing IFRS 9:

IFRS 9 Example impairment road map

Phas

e 2

Mobilise Design Build Test and deploy Parallel run and go-live

1 3 4 5

Pro

ving

run

► Data and systems

Wor

kstr

eam

s

► Models and methodology

► Programme governance

► Operating model

► Training

► Reporting and disclosure

Go-

live


Given the complexity of implementation, we recommend that entities begin planning now to make the best use of the lead time the IASB has allowed for preparers.

IFRS 9 EY impairment road map – timeline

Phas

e

Mobilise Design Build Test and deploy Parallel run

Tim

elin

e

H1 2015 H2 2015 2016 2017

Activ

ities

► Mobilise programme ► Understand IFRS 9

requirements ► Perform current state

analysis ► Perform impact

assessment ► Accounting policy

and disclosure requirements definition

► Develop accounting policy

► Perform gap analysis ► Develop pro-forma

disclosures ► Assess solution

options ► Agree on solution

options ► Agree on cost

estimates ► Agree on road map

► Potentially up to 18 months may be needed to redevelop, validate, roll out and embed new counterparty-level IFRS 9-compliant loss models

► At least 12 months typically needed to build, test and roll out new impairment calculator(s) and fill data gaps (e.g., collateral, historical data)

► Parallel run


Project structure and governance ► Board-level project sponsorship and

engagement ► Strong senior management ownership of the

project setting clear objectives and deadlines ► Inclusion of all locations and entities from the

outset with full local engagement ► End-to-end work plan with clear timelines for

delivery of key components ► Clear operational governance and ownership

of models and overlays ► Involvement of IT from initial business case

IFRS 9 Critical success factors

Partnering with risk ► Senior management engagement in risk,

partnering with finance ► Early identification and quantification of

required risk resources through creation of a detailed work plan

► Early design of process for forward-looking overlays

Finance direction and policy ► Clear policy decisions on key assumptions and

modelling dependencies ► Understand the impact on current interest

income recognition and net margin Establish data requirements ► Establishment of data requirements (including

disclosures), gaps and dependencies ► Early reconciliation of risk and finance data

where risk data will be used down to legal reporting entity level


How EY can support you


► We can advise you in implementing the new IFRS 9 requirements using an established methodology.

► We can support and advise you in your design and implementation of models, processes, systems and control changes to capture the information necessary to apply the new rules.

► We can provide tailored training on the accounting implications of the new requirements.

► We can support you in assessing the impact on regulatory capital and tax. ► We can help you to better understand how the opportunities and challenges

of IFRS 9 could impact your business, enabling you to make informed decisions about when and how to adopt.

► We can share market insights with you on current methodologies, peers’ views and options for next steps.

IFRS 9 How can EY support you?


► We have a multidisciplinary team delivering on accounting, risk, performance improvement, IT and transactions services tailored to your specific needs.

► Our services* are supported by tools and enablers for IFRS 9 classification and measurement and impairment. ► To help with assessing possible outcomes based on the IFRS 9 criteria ► To support in the classification of data ► To illustrate the amount of allowance required under the new IFRS 9 impairment

requirements ► For more EY thought leadership: please refer to our IFRS Developments and

Applying IFRS series available at ey.com/ifrs.

*Note: Certain of our services for an audit client and its affiliates may be more limited in order to comply with applicable independence standards. Please reach out to your EY contact for further information.

IFRS 9 Why EY?

http://www.ey.com/ifrs


About EY


Your regional EY network

Africa Angola, Botswana, Cameroon, Chad, Congo, Democratic Republic of Congo, Equatorial Guinea, Ethiopia, Gabon, Ghana, Guinea, Ivory Coast, Kenya, Madagascar, Malawi, Mauritius, Mozambique, Namibia, Nigeria, Rwanda, Senegal, Seychelles, South Africa, South Sudan, Tanzania, Uganda, Zambia, Zimbabwe

Belgium and Netherlands

Germany, Switzerland and Austria

Commonwealth of Independent States Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Russia, Ukraine, Uzbekistan

Central and Southeast Europe Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, Czech Republic, Estonia, Greece, Hungary, Kosovo, Latvia, Lithuania, FYR of Macedonia, Malta, Moldova, Montenegro, Poland, Romania, Serbia, Slovakia, Slovenia, Turkey

France, Maghreb and Luxembourg Algeria, France, Luxembourg, Monaco, Morocco, Tunisia

Financial Services Organizations Belgium, Channel Islands, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Switzerland, the UK

India Bangladesh, India

Mediterranean Italy, Portugal, Spain

Middle East and North Africa Afghanistan, Bahrain, Egypt, Iraq, Jordan, Kuwait, Lebanon, Libya, Oman, Pakistan, Palestinian Authority, Qatar, Saudi Arabia, Syria, Tunisia, United Arab Emirates

