Basel Committee IFRS 9 Guidance

23/03/2021

Basel Committee IFRS 9 Guidance

Expected credit losses continuously in focus

In December 2015, the Basel Committee on Banking Supervision (‘the Committee’) issued its Guidance on credit risk and accounting for expected credit losses (‘Basel Committee IFRS 9 Guidance’). The Guidance sets out supervisory guidance on sound credit risk practices associated with the implementation and ongoing application of expected credit loss (ECL) accounting frameworks, such as that introduced in IFRS 9, Financial Instruments.

The Committee expects a disciplined, high-quality approach to assessing and measuring ECL by banks. The Basel Committee IFRS 9 Guidance emphasises the inclusion of a wide range of relevant, reasonable and supportable forward looking information, including macroeconomic data, in a bank’s accounting measure of ECL. In particular, banks should not ignore future events simply because they have a low probability of occurring or on the grounds of increased cost or subjectivity.

In addition, the Basel Committee IFRS 9 Guidance notes the Committee’s view that that the use of the practical expedients in IFRS 9 should be limited for internationally active banks. This includes the use of the ‘low credit risk’ exemption and the ‘more than 30 days past due’ rebuttable presumption in relation to assessing significant increases in credit risk.

Obviously, banks keep in continued talks to their local regulator about the extent to which their regulator expects the (below) Banking IFRS 9 Guidance to apply to them.

Principles underlying the Banking IFRS 9 Guidance – in Summary

Supervisory guidance for credit risk and accounting for expected credit losses

Basel Committee IFRS 9 Guidance Basel Committee IFRS 9 Guidance Basel Committee IFRS 9 Guidance Basel Committee IFRS 9 Guidance Basel Committee IFRS 9 Guidance

Principle 1

Responsibility

A bank’s board of directors and senior management are responsible for ensuring appropriate credit risk practices, including an effective system of internal control, to consistently determine adequate allowances.

Principle 2

Methodology

The measurement of allowances should build upon robust methodologies to address policies, procedures and controls for assessing and measuring credit risk

Banks should clearly document the definition of key terms and criteria to duly consider the impact of forward-looking information including macro-economic factors, different potential scenarios and define accounting policies for restructurings

Principle 3

Credit Risk Rating

A bank should have a credit risk rating process in place to appropriately group lending exposures on the basis of shared credit risk characteristics

Principle 4

Allowances adequacy

A bank’s aggregate amount of allowances should be adequate and consistent with the objectives of the applicable accounting framework

Banks must ensure that the assessment approach (individual or collective) does not result in delayed recognition of ECL, e.g. by incorporating forward-looking information incl. macroeconomic factors on collective basis for individually assessed loans

Principle 5

Validation of models

A bank should have policies and procedures in place to appropriately validate models used to assess and measure expected credit losses

Principle 6

Experienced credit judgment

Experienced credit judgment in particular with regards to forward looking information and macroeconomic factors is essential

Consideration of forward looking information should not be avoided on the basis that banks consider costs as excessive or information too uncertain if this information contributes to a high quality implementation

Principle 7

Common systems

A bank should have a sound credit risk assessment and measurement process that provides it with a strong basis for common systems, tools and data

Principle 8

Disclosure

A bank’s public disclosures should promote transparency and comparability by providing timely, relevant, and decision-useful information

Principle 9

Assessment of Credit Risk Management

Banking supervisors should periodically evaluate the effectiveness of a bank’s credit risk practices

Principle 10

Approval of Models

Supervisors should be satisfied that the methods employed by a bank to determine accounting allowances lead to an appropriate measurement of expected credit losses

Principle 11

Assessment of Capital Adequacy

Banking supervisors should consider a bank’s credit risk practices when assessing a bank’s capital adequacy

Principles underlying the Banking IFRS 9 Guidance

1 Best Read All IFRS vs US GAAP Leases

23/03/2021

IFRS vs US GAAP Leases

1 best read of all comparisons

In 2016, the IASB and FASB issued new standards addressing the accounting for leases (IFRS 16 and ASC 842, respectively). The prior leasing standards (IAS 17 and ASC 840, respectively) were in practice significantly converged. The primary objective of the new standards was to require lessees to recognize assets and liabilities on the balance sheet for most lease contracts. Although the boards accomplished this goal, they did so in different ways.

Thus, while the boards remained largely converged with respect to scope and initial measurement, they significantly diverged on subsequent measurement for lessees: the IASB requires a single measurement model (akin to that for finance leases under U.S. GAAP) while the FASB maintains a two-class system (operating and finance lease classifications).

