IFRS 9 – Financial Instruments “Road to a Successful Implementation of the New Requirements” Introduction

IFRS 9 – Financial Instruments “Road to a successful implementation of the new requirements” Introduction

Since the first discussions in 2008, and functional, procedural, technical, organi- prioritizes classification, measurement and once again exemplified in the publication sational, and strategic areas. Therefore, impairment, particularly concentrating on of the regulation ´IFRS 9 – Financial Instru- the implementation of these regulations our proven IFRS transformation approach, ment’ by the IASB in July 2014, it is clear requires time, professional and technical as well as the critical success factors that the new accounting and valuation expertise, a robust transformational which will be essential for the effective rules for financial instruments signify the plan, as well as a validated approach to implementation of IFRS 9 requirements. need for a fundamental change in the cover all dimensions. banking sector. The new regulations set forth must be implemented by 01/01/2018. The following report contains the business This deadline presents significant chal- requirements, in particular the strategic, lenges for the majority of European banks organisational, procedural and functional and financial institution, particularly in challenges posed by IFRS 9. This report

2 IFRS 9 – Financial Instruments Significant impacts of IFRS 9

IFRS 9 will replace the requirements for Classification and Measurement A valuation of amortised costs ( FVOCI) will classification and measurement of financial In future financial statements, the classifi- only be possible if the contractual cash instruments under IAS 39. While some of cation and measurement of financial flow characteristics (CCC-Test) show that the IAS 39 requirements can be trans- assets will be derived from the allocation these costs cover solely payments of ferred almost identically into IFRS 9 of the financial instrument to one of three principal and interest (SPPI). Establishing regulation (for example accounting of business models, which will be based on a distinction between ‘recycling’ and financial liabilities, derecognition rules), the design of the contractual cash flows. ‘without-recycling’ is important when accounting of financial assets under IFRS 9 measuring at FVOCI. Recycling means will be fundamentally different. This includes There are three valuation methods (known that after derecognition of a financial the classification and measurement of from IAS 39) - amortised cost, fair value instrument, a reclassification of the financial assets, the introduction of a through other comprehensive income, accrued effects in OCI is required in the new impairment model and new hedge (FVOCI) and fair value through profit and income statement. A derivation of the accounting rules1. loss (FVP&L). measurement categories is highlighted in Figure 1.

Figure 1: Derivation of classiﬁcation/ measurement from the business model und CCC-Test

Approach for classiﬁcation of ﬁnancial assets according to IFRS 9

Financial Assets Derivatives Equity instruments

Business Model Business Model „Hold & „Hold“? Sell“? Trading intended?

Contractual cash ows are solely principal and interest (CCC-Test positive)? Fair Value Option chosen?

Fair Value Option chosen?

FVOCI FVOCI Amortised Cost FVP&L (Recycling) (no Recycling)

1 IFRS 9 regulation for hedge accounting will not be covered in this document as the focus of this report is on classification, measurement and impairment.

3 Impairment instruments, IFRS 9 requires allocations in Loss’ (generally at initial recognition and Depending on the selected business three stages, according to the credit risk low default risk) and a ‘Lifetime Expected model, a new impairment model may have of the transaction. Consequently, financial Loss”. For calculation of the loan loss to be applied. Under IAS 39 only the assets which were previously classified as allowances/ provisions, the same para- incurred losses are considered, however, ‘performing’ must now be distinguished meters which have already been used 2 now the new expected loss approach as either having a low or high default risk . under IAS 39, will predominantly be requires the recognition of the expected applied – i.e. default probabilities, expected In the future, a loan loss allowance/ future losses of each financial instrument. cash flows, and historical effective interest provision will have to be established for The new impairment model is mandatory rates. Additionally, parameters with all financial assets to which the new impair- for all financial instruments, which should forward-looking information, particularly ment model applies. This means that in be measured at amortised cost or at fair macro-economic factors, must be taken comparison to IAS 39, an expected loss value through OCI in accordance with into consideration. should already be predetermined and IFRS 9. recorded in the accounts, after the The following overview illustrates the Contrary to IAS 39 regulation which only financial instrument is recognized. The three-stage-model including the relevant requires a distinction between ‘performing’ IFRS 9 regulation distinguishes between impairment recognition. and ‘non-performing/ defaulted’ financial the determination of a ‘12 Month Expected

