Transition Resource Group debates IFRS 9 impairment implementation issues At a glance

No. INT 2015-03
15 December, 2015
Transition Resource Group debates IFRS 9
impairment implementation issues
ITG holds its third meeting of 2015
At a glance
At its meeting held on 11 December 2015, the IFRS Transition Resource Group for
Impairment of Financial Instruments (ITG) continued discussion of impairment
implementation issues related to the new IFRS 9 standard. Some of the issues
discussed related to incorporating forward-looking economic scenarios; determining
the appropriate period to measure expected credit losses for revolving credit facilities;
the inclusion of expected cash flows from credit enhancements and sales on the default
of a loan in the measurement of expected credit losses.
Background on ITG
.1 The ITG was established by the IASB as a discussion forum to provide support for
stakeholders on implementation issues arising from the new impairment requirements
following the issue of IFRS 9 Financial Instruments in July 2014. The new expected
credit loss model for impairment of financial instruments represents a fundamental
change to current practice and will therefore have significant implications from an
implementation as well as a systems perspective, particularly in the financial services
sector.
.2 Overall, the purpose of the ITG is to: solicit, analyse and discuss stakeholder issues
arising from implementation of the new impairment requirements; inform the IASB
about those implementation issues, which will help the IASB determine what, if any,
action will be needed to address those issues; and provide a public forum for
stakeholders to learn about the new impairment requirements from others involved with
implementation. During the meetings, the ITG members share their views on the issues.
The ITG will not issue guidance. The IASB will determine what action, if any, will be
taken on each issue.
.3 Additional background on the issues discussed at the ITG meeting can be found on
the IASB1 website.
1
http://www.ifrs.org/About-us/IASB/Advisory-bodies/ITG-Impairment-Financial-Instrument/Pages/Home.aspx
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Highlights of ITG discussions
Summary of issues discussed
.4 There were 10 agenda items discussed at the meeting. There was a general
consensus on all the issues presented at the meeting and accordingly no further action is
expected in respect of the issues discussed. A summary of the issues is given below:
Date
ITG
Agenda
Ref #
1
2
11 December 2015
3
4
5
6
7
8
9
10
Topic discussed
Incorporation of forward-looking economic scenarios
Scope of the requirements for determining the period over which to
measure expected credit losses for revolving credit facilities
Measurement of expected credit losses for charge cards
Period over which to measure expected credit losses for revolving
credit facilities
Inclusion of cash flows from collateral and other credit
enhancements in the measurement of expected credit losses
Inclusion of cash flows expected from the sale on default of a loan in
the measurement of expected credit losses
Meaning of effective interest rate for discounting expected credit
losses
Assessing significant increases in credit risk for financial assets with
a maturity of less than 12 months
Measurement of the loss allowance for credit-impaired financial
assets measured at amortised cost
Presentation of the loss allowance on the face of the balance sheet
Update from September 2015 meeting of the ITG
.5 At its meeting in September 2015, the ITG considered whether an entity could
estimate future draw downs on revolving credit facilities, such as credit cards, in excess
of the contractually agreed amount where an entity has a past practice of providing credit
above the contractual credit limit. At the time the ITG reaffirmed that the exception to
the contractual terms in IFRS 9 is specific to the contractual period and could not be
extended to the contractual credit limit. However, the IASB staff agreed to raise this
issue with the IASB, given the potential disconnect between the accounting and credit
risk management view noted by ITG members.
.6 This issue was raised at the October 2015 meeting of the IASB. The IASB noted the
issue and concluded that the requirements of IFRS 9 were clear. The IASB decided not to
take any further action, but noted the ITG’s concerns.
Topics discussed at the December 2015 meeting of the ITG
Incorporation of forward-looking economic scenarios
.7 The paper asked the ITG for their views about whether an entity is required to
incorporate more than one forward-looking economic scenario in the measurement of
expected credit losses and, if so, how to incorporate multiple forward-looking economic
scenarios into the calculation of expected credit losses. In addition, the paper asked the
ITG for their views about how forward-looking scenarios should be incorporated into the
assessment of significant increases in credit risk.
