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© 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

The future of IFRS financial instruments accounting

This edition of IFRS Newsletter: Financial Instruments highlights the IASB’s discussions in October 2013 on the

financial instruments (IAS 39 replacement) project, and annual improvements to IFRS 7.

Highlights

Hedge accounting

l Publication of the final general hedging standard is scheduled for November 2013. It may be possible for some entities to early adopt it in 2014.

l The macro hedging discussion paper is scheduled for Q1 2014 and will have a 180-day comment period, which is a longer period than usual because of the complexity of the topic.

Impairment

l The IASB reached tentative decisions on:

– when to recognise lifetime expected credit losses;

– operational simplifications – ’30 days past due’ rebuttable presumption and ‘low credit risk’ criterion;

– the measurement of expected credit losses; and

– asset modifications.

Classification and measurement

l The staff conducted a joint education session on the business model assessment, but did not ask the IASB and the FASB (the Boards) to make any decisions.

IFRS 7 annual improvements

l The IASB announced plans to propose amendments to IFRS 7 Financial Instruments: Disclosures, as part of the 2012–14 cycle of annual improvements.

The imminent publication of the new general hedging standard will represent a major milestone in the IAS 39 replacement project.

Chris SpallKPMG’s global IFRS financial instruments leader

IFRS NEWSLETTERFINANCIAL INSTRUMENTS

Issue 16, October 2013

© 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 2

IMPAIRMENT REDELIBERATIONS CONTINUE AS FINAL HEDGING STANDARD IS IMMINENT

The story so far …Since November 2008, the IASB has been working to replace its financial instruments standard (IAS 39 Financial Instruments: Recognition and Measurement) with an improved and simplified standard. The IASB structured its project in three phases:Phase 1: Classification and measurement of financial assets and financial liabilitiesPhase 2: Impairment methodologyPhase 3: Hedge accounting.In December 2008, the FASB added a similar project to its agenda; however, the FASB has not followed the same phased approach as the IASB.

Classification and measurementThe IASB issued IFRS 9 Financial Instruments (2009) and IFRS 9 (2010), which contain the requirements for the classification and measurement of financial assets and financial liabilities. Those standards have an effective date of 1 January 2015. In November 2012, the IASB issued an exposure draft (ED) on limited amendments to the classification and measurement requirements of IFRS 9 (the C&M ED).The FASB issued a revised ED in February 2013 – the proposed Accounting Standards Update, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (the proposed ASU). Separate and joint redeliberations by the Boards on the classification and measurement proposals are ongoing. The IASB plans to issue a final standard by mid-2014.

ImpairmentThe Boards were working jointly on a model for the impairment of financial assets based on expected credit losses, which would replace the current incurred loss model in IAS 39. The Boards previously published their own differing proposals in November 2009 (the IASB) and in May 2010 (the FASB), and published a joint supplementary document on recognising impairment in open portfolios in January 2011. However, at the July 2012 joint meeting the FASB expressed concern about the direction of the joint project and in December 2012 issued an ED of its own impairment model, the current expected credit loss model. Meanwhile, the IASB continued to develop separately its three-bucket impairment model, and issued a new ED in March 2013 (the impairment ED). Separate and joint redeliberations by the Boards on the impairment proposals are ongoing. The IASB plans to issue a final standard by mid-2014.

Hedge accountingThe IASB has split the hedge accounting phase into two parts: general hedging and macro hedging. It issued a review draft of a general hedging standard in September 2012, and is working towards issuing a final standard on general hedging in 2013 and a discussion paper (DP) on macro hedging in early 2014.

What happened in October 2013?Many were keen to hear the staff’s announcement that publication of the final general hedging standard is planned for November 2013. Some entities are eagerly awaiting its release because they want to early adopt it for 2013 or 2014 financial statements. The IASB also gave the staff permission to prepare a ballot draft of the forthcoming macro hedging DP, which is now planned for release in the first quarter of 2014.

In the impairment project, the IASB reached some tentative conclusions that mostly confirmed proposals in the impairment ED and added some clarifications.

In the classification and measurement project, the staff conducted a joint education session on the business model assessment – and although the Boards considered the staff’s recommendations on various aspects, they were not asked to make any decisions.

Finally, the IASB approved proposing two amendments to IFRS 7 that will be included in the ED of the 2012–2014 cycle of annual improvements, which is planned for the fourth quarter of 2013.

Contents


KEY DECISIONS MADE THIS MONTH

Hedge accounting• The final general hedging standard is scheduled for November 2013.

• The macro hedging discussion paper is scheduled for Q1 2014 and will have a 180-day comment period.

ImpairmentThe IASB made a number of tentative decisions on the following areas. It plans to issue a final standard by mid-2014.

When to recognise lifetime expected credit losses• Lifetime expected credit losses would be recognised when the credit risk of a financial instrument has increased significantly

since initial recognition.

• The guidance in the impairment ED on recognising lifetime expected credit losses would be clarified to address concerns about the operability of the model.

• The assessment of significant deterioration would only consider changes in the probability of default (PD). An assessment based on 12-month PD would be permitted unless circumstances indicate that a lifetime assessment is necessary.

• Assets could be moved into and out of the lifetime expected loss category in a symmetrical way.

Operational simplifications • The final standard would retain the rebuttable presumption that the credit risk on a financial instrument has increased

significantly when contractual payments are more than 30 days past due.

• The ‘low credit risk’ criterion would be retained and made available as a practical expedient.

• An entity could assume that a financial instrument has not significantly increased in credit risk if it has low credit risk at the end of the reporting period.

Measurement of expected credit losses• The measurement of expected credit losses should incorporate the best information that is reasonably available. For periods

beyond ‘reasonable and supportable forecasts’, an entity would consider how best to reflect its expectations by considering information at the end of the reporting period about the current conditions, as well as forecasts of future events and economic conditions.

• It would be clarified that 12-month expected credit losses are a portion of the lifetime expected credit losses.

Asset modifications• Modification requirements would apply to all modifications or renegotiations of contractual cash flows, regardless of the

reason for the modification.

• A modification gain or loss would be recognised in profit or loss.

• Modified financial assets would be subject to the same ‘symmetrical’ treatment – i.e. a modified asset could revert to a 12-month expected credit loss allowance – as other financial instruments.

Classification and measurement The Boards were not asked to make any decisions at this meeting. The IASB plans to issue a final standard by mid-2014.

IFRS 7 annual improvementsThe IASB agreed to propose amendments in the 2012–2014 cycle of annual improvements, to clarify that:

• servicing arrangements are generally in the scope of the disclosures in IFRS 7 Financial Instruments: Disclosures on transferred financial assets; and

• the IFRS 7 offsetting disclosures are only required for interim periods if they are required by IAS 34 Interim Financial Reporting.


HEDGE ACCOUNTING

The final general hedging standard is scheduled for November.

General hedge accountingThe IASB staff announced that the general hedging standard is expected to be issued in November 2013.

KPMG Insights

An entity will be permitted to early adopt IFRS 9, including the hedging provisions, as long as it also adopts all existing IFRS 9 requirements – i.e. if the classification and measurement requirements of IFRS 9 (2010) are applied at the same time or have already been applied. That means that if the final standard is released in November 2013, entities in some jurisdictions may be able to apply the new general hedging model in 2014.

An entity may wish to early adopt if the new general hedging model would allow hedge accounting for existing risk management activities that are currently ineligible and are a source of significant volatility in profit or loss – e.g. entities that undertake economic hedges of components of overall commodity prices.

Entities that wish to early adopt the general hedging standard may also wish to do so before the impairment and revised classification and measurement components of IFRS 9 are finalised. This is because early adopting those additional components may add complexity to the process.

However, because of the close interaction between the general hedge accounting model and macro hedging, the IASB is also permitting an entity to make a one-time election to defer adoption of the general hedging model until the standard resulting from the macro hedging project is effective, which will not be for some years.

Deciding whether to (a) early adopt the general hedging model, (b) adopt it at its mandatory effective date (which is yet to be finally determined) or (c) defer adopting it until the standard resulting from the macro hedging project is effective may be a complex analysis for some entities. Please speak to your usual KPMG contact if you would like to discuss the pros and cons of these adoption alternatives.

The macro hedging discussion paper is scheduled for Q1 2014 and will have a 180-day comment period.

Macro hedge accountingWhat’s the issue?

