Ifrs 9 Financial Instruments and Risk Management

Ifrs 9 Financial Instruments and Risk Management is a crucial aspect of the new standard. It introduces a new model for measuring financial instruments at fair value through profit or loss.

The financial institution must classify financial assets into one of four categories: measured at amortised cost, measured at fair value through profit or loss, measured at fair value through other comprehensive income, or held for sale.

Financial assets measured at fair value through profit or loss are subject to the new model, which requires the financial institution to assess whether a financial asset is a financial liability or a financial asset.

Financial liabilities are initially measured at fair value, with subsequent measurement at amortised cost.

Classification and measurement are two crucial aspects of IFRS 9 that determine how financial assets and liabilities are reported in financial statements.

Financial assets can be classified into one of three categories: Amortized Cost, FVOCI (Fair Value through Other Comprehensive Income), or FVPL (Fair Value through Profit and Loss).

For a financial asset to be classified as Amortized Cost, it must meet the contractual cash flow test and be held to collect contractual cash flows.

If a financial asset passes the contractual cash flow test, the business model assessment determines how the instrument is classified.

Financial assets can be held for various business models, such as collecting contractual cash flows, potentially selling the asset, or holding it for trading.

The business model assessment determines whether a financial asset is classified as Amortized Cost, FVOCI, or FVPL.

Financial liabilities are typically held at amortized cost, unless they utilize the fair value option.

Under the fair value option, an asset or liability can be reported at FVPL instead of amortized cost or FVOCI.

Here's a summary of the classification options:

The new impairment model under IFRS 9 requires companies to recognize projected lifetime losses more quickly, addressing a criticism of the previous model.

This change is intended to prevent companies from delaying recognition of asset impairments, which was a problem during the 2007-2008 financial crisis.

For most assets, the impairment allowance is measured as the present value of credit losses from default events projected over the next 12 months when the asset is acquired.

This approach is different from the FASB model, which requires full lifetime recognition from the time the asset is acquired.

The allowance will continue to be based on the expected losses from defaults over the next 12 months unless there is a significant increase in credit riski>.

A significant increase in credit risk requires the allowance to be measured as the present value of all credit losses projected for the instrument over its full lifetime.

If the credit risk recovers, the allowance can once again be limited to the projected credit losses over the next 12 months.

The exception to this general impairment model applies to financial assets that are credit impaired when they were originally acquired.

For these assets, the impairment allowance is always based on the change in projected lifetime credit losses since the asset was acquired.

This allows companies to more accurately reflect the true value of their assets and avoid delayed recognition of impairments.

Disclosure is a crucial aspect of financial reporting under IFRS 9. Life insurers are required to disclose the aggregate statement of financial position value and the fair value of their portfolio investments.

The quantitative disclosures should be made in the notes to the annual financial statements or in the audited portion of the annual return. This includes disclosing the fair value of portfolio investments separately for bonds and debentures, residential mortgage loans, non-residential mortgage loans, common shares, preferred shares, real estate, and other investments.

Separate disclosure is recommended for any type of portfolio investment that constitutes 10% or more of the carrying value of the total portfolio investments. For example, if a life insurer has a portfolio investment that makes up 15% of the total portfolio, it should be disclosed separately.

Life insurers are also expected to disclose separately the income, expense, and gains and losses resulting from each investment category. This helps stakeholders understand the performance of the life insurer's investments.

Here's a summary of the types of portfolio investments that require separate disclosure:

In addition to portfolio investments, life insurers are also required to disclose information about notional amounts for each class and type of derivative instrument. This includes assets such as forward rate agreements, futures contracts, swap contracts, options purchased, and options written.

The Fair Value Option is a crucial aspect of IFRS 9, allowing entities to designate financial assets or liabilities at fair value through profit or loss upon initial recognition.

This option is known as the "Fair Value Option", and it's a key feature of IFRS 9. Life insurers are exempted from this Chapter for their investments in loans if these investments would have otherwise been classified as Fair Valued through Other Comprehensive Income (FVOCI) under IFRS 9.

To apply the Fair Value Option, entities must meet the supervisory expectations set forth by OSFI, including applying the option in form and in substance, having appropriate risk management systems in place, and not applying the option to instruments for which they are unable to reliably estimate fair values.

OSFI expects institutions using the Fair Value Option to provide supplemental information to assist in assessing the impact of their utilization of the option.

Institutions using the Fair Value Option must also apply IFRS 9, as amended from time to time, including paragraphs 4.1.5 and 4.2.2.

The Fair Value Option should generally not be used for loans to companies having annual gross revenue below $75 million, for loans to individuals, or for portfolios made up of such loans. This requirement does not apply to life insurers' loans if they would have otherwise been classified as Fair Value through Other Comprehensive Income.

Here are the key requirements for using the Fair Value Option for loans:

Note that life insurers are exempt from this requirement for their investments in loans that would have otherwise been classified as Fair Valued through Other Comprehensive Income.

IFRS 9 was born out of a joint project between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) in response to the 2007-2008 financial crisis.

The project began with a joint discussion paper in March 2008, proposing a goal of reporting all financial instruments at fair value. FASB and IASB aimed to address perceived deficiencies in accounting standards that contributed to the crisis.

However, the two boards disagreed on several key issues and took different approaches to developing the new standard. FASB attempted to develop a comprehensive standard, while IASB released each component of the new standard separately.

