ifrs 9 conference presentation - philip lewis

© Aptitude Software Ltd 2014 | Aptitude Product Workshop | November 2014 © Aptitude Software Ltd 2015 | Page 1 Aptitude Topic Briefing | July 2015 CONFIDENTIAL - Copyright © Aptitude Software Ltd. 2015

The Impact of IFRS 9 on Finance Philip Lewis, Head of Accounting Product

© Aptitude Software Ltd 2014 | Aptitude Product Workshop | November 2014 © Aptitude Software Ltd 2015 | Page 2 Aptitude Topic Briefing | July 2015

IFRS 9

Revenue Growth

Operating Margin Reputation

Capital Liquidity

Products and

Volume

Portfolio and Product

Mix

Relative Market Position

Disclosures

Market Discipline

External Rating

Cost of Funding

Stakeholder Expectations

Pillar 2B Planning

Basel 3 Tier 1&2

Pillar 1 & 2A Requirements

BS Impact of

Provisioning

P&L Impact of

Provisioning

Risk and Finance

Operating Model

People Processes

Policies

Models

MI

Reporting

Data & Systems

Risk Adjusted Pricing

Organisational Impact of IFRS 9

Source: Deloitte


Asset Classification and Measurement Judgements!

•  No direct path from IAS 39 to IFRS 9 •  Business Model approach and the SPPI criterion may require judgement to

ensure assets are correctly categorised •  The SPPI criterion may require assessment of contractual provisions that do/may

change the timings or amounts of contractual cashflows. Prepayment provisions is a good example

⇒  How do you ensure that judgement is exercised appropriately and consistently throughout the organisation

⇒  How do you ensure that, where judgements are made, they are supported by appropriate evidence


Asset Classification and Measurement Equity, Regulatory Capital and Covenants

•  Asset classification changes will affect the way that capital resources and capital requirements are calculated

•  This may impact compliance with the Basel capital requirements or other capital adequacy requirements

•  Incorporating the new requirements into Stress Testing will identify potential issues and any additional volatility within profit and loss and equity.

⇒  How do you identify possible capital issues and test any plans designed to mitigate such negative consequences?

⇒  How do you ‘test’ the new requirements as part of your Stress Testing Methodologies early enough in the process to manage any potential negative outcomes.

⇒  How do you communicate the impact of such mitigation plans to analysts, shareholders, regulators and providers of finance.


Asset Impairment and Credit Losses Judgements!

•  Considered by many to be more of an art rather science! •  Judgements are required such as:

–  Whether loans will be received as due –  If not, how much will be recovered and when

•  Robust assessments are required in relation to –  The identification of any increase in credit risk –  The point at which credit risk increases significantly giving rise to… –  Expected asset impairments or defaults leading to credit losses

•  The measurement of any expected asset impairment should reflect reasonable and supportable information that is available without undue cost or effort and that includes historical, current and forecast information

⇒  How do you define ‘significant increase’; ‘default’; ‘reasonable’; ‘undue cost’; etc… ⇒  The expected increase in P&L Volatility as a result of ‘Point in Time’

measurements rather than ‘Through the Cycle’ provisions is considered to be mainly as a result of policy decisions


Asset Impairment and Credit Losses Equity, Regulatory Capital and Covenants

•  IFRS 9 is expected to have a large negative impact on equity for the financial services sector.

•  It is also expected to affect covenants and regulatory capital: Equity will reflect expected credit losses as well as incurred credit losses

⇒  How do you assess the impact of the new requirements early enough to minimise any negative impact

⇒  The nature of the impact will be shaped by the size and nature of the financial instrument holdings and their classifications. Are these known now?

⇒  Given that the classification of such instruments is heavily impact by judgements made in relation to that classification, are you able to ‘test’ those judgements and impact on the results from any impairment models?


IFRS 9 Asks Big Questions

Asset Classification and Measurement ⇒  How do you ensure that judgement is exercised appropriately,

consistently and supported by appropriate evidence? Asset Impairment and Credit Losses ⇒  How do you define ‘significant increase’; ‘default’; ‘reasonable’;

‘undue cost’; etc…? ⇒  How will P&L volatility increase as a result of ‘Point in Time’

measurements rather than ‘Through the Cycle’ provisions?


Impact on the Finance Team Finance and Risk

Why is IFRS 9 different to other International Financial Reporting Standards published to date?

⇒ Of all the regulatory pronouncements so far, this standard requires the highest level of collaboration between Risk and Finance

Many organisations have initial focus on the modified Risk Models …but how will Finance Teams absorb the new requirements and cope with the changes they will need to make as a result?


Impact on the Finance Team Importance of Asset Classification

Decisions and judgements made regarding Asset classification and measurement directly impact the asset classes that need to be included in the Impairment Calculations.