Figure 2: Overview of the new impairment model

Three-Stage Model for impairment recognition

Stage 1 Stage 2 Stage 3

High default risk/ significant Low default risk Credit-impaired Credit Quality deterioration since recognition

Impairment 12-Month-Expected Lifetime Expected Lifetime Expected recognition Credit Loss Credit Loss Credit Loss

Basis for interest Gross Carrying Gross Carrying Net Carrying revenues Amount Amount Amount

Signiﬁcant increase in credit risk Objective triggers for impairment

2 Under IFRS 9 regulations, financial instruments which have suffered a significant deterioration since entry are assigned to stage 2.

4 IFRS 9 – Financial Instruments 5 Challenges

Strategy Impairment Model Organisation Business Model The new expected loss approach for Strategic changes typically require organi- IFRS 9 regulations require financial instru- measuring impairments will have sational re-designs. As such, it is beneficial ments to be allocated to one of three a significant impact on performance to critically analyse the organisational business models. Depending on the indicators, which means that financial structure while implementing IFRS 9. business model that is assigned, the institutions and companies should • Is the current organisational initial and subsequent measurement perform indicative scenario and structure still appropriate? Are any of financial instruments may vary. As a simulation calculations early on in order adjustments required? result, these measurements are reflected to foresee potential consequences and • Which areas/ departments/ teams are differently in the balance sheet and the modify the performance indicators (incl. affected by the implementation of income statement. Therefore, before budget figures) accordingly. A solid IFRS 9? Will the affected groups implementing IFRS 9, it is essential to methodology for defining and handling be sufficiently informed about the analyse the potential consequences of the three different classification levels is changes and consequences, and assigning the individual product groups essential. It is important to establish the adequately integrated into the into one of the three business model impairment models based on common implementation project? categories. Assignment changes will only data sets. When defining an appropriate • How are prospective roles and respon- be possible in exceptional cases. The impairment model, the following key sibilities structured within the line following questions must be answered issues, amongst others, may arise: operation? Is appropriate expertise prior to the assignment of product • How will the IFRS 9 criteria be defined available? In which areas is groups: for the classification of Stage 2 training needed? • Is the assignment of the product ‘significantly deteriorated’ and Stage 3 • How can a group-wide implementation groups in line with the business ‘defaulted’ in accordance with other of IFRS 9 inclusive of all branches strategies? Are adjustments to the regulations (e.g. EBA, forbearance, and subsidiaries in compliance with existing strategies required? CRR)? the group’s accounting policies be • To which product groups can the • Can the current impairment models ensured? How will the cooperation classifications according to IAS 39 (individual vs. portfolio-based approach) with these entities take place? (held to maturity, held for sale, available still be used or adjusted to meet the The appropriate cooperation between for sale, loans and receivables) be IFRS 9 requirements? Should a new major projects and line organisations applied? Which product groups need impairment engine be established? poses a significant challenge for institutes new classification and thus a different • How should forward-looking informa- and companies, especially considering valuation methodology? tion (e.g. macroeconomic factors) in that the line organisation usually has • What (if any) impacts will the business impairment models be taken into limited resources. Nevertheless the line model assignment have on the account? How should the regular organisations must provide substantial business plan (short, medium and long validation process be performed? technical input and support. It is important term)? • Which macroeconomic factors will to keep the line organisations informed in • What impact will IFRS 9 have on the impact the business segments? Who the early stages of the project initiation in key performance indicators (particularly provides reliable forecasting data for order to ensure their support/ commitment risk management)? Are the current selected factors? to the project. The necessary cooperation company balance sheet and P&L • How is data availability and how is the between risk and finance on the IFRS 9 control mechanisms still sustainable? quality regarding the new impairment models ensured?

