1. IFRS 9: Financial Instruments

2. Background G20 Financial Stability Board Financial Crisis Advisory Group

3. EC Endorsement ARC meeting 11 November 2009 Endorsement decision deferred EFRAG draft endorsement advice deferred at least to January 2010 Outcome Endorsement delayed until at least 2010 EC may wait until the whole package of changes has been completed Endorsement 2011?

4. Project phaseExposure draftFinalisation Classification and measurement July 2009November 2009 Amortised cost and impairment October 20092010 Hedge accountingQ1 20102010 IASB Project Timetable

5. Agenda Scope Classification and measurement Embedded derivatives Permitted options Effective date and transition

6. Scope Unchanged from IAS 39 References to IAS 39 for: Impairment Hedge accounting

7. Agenda Scope Classification and measurement Embedded derivatives Permitted options Effective date and transition

8. Classification Two measurement categories Amortised cost Fair value IAS 39 categories eliminated Held to maturity Available for Sale Loans and receivables

9. Amortised cost measurement Determined on the basis of: Business model Contractual terms

10. Business model As determined by key management personnel (IAS 24) Not an instrument by instrument focus Hold financial assets to collect contractual cash flows Do not need to hold assets to maturity

11. Business model - examples Hold investments to collect contractual cash flows Can sell in particular circumstances No longer meets investment policy Insurer adjusts portfolio to match expected timing of payouts Entity needs to fund capital expenditure

12. Business model - examples Business model is to purchase portfolios of financial assets May or may not include financial assets with incurred losses Seek to obtain payment of cash flows Do not need to anticipate obtaining all contractual cash flows Entity may also enter into interest rate swaps

13. Business model - examples Business model is to originate loans and sell them Loans sold to a securitisation vehicle that is consolidated Consolidated entity business model Hold loans and collect contractual cash flows May qualify for amortised cost measurement Individual entity business model Originate and sell loans Do not qualify for amortised cost measurement

14. Contractual terms for cash flows Assess on an instrument by instrument basis Principal Interest Specified dates Interest represents consideration for Time value of money Credit risk Foreign currency Assess payments on the basis of currency in which the instrument is denominated

15. Leverage Amplifies variability of contractual cash flows Leverage does not have economic characteristics of interest Includes derivative contracts Option Forward Swap Cannot qualify for measurement at amortised cost

16. Prepayment options Debtor can prepay Creditor can demand early repayment Cash flows may be only principal and interest Prepayment provision not contingent on future events except to protect holder against Credit deterioration of the issuer Changes in taxation or law Change in control of issuer Prepayment represents Capital Interest Compensation for early termination

17. Extension options Can result in cash flows of Principal Interest on principal outstanding Conditions Not contingent on future events Cash flows in extension period are only Principal Interest on principal outstanding

18. Changes in the timing or amount of cash flows Can result in cash flows of Principal Interest on principal outstanding Only if: Variable interest rate – time value and credit risk only Not contingent on future events except to protect holder against: Credit deterioration of the issuer Changes in taxation or law Change in control of issuer Cash flows in extension period are only Principal Interest on principal outstanding

19. Cash flows of principal and interest on principal - example Bond with specified maturity date Interest payments linked to inflation rate in currency of bond Analysis Contractual cash flows are payments of principal and interest on principal Linkage to inflation rate resets time value to current level What if linkage is to another variable (eg net income or equity index)? Interest payments are not consideration for: Time value of money Credit risk of principal Contractual interest payments inconsistent with market rates of interest

20. Cash flows of principal and interest on principal - example Variable rate bond Borrower can choose one month or three month LIBOR on ongoing basis Analysis Key – does interest reflect Time value Credit risk If able to choose one month LIBOR for three months If reset each month – yes If no reset – no Term of instrument shorter than contractual interest rate Constant maturity bond with periodically reset five year rate

21. Cash flows of principal and interest on principal - example Bond with capped rate Stated maturity date Variable market rate with cap Analysis Fixed rate bond Variable rate bond Combination can qualify

22. Cash flows of principal and interest on principal – examples that do not qualify Convertible bond Holder’s perspective Principal and interest plus: Return linked to equity of issuer Inverse floating rate loan Interest is not consideration for time value

23. Cash flows of principal and interest on principal – examples that do not qualify Perpetual instrument Holder can call and pay par plus accrued interest Market rate of interest Cash payment of interest – solvency test No accrued interest on deferred amounts Analysis Potential to defer interest with lack of interest accrual disqualifies Features that do not disqualify Perpetual Callable

24. Cash flows of principal and interest on principal – examples that may not qualify Full recourse loan Secured by specified collateral Analysis Collateralisation does not affect classification What if non recourse loan? Lender entitled to repayment only from specific assets or cash flows ‘look through’ to specific assets to determine characteristics

