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IFRS Newsletter: IFRS 9 Impairment, Issue 3, December 2015

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IFRS Newsletter: IFRS 9 Impairment, Issue 3, December 2015 Issue 3, December 2015 IFRS 9 Impairment IFRS Newsletter ITG members provided insights What happened in December 2015? across a number At its third substantive meeting – in December 2015 – the IFRS Transition Resource Group for Impairment of Financial Instruments (the ITG) discussed a number of of implementation issues that were submitted by stakeholders. issues, including ITG members provided useful clarification on a number of challenging practical the use of forward- issues. Some of the main points on which ITG members appeared to agree were looking scenarios. as follows. − The objective of IFRS 9 Financial Instruments is to achieve an unbiased and probability-weighted estimate of expected credit losses (ECLs). Therefore, when incorporating forward-looking scenarios, an entity should consider the range and probabilities of different outcomes (see Issue 1.1). − The Chair emphasised that the exception in paragraph 5.5.20 of IFRS 9 was meant for a narrow set of circumstances. It is relevant where there is an inter-relationship between the drawn and undrawn amounts that are not distinguished for risk management purposes (see Issue 2). − A charge card agreement might include no commitment to extend further credit (see Issue 3). − When determining the period over which an entity is expected to be exposed to credit risk (when applying paragraph 5.5.20), an entity should consider the credit risk management actions that management expects to carry out and that serve to mitigate ECLs (see Issue 4). − An entity may include cash flows expected from the sale of a defaulted loan in measuring ECLs (see Issue 6). Next steps For each issue submitted, the IASB will consider what action – if any – is required. Currently, no further physical ITG meetings are scheduled. However, the Chair indicated that the ITG will continue to exist, and should stand ready in case any subsequent issues for discussion emerge. The Chair said that stakeholders could continue to submit questions, and that a decision would then be taken on next steps. One potential outcome would be the publication of educational material. © 2015 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 1 Agenda papers discussed at the December meeting Agenda Paper Page 1 Incorporation of forward-looking scenarios 3 2 Scope of paragraph 5.5.20 of IFRS 9 7 3 Measurement of ECLs for charge cards 9 4 Period over which to measure ECLs for revolving credit facilities 10 5 Collateral and other credit enhancements and the measurement of ECLs 11 6 Inclusion of cash flows expected from sale of a defaulted loan in the measurement of ECLs 12 7 Meaning of current effective interest rate 14 8 Assessing for significant increases in credit risk for financial assets with a maturity of less than 12 months 15 9 Measurement of the loss allowance for credit-impaired financial assets 16 10 Presentation of the loss allowance for financial assets measured at amortised cost 17 Other issues discussed at the December meeting The Chair reported that the IASB had discussed in October whether it would be appropriate to include amounts in excess of the contractual credit limits when estimating future draw-downs in respect of the undrawn element of revolving credit facilities.1 The IASB acknowledged the issue but did not propose that any further action be taken. This was mainly because the requirements of IFRS 9 are clear on how ECLs should be measured, despite the concerns raised on this particular matter. The IOSCO representative at the meeting emphasised the importance of clear disclosures in explaining to users the judgements and estimates that entities make in applying the IFRS 9 impairment model. Descriptive and summary statements in this newsletter are based on notes that have been taken in observing the IFRS Transition Resource Group for Impairment of Financial Instruments (the ITG). They are not intended to be a substitute for the final texts of the relevant records or the official summaries or minutes of ITG discussions which may not be available at the time of publication and which may differ. Entities should consult the texts of any requirements they apply and the official summaries of Board meetings and ITG meetings, and seek the advice of their accounting and legal advisors. 1. The issue was originally discussed in Agenda Paper 3 of the September 2015 ITG meeting (see our IFRS Newsletter: IFRS 9 Impairment – Issue 2) and again at the October IASB meeting (see our October web article). 