6 IFRS 9 – Financial Instruments project presents a unique challenge, • Should new processes be defined be allocated to Stage 2 – which means since these areas have different focuses, and established (allocation of financial that poor data quality leads to higher loan separated process sequences, and instruments to the different stages in loss allowances. different approaches. In addition, cultural the expected loss model)? Are these differences in these areas have to be new processes performed automatically Extensive analyses (especially data in taken into account. or manually? source systems) are usually required in order to avoid dirty data as well as to help Processes and architecture Data availability and quality identify and solve any problems that may The introduction of IFRS 9 to financial The availability of high quality data is arise. instruments does not only pose significant essential to the implementation of IFRS 9, Internal and external reporting challenges to the organisational structure, especially with regard to the allocation but also to the operational structure. of impairment calculations to the different Disclosure requirements under IFRS 9 for The new requirements for the accounting stages. In order to assess the change internal and external reporting vary. and impairment models must be mapped in credit quality and to calculate the Existing systems, processes and inter- and implemented systematically and impairment, it is important to track and faces (for internal and external reporting) procedurally. archive transaction data. Thus, it must be should be adapted, with a particular ensured (for the initial application) that a focus on disclosures, in order to meet Firstly, it must be determined whether the 12 month expected loss can be calculated the requirements and to provide the new functional requirements can be on the basis of historical data. In addition, mandatory information for reporting implemented within the existing functional the new expected loss models require purposes. For instance, a list of infrastructure. If not, the existing system new attributes and features (macroeco- unavailable data should be compiled if components will need additions or replace- nomic factors), which must be generated the unavailability is a result of restructured ments by new systems or applications or made available by the respective contracts, modified model parameters or (e.g. SAP-BA-AFI). In regard to the systems. As a result, a major challenge movers between the three stages. With existing IT systems and processes, is that existing source systems can often these issues in mind, the company should the following questions arise: only be expanded with significant effort. be aware of following challenges: New systems are also associated with • At which process stage should a External reporting high costs. In practice, time-consuming classification of financial instruments data reconciliations usually have to be • What information must be disclosed in take place (e.g. front office)? performed manually to ensure the required the financial reports? What information • Can the systems be adapted such quality and validity of these models are is already available within the company that a classification decision is met. in the different systems? possible? Can a precise and coherent • How does one deal with unavailable documentation (justification of In order to adequately address the quality data? Can it be collected without much classification decision) be ensured? and availability of data required for the effort? What consequences may arise • How do verifications/ validations of project, sufficientsimulations and quality due to missing data? these classification decisions take gates must be installed. Data delivery • How will IFRS 9 requirements and place (establishment of fixed automated must meet a minimum quality standard in its initial application in the notes be validation rules)? regard to the different requirements such displayed? • Can the existing valuation architecture as data quality tests and the analyses of • When will required data be available? approach fulfil the 3-stage expected the balance sheet and income statement. Are account closing plans and loss model? Is it necessary to introduce For instance, if there is insufficient informa- respective publications endangered?3 a new model/ system (i.e. impairment tion to allocate a transaction to the Stage 1 engine)? impairment phase, this transaction has to

7 Internal reporting assets under IFRS 9, the following tasks • Adaptation of accounting procedures: • What information does the top have to be addressed: New booking procedures in accounting management need to make decisions? • Impact on chart of account: Under must be defined for both impairment • Is the internal reporting in line with IFRS 9, a content-related reallocation and for the re-categorisation of the strategic direction of the company of financial instruments to accounts financial instruments. after reworking the business models and categories must be made – the • Expansion of internal policies: New with regard to IFRS 9? same applies for the conception of rules for accounting and measurement • How many internal reports are affected impairments. New accounts have to be of financial instruments (under IFRS 9) by the changes/ improvements? opened and/ or existing accounts have must be incorporated into the group Who is responsible for making the to be recorded. The conflict between guidelines (e.g. handling of non- necessary adjustments? a central solution and a local chart of performing loans (Stage 3) and group accounts is a particular challenge. accounting policies). Additionally, in order to ensure the proper recognition and valuation of financial