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.8 The ITG reaffirmed that the key objective of IFRS 9 is that the measurement of
expected credit losses should reflect an unbiased and probability weighted amount that is
determined by a range of outcomes. Accordingly, a single forward-looking economic
scenario would not fully meet this objective when there is a non-linear relationship
between the different possible forward-looking economic scenarios and their associated
credit losses. In such circumstances, more than one forward-looking economic scenario
that is representative of the range of possible outcomes should be used when calculating
expected credit losses.
.9 When determining appropriate forward-looking economic scenarios to incorporate
in the measurement of expected credit losses, an entity considers information from a
variety of sources but needs to ensure that the forward-looking information it uses is
reasonable and supportable. This will form the basis of the entity’s own view of the
measure of expected credit losses.
.10 Similarly, the ITG noted that when assessing significant increases in credit risk, the
forward-looking economic scenarios considered should also reflect any non-linearity in
relationships between the different possible scenarios and the associated risk of a default
occurring, where it impacts the change in credit risk since initial recognition.
Accordingly if more than one forward-looking economic scenario is relevant to the
measure of expected credit losses, the same scenarios are likely to also be relevant to the
assessment of significant increases in credit risk. However the ITG observed that there is
not necessarily always a direct mapping of forward-looking economic scenarios that are
relevant to the measurement of expected credit losses to the scenarios that are relevant to
assessing significant changes in credit risk.
.11 The ITG observed that IFRS 9 does not prescribe a particular method to calculate
expected credit losses or assess significant increases in credit risk, provided that the
measurement objectives in IFRS 9 are met. When assessing significant increases in
credit risk, appropriate approaches could include qualitative, statistical and nonstatistical quantitative approaches or a combination of these approaches. When
measuring expected credit losses, a number of methods may be used, but those used
should reflect any non-linear relationships between different forward-looking economic
scenarios and their associated credit losses.
.12 The ITG highlighted that using multiple forward-looking economic scenarios is
subject to the availability, without undue cost or effort, of reasonable and supportable
forward-looking information that is relevant to the financial instruments being assessed
for impairment.
.13 Finally, the ITG emphasised the importance of disclosures in the financial statements
about how forward-looking economic information has been incorporated into the
determination of expected credit losses, given the judgemental nature of this area.
.14 PwC observation: Entities will have different approaches to sourcing forwardlooking economic information. Many will use in-house economists, others will source
information externally and some may apply a combination of both. Whichever
approach adopted, entities will need to consider all relevant, reasonable and
supportable information that is available without undue cost or effort. In addition,
consideration should be given to the consistency of forward-looking economic data
used in the measurement of expected credit losses with other data sources, such as used
for the purpose of internal budgeting and forecasting, fair valuations, goodwill
impairment. Entities should understand where and why differences between the
different data sources might arise, if any.
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.15 PwC observation: The forward-looking information and the methods used to
calculate expected credit losses and assess significant increases in credit risk will vary
depending upon the sophistication of the reporting entity, its systems and the
characteristics of the specific financial instruments and portfolios, including their
maturity. Both a weighted probability approach and an overlay approach to a base
case, which meet the measurement objectives in IFRS 9, are appropriate methods for
incorporating forward-looking information in the calculation expected credit losses.
Revolving credit facilities
.16 The ITG discussed three papers relating to the measurement of expected credit losses
for revolving credit facilities:
(a) scope of the requirements for determining the period over which to measure
expected credit losses for revolving credit facilities;
(b) measurement of expected credit losses for charge cards; and
(c) period over which to measure expected credit losses.
Scope of the requirements for determining the period over which to measure expected
credit losses for revolving credit facilities
.17 The paper included an example of a multi-purpose revocable credit facility, that
typically included a fixed credit limit which can be drawn down by the customer in a
number of different ways, for example: a revolving overdraft; a variable or fixed rate
loan; or an amortising mortgage. The paper asked the ITG for their views about the
required characteristics of financial instruments to be in the scope of the specific
requirements in paragraph 5.5.20 of IFRS 9 for the measurement period of undrawn and
drawn loan commitments, such as revolving credit facilities. For facilities in the scope of
these specific requirements, expected credit losses are measured over the period that the
entity is exposed to credit risk and expected credit losses would not be mitigated by
credit risk management actions, even if that period extends beyond the maximum
contractual period required for all other financial instruments. This period is used to
estimate expected future draw downs on the credit facility for which expected credit
losses are determined.