Source: Deloitte


The Finance Team must collaborate with Risk to understand the Impairment Models. •  The Inputs to the models must be from ‘finance accurate’ sources with clear audit

trails through to the underlying transactions •  All credit assumptions at each stage in the process need to be validated and

agreed between Finance and Risk.

Impact on the Finance Team Finance and Risk: Impairment

Sample Factors in Assessing Credit Loss Classification. Source: E&Y

Each parameter could dramatically affect the extent to which an asset, or group of assets is impaired at each stage in the process. Finance need to be involved in the setting, and subsequent variations of these parameters during the reporting period and as-at the reporting date


Given a series of parameters, the Finance Team must collaborate with Risk to understand and validate the results generated by the Risk Models. •  The Finance team must have a level of knowledge such that they can assess the

output of the Risk Models in the context of ‘finance accurate’ inputs and credit related parameters

⇒  Finance must be able to assess whether the output is ‘reasonable’ given all of the inputs involved

•  Moving through the Reporting Period as assumptions are varied, and assets are moved between the IFRS 9 stages as credit information changes…

⇒  Finance must be able to validate the movements in any impairment provisions given input and parameter variations

⇒  Over time, the finance team will need to explain movements in the impairment provisions given a change in: ⇒  Asset Classification ⇒  Credit Assumptions



Industry feedback is shifting towards a shared responsibility between Finance and Risk throughout the process as the scale of the change within the finance function is becoming apparent. ⇒  Finance is responsible for the reported numbers and must explain movements in

the Income Statement throughout the reporting cycle ⇒  Finance is responsible for the substantiation of the Balance Sheet as at each

reporting date Fulfilling these responsibilities means that the Finance Team must fully understand all aspects of the process.

Impairment Calculation Disclosure

Data Transfer

and System Admin

Provision Sign-Off

Disclosure Preparation

Data Upload

and Validation

Disclosure Submission

Reporting Data

Preparation

Risk Finance

Data Gathering

Modelled Provision

Non-Modelled Provision

Data Entry

(Journals)



Collaboration between Finance and Risk is also critical given the changes in the Hedge requirements for IFRS 9. Recap… flaws in IAS 39… ⇒  Investors want to better understand:

⇒  The risks an entity faces ⇒  What management was doing to manage those risks ⇒  How effective those risk management strategies are

⇒  IAS 39 was felt to fall short of these requirements.

Supporting this requirements means finance need to understand the risks to which the entity is exposed such that associated reporting reflects those risks plus any mitigations. ‘Bright lines’ have been removed leaving only judgement as a guide…! Finance need to work even closer with Risk to ensure that the numbers correctly reflect the risks and mitigations during the reporting period and ‘as at’ the reporting date

Impact on the Finance Team Finance and Risk


The new expected loss and hedging models will require data at a more granular level than has previously been the case. Clear audit trails, data lineage and management oversight is fundamental within any finance function, the new standard shines a spotlight on these areas Multiple system and human interfaces between the enhanced models and the accounting stream places the focus firmly on the integrated control environment and the extent of process automation ⇒  A strategic approach will support a more granular data

architecture coupled with enhanced process controls ⇒ Opportunity to improve the joint Risk and Finance information

architecture

Key Challenges for Finance (#1) Data and Process Challenges


Asset Classification and Measurement Challenges

Interpreting IFRS 9 •  Fostering consistent interpretation across jurisdictions will take time •  Some products viewed as a “[basic] lending arrangement” may have features that are

not consistent with the “solely payments of principal and interest” (SPPI) criterion

Classification •  Storing and managing business model/business entity reference data •  Asset type classification rules to be applied at the transaction level according to

business model and cash flow tests will be very different to those used for IAS 39 •  Sourcing and storing financial amounts for accounting: new values will be needed in

many cases

Significant judgement areas •  Business model assessment – e.g. liquidity portfolios, securitisations •  Modified time value of money component •  Contractually linked instruments – e.g. relative exposure to credit risk, composition of

pool


Asset Classification and Measurement Challenges

Operational challenges •  Moving target – i.e. developing policies and methodologies while interpretation is

evolving

•  New systems/processes/controls – e.g. review of contractual terms, information on sales

•  Consistency of application across group entities •  Insurers – interaction with accounting for insurance liabilities/IFRS 4/CEIOPS SII

Financial Amounts for Accounting •  In many cases the accounting treatment under IFRS 9 will be different to that under

IAS 39. This may mean that financial amounts used previously are not required and new financial amounts must be sourced. An example may be a transaction which was previously accounted for under on a Fair Value basis may now require an Accruals based approach

Managing the Transition •  Once the IFRS 9 classifications have been determined, all calculations associated

with each transaction must be performed as if the transaction had been classified as such from its inception.