In addition, while certain presentation and disclosure requirements in IFRS 16 are similar to those in ASC 842, there are also certain differences (quantitative and qualitative) in this area. Other differences between IFRS 16 and ASC 842 may also arise as a result of differences between IFRS Standards and U.S. GAAP in other standards, including those related to (1) impairment of financial instruments and long-lived assets other than goodwill and (2) the accounting for investment properties.

The Lease Standards, effective 2019, requires that leases greater than 12 months are reported on Balance Sheets as Right of Use Assets under both US GAAP and IFRS. US GAAP distinguishes between Operating and Finance Leases (both are recognized on the Balance Sheet), while IFRS does not (any more).

Standards Reference

US GAAP¹	IFRS²
ASC 842 Leases	IFRS 16 Leases

Note

The following discussion captures a number of the more significant GAAP differences under both the standards. It is important to note that the discussion is not inclusive of all GAAP differences in this area.

IFRS 16 Good Important Read – Lease payments

16/03/2021

Lease payments – Lessee perspective

or what does a lessee include in its lease liability?

At the commencement date, a lessee measures the lease liability as the present value of lease payments that have not been paid at that date. In a simple lease that includes only fixed lease payments, this can be a simple calculation (IFRS 16.26).

Lease payments

Worked example – Fixed lease payments are included in lease liabilities

Lessee B enters into a five year lease of a photocopier. The lease payments are 10,000 per annum, paid at the end of each year.

Because the annual lease payments are fixed amounts, B includes the present value of the five annual payments in the initial measurement of the lease liability.

Using a discount rate (determined as B’s incremental borrowing rate) of 5%, the lease liability at the commencement date is calculated as follows:

Year	Lease payments	Discounted
1	10,000	9,524
2	10,000	9,070
3	10,000	8,638
4	10,000	8,227
5	10,000	7,835
Lease liability at commencement date		43,294

Categories of lease payment

IFRS vs US GAAP Employee benefits

16/03/2021

IFRS vs US GAAP Employee benefits

The following discussion captures a number of the more significant GAAP differences under both the impairment standards. It is important to note that the discussion is not inclusive of all GAAP differences in this area.

The significant differences and similarities between U.S. GAAP and IFRS related to accounting for investment property are summarized in the following tables.

Standards Reference

US GAAP¹

IFRS²

715 Compensation – Retirement benefits

710-10 Compensation- General – Overall

712-10 Compensation – Nonretirement Postemployment Benefits – Overall

IAS 19 Employee Benefits

IFRIC 14 The limit on a defined benefit asset minimum funding requirements and their interaction

Introduction

The guidance under US GAAP and IFRS as it relates to employee benefits contains some significant differences with potentially far-reaching implications.

This narrative deals with employee benefits provided under formal plans and agreements between an entity and its employees, under legislation or through industry arrangements, including those provided under informal practices that give rise to constructive obligations.

Insurances acquired in the run-off period

23/03/2021

Insurances acquired in the run-off period

An otherwise solvent insurer determines that it wishes to exit from a particular class of insurance contracts, but wishes to continue underwriting in other classes. This could be the result of strategic considerations, lack of profitability in the to be discontinued class, or a desire to restructure and to focus on the remaining classes. Insurances acquired in the run-off period

Other meanings of run-off in the insurance industry context could be: Insurances acquired in the run-off period

An insurance company will be considered to be in run-off when it ceases to take on-board any new business but will continue to honor existing claims. Usually, when the net balance of the company’s assets and liabilities is such that the insurer does not have the ability to honor all existing policies based on their predicted loss, the company will cease to write new policies and attempt to use their existing assets to pay off any claims arising from existing clients. In such instances, those with existing claims need not worry about their insurer being in a runoff, as their claim will be considered superior to that of any creditor. Insurances acquired in the run-off period
Run-off insurance, on the other hand, is a type of insurance policy that provides liability coverage against claims made against companies that have been acquired, merged, or have ceased operations. Run-off insurance is generally purchased by the company being acquired and protects it and its officers and directors, among other things, from claims and lawsuits, filed relating to the company’s activity subsequent to the date of acquisition.
This type of policy is also usually a claims-made policy, meaning that coverage is based on the fact the claim may be made several years after the incident that caused damage or loss, and the policy period is based upon the date the claim is presented and not the date of the occurrence subject of the claim. The length of the run-off policy or the “runoff” as it is usually referred to, is typically set for several years after the policy becomes active. The provision is typically purchased by the company being acquired. Insurances acquired in the run-off period

Insurances acquired in the run-off period An insurance company will considered to be in run-off when it ceases to take onboard any new business but will continue to honor existing claims. Usually when the net balance of the company’s assets and liabilities is such that the insurer does not have the ability to honor all existing policies based on their predicted loss, the company will cease to write new policies and attempt to use their existing assets to pay off any claims arising from existing clients. In such instances, those with existing claims need not worry about their insurer being in run off, as their claim will be considered superior to that of any creditor. Insurances acquired in the run-off period

Another variant on this scenario is when an otherwise solvent insurer determines that it wishes to exit from a particular class of business, but wishes to continue underwriting in other classes. This could be the result of strategic considerations, lack of profitability in the to be discontinued class, or a desire to restructure and to focus on the remaining classes.

