ifrs 9 implementation challenges & governance requirements

KPMG Indonesia

3rd Board Governance Forum IFRS9

3rd O ctober 2016,

Opening - Kusumaningsih Angkawidjaja

IFRS 9 – James Loh

Closing - Kusumaningsih Angkawidjaja

IFRS 9 – What we will cover

IFRS 9 - Background

Overview of IFRS9

IFRS 9 Implementation Challenges and Governance Requirements

IFRS 9 - Background

5© 2016 PT KPMG Siddharta Advisory (Registration No: 09.05.1.70.85569), an Indonesian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Quality = Governance x Experience x Time


Increasing Provisions for Banks in IndonesiaIFRS 9 - Background

15,000.00

25,000.00

35,000.00

45,000.00

55,000.00

65,000.00

75,000.00

Buku 3 Banks Buku 4 Banks

Provision increased by 57.6 % from Dec 14 – Jul 16

Provision increased by 96.8 % from Dec 14 – Jul 16

Buku 4 Banks

Buku 3 Banks

Source: Statistik Perbankan Indonesia - Vol. 14, No. 8, Juli 2016

In B

illio

n R

up

iah


Increase in Provisions for IFRS9 – The Experience so farIFRS 9 - Background

IAS 39 IFRS 9 - Bank A IFRS 9 - Bank B

Stage 1 Stage 2 Stage 3

IAS 39 vs. IFRS 9 Total

200%

30%


It may get extremely stressed! IFRS 9 - Background


Flipside to increase in provisions – Decline in Tier 1 RatiosIFRS 9 - Background

Source: Standard & Poor’s report “Could Ballooning Loss reserves From New Accounting Rules Deflate Bank Capital Ratios?”

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

10% 20% 30% 40% 50% 75% 100%

% D

EC

LIN

E IN

CO

RE

TIE

R 1

RA

TIO

% OF PROVISION INCREASE

Impacts of Provision Increase on Core Tier 1 Ratio

Canada Banks Western Europe Banks EEMEA Banks Asia-Pacific Banks Latin America Banks


Who will be impacted by IFRS 9IFRS 9 - Background

IFRS 9 will affect…

Banks/ Financial Institution Corporates

Severity meter Severity meter

Corporates will be moderately impacted by IFRS 9 requirements on the following areas:• Investment• Trade and

lease receivables

• Hedge accounting

• Disclosures

Banks will be severely impacted by IFRS 9 requirements due to:1. Data availability2. ECL methodology

(PD, LGD, EAD)3. Stage transfer

criteria4. Significant

increase in credit risk definition

5. Forward looking economic adjustment

6. etc


Multiple Lenses on IFRS 9 ImplementationIFRS 9 - Background

IFRS 9 is effective - 1 January 2018. Indonesia is targeted for 1 Jan 2019.

Supervisory view – BCBS (Basel Committee on Banking Supervision)

Practitioners view – GPPC (6 largest accounting networks)

Implementation of IFRS 9 requirements by Banks

GPPC released a paper of IFRS 9 to the Audit Committee to assist the AC on:1. Governance & controls2. Sophistication & proportionality3. Transition issues4. Ten questions to those charged

with governance may wish to discuss

Basel Committee released a guidelines on accounting for expected credit losses covering 8 principles sound credit risk practices that interact with expected credit loss requirements


Timeline for IndonesiaIFRS 9 - Background

Public Hearing at OJK (Participants from FI)

Release of PSAK

Adoption of Standard

Exposure DraftPublic Hearing at IAI

Scheduled to be released end of September• no changes as compared to IFRS

9 2014 version)• early adoption possibly permitted

October 2016 (TBD)

October 10 2016

1 Jan 2019

Q2 2017


Experience in MalaysiaIFRS 9 - Background

BNM sent a letter to CEO and Chairman of Audit committee to oversee the following:

1. Preparation and assess the state of readiness of IFRS 9 implementation

2. Detailed gap and impact analysis against the requirements specified in the MFRS 9, including for material foreign subsidiaries

