INTRODUCTION

Axxsys consultants engage with clients who hold or manage mandates where some of their investments are not an integral part of their business, e.g. building societies or insurance companies. These clients have chosen to recognise P/L on either amortised cost basis on the income statement or by reflecting it on the balance sheet rather than diluting the net income on the income statement. An Example of this could be a bank whose main business is mortgage lending that holds a fixed-income portfolio for solvency purposes. Another example is insurance companies that invest cash premiums in securities to meet future insurance claims.

BACKGROUND

IFRS (International Financial Reporting Standards) is a set of accounting standards developed by the International Accounting Standards Board (IASB) to provide a common global framework for companies to prepare and present their financial statements. IFRS aims to ensure consistency, transparency, and comparability in financial reporting across different countries and industries. Many countries around the world have adopted or converged with IFRS, making it a widely recognized and used standard in international financial reporting.

The IFRS 9, which deals with accounting for financial instruments, was first issued by the IASB in July 2014. It was planned to become effective for annual periods beginning on or after January 1, 2018, but it was postponed until January 1, 2022. IFRS 9 replaced the earlier IAS 39 standard and introduced new classification and measurement approaches for financial instruments, as well as changes to impairment models and hedge accounting.

One significant change in IFRS 9 was the introduction of the expected credit loss (ECL) model, which requires entities to recognize credit losses based on expected future events rather than waiting for an actual loss event to occur. This change was aimed at addressing the criticism that IAS 39 delayed the recognition of credit losses.

PRIMARY TASKS BEFORE IMPLEMENTATION OF IFRS 9

Holdings have to be examined to identify the instruments that qualify to be covered by IFRS 9. Guidelines were provided to determine if the instrument meets the Solely Payment and Principal and Interest (SPPI) criteria. The rest is Non SPPI.  The marking of SPPI or Non SPPI is irrevocable. There is no standard benchmark in place so the investment firms must interpret the guidelines.

Ratings must be available and assigned on each purchase. Additionally, ratings must be available on the reporting date to assess whether there has been a significant change in rating based on a predefined ladder of ranking specified by the client. The ladder of ranking determines if the instrument is in stage 1 (low or no risk), stage 2 (increase of risk for default), or stage 3 (potential or actual default). The ladder should clearly outline when a change in the ratings results in the instrument entering a new stage. Alterations in the stage must be reported.

A calculation model must be defined to calculate the credit loss allowance (CLA) based on the change in ECL since original recognition or alternatively, use a vendor who can calculate the CLA/ECL. Typically, vendors do not calculate CLA/ECL for instruments in stage 3.

Calculations of CLA/ECL must be based on

• Stage 1 will be calculated based on the cash flow expected over the next 12 months.

• Stage 2 will be calculated based on the cash flow expected throughout the remaining life cycle.

• Stage 3 will be calculated based on the cash flow expected throughout the remaining life cycle but with a percentage written down.

All SPPI instruments must be marked into the following classifications:

• ACOST – amortized cost (hold to collect)

• FVOCI – Fair value through other comprehensive income (hold to collect and sell) and the Non SPPI is: FVPL –Fair value through profit and loss (market value).

SYSTEM REQUIREMENTS

Tax lots: The system used by investment firms must have the capability to handle tax lots, where each purchase is treated as a separate position and yield-based amortisation adjustments. It is important to note that linear amortisation is not an option.

Transition of stage: The system must be capable of recognizing tax lots that change at the stage along with their associated values.

Additional considerations

When a SPPI instrument transitions into stage 3 the firm must have internal rules on how to handle the potential or actual defaulted instruments.

• Some firms choose not to hold instruments in stage 3 and this will result in a sale.

• Some firms have decided to retain the holding but write down the future cash flows.

Regarding the general ledger, it is necessary to determine whether all bookings should be categorized into stages or if the information can be extracted from the treasury system.

HOW CAN AXXSYS HELP

We have extensive experience working with the implementation of various reporting standards in the industry, in particular, our experts have helped clients in the following areas:

• Marking the holding with SPPI or NON-SPPI

• Rules for marking the SPPI tax lots as ACOST or FVOCI.

• Import of ratings

• Defining the rating ladder to determine the stage on the tax lots

• Import of CLA transactions

• Financial bookings – with or without stage indication

• Reports covering the current stage and holding which has changed the stage.

If you would like to find out more regarding how we can help with any part of IFRS 9 implementation, please contact us at info@axxsysconsulting.com

Blog author:  Jane Zachariae, Senior Manager, Axxsys Consulting