Runoff Provision — a provision in a claims-made policy stating that the insurer remains liable for claims caused by wrongful acts that took place under an expired or canceled policy, for a certain time period. Insurances acquired in the run-off period

For example, consider a policy written with a January 1, 2015-2016, term and a 5-year runoff provision. In this situation, coverage will apply under the runoff provision to all claims caused by wrongful acts committed during the January 1, 2015-2016, policy period that are made against the insured and reported to the insurer from January 1, 2016-2021 (i.e., the 5-year period immediately following the expiration of the January 1, 2015-2016, policy). Insurances acquired in the run-off period

Although runoff provisions function in a manner that is identical to extended reporting period (ERP) provisions, there are several differences. First, ERPs are generally written for only 1-year terms, whereas runoff provisions normally encompass multi-year time spans, often as long as 5 years.

Second, while ERPs are most frequently purchased when an insured changes from one claims-made insurer to another, runoff provisions are generally used when one insured is acquired by or merges with another. In such instances, the acquired company buys a runoff provision that covers claims associated with wrongful acts that took place prior to the acquisition but are made against the acquired company after it has been acquired.

Insurances acquired in the run-off period

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IFRS vs US GAAP Investment property – Broken in 10 great excellent reads

11/03/2021

IFRS vs US GAAP Investment property

The significant differences and similarities between U.S. GAAP and IFRS related to accounting for investment property are summarized in the following tables.

Standards Reference

US GAAP¹	IFRS²
360 Property, Plant and equipment	IAS 40 Investment property

Introduction

The guidance under US GAAP and IFRS as it relates to investment property contains some significant differences with potentially far-reaching implications.

Links to detailed observations by subject

Definition and classification	Initial measurement	Subsequent measurement
Fair value model	Cost model	Subsequent expenditure
Timing of transfers	Measurement of transfers	Redevelopment
Disposals

Overview

US GAAP	IFRS
Unlike IFRS Standards, there is no specific definition of ‘investment property’; such property is accounted for as property, plant and equipment unless it meets the criteria to be classified as held-for-sale.	‘Investment property’ is property (land or building) held by the owner or lessee to earn rentals or for capital appreciation, or both.
Unlike IFRS Standards, there is no guidance on how to classify dual-use property. Instead, the entire property is accounted for as property, plant and equipment.	A portion of a dual-use property is classified as investment property only if the portion could be sold or leased out under a finance lease. Otherwise, the entire property is classified as investment property only if the portion of the property held for own use is insignificant.
Unlike IFRS Standards, ancillary services provided by a lessor do not affect the treatment of a property as property, plant and equipment.	If a lessor provides ancillary services, and such services are a relatively insignificant component of the arrangement as a whole, then the property is classified as investment property.
Like IFRS Standards, investment property is initially measured at cost as property, plant and equipment.	Investment property is initially measured at cost.
Unlike IFRS Standards, subsequent to initial recognition all investment property is measured using the cost model as property, plant and equipment.	Subsequent to initial recognition, all investment property is measured under either the fair value model (subject to limited exceptions) or the cost model. If the fair value model is chosen, then changes in fair value are recognised in profit or loss.
Unlike IFRS Standards, there is no requirement to disclose the fair value of investment property.	Disclosure of the fair value of all investment property is required, regardless of the measurement model used.
Similar to IFRS Standards, subsequent expenditure is generally capitalised if it is probable that it will give rise to future economic benefits.	Subsequent expenditure is capitalised only if it is probable that it will give rise to future economic benefits.
Unlike IFRS Standards, investment property is accounted for as property, plant and equipment, and there are no transfers to or from an ‘investment property’ category.	Transfers to or from investment property can be made only when there has been a change in the use of the property.

IFRS vs US GAAP Investment property IFRS vs US GAAP Investment property IFRS vs US GAAP Investment property

30 days past due rebuttable presumption – simple and sufficient

23/03/2021

Past due status and more than 30 days past due rebuttable presumption

– making loss provision calculations simple –

The second simplification available in IFRS 9 sets out a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due. [IFRS 9.5.5.11]

The first simplification available in IFRS 9 is the low credit presumption.