3 Data availability is also a procedural challenge in particular

8 IFRS 9 – Financial Instruments 9 Our transformation approach

Capgemini Consulting, the global strategy simulations/ conception scenarios strategy and the definition of detailed and transformation consulting brand of are also conducted. The anaylses help business requirements, i.e. the expect- Capgemini Group, has extensive experi- identify the potential impact of IFRS 9 ed loss models, booking procedures, ence, best practices and validated process on the aforementioned areas, as well architectural components, processes, methodologies to support customers as help define measures and recognize organisation and the necessary data with the implementation of IFRS 9. The areas where action must be taken. In management. In addition, applicable process mode that Capgemini Consulting the initial phase, the development of an test concepts are developed in order has developed is divided into four phases. Architecture Blueprint is essential as it to consider the needs in the design defines the architectural framework and phase by using cases from the test Phase approach sets up ‘Principles’ for the project. The perspective. This phase is essential in • Scope & Analysis Phase –The framework will be validated and the project lifecycle to ensure that all objective here is to gain a clear adjusted during the project if neces- requirements in the functional or under-standing of customer structures. sary, depending on the applicability. technical concepts are included and The focus is on the as-is analysis • Design Phase – The design phase fully validated before the implementa- i.e. the understanding of the business defines the target picture of IFRS 9 tion phase starts. Above all, the most model, organisation, processes for risk and financial functions, the essential part of the design phase is and architecture. Gap analyses and development of a transformation the involvement of the line organization,

Figure 3: Which is the way to go in order to master the challenges?

Sucessfully initiation the Transformation – 4 Phases

Phase 1 – Scope & Analysis Phase 2 - Design Phase 3 - Implementation Phase 4 - Reporting

Collect top management‘s nance Identi cation and classi cation of Implementation of necessary Improvement of IFRS 9 processes and risk vision and ideas to de ne different project tasks IT service components and Model adjustments goals, scope and assumptions Close alignment with all involved IT architecture Optimisation of data availability Analyses of as-is situation departments Development of calculation and data quality Classi cation criteria Development of change models Analysis and report of occuring Business models management strategy Integration of data storage deviations between IFRS 9 Risk models IT architecture solutions, data streams and and IAS 39 Reporting processes Data modeling process workows Adjustment of nance and Organisational model Process design Modi cation of organisational risk reports Existing IT infrastructure, Roles & Responsibilities and nance structure Communication with business units systems and data sources Process map Adjustment of existing to de ne occurring impacts Collection and analysis of legal Creation of test concepts process maps Adjustment of organisation and requirements Creation of teaching and governance function Creation of blueprint with high- training materials (Optional: Parallel reporting) level target image that is validated Analysis of additional during the project requirements Development of simulation tools, Detailed transformation data sets and scenarios management Plan Preparations of Go-Live

1-3 Months 3-8 Months 8-12 Months

10 IFRS 9 – Financial Instruments and to ensure that they understand Capgemini Consulting also offers optional the processes, has to be performed. For the specific needs and can validate the post going live support, helping compa- this reason, it is advisable to compile a design. Within the design phase, it is nies tackle problem areas that could have blueprint in the beginning to analyse the fundamental to ensure the quality of occurred throughout the implementation processes and architecture components data in order to avoid too many manual phase or in low-priority areas. In this affected by IFRS 9. Based on the alignments and to ensure that a phase Capgemini Consulting will provide aforementioned analysis results, suitable solution with a stable process is found. continuous improvement approaches. project governance with corresponding • Implementation Phase – The project work streams should be defined in implementation phase focuses on the Parallel phase as option for 2017 order to meet all organisational, functional execution of the target picture, includ- An optional approach for the implemen- and technical requirements. A clear defi- ing the architecture components and tation is known as the ‘Parallel Run’. Here, nition of organisational structures, roles applications such as IFRS 9 calculation Capgemini Consulting supports the and responsibilities is required. Manage- engines. These calculations consist of implementation of processes and aligns ment must also remember that subsi- new booking procedures, adjustments the applicable development models. diaries and branches will need assistance of the data models or reports, as well Consequently, it is essential to quickly from the parent company in order to meet as other processes (such as new identify additional tasks that must be IFRS 9 regulations locally. reconciliation processes for ensuring accomplished, such as the validation of a high quality of data). Necessary the IFRS 9 results, or the stabilisation of Harmonisation of finance and risk changes in the organisational and the new processes. Since the regulators For the implementation of IFRS 9, it financial structure can then proceed do not necessarily require a ‘Parallel Run’, is essential that finance and risk work once the other processes are it can be considered an optional compo- together towards a joint goal. The focus completed. This includes e.g. the nent in the implementation planning. of the harmonisation should be on: involvement of line managers during However, financial institutions and • the joint usage of data for calculation the implementation phase in order to companies that decide to execute a of ‘expected loss’ as well as the obtain the practical test early on. ‘Parallel Run’ must be aware that the associated impairment bookings Another integral part of the implemen- IFRS 9 solution has to be set up by the • the harmonisation of time schedules tation phase is the collaboration of beginning of 2017. for the creation of risk and financial relevant departments throughout the reports Critical success factors for an IFRS 9 testing phase to ensure the usability of • highlighting process dependencies project IT developments and the accuracy of between finance and risk and merging the implementation. Holistic and need-based project these processes • Reporting Phase – In order to ade- approach • an efficient organisational set-up that quately prepare for going live, optimi- The chosen project approach will play satisfies the harmonised process sation possibilities will be developed an important role because a holistic in the last phase, i.e. adjustments in implementation approach is necessary in methods or analyses will be performed order to cover the individual needs and in order to explain or validate any requirements of customers. In order to discrepancies. If necessary, adjust- derive and prioritise the individual areas of ments to the organisational and action, a comprehensive analysis of the governance functions will be made at organisation, the system architecture, and this time.