Starting in September 2010, the IASB held a series of public meetings and an educational session on dynamic risk management strategies for open portfolios – i.e. macro hedging. The discussions focused on developing a ‘portfolio revaluation approach’, where the hedged risk position is identified and remeasured for changes in the hedged risk, with the gain or loss recognised in profit or loss. The Board decided to work towards issuing a discussion paper (DP) as the first due process document.

What did the IASB decide?

At the October 2013 meeting, the Board decided that the staff should begin the balloting process for the DP. The staff plan to provide the Board with the draft of the DP towards the end of November, and the final DP is planned for release in the first quarter of 2014.

The Board also agreed with the staff’s proposal that the comment period should be 180 days. The period will be longer than the more typical 120-day comment period, because:

• macro hedging and dynamic risk management are complex areas;


• the portfolio revaluation approach is a new model that is potentially much broader than the one currently applied for fair value hedging – e.g. it may allow pipeline trades to be included in the hedged portfolio; and

• the Board wants to solicit feedback from preparers outside of the banking industry and from users.

KPMG Insights

We welcome the Board’s decision to extend the comment period for the macro hedging DP to 180 days. This is a highly complex area, and preparers and users will need adequate time to understand the proposals and provide thoughtful responses to the Board.

We look forward to being an active participant in the global conversation about the Board’s macro hedging proposals next year.


IMPAIRMENT – WHEN TO RECOGNISE LIFETIME EXPECTED CREDIT LOSSES

The IASB tentatively decided to confirm that lifetime expected credit losses would be recognised when there is a significant increase in credit risk since initial recognition.

Significant increases in credit risk since initial recognitionWhat’s the issue?

The impairment ED proposed that financial assets (other than assets that were credit-impaired at acquisition) would attract, at inception, a loss allowance equal to the expected credit losses associated with the probability of default (PD) over the next 12 months.

The allowance would increase to lifetime expected credit losses if the credit risk on the financial asset has increased significantly since initial recognition. Most respondents agreed with this proposal, but some preparers made suggestions on how to improve operationality – e.g. by recognising lifetime expected losses:

• when an absolute level of credit risk has been reached;

• when there is a change in the credit risk management objective for a financial instrument;

• when the credit risk of an instrument is below the current underwriting objective of the entity; or

• based on the credit risk of the counterparty rather than an instrument.

Some respondents disagreed with the proposals – e.g. because of concerns that the model would be costlier to implement in jurisdictions, and for entities, that have less sophisticated credit risk management systems.

What did the staff recommend?

The staff’s analysis focused on two areas of the feedback: suggested operational simplifications, and concerns over the cost of implementing the model.

The staff recommended retaining the proposals in the impairment ED that lifetime expected credit losses would be recognised when the credit risk of a financial instrument has increased significantly since initial recognition. They did not recommend adopting the suggested operational simplifications, for the following reasons.

Suggested operational simplification Reason for rejection

Absolute level of credit risk The IASB considered this approach when drafting the impairment ED and rejected it.

Change in credit risk management objective

This could delay the recognition of credit losses.

Comparison to credit underwriting policies This is inconsistent with the IASB’s objective of reflecting increases in credit risk.

Credit risk of the counterparty If used as a sole factor, this may not appropriately reflect the credit risk of a particular instrument.

However, to address respondents’ operational concerns, the staff also recommended clarifying that the assessment of significant increases in credit risk could be implemented more simply by:

• establishing, at initial recognition, the maximum credit risk for a particular portfolio of financial instruments with similar credit risk; and then

• comparing the credit risk of the financial instruments in that portfolio with the origination credit risk.


In addition, the staff recommended clarifying in the application guidance that significant increases in credit risk can be assessed using a counterparty assessment – provided that:

• this assessment is consistent with the objective of the proposals; and

• the outcome would not be different than under an assessment on an individual instrument level.

The staff also discussed the concern that the model would probably be costlier to implement in jurisdictions, and by entities, that have less sophisticated credit risk management systems. The staff’s view is that the changes to systems and processes required by the impairment ED would be no greater than those needed to manage an entity’s business effectively. They also noted that the impairment ED already contains a number of operational simplifications.


The Board agreed with the staff recommendations.

The IASB tentatively decided to confirm the guidance provided in the impairment ED and provide clarifications to address concerns about the operability of the model.

Guidance on when to recognise lifetime expected credit lossesWhat’s the issue?

The proposals in the impairment ED are principles-based, and do not prescribe what is considered a significant increase in credit risk. Instead, the impairment ED includes application guidance and examples of indicators that could be used to determine whether to recognise lifetime expected credit losses – including the PD.

Many respondents supported the principles-based approach, but some noted potential inconsistencies and asked for clarification. Others – most notably regulators – were concerned that allowing entities to use their internal risk management system may make the assessment too reliant on judgement and open to manipulation. Some were concerned that the proposals would require the calculation and storage of the lifetime PD.


The staff were of a view that the concerns could be addressed through drafting. Accordingly, they recommended that the final standard:

• require all the indicators that are relevant for the particular financial instrument to be considered;

• place more emphasis on the fact that a significant increase in credit risk occurs earlier than non-performance or default;

• include the principle underlying the focus on a significant increase in credit risk more prominently in the application guidance; and

• provide examples on how non-borrower-specific macro-economic information would be factored into the assessment1.

The staff also noted that the proposals did not intend to require entities to calculate an explicit PD to apply the model, but to require them to consider the risk of default.



1 As tentatively decided in the September IASB board meeting (see Issue 15 of this Newsletter, from September 2013).

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/ifrs-newsletters/Pages/FI-newsletter-2013-15.aspx


The IASB tentatively decided that the assessment of significant deterioration should consider only changes in the PD.

An assessment based on the 12-month PD would be permitted unless circumstances indicate that a lifetime assessment is necessary.

Basis for identifying a significant increase in credit riskWhat’s the issue?

The impairment ED proposed that the assessment of when to recognise lifetime expected credit losses would be based on changes in PD, rather than changes in expected credit losses (or loss given default (LGD)). In addition, under the proposals the evaluation of whether the increase in credit risk is significant would be based on the lifetime PD, or the 12-month PD – i.e. the probability of default occurring in the next 12 months – if the information considered did not suggest that the outcome would differ.

Most respondents agreed that the assessment of when to recognise lifetime expected credit losses should be based on changes in the PD, although some disagreed or asked for clarifications.


Using PD to assess when to recognise lifetime expected credit losses

The staff noted that the IASB has already discussed this issue, and that the staff have not received any new information that they think would change the IASB’s former conclusion.

Therefore, the staff recommended confirming that the assessment of when to recognise lifetime expected credit losses should consider only changes in PD, rather than changes in the amount of expected credit losses (or the LGD).

Using 12-month rather than lifetime PD for the assessment

The staff noted that the IASB had not intended to require entities to assess based on both 12-month and lifetime PD and then to prove that the outcome would not differ, because this would not result in a simplification.

Accordingly, the staff recommended clarifying that an assessment based on the change in the 12-month PD would be permitted unless circumstances indicate that a lifetime assessment is necessary.

The staff also suggested including examples of when a 12-month assessment would not be appropriate – for example:

• for loans that only have significant payment obligations beyond the next 12 months – e.g. bullet loans or financial instruments that are non-amortising in the first few years;

• when abnormal changes in macro-economic or other credit-related factors occur that indicate an abnormal shift in the risk curve; or

• when changes in credit-related factors occur that only have an impact on credit risk beyond 12 months.




The IASB tentatively decided that assets could move into and out of the lifetime expected loss category in a symmetrical way.

Reverting to 12-month expected credit losses when lifetime criteria are no longer met What’s the issue?

Under the impairment ED, an entity would assess whether there has been a significant deterioration in credit risk at the end of each reporting period. Assets could move into and out of the lifetime expected loss category in a symmetrical way. Nearly all respondents agreed with these proposals.


The staff recommended confirming the proposal that assets could move into and out of the lifetime expected loss category in a symmetrical way.


The Board agreed with the staff recommendation.


IMPAIRMENT – OPERATIONAL SIMPLIFICATIONS

The IASB decided to retain the rebuttable presumption of more than 30 days past due proposed in the impairment ED.

Rebuttable presumption of more than 30 days past dueWhat’s the issue?

The impairment ED included a rebuttable presumption that the credit risk on a financial instrument has increased significantly when contractual payments are more than 30 days past due.

The majority of respondents supported this presumption – particularly when other borrower-specific information was not available – but many have asked for clarification in some areas. Those respondents who did not support the presumption did so principally for one of the following reasons:

• they opposed a ‘bright line’ indicator and argued that delinquency is a lagging indicator that fails to identify a significant increase in credit risk on a timely basis; or

• the rebuttable presumption should be longer than 30 days.