3. An action plan to address the gaps identified. Action plan should provide clear description of effort involved, timeline with key milestones identified, resource plan to undertake the effort, and coordination and oversight arrangement for the implementation plan

BNM also sent a survey to be filled by each Bank with the following questions:

1. State of implementation

2. Engagement with external expert (Consultant)

3. Challenges in implementation

4. Areas to be leveraged from regulatory credit risk

5. Impact on balance sheet & PL

6. Areas of operational simplification

7. Rank of product segments most likely to be affected

Overview of IFRS 9


Why IFRS 9Overview of IFRS9

IFRS 9 is the new accounting standard addressing 3 key areas that IAS 39 did not address, as evident in through Global Financial Crisis:

Complex and rule based method for classification of financial instruments

Impairment method that is deemed too little too late

Rigid hedge accounting rules that did not reflect the actual risk management activities


Key ComponentsOverview of IFRS9

1. Classification & Measurement Model

• Financial Assets:•Business model for

managing financial assets (Business unit level) i.e., classification based on business model test.

•Contractual cash flow characteristics (Instrument level) i.e., classification based on SPPI test

• Financial Liabilities:• Financial liabilities same

as IAS 39 except treatment of FV changes in own credit risk

2. Hedge Accounting

•Hedge accounting more aligned with risk management

•Macro hedge accounting still under discussion by IASB & provides options for IAS 39 to continue to be applied or to adopt IFRS 9 model

3. Impairment

•Expected credit loss (ECL) rather than incurred loss model

•Account for either 12 month ECL or life time credit losses depending on credit deterioration from origination

• Inclusion of off-balance sheet exposure

• Inclusion of forward looking macroeconomic overlay

4. Disclosure

Source:http://iaiglobal.or.id/v03/berita-kegiatan/detailberita-913=siaran-pers-iai-ifrs-conference-perubahan-standar-keuangan-global-berpotensi-goncang-dunia-bisnis-di-indonesia

http://iaiglobal.or.id/v03/berita-kegiatan/detailberita-913=siaran-pers-iai-ifrs-conference-perubahan-standar-keuangan-global-berpotensi-goncang-dunia-bisnis-di-indonesia


What Has Changed from IAS 39?1. Classification and Measurement

IFRS 9

The Bottom Line

Under IFRS 9, the mere intention of holding the assets can no longer suffice as the sole determinant of the assets’ accounting classification.

Now, such classification must be based on the contractual cash flows characteristics of financial asset itself (i.e. SPPI Test), and the business objectives to hold such financial asset (i.e. Business Model Test).

IAS 39

SPPI Test

Are the cash flows solely payments of principal and

interest?

Business Model Test

What is the entity’s business model for managing the

financial asset?

FVOCIAmortized Cost

FVTPL

Held-to-Maturity

Available-For-Sale

Loans and Receivables

Fair Value Through Profit

and Loss

SPPI Test

Are the cash flows solely payments of principal and

interest?

Business Model Test

What is the entity’s business model for managing the

financial asset?

Amortized Cost


The SPPI Test1. Classification and Measurement

SPPITest

Interest is consistent with a basic lending agreement: credit risk, liquidity risk, administrative

cost and profit margin

Examples of when SPPI Test WILL NOT be met:

• Convertible bonds

• A loan with a negative relationship with a particular interest rate index

• Financial assets that provide exposure to variables such as changes in equity prices or commodity prices.

Examples of when SPPI Test MAY be met:

• Imperfect relationship with time value of money may be allowed

• If the basis/value of interest payments change depending on some contingent future events, it may be allowed

• A loan with a provision that will only occur in rare/abnormal/very unlikely circumstances may be allowed

“Solely Payments of Principal and Interest”.


Business Model Assessment1. Classification and Measurement

Under IFRS 9, there are three types of Business Model that any particular Business Unit can possibly have.

Business Models Key Features Measured At

Held-to-collect contractual cash flows

Held both to collect contractual cash flows and for sale

Others

— Objective is to hold assets to collect contractual cash flows

— Sales are incidental to the objective— Typically lowest sales (in frequency and

volume)

— Both collecting contractual cash flows and sales are integral to achieving the objective of the business model

— Typically more sales (in frequency and volume) than held-to-collect business model

— Objective is neither held-to-collect nor held to collect and for sale.

