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IFRS 9: Financial Instruments November 2016
IFRS 9: Financial Instruments
November 2016
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Today’s agenda
EY European IFRS Power and Utilities Roundtable 2016
► Reminder of the new rules► Key areas of impact
► Q&A
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Reminder of the new rules
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Problems with IAS 39 for power and utilities sector
► Belief that IAS 39 maintained some inconsistent rule-based measures
► Desire to achieve hedge accounting for economic hedges that have not been eligible for hedge accounting under IAS 39► Most of hedging activity for “own use” customer demand
requirements but IAS 39 exemption not allowable for many contracts because of specific rules relating to net settlement
► Rigid 80%-125% test created some instances where hedge accounting could not be applied► Hedges prohibited from being in hedging relationships despite being
entered into to achieve valid risk management objectives
EY European IFRS Power and Utilities Roundtable 2016
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IFRS 9 and the power and utilities sector
► Power & utilities businesses undertake significant levels of hedging activity► Predominantly to hedge price of gas and power required to meet end
customer demand► Fair value movements on contracts can be highly material
► Consistent support for move to more principles-based approach and better alignment of risk management and accounting
► As always, need to find right balance between needs of users of financial statements and the costs of implementing “Administering the hedge accounting principles of the Exposure Draft as it stands would still require a significant level of burden through expensive system upgrades and the employment of significant numbers of extra administrative staff, which would not add value to our business.”
Company response to IASB ED on hedge accounting
EY European IFRS Power and Utilities Roundtable 2016
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Overview of the IFRS 9 project
► In July 2014, the International Accounting Standards Board (IASB) issued the final version of International Financial Reporting Standard (IFRS) 9 Financial Instruments to replace International Accounting Standard (IAS) 39 Financial Instruments: Recognition and Measurement
► The European Financial Reporting Advisory Group (EFRAG) has submitted its Endorsement Advice to the European Commission. EFRAG has recommended that all businesses in the European Union (EU) should be required to account for their financial instruments in compliance with IFRS 9 as of 2018
► Early application is permitted
► EU endorsement is expected in Q4 2016
EY European IFRS Power and Utilities Roundtable 2016
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Classification and measurement (assets) –overview
Debt (including hybrid contracts)
Pass
No
Neither (1) nor (2)
BM with objective that results in collecting contractual cash flows and selling financial assets
1 32
No
Yes
Derivatives
No
Yes
Amortized cost FVPLFVOCI
(with recycling)FVOCI
(no recycling)
Fail
Hold-to-collect contractual cash flows
Conditional fair value option (FVO) elected?
Fail FailHeld for trading?
Yes No
FVOCI option elected ?
“Business model” test (at an aggregate level)
“Contractual cash flow characteristics” test(at instrument level)
Equity
EY European IFRS Power and Utilities Roundtable 2016
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Some observations from implementation of IFRS 9 (Phase 1) in the industry
► Assessment of the business model thought through but often not yet documented or finalized ► Rarely multiple business models
► SPPI-Test ► Generally not much of an issue for the industry; however,
embedded derivatives no longer separated for financial assets ► Specific facts and circumstances give rise to FVPL accounting
from time to time
► Equity instruments @FVOCI► Strategy?: item-by-item choice – increasing importance in
Energiewende
EY European IFRS Power and Utilities Roundtable 2016
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Some observations from implementation of IFRS 9 (Phase 1) in the industry
► Debt/equity issues noted ► Non-consolidated shares in instruments under the puttables
amendment may not qualify for the accounting choice for equity instruments (BC 5.21), e.g.:► German KG► Interests in investment funds
► Own use: contract-by-contract fair value choice (IFRS 9.2.5)► Irrevocably available at inception if it eliminates or significantly
reduces a recognition inconsistency► May help avoiding hedge documentation ► Does not seem to be considered often in current implementations
EY European IFRS Power and Utilities Roundtable 2016
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Impairment: the general approach
Stage 2 Stage 3Stage 1Loss allowance updated at each reporting date
12-month expected credit
losses
Lifetime expected credit
losses
Lifetime expected credit losses criterion
Credit risk has increased significantly since initial recognition (individual or collective basis)
+Credit-impaired
Interest revenue calculated based on
Effective interest rate on gross carrying
amount
Effective interest rate on gross carrying
amount
Effective interest rate on amortized cost
Change in credit risk since initial recognitionImprovement Deterioration
Lifetime expected credit
losses
Start here
EY European IFRS Power and Utilities Roundtable 2016
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Some observations from implementation of IFRS 9 (Phase 2) in the industry
► Simplified approach dominating implementation discussion► How to determine adequate portfolios ► How to derive adequate disclosures (and reporting) under the
IFRS 9 requirements► Legal issues around contract assets – prepayments/deposits
treated differently from (unbilled) receivables or netted/embedded as collateral?
► Lease receivables: accounting choice to consider lifetime expected losses (separately available to finance vs. operating leases)
EY European IFRS Power and Utilities Roundtable 2016
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Some observations from implementation of IFRS 9 (Phase 2) in the industry
► General approach ► Often limited number of items – portfolio-based assessment often
not feasible► Difficulty in gathering market credit risk information on several
counterparties – internal ratings used, increasing use of credit risk information by credit agencies observable
► Assumption of when credit risk increased significantly – changes within investment grade often considered to have no significant change (B5.5.23)
► 30 days past due rebuttable assumption
EY European IFRS Power and Utilities Roundtable 2016
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Carrying values of impaired financial assets
? IFRS Transition Resource Group for Impairment of Financial Instruments (ITG) members recognized that IAS 39 does not provide specific guidance and, in practice, different approaches are observable
Definition of Gross carrying value
Example: impaired financial asset with amortized cost of CU100 at an effective interest rate of 10%
As of 31 December 20X1, an impairment of CU60 was accounted for
During 20X2 no changes occurred. Therefore, the amortized cost at 31 December 20X2 is 44WE (40WE+ [40WE X 10%])
Method A B C
Gross carrying value 110 104 100
Impairment reserve (66) (60) (56)
Amortized cost 44 44 44
ITG members agreed on Method A as the only method in line with IFRS 9, since IFRS 9 now provides for a definition of the gross carrying value. Under Method A, an entity needs to determine the following:
1. The gross carrying value through discounting of the estimated contractual cash flows using the initial effective interest rate
2. The impairment reserve throughdiscounting of the expected negative payment differences using the initial effective interest rate
EY European IFRS Power and Utilities Roundtable 2016
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Hedge accounting Overview of key changes
Requirement IAS 39 IFRS 9Risk component as eligible hedged item Financial Items All ItemsHedging of aggregated exposures X
80%-125% test XRetrospective effectiveness testing XQuantitative effectiveness test DependsQualitative effectiveness test X DependsRebalancing of hedge ratio X
Accounting for “costs of hedging” X
Dedesignation (risk management objective unchanged) X
Fair value option for own use contracts
EY European IFRS Power and Utilities Roundtable 2016
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Some observations from implementation of IFRS 9 (Phase 3) in the industry
► Implementation as the first step, optimization may follow► Software availability may hinder early application► Challenges related to measurement and accounting for
parts of the fair values (e.g., FX basis spreads) – software availability perceived as bottleneck
► Technical issues discussed include the following: ► “Sub-LIBOR” issue ► Risk components ► Rebalancing – how frequently to perform? Which threshold?► Measurement issues – how to derive basis spreads?
EY European IFRS Power and Utilities Roundtable 2016
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Q&A
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Thank you
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