In addition, during the fieldwork conducted by the IASB, participants observed that when an instrument became more than 30 days past due there was a corresponding increase in lifetime PD ranging between 160 and 1,000 percent.


In light of the responses, the staff recommended retaining the rebuttable presumption of more than 30 days past due, and clarifying that:

• the objective of the rebuttable presumption is to serve as a backstop for identifying instruments that have experienced a significant increase in credit risk;

• it is intended that application of the presumption should result in lifetime expected credit losses being recognised before there is objective evidence of impairment; and

• rebutting the presumption would not require an instrument-by-instrument assessment, but rather could be made for a group of assets – e.g. a particular product, region or borrower type.

The staff observed that the presumption would make the proposals more operable for entities that do not have sophisticated credit risk management systems and those products or regions where borrower-specific information is not available. It would also enable entities to leverage information they are currently using, without having to undertake an exhaustive search for new information.


The Board tentatively decided to retain the rebuttable presumption that the credit risk on a financial instrument has increased significantly when contractual payments are more than 30 days past due. The final standard would also clarify that:

• the objective of the rebuttable presumption is to serve as a backstop or latest point at which to identify financial instruments that have experienced a significant increase in credit risk;

• the presumption is rebuttable; and

• the application of the rebuttable presumption is to identify significant increases in credit risk before default or objective evidence of impairment.


KPMG Insights

The IASB faced a dilemma, as the ‘30 days past due’ status is a lagging indicator and some might challenge whether it is consistent with the expected loss model. This seems to be supported by the IASB fieldwork (referred to above), which indicated that when an instrument became more than 30 days past due there was a corresponding large increase in lifetime PD ranging between 160 and 1,000 percent. Many would regard this to be considerably above a ‘significant increase’ level.

However, the Board acknowledged that sometimes more forward-looking, borrower-specific information is simply not available – e.g. for many retail loans. Accordingly, the Board’s tentative decision seems to be a compromise, emphasising that:

• the more than 30 day presumption serves as a backstop only where there is no other forward-looking information available; and

• forward-looking information includes macro-economic factors on a portfolio level.

The IASB tentatively decided to retain as a practical expedient the low credit risk criterion proposed in the impairment ED.

‘Low credit risk’ exceptionWhat’s the issue?

The impairment ED included an exception from identifying a significant increase in credit risk for instruments with ‘low credit risk’. Such instruments could never be regarded as being subject to a significant increase in credit risk, and so would always attract a credit loss allowance equal to 12-month expected credit losses.

Most respondents supported the exception, stating that it would reduce the costs of implementation – particularly for entities that invest only in high-quality assets, such as some insurance companies – and because they did not think it would be appropriate to recognise lifetime expected losses on high-quality instruments. However, they asked for some clarification of the definition of ‘low credit risk’ and how it should be applied.

Those respondents who did not support the proposals argued that the exception would result in diversity, because there is no clear definition of ‘low credit risk’. Also, for entities that invest in assets of differing qualities, it would lead to additional operational complexity, because the entities would have to modify their systems to differentiate between financial instruments that are low credit risk and those that are not. The staff noted that no respondents disagreed with the proposals because they thought that ‘low credit risk’ is an inappropriate threshold.


The staff focused their analysis on the meaning of ‘low credit risk’ and the nature of the low credit risk exception.

Meaning of ‘low credit risk’

The staff made the following observation: in introducing the exception, the IASB had argued that if an instrument has low credit risk, then the effect on timing and recognition of lifetime expected credit losses would be minimal – even if the change in credit risk was deemed to be significant.

The staff recommended the following clarifications:

• the objective of the low credit risk notion is to provide operational relief for high-quality financial instruments with a low risk of default;


• when an instrument no longer carries a low credit risk, an entity would assess the extent of the increase in credit risk to determine whether lifetime expected credit losses should be recognised; and

• this exception would not require instruments to be externally rated, but would require the instrument to have a level of credit risk comparable to a global (rather than national) credit rating of ‘investment grade’.

They also recommended modifying the proposed description of ‘low credit risk’ as follows:

• the instrument has a low risk of default;

• the borrower is considered to have a strong capacity to meet its obligations in the near term; and

• the lender expects that adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its obligations.

Options considered

The staff considered three options:

1. to retain the proposals in the impairment ED;

2. to remove the exception; or

3. to allow entities an accounting policy choice as to whether they apply the exception.

They recommended Option 3 because, although it would reduce comparability between entities, more preparers would find it simpler to operationalise. The staff drew parallels with the accounting policy choice over recognising expected credit losses for trade receivables with a significant financing component and for lease receivables.

The staff then considered the level at which the accounting policy choice should be exercised. Five potential approaches were considered:

a. instrument-by-instrument;

b. portfolio level;

c. level at which significant increases in credit risk are assessed;

d. reporting entity level; and

e. classes of financial instruments, similar to the requirements in IFRS 7.

The staff believed that Approach (d) would be a viable approach, because it would be simpler for those who supported the exception, without increasing the complexity for those who did not support it.

However, they recommended Approach (e) because they believed that this would be consistent with the level of detail that entities already disclose, thereby providing the operational simplification for which the exemption was intended.


The Board tentatively decided that an entity could assume that a financial instrument has not significantly increased in credit risk if it has low credit risk at the end of the reporting period. In keeping with the staff recommendations, the final standard would include clarifications on the application and meaning of the low credit risk notion.


KPMG Insights

The proposed amendments and clarifications of what is meant by ‘low credit risk’ are helpful in resolving the apparent inconsistency in the definition proposed in the impairment ED. They also help to articulate the concept more clearly – in particular, how it would apply to instruments that are not subject to a global external rating.

The decision to allow entities to use a practical expedient of treating assets with low credit risk as not qualifying for recognition of lifetime expected credit losses caters for both those that invest primarily in high-quality instruments and those that invest in instruments of differing credit qualities.


IMPAIRMENT – MEASUREMENT OF EXPECTED CREDIT LOSSES

The IASB discussed potential clarifications to the guidance on measuring expected credit losses.

What’s the background? The impairment ED proposed that the estimates of expected credit losses should incorporate the best available information that reflects:

• an unbiased and probability-weighted amount of expected credit losses; and

• the time value of money.

The Board discussed the following aspects of the measurement of expected credit losses:

• whether the requirements in the impairment ED on the discount rate should be retained;

• clarifying certain other measurement requirements; and

• clarifying the measurement of 12-month expected credit losses.

The IASB took a tentative decision to step away from allowing entities to use any rate between the risk-free rate and the EIR for measuring lifetime expected losses.

Discount rate What’s the issue?

The impairment ED proposed that estimates of expected credit losses should reflect the time value of money. To achieve this, an entity would, for a non-credit-impaired financial asset, use any reasonable rate that is between (and including) the risk-free rate and the effective interest rate (EIR) to discount the expected credit losses.

The extent of support for using a range is unclear. The impairment ED did not ask for comments on the discount rate to be used, but several respondents gave feedback on this issue – and most of them did not agree with the proposals.

These respondents made the following observations:

• using the EIR is consistent with other proposals in the ED;

• discounting using the risk-free rate is inappropriate because it ignores the risk associated with financial instruments; and

• the amount of expected losses can be very different depending on whether the EIR or a risk-free rate is used (the staff outreach has indicated that the EIR could be as much as 20 times higher than the risk-free rate in some jurisdictions).

Respondents also asked for clarification of what can be regarded as a ‘reasonable’ rate.


Based on the feedback received, the staff discussed two alternatives.

1. To confirm the proposals in the ED, while clarifying that a ‘reasonable rate’ is a rate that approximates the EIR and reflects:

– the time value of money (‘risk-free rate’);

– compensation for initial expected credit losses;

– compensation for accepting risk – e.g. unexpected credit loss, liquidity risk etc;

– a profit margin; and

– adjustments for premiums or discounts, fees and points paid, and/or transaction costs.

2. To require the use of the EIR (or an approximation thereof), but permit the use of the risk-free rate when it is impracticable to determine the EIR.

The staff recommended Alternative 1, because it would allow preparers to choose a rate that is suitable for the level of sophistication of their systems and their operational capability, and


would provide flexibility to help ease the operational challenges in determining and maintaining the discount rate. The staff also noted that market forces may encourage entities to use the EIR, because it results in lower expected losses than the risk-free rate.

What did the IASB discuss?