Amortized cost*

FVOCI*

FVTPL**

* Subject to irrevocable option to designate at FVTPL on initial recognition if it reduces accounting mismatch. ** SPPI criterion is irrelevant

Time Deposits


Overview of Hedge Accounting2. Hedge Accounting

Derivative Risk exposure

A typical hedging activity would be the usage of derivatives to hedge against a certain risk exposure

Is used to hedge

-

-

-

-

-

--

-

-

-

Changes in the fair value of this derivative instrument are recognized in profit or loss as per normal accounting treatment.

Certain risk exposures are not reflected in the financial statements. However, hedge accounting allows you to recognise changes in the fair value of these in profit or loss.

The economic benefits of the hedging activity are now reflected in the firm’s financial statements.

offsetting


How Hedge Accounting Can Help2. Hedge Accounting

Hedge accounting can help you to:

Reduce the volatility of reported earnings

Reflect the effectiveness of your hedging activities

Hedge accounting modifies the normal accounting treatment of hedging instruments and/or hedged items.

Gains and losses on hedging instruments are recognized in the same period as the corresponding offsetting gains and losses on hedged items.

While hedging activities can help to reduce economic risks, the benefits of these hedging activities may not always be properly reflected in the financial statements.

Hedge accounting will bring to you a systematic and representative means of reflecting the effectiveness of your hedging activities in your financial statements.


Overview of Impairment3. Impairment

Significant increase in credit risk

Loss allowance(% of gross carrying amount)

Deterioration in credit quality from initial recognition

Incurred lossIFRS 9IAS 39

1. “Expected loss model” replaces IAS 39/ PSAK 55 “Incurred loss model”

2. Impairment trigger no longer required before impairment allowance is recognised

3. Impairment does not apply to equity investments

Three key differences from current IAS 39/ PSAK 55 are:


Expected Credit Losses (ECL)3. Impairment

12-month expected credit losses

Lifetime expected credit losses

TransferIf the credit risk on the financial asset has increased significantly since recognition

Move backIf transfer condition is

no longer met

Under the general principle, impairment would be measured as either:

• 12-month expected credit losses; or

• lifetime expected credit losses

The measurement basis would depend on whether there has been a significant increase in credit risk since initial recognition. The assessment should be made at each reporting date.


Stage Allocation and Transfer Logic3. Impairment

DefaultInvestment Grade Non Investment Grade

Dt0 Dt1 Xt0

Xt1Loan X at the end of the first period (t1)

Loan X at origination (t0)

Stage 1

Stage 2

Stage 3

Lifetime EL Notion

1yr EL Notion

Ct0

Definition

“Credit-impaired”

Significant deterioration

Insignificant deterioration

Ct1

Bt1

PD-Threshold(Non-investment grade)

Bt0

Ft1Ft0

PD

“Assets with low credit risk”

At0 At1

Internal master rating scale

Its about the Quantum!


Key Differences Between IAS 39 and IFRS 93. Impairment

IFRS9

Stage 1 Assets

IAS 39

12 - Month Expected Credit

Losses

LifetimeExpected Credit

Losses

Forward Looking

Adjustments

Off Balance Sheet Positions

Size depends on current loss emergence

period under IAS 39 and new IFRS

9 calculation requirements

Key judgementaround

“significant increase in credit

risk”

Must calculate the lifetime credit loss for the asset

Losses must include the impact of multiple

probability weighted economic forecastsRequired to

include off balance sheet

items and estimate lifetime.