2 © 2015 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 1. Incorporation of forward-looking scenarios 1.1 When measuring ECLs can entities use one single forward-looking economic scenario, or do they need to incorporate more than one forward-looking economic scenario and, if so, how? What’s the issue? The objective in measuring ECLs is to determine an unbiased and probability- weighted estimate of credit losses by evaluating a range of possible outcomes2. The following questions were posed to the ITG. − Are single or multiple forward-looking economic scenarios required in measuring ECLs? − How should an entity incorporate multiple forward-looking economic scenarios into the measurement of ECLs? − What sources of information are used to determine forward-looking scenarios? The submitter identified the following possible approaches to incorporating multiple forward looking-scenarios. Methods 1 Use a single forward-looking economic scenario that represents the most likely scenario. 2 Use a single forward-looking economic scenario that represents the weighted average of all the scenarios considered, weighted by the likelihood of occurrence for each scenario. 3 Estimate ECLs for each of the scenarios considered, and weight the outcomes based on their probabilities. 4 Use the most likely scenario (as in Method 1) and apply an ‘overlay’ adjustment so that the ECLs also reflect the less likely scenarios. A simple example was given. Assume that an economist predicts that future unemployment is most likely to be 5% over the next year, but that it could be: − 4% (a 20% likelihood, in which case ECLs would be 30); − 5% (a 50% likelihood, in which case ECLs would be 70); or − 6% (a 30% likelihood, in which case ECLs would be 170). In this scenario, ECLs would be measured as follows. − Method 1: 70, based on the most likely scenario. − Method 2: future unemployment would be predicted as 5.1%, being (4% x 0.2) + (5% x 0.5) + (6% x 0.3). − Method 3: 92, being (30 x 0.2) + (70 x 0.5) + (170 x 0.3). 2. Paragraph 5.5.17 of IFRS 9. © 2015 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 3 ITG members What did the ITG discuss? appeared to agree that the objective of Issue ITG discussion IFRS 9 is to achieve Can an entity ITG members appeared to agree that the objective of IFRS 9 an unbiased and use a single is to achieve an unbiased and probability-weighted estimate forward-looking of ECLs. This means that an entity should consider the probability-weighted scenario in range and probabilities of different outcomes. estimate of ECLs. estimating ECLs? What methods ITG members appeared to agree on the following. of incorporating − When there is significant non-linearity across the multiple outcomes of different forward-looking scenarios, then forward-looking basing the estimate of ECLs on the results of only one scenarios are scenario – e.g. a best estimate or using the mean of acceptable? multiple parties’ best estimates of inputs – would not achieve this objective. − IFRS 9 does not require a specific method, and so different methods may be appropriate – an entity should use an approach consistent with the measurement objective. − An entity’s estimate of ECLs reflects reasonable and supportable information that is available without undue cost and effort about forecasts of future economic conditions. Therefore, the approach that is used would depend on what reasonable and supportable information is available without undue cost and effort – this might vary by entity, jurisdiction and portfolio (including the significance of the portfolio). − It is important that the scenarios used to estimate ECLs are consistent with information used by the entity for other purposes – e.g. capital models, budgeting – but there may be valid differences – e.g. if information was prepared for a different point in time. Can an entity Many ITG members noted that, although ECLs are entity- rely on its specific estimates, an entity is required to use reasonable own internal and supportable information that is available without undue projections, or cost and effort; therefore, they would expect external does it need information to be considered in developing and validating an to take into entity’s internal estimates. account external Some ITG members thought that external projections may projections? not be sufficiently granular to estimate ECLs for specific portfolios of instruments. 4 © 2015 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 1.2 How should an entity take into account forward-looking economic scenarios when determining whether there has been a significant increase in credit risk? What’s the issue? Information used to determine whether there has been a significant increase in credit risk has to include reasonable and supportable forward-looking information if it is available without undue cost or effort3. The issues identified by the submitter were: − whether more than one forward-looking economic scenario should be considered; and − how to incorporate forward-looking economic scenarios into the assessment of significant increases in credit risk. The submitter suggested the following potential approaches. Approaches A Consider the change in risk of default since initial recognition using a single forward-looking economic scenario. This is consistent with Method 1 for Issue 1.1 above.
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