The Board discussed the concept of a ‘reasonable rate’. One Board member said that the attributes of a ‘reasonable rate’ set out by the staff under Alternative 1 would appear to deliver the EIR or an approximation of the EIR. Some Board members questioned whether a risk-free rate could be considered to be a ‘reasonable rate’.

Throughout their discussion, the Board members acknowledged that when considering the appropriate discount rate for measuring expected credit losses, it was important to provide preparers with some flexibility. In that respect, some Board members said that, although they agreed that the model needed simplifying, a discount rate range between the risk-free rate and the EIR would be too wide.


The Board tentatively decided to require expected credit losses to be discounted at the EIR or an approximation thereof.

The Board confirmed that expected credit losses would be based on reasonable and supportable forecasts.

Forecasting expected credit lossesWhat’s the issue?

The impairment ED did not propose any specific measurement method for estimating expected credit losses. However, it did propose that an entity include a reasonable and supportable forecast of future events and economic conditions.

The IASB received very little feedback on this proposal; however, to reflect the points considered by the FASB during the September 2013 joint board meeting, the staff recommended that the final standard should clarify the interaction between historical, current and forward-looking information. During the September meeting, the FASB had tentatively decided that entities should use historical average loss experience to calculate expected credit losses for future periods beyond which they are able to make or obtain reasonable and supportable forecasts.

Some respondents also asked the IASB to again consider permitting the use of regulatory approaches to measurement – in particular, risk parameters covering the entire economic cycle (‘through-the-cycle’).


The staff believed that historical information is always an important base to measure expected credit losses; however, it cannot be assumed that, if unadjusted, it is appropriate in all circumstances. Instead, it should be used as a starting point from which adjustments are made to determine expected credit losses on the basis of reasonable and supportable information that includes both current and forward-looking information.

The staff also believed that regulatory information may be used as a basis for measuring expected credit losses – but only if appropriate adjustments are made to achieve the objectives of the impairment ED.

Therefore, the staff recommended:

• confirming the impairment ED’s proposal to include reasonable and supportable forecasts of future events and economic conditions in estimating expected credit losses, supplemented by the detailed application guidance in paragraphs B5–B8 of the impairment ED; and


• confirming the impairment ED’s proposals on using the regulatory model as a basis for calculating expected credit losses, but with adjustments to meet the objective of the standard.


The IASB agreed with the staff recommendation and tentatively reached the following conclusions.

• The measurement of expected credit losses should incorporate the best information that is reasonably available – including information about past events, current conditions and reasonable and supportable forecasts of future events and economic conditions at the end of the reporting period. For periods beyond ‘reasonable and supportable forecasts’, an entity would consider how best to reflect its expectations by considering information at the end of the reporting period about the current conditions, as well as forecasts of future events and economic conditions.

• Regulatory expected credit loss models may form a basis for expected credit loss calculations, but the measurement may need to be adjusted to meet the objectives of the proposed model.

KPMG Insights

The IASB rejected requests to permit the use of through-the-cycle regulatory risk parameters, because the expected credit loss approach proposed in the impairment ED:

• is based on information available at the end of the reporting period; and

• is designed to reflect economic reality, rather than adjusting the assumptions and inputs applied to achieve a counter-cyclical effect.

This means that banks currently using through-the-cycle regulatory parameters may need to consider system modifications to arrive at the ‘point-in-time’ estimates proposed by the impairment ED.

There may also be other differences between regulatory requirements and the proposals in the impairment ED that would require entities to adjust their systems – e.g. regulatory calculations may reflect downturn LGD and EAD (exposure at default), whereas the proposals would not.

The Board confirmed its intentions for measuring 12-month expected credit losses.

Measurement of 12-month expected credit losses

What’s the issue?

The impairment ED proposed that impairment losses be measured at an amount equal to 12-month expected credit losses, unless the credit risk on the financial instrument has increased significantly since initial recognition.

Comment letter responses and feedback from the staff’s outreach indicate that respondents want clarification about what this 12-month measure represents.


To address these concerns, the staff recommended including the information provided in paragraph BC63 of the impairment ED in the final standard’s application guidance, to clarify that 12-month expected credit losses do not capture:

• the cash shortfalls expected in the next 12 months; or


• the lifetime expected credit losses on instruments that the entity predicts will default in the next 12 months.

Instead, 12-month expected credit losses are the lifetime cash shortfalls that will result if a default occurs in the 12 months after the end of the reporting period, weighted by the probability of that default occurring.


The Board agreed with the staff recommendation and tentatively decided to clarify the measurement of 12-month expected credit losses by incorporating the discussion in paragraph BC63 of the ED as part of the application guidance. Accordingly, the application guidance would clarify that 12-month expected credit losses are a portion of the lifetime expected credit losses.

Therefore, 12-month expected credit losses are neither:

• the cash shortfalls that are predicted over the next 12 months; nor

• the lifetime expected credit losses that an entity will incur on financial instruments that it predicts will default in the next 12 months.


IMPAIRMENT – ASSET MODIFICATIONS

Issue Recommendation Rationale for recommendation

Scope of modifications – Should modifications performed for commercial purposes be distinguished from modifications performed for credit risk management purposes?

The proposed guidance should continue to apply to all modifications, irrespective of the reason for the modification.

Previous feedback indicated that distinguishing between modifications for credit and commercial reasons may be difficult.

The carrying amount of an asset measured at amortised cost should reflect changes in contractual cash flows, irrespective of the reason for the modification.

Modifications of contractual terms will always have an impact on credit risk – therefore, requiring a different accounting treatment may create opportunities for manipulation.

When does a modification result in derecognition?

No further guidance on this should be developed within the impairment project.

Developing this guidance is outside the scope of the impairment project and would require substantial time and resources – which would delay finalisation of the impairment project.

The Board focused on a number of concerns raised by respondents in respect of modifications.

What’s the issue?Under the impairment ED, modifications that do not result in derecognition (irrespective of the reason for modification) would require an entity to adjust the asset’s gross carrying amount to reflect the revised contractual cash flows. The gross carrying amount would be the present value of the estimated future contractual cash flows, discounted at the asset’s original EIR. A corresponding modification gain or loss would be recognised in profit or loss.

Constituents have asked the IASB to clarify:

• the scope of the modification requirements;

• how the model would apply to modified assets;

• operational concerns about tracking modifications over the remaining life; and

• the presentation of modification gains or losses.

What did the staff recommend? The staff made the following recommendations.



Derecognition and subsequent recognition of modified financial assets – Is the ‘new’ asset credit-impaired?

No changes should be made to the requirements of the proposed general model. However, the application guidance should be clarified to require an entity to consider whether there is objective evidence of impairment on initial recognition of a modified financial asset.

Under the impairment ED, the measurement of newly recognised modified financial assets would depend on whether:

• the terms and pricing of the asset reflect the newly assessed credit risk – and therefore require treatment of the modified asset within the requirements of the general model – i.e. initial recognition of 12-month expected credit losses; or

• the modified asset is considered to be credit-impaired at initial recognition – and would therefore require lifetime expected credit losses to be recognised at initial recognition by adjusting the EIR.

Applying the symmetry of the general model – Should modified financial assets be excluded from the general symmetrical model (in which an asset can revert to 12-month expected credit losses)?

The Board should confirm that the symmetrical treatment of the general model would apply equally to modified financial assets, and should clarify that the application guidance in paragraph B24 – which emphasises that modification of contractual cash flows would not automatically improve the credit quality of the financial asset – would apply to all modified financial assets.

Under the impairment ED:

• the proposed deterioration model faithfully represents the economics of the transaction – for both modified and unmodified assets;

• evidence that criteria for the recognition of lifetime expected credit losses are no longer met includes a history of full and timely payment performance against revised contractual cash flows – therefore, modification of contractual cash flows would not automatically result in decreased credit risk;

• the assessment of significant increases in credit risk would be based on all reasonable and supportable information, which would include circumstances that led to the modification; and

• the recognition of lifetime expected losses would be determined by reference to the initial credit risk, based on the original terms.



Operational concerns – Would the proposals present operational difficulties and complexities for modified financial assets?

It should be clarified that entities would not need to track financial assets on an individual basis or to use a mechanistic approach to tracking.

Under the ED:

• the assessment of significant deterioration of modified assets is the same as for the general model (including available practical expedients); and

• tracking of financial assets on an individual basis is not required.

Presentation requirements – Should the modification gain or loss for modifications performed for credit risk reasons be recognised within the impairment line item?

The Board should confirm that modification gains and losses would be recognised in profit or loss, but should not include any specific presentation requirements in the final standard.