• Must include estimates of Point in Time (PIT) PD%, LGD, EAD • Pre-payment & Transition Probabilities. also need to be modelled

Stage 2 / 3 Assets


Case Study ASIAN BANK– IAS39 vs. IFRS 9 Provisions3. Impairment

0

100

200

300

400

500

600

IAS 39 IFRS 9

Mill

ions

Stage 1 Stage 2 Stage 3

CORPORATES & COMMERCIAL

24%

SME28%

SELF EMPLOYED MASS MARKET

1%

CREDIT CARD -CONSUMER

7%

AUTO LOAN3%

MORTGAGE16%

PERSONAL LOANS6%

OTHERS15%

CORPORATES & COMMERCIAL SMESELF EMPLOYED MASS MARKET CREDIT CARD - CONSUMERAUTO LOAN MORTGAGEPERSONAL LOANS OTHERS

IAS 39 vs. IFRS 9 Total IFRS 9 Impairments by LOB

45.76%


Impact on Investments3. Impairment

Investments

Potential impact Actions to consider

• The classification of financial assets as measured at amortized cost, fair value through profit and loss (FCTPL) or fair value through other comprehensive income (FVOCI) will depend on each investment’s contractual cash flows and how the entity manages groups of investments.

• All investments in equity instruments – including unquoted shares – will be classified as FVTPL subject to an option to present at FVOCI if the investments are not held for trading.

• Impairment losses must be recognized for all investments in debt securities not classified as FVTPL. These reflect probability-weighted estimates of Expected Credit Losses (ECLs) based on historical experience and forward-looking information: 12-month ECLs for assets that have not suffered a significant increase in credit risk; lifetime ECL for those that have.

• Review the contractual terms of investments.

• Analyze and document the business model for managing investments.

• Review credit risk management processes and data availability

• Assess whether credit risk management system can track changes in credit risk since initial recognition

• Design and test new impairment methodologies


Impact on Trade and Lease Receivables3. Impairment

Trade and Lease Receivables

Potential impact Actions to consider

• The new classification model must be applied to all receivables. Trade receivables will generally meet the criteria to be held at amortized cost, but watch out for the impact of securitization or factoring agreements and more complex contractual terms.

• Bad debt provisions are likely to be larger and more volatile. Impairment of trade receivables and contract assets without a significant financing component will be based on lifetime ECLs.

• For trade receivables or contract assets with a significant financing component, and lease receivables, an entity may choose to either apply the general approach or recognize lifetime ECLs at all times.

• Review the contract terms, and securitization and factoring arrangements.

• Redesign impairment methodology to comply with new standard.

• Evaluate impacts of differing policy choices.

• Review management information under the current requirements and assess how it could be aligned with the new classification and measurement, and impairment requirements.


IFRS 9 Disclosures Requirements4. Disclosures

Quantitative

Qualitative

• Reconciliation of opening to closing amounts of loss allowance showing key drivers of change

• Write off, recoveries, & modifications of loan agreements (ie forbearance or restructures)

• Reconciliation of opening to closing amounts of gross carrying amounts showing key drivers of change

• Gross carrying amounts per individual credit risk grade

• Inputs, assumptions & estimation techniques for estimating ECL• Write off policies, modification policies & collateral• Inputs, assumptions & estimation techniques to determine significant increases in

credit risk & default• Inputs, assumptions & techniques to determine credit impaired

• Significant data required to meet new disclosure requirements• Need to balance between data / compliance reporting vs being useful & meaningful to users of financial statements• Need to consider impacts of OCI movements on key ratios (NAV) & location of fair value reporting in NIR (P/L) &

Reserves (OCI).

IFRS 9 Implementation Challenges & Governance Requirements


Time is Running OutIFRS 9 Implementation Challenges & Governance Requirements

Kick off Jan 17- Group reporting: 1 Jan 2018 – 12 months - Indonesian deadline: 1 Jan 2019 – 24 months


2018 running IFRS 9 in parallel to ensure 2019 Deadline is operational

Typical Timeline – 1.5 - 2.5 yearsIFRS 9 Implementation Challenges & Governance Requirements

Nov 2016 June 2018 JAN 2019Feb 2017

Design, develop, and validate the IFRS C& M, Hedge Accounting, and Impairment

Phase 1:Assess

Phase 2:Design & Develop

Phase 3:Implement

Phase 4: Go Live

Impact Assessment for both quantitative & qualitative impacts and Data & System

Build, Integrate and Test the system and Quality Assurance

3-4 months 12-15 months 6-9 monthsFINAL

DEADLINE

BAU“Business as usual”

