IFRS 9 conference presentation - Philip Lewis

© Aptitude Software Ltd 2014 | Page 1Aptitude Product Workshop | November 2014 © Aptitude Software Ltd 2015 | Page 1Aptitude Topic Briefing | July 2015
CONFIDENTIAL - Copyright © Aptitude Software Ltd. 2015
The Impact of IFRS 9 on Finance
Philip Lewis, Head of Accounting Product

IFRS 9
Revenue
Growth
Operating
Margin Reputation
Capital Liquidity
Products
and
Volume
Portfolio
and Product
Mix
Relative
Market
Position
Disclosures
Market
Discipline
External
Rating
Cost of
Funding
Stakeholder
Expectations
Pillar 2B
Planning
Basel 3 Tier
1&2
Pillar 1 & 2A
Requirements
BS Impact
of
Provisioning
P&L Impact
of
Provisioning
Risk and
Finance
Operating
Model
People
Processes
Policies
Models
MI
Reporting
Data &
Systems
Risk
Adjusted
Pricing
Organisational Impact of IFRS 9
Source: Deloitte

Asset Classification and Measurement
Judgements!
•  No direct path from IAS 39 to IFRS 9
•  Business Model approach and the SPPI criterion may require judgement to
ensure assets are correctly categorised
•  The SPPI criterion may require assessment of contractual provisions that do/may
change the timings or amounts of contractual cashflows. Prepayment provisions is
a good example
⇒  How do you ensure that judgement is exercised appropriately and consistently
throughout the organisation
⇒  How do you ensure that, where judgements are made, they are supported by
appropriate evidence

Equity, Regulatory Capital and Covenants
•  Asset classification changes will affect the way that capital resources and capital
requirements are calculated
•  This may impact compliance with the Basel capital requirements or other capital
adequacy requirements
•  Incorporating the new requirements into Stress Testing will identify potential
issues and any additional volatility within profit and loss and equity.
⇒  How do you identify possible capital issues and test any plans designed to
mitigate such negative consequences?
⇒  How do you ‘test’ the new requirements as part of your Stress Testing
Methodologies early enough in the process to manage any potential negative
outcomes.
⇒  How do you communicate the impact of such mitigation plans to analysts,
shareholders, regulators and providers of finance.

Asset Impairment and Credit Losses
Judgements!
•  Considered by many to be more of an art rather science!
•  Judgements are required such as:
–  Whether loans will be received as due
–  If not, how much will be recovered and when
•  Robust assessments are required in relation to
–  The identification of any increase in credit risk
–  The point at which credit risk increases significantly giving rise to…
–  Expected asset impairments or defaults leading to credit losses
•  The measurement of any expected asset impairment should reflect reasonable
and supportable information that is available without undue cost or effort and that
includes historical, current and forecast information
⇒  How do you define ‘significant increase’; ‘default’; ‘reasonable’; ‘undue cost’; etc…
⇒  The expected increase in P&L Volatility as a result of ‘Point in Time’
measurements rather than ‘Through the Cycle’ provisions is considered to be
mainly as a result of policy decisions

Equity, Regulatory Capital and Covenants
•  IFRS 9 is expected to have a large negative impact on equity for the financial
services sector.
•  It is also expected to affect covenants and regulatory capital: Equity will reflect
expected credit losses as well as incurred credit losses
⇒  How do you assess the impact of the new requirements early enough to minimise
any negative impact
⇒  The nature of the impact will be shaped by the size and nature of the financial
instrument holdings and their classifications. Are these known now?
⇒  Given that the classification of such instruments is heavily impact by judgements
made in relation to that classification, are you able to ‘test’ those judgements and
impact on the results from any impairment models?

IFRS 9 Asks Big Questions
⇒  How do you ensure that judgement is exercised appropriately,
consistently and supported by appropriate evidence?
⇒  How do you define ‘significant increase’; ‘default’; ‘reasonable’;
‘undue cost’; etc…?
⇒  How will P&L volatility increase as a result of ‘Point in Time’
measurements rather than ‘Through the Cycle’ provisions?

Impact on the Finance Team
Finance and Risk
Why is IFRS 9 different to other International Financial Reporting
Standards published to date?
⇒  Of all the regulatory pronouncements so far, this standard
requires the highest level of collaboration between Risk and
Finance
Many organisations have initial focus on the modified Risk Models
…but how will Finance Teams absorb the new requirements and
cope with the changes they will need to make as a result?