The emphasis of the ED is on the requirement to recognise a modification gain or loss, rather than on how to present it.

A modification gain or loss may not necessarily represent a change in expected credit losses.

Not all modifications are performed for credit risk reasons; therefore, requiring entities to present modification gains and losses together with impairment losses would not be appropriate.

What did the IASB discuss?The Board agreed with the staff recommendations to provide clarifications on a number of aspects in the ED in relation to financial asset modifications.

Several Board members noted the importance of transparent disclosures on modified assets, and the benefit that could be achieved by considering regulatory requirements and the recommendations of the Enhanced Disclosure Task Force (EDTF) on forbearance practices and non-performing financial assets, when developing these disclosure requirements at a later stage.

What did the IASB decide?The Board agreed with the staff and tentatively decided to confirm the proposals that:

• the modification requirements would apply to all modifications or renegotiations of contractual cash flows, regardless of the reason for the modification;

• the modification gain or loss would be recognised in profit or loss; and

• modified financial assets would be subject to the same ‘symmetrical’ treatment – i.e. a modified asset could revert to a 12-month expected credit losses allowance – as other financial instruments.

In addition, the Board tentatively decided to clarify the application guidance to emphasise that the credit risk on a financial asset would not automatically improve merely because the contractual cash flows have been modified.


KPMG Insights

Some respondents to the IASB’s proposals on modifications suggested that the scope should be limited and aligned to the European Banking Authority’s proposed descriptions of forbearance2. However, the population of modified assets in the impairment ED is wider than assets subject to forbearance, because assets may also be modified for other reasons that are not related to financial difficulties of the borrower. Banks reporting under both frameworks would need to evaluate the overlaps, but most importantly the differences, between both sets of requirements.

The impairment ED contained explicit guidance on recognising gains or losses on modification, and the impairment of modified financial assets. However, similar to IAS 39, the proposals did not contain guidance on when a modified asset should be derecognised. The general guidance on derecognising financial assets requires an assessment of whether contractual rights to cash flows from financial assets have ‘expired’; however, it does not discuss how this criterion should be applied to modifications of a financial asset to determine whether it should be derecognised as a result of the modification. Accordingly, entities would continue to face challenges in assessing when the modification results in derecognition.

2

Next steps At forthcoming meetings, the IASB intends to discuss the following topics:

• loan commitments and financial guarantee contracts;

• purchased or originated credit-impaired instruments;

• expected credit losses for instruments measured at fair value through other comprehensive income (FVOCI);

• measuring and presenting interest revenue; and

• application of the simplified approach for trade and lease receivables.

The IASB will also consider the future possibilities for convergence after considering any amendments to the proposals in the impairment ED and any changes that have been made by the FASB to its proposals. The IASB plans to issue a final standard by mid-2014.

2 EBA final draft implementing technical standards: On Supervisory reporting on forbearance and non-performing exposures under article 99(4) of Regulation (EU) No. 575/2013.

The IASB agreed to look at future possibilities for convergence.

http://www.eba.europa.eu/documents/10180/449824/EBA-ITS-2013-03+Final+draft+ITS+on+Forbearance+and+Non-performing+exposures.pdf

http://www.eba.europa.eu/documents/10180/449824/EBA-ITS-2013-03+Final+draft+ITS+on+Forbearance+and+Non-performing+exposures.pdf


CLASSIFICATION AND MEASUREMENT

The staff conducted a joint education session on the business model assessment, making recommendations on various matters. However, the Boards were not asked to make any decisions.

What was discussed during the October meeting?The Boards conducted a joint education session on the business model assessment in IFRS 9, including the FASB’s proposed Accounting Standards Update Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (‘the proposed ASU’).

The staff provided an overview of the relevant feedback received on the C&M ED and the proposed ASU. They recommended clarifications to the business model assessment in general, as well as to each of the three measurement categories – amortised cost, FVOCI and fair value through profit or loss (FVTPL). The Boards were not asked to make any decisions at this meeting.

We expect that the key decisions will be finalised by the end of 2013.

Overall business model assessment

What’s the issue?

Under IFRS 9, entities classify financial assets based on the business model for managing them (subject to the assessment of the assets’ cash flow characteristics). The proposed ASU provided similar guidance to that in the C&M ED. The C&M ED states that an entity’s business model for managing financial assets is a matter of fact that can be observed by the way the business is managed, and its performance evaluated, by key management personnel.


The staff considered the feedback received and made the following recommendations.


Issue Recommendation

The meaning of the term ‘business model’

The staff acknowledged that the term ‘business model’ can have a broad range of formal and informal definitions. It is often used to describe the core aspects of a business. However, the staff noted that the Boards have used the term ‘business model’ in a particular way – specifically, the objective of the business model assessment is to ensure that financial assets are measured in a way that enables users to predict the likely amounts, timing and uncertainty of future cash flows. Both IFRS 9 and the proposed ASU include a notion of cash realisation.

The staff recommended that the application guidance be supplemented to clarify the following points.

• The term ‘business model’ should refer to the way in which financial assets are managed in order to generate cash flows and create value for the entity – i.e. whether the cash flows will result primarily from the collection of contractual cash flows, sales proceeds or both.

• The business model assessment should result in financial assets being measured in a way that will provide the most relevant and useful information about how activities and risks are managed to create value.




The level at which a business model is assessed

IFRS 9 does not mandate the level at which the business model should be assessed. The assessment is not an instrument-by-instrument approach, but should be determined at a higher level of aggregation; and a single entity may have more than one business model. Therefore, the assessment need not be determined at the reporting entity level.

The staff did not believe that there is a single universal level of aggregation that would be appropriate to all reporting entities in all circumstances.

However, they did recommend clarifying in the application guidance that the business model should be assessed at a level that reflects financial assets that are managed together to achieve a particular objective. In short, this assessment should reflect the way in which the business is managed.

The information that should be considered when making the business model assessment

The staff recommended that the Boards clarify that:

• the business model is often observable through particular activities that are undertaken to achieve the objectives of that business model;

• these business activities usually reflect the way in the which the performance of the business is evaluated and reported – i.e. key performance indicators – and the risks that typically impact that performance; and

• an entity should consider all relevant and objective information, but not every ’what if’ or worse-case scenario.

The role of sales in the business model assessment

Most respondents noted that the application guidance seems to focus on the volume and frequency of sales, rather than the reasons for those sales.

Respondents questioned whether this guidance results in an implicit tainting notion – and some questioned whether a significant volume of unexpected sales would require the entity to restate prior periods as a result of making an ‘error’.

Therefore, the staff recommended that the application guidance should make the following clarifications.

• Information about sales activity should not be considered in isolation, but as part of an holistic assessment of the way in which financial assets will be managed.

• Historical sales patterns could provide useful information about how an entity currently manages its financial assets. Such information should be considered in the context of the reasons for those sales, the conditions that existed at that time, the entity’s expectations about future sales activities and the reasons for expected future sales.

• If cash flows are realised in a way that is different from the entity’s expectations, then this will neither:

– result in the restatement of prior period financial statements; nor

– change the classification of the remaining financial assets in the business model.




Change in business model and reclassification

The staff recommended that the Boards supplement the existing application guidance to clarify that:

• a change in business model would occur only when an entity has either stopped or started doing something on a level that is significant to its operations; and

• this would generally be the case only when the entity has acquired or disposed of a business line.

Reclassification date

Several respondents raised concerns that the IASB and the FASB define ‘reclassification date’ differently. IFRS 9 defines it as “…the first day of the first reporting period following the change in business model…”; whereas the proposed ASU describes it as “…the last day of the reporting period in which the change in the business model occurs…”.

The staff do not believe that the date of reclassification is a key difference between the Boards’ respective models, particularly given the anticipated infrequency of such events occurring. Therefore, they did not recommend any changes to the requirements for the date of reclassification.

Hold to collect business modelWhat’s the issue?

Financial assets that meet the hold to collect business model criteria would be eligible for classification at amortised cost, subject to the contractual cash flow characteristics assessment.

Most respondents continued to express support for measuring financial assets at amortised cost if they are held within a business model whose objective is to hold assets to collect contractual cash flows. The staff noted that most of the concerns about the scope of the hold to collect business model were related to the guidance on sales out of that model.


The staff recommendations on the overall assessment are relevant. In particular, for the hold to collect model the staff recommended that the Boards:

• discuss, and provide examples of, the activities that are commonly associated with the hold to collect business model;

• clarify that credit risk management activities are integral to the hold to collect objective; and

• clarify that determining whether sales are insignificant – both individually and in the aggregate – and/or infrequent is a matter of judgement, and would be based on facts and circumstances.