Nordics Denmark, Finland, Norway, Iceland, Sweden

United Kingdom and Ireland The UK, the Isle of Man, the Republic of Ireland


Financial Accounting Advisory Services Contacts – EMEIA

Tara Kengla Financial instruments standard implementation [email protected] + 44 207 951 3054 + 44 776 863 0062

Francesca Amatimaggio Financial instruments standard implementation [email protected] +39 338 785 7277


Appendix: Other credentials


IFRS 9 Selected credentials

Project name

Gap analysis (data, models, systems, processes, reporting)

Financial impact assessment

Implementation planning

Solution options and model development

Major UK Bank 1 IFRS 9 impact, design and implementation

Major UK Bank 1 IFRS 9 project plans and cost review

Major UK Bank 2 IFRS 9 impact assessment, model design and implementation planning

Major UK Bank 3 IFRS 9 impact assessment, gap analysis and road map

Major UK Bank 4 Modelling input and project management

Major UK Bank IAS 39 impairment model design and implementation

Major UK Bank Lifetime expected loss forecasting


IFRS 9 Selected credentials (continued)

Client/project name

Gap analysis (data, models, systems, processes, reporting)

Financial impact assessment

Implementation planning

Solution options and model development

Major Irish Bank Provisioning policies and models review, and development of an independent loss forecasting

Spanish and International Bank Impairment impact assessment and data requirements

French Bank Impairment scenarios simulation and data impact assessment

Dutch Universal Bank Impairment scenarios simulation and data impact assessment

Netherlands-based Bank Impairment scenarios simulation and data impact assessment

Major Swiss Bank IFRS 9 impact assessment and implementation support

Major Italian Bank IFRS 9 impact assessment and implementation support



Major UK Bank: IFRS 9 impact, design and implementation

Overview

EY was selected as the technical associate supporting this UK banking group’s multi-year programme of impact assessment, design and implementation for IFRS 9.

EY role

► Developed phased governance structures and a responsibility matrix for IFRS 9 to drive consistent application across the group while maintaining divisional influence and ownership

► Led detailed baselining of current state impairment models and data, in order to then identify and assess available options under IFRS 9. Proposed options leveraged wherever possible on existing systems, data, processes and models

► Led the design and continuous re-challenge of implementation road maps in each division ► Co-developed method by portfolio for each division using option analysis with a broad group of stakeholders (including risk, finance and group IT) to achieve

early buy-in ► Evaluated numerous modelling options ranging from minimal change options leveraging existing infrastructure through to extensive new developments,

identifying the costs and benefits of these options ► Performed detailed financial impact assessments, quantifying the balance sheet, forecast P&L and regulatory capital impacts of the various modelling options

and key methodology/standard interpretation assumptions ► Modelled scenarios to understand likely volatility driven by various modelling options ► Reviewed key interpretation questions (for example, commercial lifetime expected loss transfer criteria), and mapped how different options would affect

modelling options, financial impacts and operational practices ► Assisted client by facilitating meetings with IASB staff and peer-to-peer meetings with other banks to discuss key interpretation questions and interpretation

uncertainties ► Provided technical support on build of prototype expected loss models for ultimate adaptation into production environments, including production of technical

specifications, assisting with model build and testing ► Held training sessions for the group executives and audit committee, and led technical awareness and training sessions with finance, risk management and

capital management personnel



Major UK Bank: IFRS 9 impact, design and implementation (continued)

Value delivered

► Throughout the project, EY brought insights from across the industry, as well as from being the organisation working most closely with the IASB and UK and international regulators.

► We provided an experienced team to support and drive IFRS 9 interpretations and judgements, including across areas such as accounting policy, model design and operating model changes. The team delivered right-first-time technical advice that reduced risks and implementation costs.

► EY brought experience in IFRS 9 requirements and modelling solutions, which aligned the new requirements to existing accounting and regulatory capital models, enabling higher-quality solutions to be developed.

► Being involved as the only provider in this bank’s overall accounting change programme provided continuity and consistency of thinking and solutions across workstreams. In addition, our approach enabled linkages, crossovers and common issues to be identified and addressed.



Major UK Bank 1: IFRS 9 project plans and cost review

Overview

EY was asked to conduct two accelerated reviews of the IFRS 9 programme plans and cost estimates. These were undertaken at the start of the “define” phase of work, and following the final standard being issued. The review findings were used by the programme to validate the reasonableness of the planned activities, budget assumptions and resulting cost calculations.