.18 The ITG noted that to be in the scope of these specific requirements, the financial
instrument is required to have all of the following characteristics:
(a) the ability to have both a loan and undrawn commitment components;
(b) the lender has the contractual ability to demand repayment of the loan component
and cancel the undrawn commitment component on the same terms (so that there is
similar period of credit risk exposure for both drawn and undrawn elements
(excluding recovery periods)); and
(c) despite this, the lender’s exposure to credit losses is not limited to the contractual
notice period (because the lender does not have access to information until a later
point in time (for example when delinquency information becomes available)).
.19 The ITG observed that to meet the above requirements, a financial instrument would
generally have the following characteristics:
(a) no fixed term or repayment structure and usually a short contractual cancellation
period;
(b) the contractual ability to cancel the contract is not enforced in the normal day-to-day
management and the contract may only be cancelled when the entity becomes aware
of an increase in credit risk at the facility level; and
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(c) managed on a collective basis. This can be both from the perspective of the drawn
and undrawn elements being managed collectively as one set of cash flows and
financial instruments within a portfolio being managed collectively.
.20 The ITG observed that all the characteristics of the financial instrument must be
assessed, including how that facility is managed, however:
(a) a credit facility that has a fixed term (eg 5 years), but the undrawn and drawn
elements are still immediately revocable by the lender without cause, is not
prevented from falling into the scope of paragraph 5.5.20 of IFRS 9;
(b) a credit facility that is immediately revocable, but once drawn the repayment terms
become fixed (eg a 5 year term loan) and the lender cannot demand repayment at
any time, would not meet the conditions for falling into the scope of paragraph
5.5.20 of IFRS 9.
.21 For combined facilities, such as that outlined in the paper, the ITG observed that it is
important to determine the appropriate unit of account. Just because several different
products are packaged within one contract does not necessarily mean that they should be
accounted for together as one unit of account.
.22 PwC observation: Judgement is required to determine the substance of the
contractual terms. For example, if a revolving credit facility is immediately revocable,
but once drawn down the lender cannot demand repayment for a short period of time
(eg 1 month), instead of say a period of years, then the characteristics of the facility as a
whole may meet the conditions outlined above to be in the scope of paragraph 5.5.20 of
IFRS 9.
Measurement of expected credit losses for charge cards
.23 The paper contains an example of a charge card issued by a bank to its retail
customers that has no absolute spending limit included its written terms. Instead the
bank approves charges dynamically at the point of sale. The bank can revoke the card at
its discretion, but balances remain due and payable at the end of the month. The paper
asks the ITG for their views about whether future draw downs on charge cards that do
not have a contractual credit limit should be taking into account when measuring
expected credit losses.
.24 The ITG observed that, in the specific fact pattern presented, if the lender approves
the borrowing, and exercises its discretion, every time the card is used by the customer,
there is no loan commitment until each transaction is approved. In such circumstances
expected credit losses are determined only for the drawn amount at the reporting date.
.25 PwC observation: Judgement is needed when considering whether the lender does
in substance approve draw downs on a transaction by transaction basis and not
beforehand. For example up to a certain limit, such approval may be automatic. In
these circumstances, it will be a matter of judgement, based on the particular facts and
circumstances, whether there is no contractual credit limit or an implied contractual
credit limit and if so, for how much. If it is determined that there is a contractual credit
limit other than zero for undrawn commitments, it will be necessary to consider
whether the characteristics of the facility meet the conditions to fall within the scope of
paragraph 5.5.20 of IFRS 9 for revolving credit facilities.