Fair value measurement categoriesWhat’s the issue?

Financial assets that meet the ‘hold to collect and sell’ business model criteria would be eligible for measurement at FVOCI – subject to the assessment of the contractual cash flow characteristics. Assets that are neither ‘hold to collect’ nor ‘hold to collect and sell’ would be measured at FVTPL.

The staff analysis and recommendations focused on the two fair value measurement categories, and on clarifying the proposed application guidance.


The staff considered the feedback received and made recommendations on the following matters.

Fair value measurement categories


Retaining FVOCI as a measurement category

The staff acknowledged concerns that a third measurement category would add complexity to IFRS 9. However, they believed that this complexity is justified by the usefulness of the information provided.

Therefore, the staff recommended that the Boards retain two fair value measurement categories – FVOCI and FVTPL.

Determining which fair value category should be defined, and which should be the residual

The staff recommended that the Boards confirm the proposals to define the business model that results in measurement at FVOCI and retain the FVTPL measurement category as the residual category.

To supplement the guidance on the FVTPL measurement category, they recommended that the Boards explain the meaning of managing financial assets on a fair value basis. This could be accomplished by clarifying that:

• when financial assets are either held for trading or managed on a fair value basis, the entity makes decisions – i.e. whether to hold or sell the asset – based on changes in, and with the objective of realising, the assets’ fair value; and

• the activities that the entity undertakes are primarily focused on fair value information, and key management personnel use that information to assess the assets’ performance and to make decisions accordingly.


Fair value measurement categories


Clarifying the proposed application guidance for the FVOCI measurement category

The staff recommended that:

• the Boards clarify that managing financial assets both to collect contractual cash flows and for sale reflects the way in which financial assets are managed to achieve a particular objective, rather than the objective in itself;

• the application guidance should more clearly articulate that FVOCI provides relevant and useful information when both the collection of contractual cash flows and the realisation of cash flows through selling are integral to the performance of the business model; there is no threshold for the frequency or amounts of sales; and

• the application guidance should describe activities that are typically associated with a business model where financial assets are managed both to collect the contractual cash flows and for sale – for example:

– the key performance indicators include both the interest yield and credit information and fair value changes;

– financial assets are held in a liquidity portfolio and significant portions of the portfolio are frequently sold to meet everyday liquidity needs;

– the durations of the financial assets are matched to those of the liabilities they are funding by regularly rebalancing the portfolio of financial assets; and

– the entity seeks to maintain a particular yield profile or to manage its exposure to interest rate risk by holding and selling financial assets in accordance with a stated risk management policy.

KPMG Insights

We are pleased that the staff suggest responding to concerns that the proposals placed too much emphasis on the frequency and significance of sales. We hope that the IASB will support the recommendation to base the business model assessment on a more balanced assessment of which activities are integral and which are incidental to the objectives established for managing groups of financial assets.


IFRS 7 ANNUAL IMPROVEMENTS

The IASB plans to clarify that servicing arrangements are generally in the scope of the IFRS 7 disclosures on transferred financial assets.

Applicability of continuing involvement disclosures to servicing arrangementsWhat’s the issue?

In October 2010, the IASB issued Disclosures – Transfers of Financial Assets (Amendments to IFRS 7). These amendments added paragraphs 42A–H to IFRS 7, which require disclosure of information on transfers of financial assets, including an entity’s continuing involvement in transferred assets that are derecognised.

In January 2013, the IFRS Interpretations Committee (the Committee) initially discussed a request for guidance on whether servicing arrangements are deemed continuing involvement when applying the transfer disclosure requirements. That kicked off a series of Committee and Board meetings on this issue – see, for example, Issue 10 of this Newsletter from February 2013.


In October 2013, the Board agreed to propose amendments in the 2012–2014 cycle of annual improvements, to clarify that servicing arrangements are generally in the scope of the IFRS 7 disclosures on continuing involvement in transferred financial assets that are derecognised in their entirety. Under the amendments, a servicer would be deemed to have continuing involvement in the transferred financial asset if the servicing fee is dependent on the amount or timing of the cash flows collected from the transferred financial asset. Similarly, a fixed fee that is not paid in full because of non-performance of the transferred financial asset would cause the servicer to have continuing involvement for the purposes of the disclosure requirements.

In addition, the Board agreed to amend paragraph B30 of IFRS 7 to clarify that the term ‘payment’ in that paragraph does not include amounts that an entity collects from a transferred financial asset that it is required to remit to the transferee.

The Board also agreed to provide transition relief whereby an entity need not apply the amendments to any period presented that begins before the date of initial application of the amendments. Similar relief would be provided for first-time adopters of IFRS.

KPMG Insights

Entities should evaluate whether they have servicing arrangements that represent continuing involvement in transferred financial assets and are subject to these disclosures. If they have, they will also have to evaluate what disclosures should be made. The basis for conclusions of the proposed amendments states that an entity may have to disclose the fair value of servicing assets or servicing liabilities, which the entity may not previously have determined for recognition or disclosure purposes.



The IASB also plans to clarify that the IFRS 7 offsetting disclosures are only required for interim periods if they are required by IAS 34.

Applicability of offsetting disclosures in interim periods

What’s the issue?

In January 2013, the Committee received a request to clarify whether the disclosures in Disclosures – Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7) issued in December 2011 were required in condensed interim financial statements prepared in accordance with IAS 34. In particular, the issue considered was how to interpret the requirement in the effective date and transition section of IFRS 7 to apply the amendments for ‘interim periods’ within annual periods beginning on or after 1 January 2013.

During 2013, a series of Committee and Board meetings took place on this issue – see, for example, Issue 11 of this Newsletter from April 2013.


In October 2013, the Board agreed to propose amendments in the 2012–2014 cycle of annual improvements, to remove the words “and interim periods within those annual periods” from paragraph 44R of IFRS 7. Its aim is to clarify that the offsetting disclosures need only be presented for interim periods if they are required by IAS 34.

KPMG Insights

Paragraph 15 of IAS 34 requires an entity to disclose events and transactions that are significant to an understanding of changes in financial position and performance since the end of the last annual reporting period. This is to update the relevant information presented in the most recent annual report. Paragraph 10 of IAS 34 requires the inclusion of additional notes if their omission would make the condensed interim financial statements misleading.

In addition, the basis for conclusions of the proposed amendments states that the over-riding goal of IAS 34 is to ensure that an interim financial report includes all information that is relevant to understanding an entity’s financial position and performance during the interim period. We observe that the wording is different from that which appears in the objective paragraph of IAS 34.

Next steps AThe IASB plans to include both proposed amendments to IFRS 7 as part of the exposure draft Annual Improvements 2012–2014 Cycle, which is planned to be published for comment in the fourth quarter of 2013.



APPENDIX A: SUMMARY OF IASB’S REDELIBERATIONS ON CLASSIFICATION AND MEASUREMENT ED


What did the IASB tentatively decide? Is there an identified change to IFRS 9?

Is there an identified change to the C&M ED?

Th

e S

PP

I cri

teri

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Meaning of ‘principal’

‘Principal’ is the amount transferred by the current holder for the financial asset.

Yes Yes

Meaning of ‘interest’

The IASB tentatively decided:

• to clarify that de minimis features should be disregarded for classification;

• to emphasise the underlying conceptual basis for the ‘solely P&I’ condition – i.e. the notion of a basic lending-type return;

• to confirm that time value of money and credit risk are typically the most significant components of a basic lending-type return, but not the only possible components;

• to clarify that a basic lending-type return also generally includes consideration for liquidity risk, profit margin and consideration for costs associated with holding the financial asset over time – e.g. servicing costs;

• to emphasise what are not the components of a basic lending-type return and why – e.g. indexation to equity prices; and

• to clarify the meaning of the time value of money – specifically:

– to clarify the objective of the consideration for the time value of money – i.e. to provide consideration for just the passage of time, in the absence of return for other risks and costs associated with holding the financial asset over time;

– to articulate the factors relevant to providing consideration for the passage of time – notably, the tenor of the interest rate and the currency of the instrument;

– to clarify that both qualitative and quantitative approaches could be used to determine whether the interest rate provides consideration for just the passage of time, if the time value of money component of the interest rate is modified – e.g. by an interest rate tenor mismatch feature – but not to prescribe when each approach should be used; and

– to not allow a fair value option in lieu of the quantitative assessment;

• to accept regulated interest rates as a proxy for the consideration for the time value of money if those rates provide consideration that is broadly consistent with consideration for the passage of time and do not introduce exposure to risks or volatility in cash flows that are inconsistent with the basic lending-type relationship; and

Yes Yes



What did the IASB tentatively decide? Is there an identified change to IFRS 9?