Importance of Asset Classification
Decisions and judgements made regarding Asset classification and measurement
directly impact the asset classes that need to be included in the Impairment
Calculations.
Source: Deloitte

The Finance Team must collaborate with Risk to understand the Impairment Models.
•  The Inputs to the models must be from ‘finance accurate’ sources with clear audit
trails through to the underlying transactions
•  All credit assumptions at each stage in the process need to be validated and
agreed between Finance and Risk.
Finance and Risk: Impairment
Sample Factors in Assessing Credit Loss Classification. Source: E&Y
Each parameter could dramatically
affect the extent to which an asset,
or group of assets is impaired at
each stage in the process.
Finance need to be involved in the
setting, and subsequent variations
of these parameters during the
reporting period and as-at the
reporting date

Given a series of parameters, the Finance Team must collaborate with Risk to
understand and validate the results generated by the Risk Models.
•  The Finance team must have a level of knowledge such that they can assess the
output of the Risk Models in the context of ‘finance accurate’ inputs and credit
related parameters
⇒  Finance must be able to assess whether the output is ‘reasonable’ given all of the
inputs involved
•  Moving through the Reporting Period as assumptions are varied, and assets are
moved between the IFRS 9 stages as credit information changes…
⇒  Finance must be able to validate the movements in any impairment provisions
given input and parameter variations
⇒  Over time, the finance team will need to explain movements in the impairment
provisions given a change in:
⇒  Asset Classification
⇒  Credit Assumptions

Industry feedback is shifting towards a shared responsibility between Finance and
Risk throughout the process as the scale of the change within the finance function is
becoming apparent.
⇒  Finance is responsible for the reported numbers and must explain movements in
the Income Statement throughout the reporting cycle
⇒  Finance is responsible for the substantiation of the Balance Sheet as at each
reporting date
Fulfilling these responsibilities means that the Finance Team must fully understand all
aspects of the process.
Impairment Calculation Disclosure
Data
Transfer
and
System
Admin
Provision
Sign-Off
Disclosure
Preparation
Data
Upload
and
Validation
Disclosure
Submission
Reporting
Data
Preparation
Risk Finance
Data
Gathering
Modelled
Provision
Non-
Modelled
Provision
Data
Entry
(Journals)

Collaboration between Finance and Risk is also critical given the changes in the
Hedge requirements for IFRS 9.
Recap… flaws in IAS 39…
⇒  Investors want to better understand:
⇒  The risks an entity faces
⇒  What management was doing to manage those risks
⇒  How effective those risk management strategies are
⇒  IAS 39 was felt to fall short of these requirements.
Supporting this requirements means finance need to understand the risks to which the
entity is exposed such that associated reporting reflects those risks plus any
mitigations.
‘Bright lines’ have been removed leaving only judgement as a guide…!
Finance need to work even closer with Risk to ensure that the numbers correctly
reflect the risks and mitigations during the reporting period and ‘as at’ the reporting
date
Finance and Risk

The new expected loss and hedging models will require data at a
more granular level than has previously been the case.
Clear audit trails, data lineage and management oversight is
fundamental within any finance function, the new standard shines a
spotlight on these areas
Multiple system and human interfaces between the enhanced
models and the accounting stream places the focus firmly on the
integrated control environment and the extent of process automation
⇒  A strategic approach will support a more granular data
architecture coupled with enhanced process controls
⇒  Opportunity to improve the joint Risk and Finance information
architecture
Key Challenges for Finance (#1)
Data and Process Challenges

Challenges
Interpreting IFRS 9
•  Fostering consistent interpretation across jurisdictions will take time
•  Some products viewed as a “[basic] lending arrangement” may have features that are
not consistent with the “solely payments of principal and interest” (SPPI) criterion
Classification
•  Storing and managing business model/business entity reference data
•  Asset type classification rules to be applied at the transaction level according to
business model and cash flow tests will be very different to those used for IAS 39
•  Sourcing and storing financial amounts for accounting: new values will be needed in
many cases
Significant judgement areas
•  Business model assessment – e.g. liquidity portfolios, securitisations
•  Modified time value of money component
•  Contractually linked instruments – e.g. relative exposure to credit risk, composition of
pool

Challenges
Operational challenges
•  Moving target – i.e. developing policies and methodologies while interpretation is
evolving
•  New systems/processes/controls – e.g. review of contractual terms, information on
sales
•  Consistency of application across group entities
•  Insurers – interaction with accounting for insurance liabilities/IFRS 4/CEIOPS SII
Financial Amounts for Accounting
•  In many cases the accounting treatment under IFRS 9 will be different to that under
IAS 39. This may mean that financial amounts used previously are not required and
new financial amounts must be sourced. An example may be a transaction which
was previously accounted for under on a Fair Value basis may now require an
Accruals based approach
Managing the Transition
•  Once the IFRS 9 classifications have been determined, all calculations associated
with each transaction must be performed as if the transaction had been classified as
such from its inception.