Impact Assessment and

recommendations to sync with OJK plan

Classification &Measurement

Impairment Hedge Accounting

Finalize Plan for Parallel Run (2018) to

sync with OJK plan

Systems Reconciliations

Review / Refine IFRS 9 Models (Calibration)

Key IFRS 9 financial and reporting

controls

Key IFRS 9 balances on- and off – B/S and

in P/L

Key IFRS 9 Disclosures

Audit & Assurance

Training & Handover

Decisions and Roadmap

1

Design & Document IFRS 9 Controls, Disclosure, Governance Framework, ECL models, IFRS 9 Policies and ProceduresUtilised KPMG tools i.e.

gCLAS, SPPI Quest, Lending Tools, Data

Dictionary

5

2 3 4

Approx. 2 years!


Global Public Policy Committee (GPPC)IFRS 9 Implementation Challenges & Governance Requirements

Global Public Policy Committee (GPPC) paper

1

2

3

4

Governance & controls - sets out broad recommendations for a governance and controls framework in the areas of data quality, modeling, systems, processes and internal controls, providing for clear senior management oversight before, during and after implementation

Sophistication & proportionality - discusses sophistication and proportionality. It acknowledges that the implementation of expected credit loss methodologies across a bank will need to be commensurate with the complexity, structure, economic significance and risk profile of the bank’s exposures and should consider all reasonable and supportable information that is available without undue cost or effort.

Transition issues -provides guidance on certain areas of specific importance at transition such as key (pre-existing) accounting policies, current risk management and modeling activities and dealing with limitations in data quality.

Ten questions to those charged with governance may wish to discuss - a list of ten questions that audit committees can use to focus their discussions with senior management.


Implementation will be challengingIFRS 9 Implementation Challenges & Governance Requirements

The new impairment requirements in IFRS 9 pose three particular challenges

Increased complexity for preparers

A diverse range of approaches and

outcomes

Under IFRS 9, banks will need to provide for expected credit losses (ECLs). While this notion is largely intuitive, it may be more difficult for audit committees to understand the detailed application, as well as the systems and controls implications. The GPPC paper seeks to direct audit committees to key implementation issues.

IFRS 9’s principles-based approach aims to cater for the diversity of organisations within its scope. Therefore, it generally does not prescribe specific detailed methods. Selecting techniques and estimating ECLs involves a high degree of management judgement, and methods may vary between institutions.

The paper outlines factors for banks to consider in developing approaches to implementation and provides example approaches. It also stresses the importance of strong governance and controls over the way judgement is exercised.

A short amount of time remain until IFRS 9’s effective date. Implementation programmes may be large, complex and expensive, so audit committees need to be active now.

Time and effort to implement

35

Document Classification: KPMG Confidential

MA

GN

ITU

DE

OF

TH

EIM

PAC

T

COMPLEXITY OF THE PROBLEM

DataLittle historical loss data on which to build / validate

IFRS 9 models & assumptions

Resources Capacity

available skilled resource from

across the bank

Alignment with peers

andexpectations

End to End Process (TOM)

Lack of comprehensive end

to end IFRS 9 infrastructure

IFRS 9Governancenew controls and

governance have yet to be established

Internal External

Communicationon Impacts

Accounting andJournal EntriesReconciliation

Stage TrackingLack of robust historical credit

ratings, PD%, or other data points

IFRS 9Disclosurenew reporting and

MIS

ECLCalculation

Lack of tools methodology to for 12m and Lifetime

ECL’s

Accounting Policy

Updates

© 2016 KPMGAdvisory (Hong Kong) Limited, a Hong Kong limited liability company and a member firm of the KPMG networkof independent member firms affiliated with KPMGInternationalCooperative ("KPMGInternational"), a Swiss entity. All rights reserved. 26

KPMG Survey – 2015IFRS 9 Implementation Challenges & Governance Requirements


Governance & ControlsIFRS 9 Implementation Challenges & Governance Requirements

Key focus areas for those charged with governance will include:

― Timely monitoring, review and challenge of IFRS 9 implementation plans, key decisions and outputs