Is there an identified change to the C&M ED?

Th

e S

PP

I cri

teri

on

(co

nti

nu

ed)

Meaning of ‘interest’ (continued)

• to provide guidance on how the quantitative assessment of a financial asset with a modified time value of money component should be performed – i.e. by considering the contractual (undiscounted) cash flows of the instrument relative to the benchmark instrument – and to replace the ‘not more than insignificant’ threshold in the C&M ED with the ‘not significant’ threshold – i.e. a financial asset with the modified time value of money component of the interest rate would meet the ‘solely P&I’ condition if its contractual cash flows could not be significantly different from the benchmark instrument’s cash flows.

Contingent features

The nature of the contingent trigger event in itself does not determine the classification of the financial asset.

A contingent feature that results in contractual cash flows that are not solely P&I is inconsistent with the ‘solely P&I’ condition unless the feature is non-genuine.

Yes Yes

Prepayment and extension features

No distinction should be made between contingent prepayment and extension features and other types of contingent features.

A prepayment feature that results in contractual cash flows that are not solely P&I is inconsistent with the ‘solely P&I’ condition unless the feature is non-genuine – with an exception for financial assets that meet the following conditions:

• the financial asset is acquired or originated with a significant premium or discount;

• the financial asset is prepayable at the amount that represents par and accrued and unpaid interest (and may include reasonable additional compensation for the early termination of the contract); and

• the fair value of the prepayment feature on initial recognition of the financial asset is insignificant.

Financial assets meeting the conditions for this exception would be eligible for classification at other than FVTPL (subject to the business model assessment).

Yes Yes

Oth

er m

atte

rs

Early application of ‘own credit’ requirements

The early application guidance in IFRS 9 should be amended to permit entities to early apply only the own credit requirements in IFRS 9 when the IASB adds the hedge accounting chapter to IFRS 9.

Yes No

Deferral of mandatory effective date

The current mandatory effective date of 1 January 2015 will be deferred and the mandatory effective date should be left open, pending the finalisation of the impairment and classification and measurement requirements.

Yes N/A


APPENDIX B: SUMMARY OF IASB’S REDELIBERATIONS ON IMPAIRMENT ED

Note: Decisions made in October 2013 are shaded.


What did the IASB tentatively decide? Is there an identified change to the impairment ED?

Th

e ge

ner

al p

rin

cip

les

Responsiveness of the impairment model to forward-looking information

The objective of the model is to recognise lifetime expected credit losses on all financial instruments for which there has been a significant increase in credit risk – whether on an individual or a portfolio basis. All reasonable and supportable information, including forward-looking information that is available without undue cost or effort, would need to be considered. In addition, the final standard would include illustrative examples to reflect the intention of the proposals.

Yes. The final standard would clarify the objective and include application examples

Recognition of expected credit losses for financial instruments that have not significantly deteriorated

For financial instruments for which there has not been a significant increase in credit risk since initial recognition, an entity would measure the expected credit losses at an amount equal to the 12-month expected credit losses.

No

Timing of recognition of lifetime expected credit losses

Lifetime expected credit losses would be recognised when there is a significant increase in credit risk since initial recognition. The final standard would clarify (potentially through examples) that:

• the assessment of significant increases in credit risk could be implemented more simply by establishing the initial maximum credit risk for a particular portfolio (of financial instruments with similar credit risk on initial recognition) and then comparing the credit risk of financial instruments in that portfolio at the end of the reporting period with that origination credit risk;

• the assessment of significant increases in credit risk could be implemented through a counterparty assessment – provided that this assessment achieves the objectives of the proposed model;

• the assessment of the timing of recognition of lifetime expected credit losses would consider only changes in the risk of a default occurring, rather than changes in the amount of expected credit losses (or the credit LGD);

• an assessment based on the change in the risk of a default occurring in the next 12 months would be permitted unless circumstances indicate that a lifetime assessment is necessary; and

• a loss allowance measured at an amount equal to 12-month expected credit losses would be re-established for financial instruments for which the criteria for the recognition of lifetime expected credit losses are no longer met.

Yes. The final standard would include clarifications and potentially examples to articulate how to identify a significant increase in credit risk since initial recognition




Definition of ‘default’ An entity would apply a definition of ‘default’ that is consistent with its credit risk management practices. Qualitative indicators of default should be considered when appropriate – e.g. for financial instruments that contain covenants. Also, the final standard would include a rebuttable presumption that default does not occur later than 90 days past due unless an entity has reasonable and supportable information to corroborate a more lagging default criterion.

Yes. The rebuttable presumption was not included in the impairment ED

Op

erat

ion

al s

imp

lifica

tio

ns

‘More than 30 days past due’ rebuttable presumption

The rebuttable presumption that there is a significant increase in credit risk when contractual payments are more than 30 days past due would be retained in the final standard.

Also, it would be clarified that:

• the objective of the rebuttable presumption is to serve as a backstop or latest point at which to identify financial instruments that have experienced a significant increase in credit risk;

• the presumption is rebuttable; and

• the application of the rebuttable presumption is to identify significant increases in credit risk before default or objective evidence of impairment.

Yes. The final standard would provide clarifications to resolve some of the operational concerns

‘Low credit risk’ operational simplification

An entity can assume that a financial instrument has not significantly increased in credit risk if it has low credit risk at the end of the reporting period.

The meaning and application of the low credit risk notion would be clarified as follows:

• the proposed description of low credit risk would be modified to state that:

– the instrument has a low risk of default;

– the borrower is considered to have a strong capacity to meet its obligations in the near term; and

– the lender expects that adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its obligations;

• the low credit risk notion is not a bright-line trigger for the recognition of lifetime expected credit losses; and

• financial instruments are not required to be externally rated; however, low credit risk equates to a global credit rating definition of ‘investment grade’.

Yes. For low credit risk instruments, it seems that the final standard would allow (rather than require) entities to assume that the credit risk had not significantly increased; also, clarifications on the meaning and application of low credit risk would be provided




Mea

sure

men

t o

f ex

pec

ted

cre

dit

loss

es

Discount rate The expected credit losses would be discounted at the effective interest rate (EIR) or approximation thereof.

Yes. The final standard would explicitly require the use of EIR or its approximation

Use of forward-looking information

The measurement of expected credit losses would incorporate the best information that is reasonably available, including information about past events, current conditions and reasonable and supportable forecasts of future events and economic conditions at the end of the reporting period.

No

Use of regulatory models

The regulatory expected credit loss models may form a basis for expected credit loss calculations, but the measurement may need to be adjusted to meet the objectives of the proposed model.

No

12-month expected credit losses

The final standard would clarify the measurement of 12-month expected credit losses by incorporating paragraph BC63 of the ED as part of the application guidance, namely that 12-month expected credit losses are a portion of the lifetime expected credit losses, and therefore that they are neither:

• the lifetime expected credit losses that an entity will incur on financial instruments that it predicts will default in the next 12 months; nor

• the cash shortfalls that are predicted over the next 12 months.

Yes. The final standard would clarify that 12-month expected credit losses are a portion of the lifetime expected credit losses by incorporating the discussion in the basis for conclusions into the application guidance

Ass

et m

od

ifica

tio

ns

Scope of application The modification requirements in the ED would apply to all modifications or renegotiations of contractual cash flows, regardless of the reason for the modification.

No

Modification gain or loss

The modification gain or loss would be recognised in profit or loss.

No

Applicability of the general model to modified financial assets

Modified financial assets would be subject to the same ‘symmetrical’ treatment – i.e. could revert back to 12-month expected losses – as other financial instruments; however, clarifications would be made in paragraph B24 of the application guidance to emphasise that the credit risk on a financial asset would not automatically improve merely because the contractual cash flows have been modified.

Yes. The final standard would clarify that the application guidance in paragraph B24 applies to all modified financial assets


PROJECT MILESTONES AND TIMELINE FOR COMPLETION

Discussionpaper(Q1)

Revisedstandard

(H1)

201220102009

Asset andliability

offsetting

Impairment

Classification&

measurement

General hedgeaccounting

Source: IASB work plan – projected targets as at 5 November 2013

Standardon assets:

IFRS 9 (2009)

Supplementarydocument

Exposuredraft

2011

Effective

1/1/2015*date

Exposuredraft

Standardon liabilities:IFRS 9 (2010)

Amendmentsto IFRS 7 and

IAS 32

Deferral ofeffective date

Exposuredraft – limitedamendments

1 2 3

4 5

6

7

Reviewdraft

8

2013 (H2)

Final standard(Q4)

Macro hedgeaccounting

9

Exposuredraft

10

2013 (H1)

Finalstandard

(H1)

Effectivedate?