When payments are 30 days past due, a financial asset is considered to be in stage 2 and lifetime expected credit losses are recognised.

An entity can rebut this presumption when it has reasonable and supportable information available that demonstrates that even if payments are 30 days or more past due, it does not represent a significant increase in the credit risk of a financial instrument.

This 30 days past due simplification permits the use of delinquency or past due status, together with other more forward-looking information, to identify a significant increase in credit risk. The IASB decided that this simplification should be required as a rebuttable presumption to ensure that its application does not result in an entity reverting to an incurred loss model.[IFRS 9.BC5.190]

The IASB is concerned that past due information is a lagging indicator. Typically, credit risk increases significantly before a financial instrument becomes past due or other lagging borrower-specific factors (for example, a modification or restructuring) are observed.

Consequently, when reasonable and supportable information that is more forward-looking than past due information is available without undue cost or effort, it must be used to assess changes in credit risk and an entity cannot rely solely on past due information. However, if more forward-looking information (either on an individual or collective basis) is not available without undue cost or effort, an entity may use past due information to assess changes in credit risks.

Best Read – IFRS 10 Silos and deemed separate entities

06/03/2021

IFRS 10 Silos and deemed separate entities

generally require the control assessment to be made at the level of each investee entity. However, in some circumstances the assessment is made for a portion of an entity (a deemed separate entity). This is the case if, and only if, all the assets, liabilities and equity of that part of the investee entity are ring-fenced from the overall investee (often described as a ‘silo’) [IFRS 10 B76 – B79]. IFRS 10 Silos and deemed separate entities

Silos most often exist within special purpose vehicles in the financial services and real estate sectors (for example, ‘multi-seller conduits’ and captive insurance entities). However, the conditions for a silo to be deemed a separate entity for IFRS 10 purposes are strict. The example below illustrates the silo concept: IFRS 10 Silos and deemed separate entities

Example Bank – SPV – 2 Corporate clients

The case

Bank A establishes and administers a special purpose vehicle that enables two corporate clients – Companies A and B – to sell trade receivables in exchange for cash and rights to deferred consideration. The vehicle issues loan notes to outside investors to fund the purchases. Each company remains responsible for managing collection of its own transferred receivables. Bank A provides credit enhancements in exchange for a fee. The terms of the loan notes and contractual document establish how cash collected from each pool of receivables is allocated to meet payments of the loan notes. Cash collected in excess of the specified allocation is paid to the originators.

What does this mean?

A portion of an entity is treated as a silo if, and only if, the following conditions are met:

specified assets of the investee (and related credit enhancements) are the only source of payment for specified liabilities
parties other than those with the specified liability do not have rights or obligations related to the specified assets or to residual cash flows from those assets
in substance, none of the returns from the specified assets can be used by the remaining investee and none of the liabilities of the deemed separate entity are payable from the assets of the remaining investee.

However, in a real life case, further analysis will be required to determine whether the allocation provisions create a situation in which each pool of assets is substantially viewed as the only source of payment for specified liabilities.

Best short read – IFRS 9 Basis adjustment

23/02/2020

Basis adjustment

is used in hedge accounting and is the adjustment on an individual asset basis of the hedged item or portfolio basis of hedged items using a systemic and rational method for changes in business risks (for example interest rate risk, foreign currency risk) occurring throughout the hedging relationship’s life. The name comes from the fact that the (measurement) basis of the hedged item is always amortised costs

Basis adjustments are accounted for in the same manner as other components of the amortized cost basis of the hedged item. Partial dedesignation is permitted when expectations about the last of layer have changes such that the remaining amount is expected to be outstanding at the end of the hedging relationship is less than the hedged item. Partial dedesignation is required for the amount no longer expected to be outstanding. The basis adjustment associated with the amount of the hedged item dedesignated is allocated to all remaining assets in the closed portfolio using a systemic and rational method.

When the last layer is breached, full dedesignation is required. An entity would recognize a portion of the basis adjustment immediately on profit or loss. The remaining outstanding basis adjustment would be allocated to all remaining individual assets in the closed portfolio using a systemic and rational method.

Principles underlying the Banking IFRS 9 Guidance

Standards Reference

Lease payments – Lessee perspective

Categories of lease payment

Insurances acquired in the run-off period

IFRS 16 Variable lease payments

Context of this narrative

IFRS 10 Silos and deemed separate entities

Example Bank – SPV – 2 Corporate clients

Basis adjustment

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