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Maximum period to consider when measuring expected credit losses for revolving
credit facilities
.26 In the context of revolving credit facilities that are within the scope of paragraph
5.5.20 of IFRS 9 (ie when expected credit losses are measured over the period that the
entity is exposed to credit risk and expected credit losses would not be mitigated by
credit risk management actions, even if that period extends beyond the maximum
contractual period), the paper asked the ITG for their views on:
(a) how to determine the starting point of the maximum period to consider when
measuring expected credit losses; and
(b) how to determine the end point of the maximum period to consider when measuring
expected credit losses and, in particular, what is meant by the period that ‘expected
credit losses would not be mitigated by credit risk management actions’.
.27 In respect of the first issue, the ITG noted that the starting date of the period to
consider when measuring expected credit losses for all financial instruments is the
reporting date.
.28 In respect of the second issue, the ITG observed that when determining the end point
of the measurement period for revolving credit facilities:
(a) an entity should take into account its normal credit risk management actions that it
expects to take, rather than all credit risk management actions that are legally and
operationally available to the entity. Determining the credit risk actions that an
entity expects to take will depend upon the entity’s processes and reasonable and
supportable information about past, current and future expectations of the entity’s
normal risk management actions;
(b) the measurement period should not be extended by considering future actions within
the control of the lender beyond the period that expected credit losses would not be
mitigated by credit risk management actions, such as reinstating previously curtailed
limits on assets that may subsequently cure. In April 2015, the ITG briefly discussed
the probability of assets defaulting and curing. This subsequent discussion clarifies
that the measurement period for the purpose of determining the expected exposure
at default should not include consideration of subsequent cures after default;
(c) credit risk management actions that serve to mitigate credit losses are not limited to
actions that terminate the entity’s exposure to credit risk;
(d) if an entity carries out periodic review processes that are at least as thorough as that
which took place on origination and the entity’s normal business practice is to take
credit risk management actions as part of this review process, it may be appropriate
to consider that the maximum measurement period should not extend beyond this
point. The ITG emphasised that it is the credit risk management actions that are
relevant rather than the review process itself.
.29 In addition, the ITG noted that it is important to appropriately segment the portfolio
according to its credit risk characteristics, taking into account expectations of the entity’s
risk management actions. For example, an entity may not take any credit risk
management actions in respect of its stage 2 credit card portfolio for which the borrowers
pay the minimum contractually required amount each month. Accordingly a longer
measurement period will be appropriate for such credit cards compared with those stage
2 credit cards that are expected to miss some monthly payments, triggering credit risk
management actions.
.30 Finally, the ITG highlighted the need for disclosures about the inputs, assumptions
and estimation techniques used to apply the impairment requirements of IFRS 9, as
required by IFRS 7 Financial Instruments: Disclosures.
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.31 PwC observation: The ITG noted that an entity has the ability to withdraw any
unused credit limit with immediate effect. However, demanding immediate repayment
of drawn amounts is likely to be more difficult and in practice it may take some time to
recover drawn balances after instigating credit risk mitigation actions. Cash shortfalls
over this recovery period will be taken into account when measuring expected credit
losses. However such recovery periods will not be used to determine the amount of the
exposure at default through estimating future draw downs.
Estimating cash shortfalls in the measurement of expected credit losses
.32 Two papers looked at which cash flows should be included in the estimate of cash
shortfalls in the measurement of expected credit losses, in respect of:
(a) collateral and other credit enhancements; and
(b) expected sales of the financial asset on default of the loan.
Inclusion of cash flows from collateral and other credit enhancements in the
measurement of expected credit losses
.33 The paper asks the ITG for its views on whether cash flows from collateral and other
credit enhancements, such as financial guarantees, that are not accounted for separately
by the entity, should be included in the expected cash flows when measuring expected
credit losses for the related financial asset.
.34 The ITG generally agreed that expected cash flows from collateral and other credit
enhancements that are integral to the contractual terms of the financial assets and are
not accounted for separately should be taken into account when measuring expected
credit losses. This is consistent with the definition of credit losses in IFRS 9. The ITG
noted that such an approach does not limit credit enhancements to those that are
explicitly included in the terms of the financial asset.