25. Subordinated instruments May still have contractual cash flows Principal Interest on principal outstanding Conditions: Issuer’s non payment is breach of covenant Holder has right to unpaid amounts even if issuer bankrupt Unsecured trade receivable when debtor has collateralised loans

26. ‘Waterfall’ structures Example SPE purchases a portfolio of mortgage receivables Finance raised through issue of tranches of debt Tranches have subordination ranking for payment Cash flows of principal and interest on principal if: Contractual terms of the tranche itself qualify Underlying pool of financial instruments have specified characteristics Credit risk of tranche is equal to or lower than average If cannot ‘look through’ Fair value measurement

27. ‘Waterfall’ structures Underlying pool of financial instruments Some required to have cash flows of principal and interest on principal May also have: Instruments that change the cash flow variability Interest rate swap that changes rate on underlying assets from floating to fixed Instruments that align cash flows of tranches and underlying instruments Foreign exchange contract

28. Reclassification and ‘tainting’ Reclassification Required on change of business model ‘Very infrequent’ Not changes Changes in intentions (even if significant market changes) Temporary disappearance of market Transfer of financial assets between existing business models IAS 39 HTM ‘tainting’ eliminated

29. Reclassification Examples Entity has portfolio of commercial loans – intention to sell in short term Acquires a company that manages commercial loans Portfolio of commercial loans no longer for sale Financial services firm Decision to close retail mortgage business No new business accepted Existing loan portfolio now actively marketed for sale

30. Measurement Initial recognition Fair value Add transaction costs if amortised cost Subsequent measurement Definition of amortised cost in appendix Reference to IAS 39 for impairment of assets at amortised cost, fair value measurement and hedge accounting

31. Agenda Scope Classification and measurement Embedded derivatives Permitted options Effective date and transition

32. Embedded derivatives Financial host asset (within scope)? Yes: no separation Does the instrument as a whole give rise to payments of principal and interest? Yes – amortised cost, no – fair value of entire instrument No: apply existing IAS 39 rules Potential separation Financial liability, financial asset (outside scope of IFRS 9), and non- financial asset host contracts Existing guidance for embedded derivatives retained

33. Agenda Scope Classification and measurement Embedded derivatives Permitted options Effective date and transition

34. Fair value option Election available to designate at FVTPL Initial recognition and irrevocable Eliminates/substantially reduces an accounting mismatch Other IAS 39 options obsolete Managed on a fair value basis Embedded derivatives

35. Equity instruments Do not have cash flows that are solely principal and interest Fair value measurement Optional recognition in OCI Not held for trading Irrevocable election on initial recognition of each investment All changes in fair value in OCI No recycling to income statement Dividends recognised in profit or loss

36. Agenda Scope Classification and measurement Embedded derivatives Permitted options Effective date and transition

37. Effective date Periods beginning 1 January 2013 Linked to effective date for impairment and hedge accounting Early adoption permitted for December 2009 year ends

38. Transition Retrospective application with exceptions IAS 8 applies Date of initial application Date on which the requirements of the new standard are first applied

39. Date of initial application Any date between: Date of issue of IFRS 9; and Before 1 January 2011 Beginning of first reporting period if adopt on/after 1 January 2011 If date of initial application not beginning of a reporting period: Disclose that fact and reasons for using that date

40. Transition - exceptions Assessment of whether hold to collect contractual cash flows Date of initial application Retrospective application Designation as at FVTPL – applies to financial assets AND liabilities Circumstances as at date of initial application Retrospective application of FV Previous optional designation as at FVTPL May revoke based on facts/circumstances Required to revoke if eligibility criteria not met Based on facts at date of initial application

41. Transition - exceptions Hybrid contracts that are required to be at fair value, if fair value not determined in prior periods Measure at sum of fair value of components Measure at fair value in entirety at date of initial application Treatment of differences in fair value of components and whole Opening retained earnings (if apply at start of reporting period) Profit or loss (if apply during reporting period) Designation of equity instruments as at FVTOCI Optional if not held for trading Assessment at date of initial application Retrospective application

42. Transition - exceptions Hedge accounting Apply IAS 39 hedge cessation rules if no longer qualify Instruments previously measured at fair value that are restated to amortised cost If impracticable to apply effective interest rate method, amortised cost and impairment based on previous period end fair values Fair value at date of initial application is deemed amortised cost

43. Transition - exceptions Unquoted equity instruments measured at cost under IAS 39 Remeasure to fair value at date of initial application Difference between fair value and previous carrying amount to opening retained earnings Interim financial reports Comparatives not required to be restated if impracticable (IAS 8)

44. Transition - exceptions Comparative information – annual financial statements Adopt in reporting period beginning before 1 January 2012 Not required to restate comparatives Differences between previous carrying amount and fair value on initial application recognised in opening retained earnings Adopt in reporting period beginning on/after 1 January 2012 Restate comparatives

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