EY role

In both reviews, we divided the review into three components: 1. A review of the programme documentation

► Reviewed relevant documents setting out the assumptions, approach and breakdown of the estimated cost ► Raised follow-up questions and requested additional analysis

2. Workshops with key project stakeholders ► Discussed the key assumptions, implementation plans and cost drivers ► Followed up on issues arising from the documentation review and discussion on peers approaches

3. Review of the programme activities against peers ► Compared the planned activities and the timing of these activities against peer programmes, identifying and reviewing key differences in approach, solution

design, data availability, etc. ► Reviewed the costs of activities against comparable peers, identifying key differences such as the programme resource delivery model

Value delivered to client

EY contributed to the success of the project by: ► Identifying key differences with peers in the proposed design at an early stage. The client was able to change the design before spending time and money

on build ► Identifying recommendations on areas where costs could be saved, so that the client was able to secure programme funding and increase sponsor support ► Providing a range of recommendations on how to improve programme and project governance, reduce delivery risk and alter the phasing of activities to align

to peers



Major UK Bank 2: IFRS 9 impact assessment, model design and implementation planning

Overview

EY supported the bank in assessing different modelling options for commercial banking and in planning IFRS 9 implementation. This included high level cost estimates for significant investments in systems, data and models. In parallel, we also led a commercial banking impact assessment and co-ordinated the organisations’s efforts on retail banking impact assessment.

EY role

As part of this comprehensive IFRS 9 change programme, EY: ► Produced detailed gap analysis and service options, leveraging existing accounting methodologies and processes, developing from broader regulatory

models and infrastructure, and new bespoke IFRS 9 solutions ► Supported the initial quantitative impact assessment across the global group, including design of distinct methodologies and models for impairment in

commercial and retail banking businesses ► Coordinated across each of the group’s global regions, managing multiple stakeholders and locations to deliver global workshops and development forums in

London. These worked through key issues, assumptions, quantification methods and IFRS 9 principles ► Provided technical guidance and peer comparisons on quantification analysis ► Produced a detailed plan for IFRS 9 implementation, taking into consideration different modelling options. We also supported a high-level cost assessment –

this included different staffing approaches, changes in systems, underlying finance and risk data and models


► EY supports implementations at many major UK banks and brought a range of insights from peers’ IFRS 9 projects that accelerated and simplified the solution options range, the impact analysis modelling, and the implementation planning.



Major UK Bank 3: IFRS 9 impact assessment, gap analysis and road map

Overview

EY led a comprehensive, group-wide impact and readiness assessment for IFRS 9 for this UK bank. The project included a detailed financial impact assessment, gap and solution analysis, and development of a multi-year IFRS 9 road map.

EY role

We structured the project to cover three workstreams: 1. A quantitative financial impact assessment

► The objective of the impact assessment was to calculate an estimate of the provision and capital impact under IFRS 9 impairment for the group. ► Data was gathered for loans and advances across all divisions (retail and wholesale) and supplemented with risk parameters considered appropriate for

the purposes of IFRS 9. The data was validated, and impact and sensitivity calculations were performed at different levels of granularity depending on the portfolio. The assessment was based on the IASB standard and the current FASB approach for US businesses.

► The base impact results, drivers and sensitivities were analysed in detail and presented. 2. An assessment of the implementation and technical challenges, based on a current state analysis and identification of the main gaps for IFRS 9 adoption

► The gap analysis covered impairment models, calculation processes, policies and data. 3. Identification of solutions for implementation of the models to be used for IFRS 9 impairment and the IFRS 9 operating model, and the development of a road

map for implementation ► Existing impairment, regulatory capital and stress-testing models were assessed to determine if existing models could be used for impairment

implementation, or alternatively whether bespoke models should be developed. ► A small number of viable operating model options for the IFRS 9 impairment calculations were highlighted and assessed. ► A multi-year implementation road map was prepared, showing key activities, supported by resource and cost requirements.


EY drove the success of the project by: ► Initially working with both finance and risk stakeholders across the organisation to establish the project and agree on an effective mandate, governance and

approach ► Establishing initial design principles and baseline IFRS 9 assumptions, and driving and accelerating the three project workstreams. EY provided insights and

peer benchmarks all the way through, leveraging our deep experience in IFRS 9 requirements and modelling solutions ► Delivering, syndicating and disseminating the project’s findings, and leading group-wide training and awareness sessions, covering technical and practical

requirements of IFRS 9 ► Delivering a road map that set the project up for successful ongoing delivery



Major UK Bank 4: Modelling input and project management

Overview

EY enabled the establishment of this bank’s group-wide IFRS 9 programme through specialist project management and technical quantitative credit risk support

EY role

► Developed phased governance structures and responsibility matrix to drive consistent application of IFR 9 across the group ► Developed 2014-16 implementation plan over an eight-week period, including resource estimates and identification of key skill gaps ► Performed high-level gap analysis for existing IAS 39 credit risk modelling infrastructure between current state and IFRS 9 requirements ► Provided programme governance support from range of EY partners to senior bank management


EY has successfully supported the bank to plan for the implementation phase of IFRS 9. It has done that effectively given the resource and timeline constraints.

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