11 Efficient project and change Robust system architecture Profound business impact analysis management Each institution must define an efficient A profound and early ascertainment of In order to ensure a successful project system architecture for the IFRS 9 solution the quantitative effects of IFRS 9 on the implementation, an efficientProject based on the system architecture that company’s performance indicators and Management Office (PMO) has to be adapts best to the existing infrastructure. financials is essential in order to take stra- established. The PMO is responsible for When selecting systems and applications, tegic measures (e.g. corporate strategy, the definition and implementation of important decisions need to be made product line) early on and to sustainably comprehensive unified reporting and regarding compatibility, adaptability and align the business plan accordingly. project processes (standard reporting, local or centralised implementation. Besides long-term expected changes, a meeting framework, staffing process, risk Here, IFRS 9 should represent an business impact analysis should definitely register, and administrative checks). additional component of an integrated include the ascertainment of initial adoption finance and risk architecture. An effects, which must be disclosed and A central change management team sup- integrated finance and risk architecture explained in detail in the external report. ports and coordinates the project commu- enables the centralisation of the major nication within the company and ensures functionalities. that there is adequate stakeholder management, particularly at the top management level, in order to ensure the ongoing Figure 4: Exemplary central IFRS solution incl. functional overview support and agreement at all hierarchical levels. A structured communication, Germany Italy separation and integration of potentially competing projects (e.g. BCBS 239, Customer/Market Customer/Market AnaCredit) can generate additional Operating system Operating system synergy effects.

However, the main responsibility of the Local Local general Local Local general subledger ledger subledger ledger change management team is to ensure the efficient and transparent handover of project activities to the line organisation. Early on it is recommended that regular Central IFRS 9 solution meetings (e.g. brown bag sessions, Stage Expected loss Alignment and Data communication forums, newsletters) take Impairment Booking de nition calculation control warehouse place, where employees outside the project can be informed on project topics and statuses. With the help of a training Group consolidation concept adjusted for the line organisation, professional, procedural and technical changes can be transferred into the business organisation. © Capgemini Consulting 2016