.35 The ITG observed that judgement will be needed to determine whether collateral and
other credit enhancements are integral to the contractual terms of the financial asset.
.36 Cash flows from collateral and other credit enhancements that are accounted for
separately should not be included in the measurement of expected credit losses to avoid
double counting the same cash flows.
.37 PwC observation: We welcome this wider interpretation, as it more closely reflects
the entity’s credit risk management and the economics of holding collateral and other
credit enhancements to reduce the entity’s expected cash shortfalls. A credit
enhancement obtained some time after the origination of the financial asset may be
included in the measurement of expected credit losses of the financial asset in
circumstances when it is considered to be integral to the contractual terms of the
financial asset and is not accounted for separately.
Inclusion of cash flows expected from the sale on a default of a loan in the measurement
of expected credit losses
.38 The paper asks the ITG for their views on whether cash flows that are expected to be
recovered through the sale of the financial asset to a third party on a default can be
included in the measurement of expected credit losses.
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.39 The ITG generally agreed that an entity can include estimated cash flows from
expected sales of financial assets that are part of an entity’s recovery processes when
considering possible credit loss or default scenarios for inclusion in the measurement of
expected credit losses. Such cash flows, net of selling costs, can form the basis of the loss
given default amount. For example, if an entity expects to recover 30% of its financial
asset on default through selling the asset, but would only recover 25% if it continued to
hold onto the asset, the loss given default would be 70% instead of 75%.
.40 This is relevant to the measurement of expected credit losses for all financial assets
in stages 1, 2 and 3 (ie performing, underperforming and credit-impaired financial
assets). This is because even for performing financial assets in stage 1, there is some
probability of a credit loss within 12 months, however unlikely, for which cash shortfalls
(or a loss given default) must be determined.
.41 The ITG emphasised that to include such cash flows, the entity must expect to
recover the cash flows from its asset on a default through selling the asset and therefore
must have the intent and ability (both legally and practically) to sell or otherwise transfer
the financial asset to achieve derecognition. The entity’s expectations and assumptions
should be based upon reasonable and supportable information that is available without
undue cost and effort.
.42 PwC observation: Such an approach is to be welcomed as it allows an entity to
more closely reflect its credit risk management actions in the measurement of expected
credit losses when an asset is not performing. We note that the expected proceeds from
such sales will still need to be discounted to the reporting date using the financial asset’s
effective interest rate in the calculation of expected credit losses.
Meaning of current effective interest rate
.43 IFRS 9 requires that expected credit losses are discounted using the current effective
interest rate (or an approximation to it). The paper asks the ITG for its views on what is
meant by the current effective interest rate for a floating rate financial asset.
.44 The ITG observed that, like IAS 39, IFRS 9 does not specify whether the effective
interest rate for floating rate instruments should be the current interest rate used at the
reporting date under the terms of the financial instrument for all cash flows or the
projected interest rates derived from the current yield curve applied to the relevant
future cash flows. However, ITG members observed that in their experience using the
current interest rate used at the reporting date under the terms of the financial
instrument was more common and would expect that to continue under IFRS 9.
.45 The ITG emphasised that it is important that there is consistency between the
interest rates used to project future cash shortfalls and the effective interest rates used to
discount those cash shortfalls. In addition, the ITG observed that the effective interest
rate used to discount cash shortfalls in the measurement of expected credit losses should
be consistent with the rate used at the reporting date to measure interest revenue.
.46 PwC observation: For the calculation of the expected credit losses, using the current
interest rate used at the reporting date under the terms of the financial instrument
applied to all the future cash flows is operationally easier to implement than using the
projected interest rates derived from the current yield curve applied to the relevant
future cash flows.
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Assessing for significant increases in credit risk in respect of financial assets with a
maturity of less than 12 months
.47 The paper notes that for financial assets that have a maturity of less than 12 months
on initial recognition, the amount of the 12-month expected credit loss allowance will be
the same as the lifetime expected credit loss at any specific point in time. The paper asks
the ITG for their views as to whether in such circumstances an entity is required to assess
for significant increases in credit risk.
