1. Hasan Marfani December 2018
IFRS 9 - NEW ACCOUNTING MODEL FOR FINANCIAL INSTRUMENTS (Replacing IAS-39)
Hasan Marfani
December 2018

2. Agenda
Background
Reasons for Replacement of IAS-39/Key Elements of IFRS 9
Overview of Classification and Measurement Requirements
IFRS 9 Credit Impairment Overview
Key Judgments and Challenges related to IFRS 9 implementation
Impact on Modaraba/Leasing Sector
By Hassan Marfani, ACA

3. Background
On 24 July 2014, the International Accounting Standards Board (IASB) issued the final version of IFRS 9. As per IASB, IFRS 9 is effective for accounting periods beginning on or after 1 January SECP has already adopted IFRS with effective date of 01 July
By Hassan Marfani, ACA

4. Reasons for replacement of IAS-39- Cont…
The criticism on IAS-39, in brief :
Fair value accounting was said to have created cycles of accounting write downs and distressed selling of assets during the Crisis
The application of IAS-39 impairment model for loan loss provisions results in delayed recognition of credit losses
The over complexity of IAS-39 such as mined valuation models, multiple impairment approaches, complicated category transfer rules and hedge accounting requirement.
By Hassan Marfani, ACA

5. Reasons for replacement of IAS-39- Cont…
In view of above criticism, IASB received calls to reduce the complexity of accounting standards for financial instruments from G-20, the Financial Stability Board, the European Union and regulators and other stakeholders from around the world.
The work on IFRS 9 started in 2009 and after 5 years of extensive technical work and stakeholders consultations, the final standard was issued in July
By Hassan Marfani, ACA

6. IFRS-9 – Classification and Measurement of financial instruments
By Hassan Marfani, ACA

7. By Hassan Marfani, ACA

8. By Hassan Marfani, ACA

9. Classification of Financial Assets
1.Fair Value through P/L
2.Fair Value through OCI
3. Amortized Cost (AC)
Types of Instruments
Note
FV through P/L
FV Through OCI
Amortized Cost
Debt Instrument
Note 3
yes
Note 2
Yes
Note 1
Equity Instrument
Note 4
Never
Note 1
1.Business model: Hold to collect (sole purposes is to earn interest and then in end principal) &
2.cashflows are SPPI(sole principal payment and interest)- Important note: return must not be linked to performance of the entity
Note 2
1.Business model: Hold to collect (sole purposes is to earn interest and then in end principal) & Sale &
Note 3
1.Business model: Hold to Sale &
Note 4
Only if company has initially designated the instrument at FV through OCI, however it is irrevocable option and all the gains/losses shall be routed through OCI except for Dividend income
By Hassan Marfani, ACA

10. Summary Of Financial Assets
Amortized Cost
F.V through OCI
F.V through P/L
Business Model
Hold to Collect
Hold to collect and Sell
Hod to sell
Cashflows
SPPI
No condition
Categories
Only debt securities
Debt and equity Securities
Initial Measurement
FV + TC FV
Subsequent measurment
Fair Value
Change in FV
N/A
OCI
P/L
Recycling of gains
Impairment
Can be impaired
By Hassan Marfani, ACA

11. Classification of Financial Liabilities
1.Fair Value through P/L
2. Amortized Cost
By Hassan Marfani, ACA

12. IFRS-9 Classification and Measurement – Un-quoted Equity Instruments
No cost exemption for unquoted equity instruments  all equities at fair value
Cost may be used as a proxy for fair value in certain circumstances
Indicators of when cost might not represent fair value
A significant change in the performance of the investee
Changes in expectation that technical milestones will be achieved
A significant change in the market for the investee company or its products
A significant change in the global economy or the economic environment
A significant change in the observable performance of comparable companies, or in the valuations implied by the overall market.
Internal matters such as fraud, commercial disputes, or litigation, or changes in management or strategy.
Evidence from external transactions in the investee’s equity, either by the investee (such as a fresh issue of equity), or by transfers of equity instruments between third parties.
By Hassan Marfani, ACA

13. IFRS-9 Classification and Measurement – Debt Instruments (Cont…)
Business Model Test
In some cases, an entity may have more than one business model, in which case, the assessment would be made at a portfolio level rather than an entity level.
Is a matter of fact and not management intention.
Reclassifications of portfolio is not allowed unless there is a change in business model
By Hassan Marfani, ACA

14. Reclassification of Financial Assets-b/w Categories-AC,FVOCI,FVP/LTo AC
FVTOCI
FVTPL
From
N/A
FV is measured at reclassification date. Difference from amortized cost should be recognized in OCI.IRR not adjusted as a result of reclassification
FV is measured at reclassification date.Difference from CA should be recognized in P/L.IRR is adjusted as a result of reclasssification
FV at reclassification date becomes its new ACCA, cumulative gain/loss in OCI is adjusted against FV of FA at reclassification date. IRR does not change.(In short bring asset to amortized cost again as per original table)
FV at reclassification date becomes its new CA.Effective intrest rate is changed, Cumulative gain/loss on OCI is reclassified to profit or loss at reclassfication date
FV at reclassification date becomes its nw gross CA.New IRR is calculated
FV at reclassification date becomes its CA.New IRR is calculated
By Hassan Marfani, ACA

15. Impairment of Financial Assets Under IFRS 9
By Hassan Marfani, ACA

16. Background
In response to the reporting issues highlighted by the Global Financial Crisis, a Financial Crisis Advisory Group (FCAG) was setup in October 2008 The objective of FCAG was to advice IASB and US FASB to bring improvements in the financial reporting standards that could enhance investor confidence in the financial markets The FCAG, in its report published in July 2009, identified delayed recognition of loan losses as one of the primary weaknesses in the accounting standards and recommended to explore alternatives model which is more forward looking
By Hassan Marfani, ACA