12 IFRS 9 – Financial Instruments Early involvement of locations In addition, the quality gatekeeper has to Transformation manager Among global financial institutions or ensure that the quality of the data meets In large companies, the establishment of companies, it is essential to involve the the standards of the IFRS 9 solution ´transformation managers’ is recom- locations early on, so that the country- definition. This means that the quality mended, as these managers represent specific requirements are understood gatekeeper has to ensure that data the link between the project and the and included in the solution making validation receives technical support line organisation. This role is usually process. This is especially important for a throughout the entire process, so that the performed by representatives from the centralised solution for IFRS. In order to significance of numbers is improved and departments that participate in regular take resulting complexity into account, costly manual alignment is not required. meetings, maintain the flow of information sufficient time for coordination between Taking these steps can drastically reduce in both directions, communicate project the different locations must be planned the error rate and manual work steps. requirements and ensure the subsequent throughout the design and implementation implementation in the line. Profound test management phase. In order to ensure a smooth execution of Early involvement of the auditor Appropriate data management, data the testing phase and due to the large Early and ongoing involvement of governance and data quality number of required system-based a corresponding auditor should be A suitable data management with uniform adjustments, efficient test management established in order to discuss and functional language, appropriate data should be set up early on. These include prevent possible consequences for non- quality and data governance has to be i.e. conception of test plans, definition of compliance/ deviations from the IFRS 9. built. Companies are encouraged to hire test principles, selection of appropriate This ensures that the design does not lead a Quality Gatekeeper who will be solely testing tools for documentation purposes, to serious issues during the annual audit responsible for the fulfilment of data definition of test environments, creation procedure. standards and maintaining the quality of test frameworks as well as test case of data. definitions etc. – thus, a test management should already be set up and involved in The Quality Gatekeeper should also the design phase. ensure the uniform treatment of different data standards. In financial institutions, it is not unusual that different data standards are used in finance and risk functions.

13 Why Capgemini Consulting?

Together with our clients we develop an individual and efficient project approach, which accounts for the needs and characteristics of our clients. For this purpose we draw on our long-term expertise, international experience, latest trends and best practices from the banking and industry sector. With the support of our colleagues from Capgemini Application Services and our subsidiary Sogeti, we can provide a comprehensive project team comprising technical, process and project management experts combined with IT implementation and testing experts. Thus, we offer a holistic transformation approach from a single source that covers the project setup right up to go-live support of all phases in a project.

14 IFRS 9 – Financial Instruments Authors

Joachim von Puttkamer Dr. Ulrich Windheuser Vice President – Corporate Excellence & Principal – Corporate Excellence & Transformation Transformation [email protected] [email protected]

Patricia Sagert Daniel Biechele Manager – Corporate Excellence & Manager – Corporate Excellence & Transformation Transformation [email protected] [email protected]

Dr. André Schultz Senior Consultant – Corporate Excellence & Transformation [email protected]

Capgemini Consulting Contacts

Global Germany/Austria/Switzerland India Jean Coumaros Christian Kroll Natarajan Radhakrishnan [email protected] [email protected] [email protected]

Norway Belgium/Luxembourg Asia Jon Waalen Robert van der Eijk Frederic Abecassis [email protected] [email protected] [email protected]

United States Spain Netherlands Scott Tullio Christophe Mario Freek Roelofs [email protected] [email protected] [email protected]

France United Kingdom Stanislas de Roys Keith Middlemass [email protected] [email protected]

15 About Capgemini Consulting

Capgemini Consulting is the global strategy and transformation consulting organisation of the Capgemini Group. More than 3,600 consultants advise and support enterprises in their sustainable processes of change. The services range from the conception of innovative strategies to their execution, always with an unstinting focus on results. With the substantial changes of economy and society through digitalisation, Capgemini Consulting works with leading companies and governments in their individual Digital Transformation. The basis for this rests upon on a profound expertise for the digital economy and a leading role in business transformations and organisational change.

Find out more at www.de.capgemini-consulting.com

About Capgemini

With more than 180,000 people in over 40 countries, Capgemini is one of the world‘s foremost providers of consulting, technology and outsourcing services. The Group reported 2015 global revenues of EUR 11.9 billion. Together with its clients, Capgemini creates and delivers business, technology and digital solutions that fit their needs, enabling them to achieve innovation and competitiveness. A deeply multicultural organization, Capgemini has developed its own way of working, the Collaborative Business ExperienceTM, and draws on Rightshore®, its worldwide delivery model.

Find out more at www.de.capgemini.com

About Capgemini and Sogeti

Sogeti Deutschland GmbH is a leader in the area of ‘testing and quality assurance of software’ and part of the international Capgemini Group. Sogeti has dedicated itself to optimise the quality of software projects. Our customers are especially banks, insurance companies, telecom companies, trade, industry and public authorities. Our expertise is expressed through Sogeti’s developed quality assurance methods TMap® und TPI®, which are practice-oriented and recognised internationally in the market. For this purpose Sogeti publishes literature.

Find out more at www.sogeti.de