•  It is critical that Finance understand the results generated from
any risk models. It is Finance that must sign off the numbers!
•  Key to this is the ability to ‘Scenario Model’. By varying
assumptions and analysing results the finance teams can better
understand the risks inherent within an asset class.
⇒  Using a base data set, Finance Teams must be able to overlay
scenario model results to better understand the impact in
reported numbers.
⇒  An architecture supporting this needs to be highly automated with
enough flexibility to support scenario modelling without impacting
‘business as usual
⇒  Flexibility and agility without unexpected volatility are watchwords
Key Challenges for Finance (#2)
Understanding Model Results

IFRS 9 brings in many new operational stresses
•  Coping with higher accounting data ‘churn’. The volume of data passing
through the finance environment will simply increase significantly.
•  Higher data transaction volumes stemming from increased volatility in
model results.
•  Extensive additional disclosure and reporting requirements
•  The need to understand complex risk models in detail for both Asset
Impairment and Hedging to validate assumptions and correctly interpret
results and identify anomalies
•  Justification of the results in order to validate classifications, valuations
and provision adjustments whilst substantiating the Balance Sheet and
Income Statement
•  Supporting differences in interpretation across multiple jurisdictions,
particularly during the transition period
Key Challenge for Finance (#3)
Simply managing the Day to Day…!

⇒  All of this will typically require extensive modification of the
accounting environment – how can this be a good thing?
⇒  The key is to turn the need for regulatory change into an
opportunity to dramatically improve the finance function such that
futures regulatory demands can be more easily met.
⇒  This is an opportunity to do more than add another ‘sticking
plaster’!
⇒  Organisations who can see the opportunity beyond just
compliance will likely see a competitive advantage
Key Challenges for the Finance Team
Simply managing the Day to Day…!

Equipping Finance – Key Aspects
•  Automation of Accounting
–  With the anticipation of higher transaction volumes stemming from increased
asset value movements, particularly between impairment stages, full
automation is essential
•  Management Overlays
–  The ability to access impairment model rules and to apply and annotate
adjustments - both on actual flows and scenarios driven from stress testing
(for example)
•  Transparency
–  Detailed transaction drill-back from aggregated balances (in General Ledger
and BI reports), with access to/reporting of rules, annotations, workflow, and
audit information
•  Data Quality and Data Governance
–  Finance teams must understand the full data workflow at a more granular
level more than ever before. Not just change states, but the drivers and
reasons for change must be recorded and accessible
–  Data Quality is vital to get right up-front – some systems upgrade may not be
optional!

Equipping Finance – What
Approach?
•  Modify/extend existing systems and processes?
–  Initially attractive as it may appear to be additive change with less disruption
of BAU
–  However, IFRS 9 involves deep penetration into the fabric of the financial
transaction process, potentially requiring multiple points of change
–  Tools for finance to interrogate, adjust, annotate, explain and sign-off on the
asset valuations and capital provisions may be missing or inadequate
•  Buy or build fit-for-purpose components?
–  Build may be possible – if the build team are available, have access to good
Finance resources, and have well defined requirements and appropriate
skills, then design should result in solution to meet exact requirements.
–  Buy has advantages that end-state can be seen in advance. Solution
becomes an implementation and integration issue, with less reliance on
scarce internal (IT and Finance) resources
•  A good Buy decision can accelerate delivery, lower implementation costs, lower
delivery risk and provide functionality for future change

Solution: Key Points of the “HUB”
Approach
•  Integrated Processing Platform:
–  Single point for design, implementation and management of business rules,
control framework, workflow
–  Flexible Web Application for configured to the business operating model
–  Clear, robust, performant data integration: acquisition, standardisation,
preparation, publication
–  Encapsulated business processes as service offering to business base
•  Accounting and Operating Storage Hub designed for:
–  Multi-dimensional, multi-GAAP, real-time accounting processing
–  Full Trade, Position, Product and Party Models
–  Operational Sub-Ledger to support aggregated GL level to detailed postings
•  Integrated Calculation Engine specifically designed for:
–  High volume, high-speed processing
–  Multiple simultaneous / parallel calculation methods
–  User-configuration/construction of calculation logic
–  High performance Cash Flow generation for contractual flows

Summary Points
•  IFRS 9 has deeper impact on systems and processes than IAS 39
– most have found it needs a new approach
•  Appropriate automation will help reduce complexity and speed
delivery
•  SME Resources will be scarce – buying in impact expertise is
good option
•  Close cooperation between Risk and Finance teams will deliver
better results
•  Finance must engage with project. The countdown has started …

IFRS 9 conference presentation - Philip Lewis

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