17. Incurred Loss Model under IAS-39
Interest income is recognized over the period of the loan on the basis of contractual cash flows (Effective interest method) Impairment is recognized only when there is a objective evidence of impairment i.e. when a loss event has occurred It may argued that interest income is overstated in periods before a loss event occurs because it is inherent in the nature of assets that certain credit losses will occur
By Hassan Marfani, ACA

18. Expected Loss Model of IFRS 9
The impairment requirements applies to debt instruments such as loans, debt securities, bank deposits, lease receivables, loan commitments and financial guarantee contracts. Under the expected loss model impairment is recognized over the life of assets on the basis of future expected loss events In other words, impairment allowance is made even before there any objective evidence of impairment or occurrence of default event The scope of impairment requirements, therefore is much broader and are designed to result in earlier recognition of credit losses This model will potentially address the concerns about IAS 39 incurred loss model i.e. too little and too late
By Hassan Marfani, ACA

19. Overview of Expected Loss Model of IFRS 9
3 stage model which recognizes impairment over time based on changes in credit quality since origination of loans
Stage 1
Stage 2
Stage 3
Performing
Under-performing
Non-performing
Loans with low credit risk and with no significant increase in credit risk since origination
Loans for which credit risk has increased significantly since initial recognition
Loans with objective evidence of impairment
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20. IFRS 9 Credit Impairment Overview
The key change brought by IFRS 9 is in relation to the accounting provisions for loan losses which are required to be made using expected loss model under the IFRS 9. Currently, loan loss provisions are made when there is an objective evidence of impairment (i.e. incurred loss model). This is a fundamental shift in provisioning.

21. IFRS 9 Credit Impairment Overview
The credit risk has increased significantly since initial recognition
improvement deterioration
Stage 1
Stage 2
Stage 3
12-month expected credit losses
Allowance:
Lifetime expected credit losses +
Objective evidence of impairment
Criterion:
Talk to:
Not ‘just an accounting thing’ - impact on business models, credit processes, apparent profitability of institutions
Main drivers of IFRS 9 – perceived weaknesses in the old standard particularly in light of the GFC
Implementation – some institutions will directly follow IFRS (correct?) while for others it will depend on local implementation into accounting standards which may or may not follow the same timelines as the overarching standard (e.g. Thailand and Indonesia have 2019 implementation dates)
Interest revenue based on:
Gross carrying amount
Gross carrying amount
Gross carrying amount
Net carrying amount
If no reasonable expectation of recovery – Write off

22. IFRS 9 Credit Impairment Overview Staging Approach
Information to take into account for assessment of increased credit risk
Internal watch-list accounts
Changes in external market indicators – price of borrower debt or equity
Adverse changes in business or economic conditions
Changes in the value of collaterals and repayment behaviour
Changes in internal price indicators and credit ratings downgrade
30 days past due rebuttable presumption
Changes in external credit ratings
Changes in operating results
However….
By Hassan Marfani, ACA

23. IFRS 9 Credit Impairment Overview Expected Credit Loss1 2 3
ECL = PD x LGD x EAD
Risk Parameters 1 2 3 PD
The probability of defaulting if you haven’t already
LGD
The forecasted economic loss if the default happens
EAD
The forecasted exposure at each point in time
Discount factor (EIR)
By Hassan Marfani, ACA

24. IFRS 9 Credit Impairment Overview Steps Involved
Portfolio Segmentation and Staging
Step 1
Determination of Exposure at default (EAD)
Step 2
Determination of segment wise PDs
Step 3
Estimation of LGD
Step 4
Computation of
ECL and Scenarios
Step 5
By Hassan Marfani, ACA

25. Key Challenges Exposure at Default (EAD):
Revocable and Irrevocable commitments
Credit Conversion Factors Estimation
Behavioral analysis of revolving facilities
Probability of Defaults (PDs)
Lack of availability of historical data of 5 to 7 years
Determination of statistically significant relationship between Macro-economic factors and defaults ratio
Loss Given Default (LGD):
Economic LDG rather than collateral based LGD
Lack of availability of historical recovery data for credit portfolio to compute workout LGD
Allocation of collateral amongst facilities
Discounting of future cash flows
By Hassan Marfani, ACA

26. Implementation Challenges
Components
Implementation challenges
Portfolio segmentation
Determine segmentation criteria
Consider existing models and data availability for various portfolios
Criteria for low credit risk
Transfer criteria
Definition of trigger events
Significant deterioration in credit
Expected loss modeling
Determination of models for 12 month and lifetime expected loss
Discount rate
Sources of information
Internal data (internal credit ratings, historical loss experiences)
External data – Macro economic statistics and credit ratings
Update of internal data used for credit risk management regularly
By Hassan Marfani, ACA

27. Challenges for Modaraba and/or Leasing Sector while adopting IFRS-9
Since recycling of Gain for equity instruments is not allowed under FV through OCI category, realized gain will not be distributed to certificate holders.
Impairment model as suggested in IFRS-9 uses proactive approach which has more inclination towards risk assessment side, historical data and economic indicators which create following challenges for Modaraba/leasing sector:
Lack of Human Resource with relevant expertise
Dealing of Modaraba/leasing sector in SME sector posing risk of non availability of relevant data for assessment of credit risk
Categorizing any financing as stage1 or 2 is always a subjective matter raising difference of opinions b/w Mgt. and auditors
Cost Constraints
Initial impact on profitability
By Hassan Marfani, ACA