.48 The ITG agreed that an assessment of significant increases in credit risk is required,
as IFRS 9 does not contain a specific exemption on the basis of maturity. In addition, the
assessment of significant increases in credit risk is needed to comply with the disclosure
requirements in IFRS 7.
.49 PwC observation: Even though the measurement of expected credit losses at the
reporting date is not affected by the assessment of significant increases in credit risk,
the assessment is needed for the disclosures in the notes to the financial statements to
inform the user about the different credit circumstances associated with stage 1 and
stage 2 financial assets.
Measurement of the loss allowance for credit-impaired financial assets
.50 The paper asks the ITG to consider the measurement of the gross carrying amount
and the loss allowance (ie expected credit losses) for financial instruments that are
measured at amortised cost and are credit-impaired (stage 3 financial assets), but not
purchased or originated credit-impaired financial assets.
.51 The ITG confirmed that for credit-impaired financial assets, IFRS 9 is clear that:
(a) the gross carrying amount is calculated by discounting the estimated contractual
cash flows using the original effective interest rate determined at initial recognition,
(or the effective interest rate at the reporting date used for the recognition interest
revenue for floating rate financial assets); and
(b) the loss allowance is calculated by discounting the expected cash shortfalls using the
original effective interest rate determined at initial recognition, or an approximation
of it (or the effective interest rate at the reporting date used for the recognition
interest revenue for floating rate financial assets).
.52 PwC observation: For credit-impaired financial assets, interest revenue is
recognised net of the unwinding of the discount on the loss allowance, unlike financial
assets that are not credit-impaired. However this different treatment for interest
revenue does not affect the method of the calculation of the gross carrying amount or
the loss allowance for credit-impaired financial assets.
Presentation of the loss allowance for financial assets measured at amortised cost
.53 The paper asks the ITG to consider whether an entity is required to present the loss
allowance separately on the face of the balance sheet for financial assets measured at
amortised cost.
.54 The ITG confirmed that in their view there is no requirement to present the loss
allowance separately on the face of the balance sheet for financial assets measured at
amortised cost. However, this does not preclude an entity from presenting the loss
allowance on a separate line on the face of the balance sheet as a part of the total carrying
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amount at amortised cost, if it was judged to be relevant to an understanding of the
entity’s financial position.
.55 PwC observation: Regardless of whether the loss allowance is presented separately
on the face of the balance sheet, IFRS 7 requires disclosures of the loss allowance in the
notes to the financial statements for all financial assets.
What’s next
.56 There was a general consensus on all the issues presented at the meeting and no
further action in respect of these issues is expected. The IASB staff will prepare a report
of the meeting to be made publicly available and maintain a log of issues and associated
action points.
.57 This may have been the last meeting of the ITG. All submissions received by the
IASB as at the date of the ITG meeting have been considered and raised with the ITG as
appropriate.
.58 There are no further scheduled or planned meetings of the ITG because the IASB
would like there to be a ‘stable platform’ so that entities can proceed with their
implementation plans. However the ITG will remain in place and further meetings will
be convened if circumstances warrant it. Stakeholders can continue to submit potential
implementation issues to the IASB through its website and the IASB will decide on the
most appropriate channel to address each question.
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PwC has developed the following publications and
resources related to IFRS 9: Impairment:
– In depth INT2014-06, IFRS 9: Expected credit losses
– In depth INT2015-02, IFRS 9: Expected credit loss
disclosures for banking
– In depth INT2015-13, IFRS 9: Impairment of
financial assets – Questions and answers
– In transition INT 2015-01, Transition Resource
Group debates IFRS 9 impairment implementation
issues
– In transition INT 2015-02, Transition Resource
Group debates IFRS 9 impairment implementation
issues
For more information on this publication please contact:
John McDonnell
Partner
+ 353 1 792 8559
[email protected]
Jessica Taurae
Partner
+44 (0) 20 7217 5700
[email protected]
Hannah King
Senior Manager
+44 (0) 20 7213 8158
[email protected]
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