•  It is critical that Finance understand the results generated from any risk models. It is Finance that must sign off the numbers!

•  Key to this is the ability to ‘Scenario Model’. By varying assumptions and analysing results the finance teams can better understand the risks inherent within an asset class.

⇒  Using a base data set, Finance Teams must be able to overlay scenario model results to better understand the impact in reported numbers.

⇒  An architecture supporting this needs to be highly automated with enough flexibility to support scenario modelling without impacting ‘business as usual

⇒  Flexibility and agility without unexpected volatility are watchwords

Key Challenges for Finance (#2) Understanding Model Results


IFRS 9 brings in many new operational stresses •  Coping with higher accounting data ‘churn’. The volume of data passing

through the finance environment will simply increase significantly. •  Higher data transaction volumes stemming from increased volatility in

model results. •  Extensive additional disclosure and reporting requirements •  The need to understand complex risk models in detail for both Asset

Impairment and Hedging to validate assumptions and correctly interpret results and identify anomalies

•  Justification of the results in order to validate classifications, valuations and provision adjustments whilst substantiating the Balance Sheet and Income Statement

•  Supporting differences in interpretation across multiple jurisdictions, particularly during the transition period

Key Challenge for Finance (#3) Simply managing the Day to Day…!


⇒  All of this will typically require extensive modification of the accounting environment – how can this be a good thing?

⇒  The key is to turn the need for regulatory change into an opportunity to dramatically improve the finance function such that futures regulatory demands can be more easily met.

⇒  This is an opportunity to do more than add another ‘sticking plaster’!

⇒ Organisations who can see the opportunity beyond just

compliance will likely see a competitive advantage

Key Challenges for the Finance Team Simply managing the Day to Day…!


Equipping Finance – Key Aspects •  Automation of Accounting

–  With the anticipation of higher transaction volumes stemming from increased asset value movements, particularly between impairment stages, full automation is essential

•  Management Overlays –  The ability to access impairment model rules and to apply and annotate

adjustments - both on actual flows and scenarios driven from stress testing (for example)

•  Transparency –  Detailed transaction drill-back from aggregated balances (in General Ledger

and BI reports), with access to/reporting of rules, annotations, workflow, and audit information

•  Data Quality and Data Governance –  Finance teams must understand the full data workflow at a more granular

level more than ever before. Not just change states, but the drivers and reasons for change must be recorded and accessible

–  Data Quality is vital to get right up-front – some systems upgrade may not be optional!


Equipping Finance – What Approach? •  Modify/extend existing systems and processes?

–  Initially attractive as it may appear to be additive change with less disruption of BAU

–  However, IFRS 9 involves deep penetration into the fabric of the financial transaction process, potentially requiring multiple points of change

–  Tools for finance to interrogate, adjust, annotate, explain and sign-off on the asset valuations and capital provisions may be missing or inadequate

•  Buy or build fit-for-purpose components? –  Build may be possible – if the build team are available, have access to good

Finance resources, and have well defined requirements and appropriate skills, then design should result in solution to meet exact requirements.

–  Buy has advantages that end-state can be seen in advance. Solution becomes an implementation and integration issue, with less reliance on scarce internal (IT and Finance) resources

•  A good Buy decision can accelerate delivery, lower implementation costs, lower delivery risk and provide functionality for future change


Solution: Key Points of the “HUB” Approach •  Integrated Processing Platform:

–  Single point for design, implementation and management of business rules, control framework, workflow

–  Flexible Web Application for configured to the business operating model –  Clear, robust, performant data integration: acquisition, standardisation,

preparation, publication –  Encapsulated business processes as service offering to business base

•  Accounting and Operating Storage Hub designed for: –  Multi-dimensional, multi-GAAP, real-time accounting processing –  Full Trade, Position, Product and Party Models –  Operational Sub-Ledger to support aggregated GL level to detailed postings

•  Integrated Calculation Engine specifically designed for: –  High volume, high-speed processing –  Multiple simultaneous / parallel calculation methods –  User-configuration/construction of calculation logic –  High performance Cash Flow generation for contractual flows


Summary Points

•  IFRS 9 has deeper impact on systems and processes than IAS 39 – most have found it needs a new approach

•  Appropriate automation will help reduce complexity and speed delivery

•  SME Resources will be scarce – buying in impact expertise is good option

•  Close cooperation between Risk and Finance teams will deliver better results

•  Finance must engage with project. The countdown has started …

© Aptitude Software Ltd 2014 | Aptitude Product Workshop | November 2014 © Aptitude Software Ltd 2015 | Page 25 Aptitude Topic Briefing | July 2015 CONFIDENTIAL - Copyright © Aptitude Software Ltd. 2015

www.aptitudesoftware.com

ifrs 9 conference presentation - philip lewis

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