2014

Effectivedates 1/1/2013and 1/1/2014

* Currently, IFRS 9 is effective for annual periods beginning on or after 1 January 2015. However, in July 2013 the IASB tentatively decided to defer the effective date of IFRS 9 to an unspecified date, pending the finalisation of the impairment and classification and measurement phases. In addition, in April 2013 the IASB decided to make application of the new general hedging model optional until the completion of the macro hedging project.

Our suite of publications considers the different aspects of the work plan, and provides a comparison to IAS 39 where relevant.

KPMG publications

1First Impressions: IFRS 9 Financial Instruments (December 2009)• For KPMG’s most recent and comprehensive views on IFRS 9, refer to Insights into IFRS: Chapter 7A – Financial

instruments: IFRS 9.

2First Impressions: Additions to IFRS 9 Financial Instruments (December 2010)• For KPMG’s most recent and comprehensive views on IFRS 9, refer to Insights into IFRS: Chapter 7A – Financial

instruments: IFRS 9.

3 In the Headlines: Amendments to IFRS 9 – Mandatory effective date of IFRS 9 deferred to 1 January 2015 (December 2011)

4 New on the Horizon: ED/2009/12 Financial Instruments: Amortised Cost and Impairment (November 2009)

5 New on the Horizon: Impairment of financial assets measured in an open portfolio (February 2011)

6 New on the Horizon: Hedge Accounting (January 2011)

7 First Impressions: Offsetting financial assets and financial liabilities (February 2012)

8 New on the Horizon: Hedge Accounting (September 2012)

9 New on the Horizon: Classification and Measurement – Proposed limited amendments to IFRS 9 (December 2012)

10 New on the Horizon: Financial Instruments – Expected credit losses (March 2013)

For more information on the project, see our website.

The IASB’s website and the FASB’s website contain summaries of the Boards’ meetings, meeting materials, project summaries and status updates.

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/first-impressions/Documents/First-Impressions-IFRS-9-Financial-Instruments.pdf

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/first-impressions/Documents/IFRS-9-additions-dec-2010.pdf

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/In-the-Headlines/Documents/in-the-headlines-2011-39.pdf

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/New-on-the-Horizon/Documents/New-on-the-Horizon-Financial-Instruments.pdf

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/New-on-the-Horizon/Pages/new-on-the-horizon-impairment-of-financial-assets.aspx

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/New-on-the-Horizon/Documents/New-on-the-Horizon-Hedge-Accounting-January-2011.pdf

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/first-impressions/Documents/first-impressions-offsetting.pdf

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/New-on-the-Horizon/Pages/NOTH-hedge-accounting.aspx

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/New-on-the-Horizon/Pages/NOH-classification-measurement.aspx

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/New-on-the-Horizon/Pages/NOH-credit-losses.aspx

http://www.kpmg.com/Global/en/topics/Global-IFRS-institute/ifrs-topics/Pages/IFRS-for-FI.aspx

http://www.ifrs.org/

http://www.fasb.org/


For more information on the financial instruments (IAS 39 replacement) project, please speak to your usual KPMG contact or visit the IFRS – financial instruments hot topics page, which includes line of business insights.

For more information on the financial instruments (IAS 39 replacement) project, please speak to your usual KPMG contact or visit the IFRS – financial instruments hot topics page, which includes line of business insights.

You can also go to the Financial Instruments page on the IASB website.

Visit KPMG’s Global IFRS Institute at kpmg.com/ifrs to access KPMG’s most recent publications on the IASB’s major projects and other activities.

Our IFRS – revenue hot topics page brings together our materials on the revenue project, including our IFRS Newsletter: Revenue. Our IFRS – insurance hot topics page brings together our materials on the insurance project, including our IFRS Newsletter: Insurance and our suite of publications on the IASB’s recently published re-exposure draft on insurance contracts.

Our IFRS – leases hot topics page brings together our materials on the leases project, including our New on the Horizon, which provides detailed analysis on the leases exposure draft published in May 2013. Our IFRS Breaking News page brings you the latest need-to-know information on international standards in the accounting, audit and regulatory space.

FIND OUT MORE


IFRS NEWSLETTER

INSURANCEIssue 32, December 2012

In December, the IASB discussed the residual margin and impairment of reinsurance contracts held by an insurer.

Moving towards global insurance accountingThis edition of IFRS Newsletter: Insurance highlights the results of the

IASB-only discussions in December 2012 on the joint insurance contracts project. In addition, it provides the current status of the project and an

expected timeline for completion.

Highlights

l The residual margin would be unlocked for differences between current and previous estimates of cash flows relating to future coverage or other future services.

l The residual margin for participating contracts would not be adjusted for changes in the value of the underlying items as measured using IFRS.

l At inception, a cedant would determine the residual margin on a reinsurance contract by reflecting in the expected fulfilment cash flows all the effects of non-performance, including those associated

with expected credit losses. Subsequent changes in expected cash flows resulting from changes in expected credit losses would be recognised in profit or loss.

IFRS

New on the Horizon: Leases

May 2013

kpmg.com/ifrs


http://www.kpmg.com/ifrs

http://www.kpmg.com/Global/en/topics/Global-IFRS-institute/ifrs-topics/Pages/ifrs-for-revenue.aspx

http://www.kpmg.com/Global/en/topics/Global-IFRS-institute/ifrs-topics/Pages/IFRS-for-insurance.aspx

http://www.kpmg.com/Global/en/topics/Global-IFRS-institute/ifrs-topics/Pages/IFRS-for-leases.aspx

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/ifrs-breaking-news/Pages/default.aspx


http://www.kpmg.com/Global/en/topics/Global-IFRS-institute/ifrs-topics/Pages/IFRS-for-insurance.aspx

http://www.kpmg.com/Global/en/topics/Global-IFRS-institute/ifrs-topics/Pages/IFRS-for-leases.aspx

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/ifrs-breaking-news/Pages/default.aspx


http://www.ifrs.org/Current-Projects/IASB-Projects/Financial-Instruments-A-Replacement-of-IAS-39-Financial-Instruments-Recognitio/Pages/Financial-Instruments-Replacement-of-IAS-39.aspx

KPMG CONTACTS

AmericasMichael HallT: +1 212 872 5665E: [email protected]

Tracy BenardT: +1 212 872 6073E: [email protected]

Asia-PacificReinhard KlemmerT: +65 6213 2333E: [email protected]

Yoshihiro KurokawaT: +81 3 3548 5555 x.6595E: [email protected]

Europe, Middle East and AfricaColin MartinT: +44 20 7311 5184E: [email protected]

Venkataramanan VishwanathT: +91 22 3090 1944E: [email protected]

AcknowledgementsWe would like to acknowledge the efforts of the principal authors of this publication: Varghese Anthony, Tal Davidson, Hiroaki Hori, Robert Sledge and Arevhat Tsaturyan.


KPMG International Standards Group is part of KPMG IFRG Limited.

Publication name: IFRS Newsletter: Financial Instruments

Publication number: Issue 16

Publication date: November 2013

The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

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 upon such information without appropriate professional advice after a thorough examination of the particular situation.

The IFRS Newsletter: Financial Instruments contains links to third party websites not controlled by KPMG IFRG Limited. KPMG IFRG Limited accepts no responsibility for the content of such sites or that these links will continue to function. The use of third party content is to be governed by the terms of the site on which it is hosted and KPMG IFRG Limited accepts no responsibility for this.

Descriptive and summary statements in this newsletter may be based on notes that have been taken in observing various Board meetings. They are not intended to be a substitute for the final texts of the relevant documents or the official summaries of Board decisions which may not be available at the time of publication and which may differ. Companies should consult the texts of any requirements they apply, the official summaries of Board meetings, and seek the advice of their accounting and legal advisors.

kpmg.com/ifrs

IFRS Newsletter: Financial Instruments is KPMG’s update on the IASB’s financial instruments project.

If you would like further information on any of the matters discussed in this Newsletter, please talk to your usual local KPMG contact or call any of KPMG firms’ offices.

http://www.kpmg.com/ifrs

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