― Considering whether assumptions and methodologies are consistent with business and risk management practices and strategies

― Establishing strong governance and controls framework over ECL estimation and reporting, focusing on data integrity and model validation

― Establishing key performance indicators (KPIs) relating to ECL estimation and processes for regular reporting of those KPIs

― Establishing a plan to deliver high-quality disclosures before, during and after transition, taking into account the recommendations of the EDTF and the expectations of regulators and investors

ECL estimation is complex and inherently judgemental – there is a risk of material bias affecting the financial statements and hence it is important that ECLs are determined in a well-governed environment

An effective governance and control framework will utilise all three lines of defence. Focus will be on the following key areas:

― Data quality and availability in relation to the additional credit risk information required by IFRS 9

― New ECL methodologies and models, including the use of expert judgement and any separately calculated adjustments to model results

― Systems, processes and internal controls


BCBS Guidance on Accounting for Expected Credit Losses IFRS 9 Implementation Challenges & Governance Requirements

BCBS Principles on Accounting for Expected Credit losses

1

2

3

4

5

6

7

8

A bank’s board of directors and senior management are responsible for appropriate credit risk practices, including internal controls to consistently determine allowances

A bank should have methodologies for assessing and measuring the level of credit risk on all exposures, with timely measurement of allowances building upon them

A bank should have a process in place to appropriately group lending exposures on the basis of shared credit risk characteristics

A bank’s aggregate amount of allowances, should be adequate as defined by the Basel Core Principles, which is consistent with the objectives of IRFS9

A bank should have policies and procedures in place to appropriately validate its internal credit risk assessment models

A bank’s use of experienced credit judgment, especially in the consideration of forward-looking information and macro-economic factors, is essential to ECL measurement

A bank should have, via its credit risk process, a strong basis for common systems, tools and data to assess and price credit risk, and account for ECL

A bank’s public reporting should promote transparency and comparability by providing timely, relevant and decision-useful information

Issued Dec 2015.

Apart from this guidance, BCBS also issued

BCBS239 - “Principles for Effective Risk Data

Aggregationand Risk Reporting”

which will contribute to high quality IFRS 9

implementation


Ten Key Questions that AC can use to focus their discussion IFRS 9 Implementation Challenges & Governance Requirements

Key decisions and interpretations of IFRS 9

― What plans are in place to conclude on key decisions, build and test necessary models and infrastructure, execute dry/parallel runs and deliver high quality implementation by 2018/2019?

― What are the key accounting interpretations and judgements and why are they appropriate?

― How will implementation decisions be monitored to ensure they remain appropriate?

Expected loss credit modelling

― What are the planned levels of sophistication for different portfolios and why are these appropriate?

― How will a ‘significant increase in credit risk’ be identified and why are the chosen criteria appropriate?

― How will a representative range of forward-looking scenarios be used to capture non-linear and asymmetric impacts?

Audit committees can focus their discussions with management using these ten key questions

Systems and controls

― Has the bank identified all changes to existing systems and processes, including data requirements and internal controls, to ensure they are appropriate for use under IFRS 9?

― How will reporting processes and controls be documented and tested, particularly where systems and data sources have not previously been subject to audit?

Transparency

― What KPIs and management information will be used to monitor drivers of ECLs and support effective governance over key judgements?

― How will the IFRS disclosure requirements be met and how will those disclosures facilitate comparability?


Conclusion

IFRS 9 is not just an accounting standard change

The impacts will be felt across the entire stakeholder community

In today’s capital constrained environment the cumulative impact of all theseregulations and changes will be critical

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The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2016 PT KPMG Siddharta Advisory, an Indonesian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss entity. All rights reserved.

The KPMG name and logo are registered trademarks or trademarks of KPMG International.

James LohPartner

Wisma GKBI 35 FloorJl Jendral Sudirman Kav 28Jakarta 10210 IndonesiaTel: +62 21 5799 0877Fax: +62 21 574 0313Email: [email protected]

Kusumaningsih AngkawidjajaPartner


Liana Lim Partner


http://kpmg.com/socialmedia

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