In 2009, IASB issued the first portion of IFRS 9, covering classification and measurement of financial assets, which was intended to replace the asset classification and measurement sections of IAS 39. This marked the beginning of the IFRS 9 project.

The IASB's initial proposal was criticized for not including a category for fair value with certain changes in fair value reported in other comprehensive income (FVOCI). This criticism led to the issuance of an exposure draft in 2012 proposing limited amendments to the classification and measurement of financial instruments.

FASB and IASB worked together to develop a model for impairment of financial assets, with IASB issuing an exposure draft in 2013. The two boards also developed their hedge accounting models independently, with IASB issuing its portion of the IFRS 9 standard in 2013.

The final IFRS 9 standard was issued on July 24, 2014, after years of development and revision.

The Board formed the Transition Resource Group for Impairment of Financial Instruments (ITG) in August 2014 to help with implementation issues related to IFRS 9.

The ITG had only one introductory call in 2014 and three meetings in 2015, which resulted in a single issue being raised with the Board.

The Board noted the issue but decided no further action was necessary because the requirements of IFRS 9 were clear.

The Transition Resource Group was formed by the Board on 22 August 2014 to provide support on implementation issues for IFRS 9.

This group had a total of four meetings, including an introductory call in 2014 and three meetings in 2015.

Only one issue was raised with the Board as a result of these meetings, but the Board observed that the requirements of IFRS 9 were clear and no further action was necessary.

For more information on the Transition Resource Group for Impairment, you can visit the IFRS Transition Resource Group for Impairment page.

When implementing and transitioning to a new ECL methodology, it's essential to understand the pre-notification requirements to OSFI.

You must pre-notify OSFI of any material changes to a bank's ECL methodology and/or level, consistent with OSFI's past practice.

OSFI expects banks to establish and maintain a materiality definition with respect to modifications to its methodology for establishing ECL allowances and the level of ECL.

This definition should consider factors such as impact to systems, data, and processes, amongst other considerations.

OSFI may review the bank's materiality definition as part of its ongoing supervisory examination process.

Routine adjustments that are consistent with the institution's methodology to establish the ECL do not require pre-notification to OSFI, unless the adjustment could result in a material change to the ECL allowance level.

However, OSFI's review will focus on non-routine adjustments.

Here's a breakdown of the key points to keep in mind:

Management should closely monitor changing conditions and reflect such changes through the ECL allowance as appropriate.

This will help ensure that the bank's ECL allowance level accurately reflects the current economic conditions and portfolio composition.

The European Union endorsed IFRS 9 in November 2016 for mandatory application from 1 January 2018 onwards. A complete list of jurisdictions implementing IFRS 9 can be found by checking the list of worldwide adopted Financial Reporting Standards.

IFRS 9 is a financial reporting standard developed by the International Accounting Standards Board (IASB). It's applicable for annual periods beginning on or after 1 January 2018.

The standard has a broad scope, applying to all entities and types of financial instruments, with a few exceptions. These exceptions include interests in subsidiaries, associates, and joint ventures, as well as rights and obligations under leases.

The exceptions also include employer benefit plans, such as pensions, and own equity type instruments like stock options and warrants. Underwritten insurance contracts are also excluded, except for financial guarantees.

The objective of IFRS 9 is to establish principles for the financial reporting of financial assets and liabilities, providing relevant and useful information to users of financial statements.

IFRS 9 is a financial reporting standard developed by the International Accounting Standards Board (IASB) for financial instruments.

The standard is applicable for annual periods beginning on or after 1 January 2018, and earlier application is permitted.

The objective of IFRS 9 is to establish principles for the financial reporting of financial assets and liabilities.

These principles aim to present relevant and useful information to users of financial statements for their assessment of the amounts, timing, and uncertainty of an entity's future cash flows.

Financial statements, alongside disclosures mandated by regulators, are the main source of information about a financial institution's Balance Sheet.

The scope of IFRS 9 is quite broad, applying to all entities and types of financial instruments with a few exceptions.

These exceptions include interests in subsidiaries, associates, and joint ventures, which are not subject to the standard.

Rights and obligations under leases are also excluded from the scope of IFRS 9.

Employer benefit plans, such as pensions, are not covered by the standard.

Own equity type instruments, including stock options and warrants, are also outside the scope of IFRS 9.

Underwritten insurance contracts, except for financial guarantees, are not subject to the standard.

Here is a list of the exceptions to the scope of IFRS 9:

Recognition and Derecognition is a crucial part of IFRS 9. It all starts with initial recognition, which occurs when a reporting entity becomes party to the contractual provisions of an instrument, such as when purchasing an asset.

Recognition happens when the entity originates or purchases an asset, allowing it to appear in the statement of financial position. This is a key milestone in the financial reporting process.

Derecognition, on the other hand, happens when the contractual rights to the cash flows from a financial asset expire, or when the reporting entity transfers the financial asset.

Recognition is a crucial step in financial reporting, and it happens when a company becomes party to the contractual provisions of an instrument, such as when originating or purchasing an asset.

This means that a company must recognize a financial asset or liability in its statement of financial position as soon as it's involved in the contractual agreement.

Recognition is the first inclusion of an asset or liability in financial reporting, and it's essential for providing a true and fair view of a company's financial position.

To illustrate this, consider a company purchasing a new machine for its operations. The machine is a financial asset, and the company must recognize it in its financial statements as soon as the purchase is made.

Derecognition, on the other hand, occurs when a company transfers a financial asset or when the contractual rights to the cash flows from the financial asset expire.

OSFI Credit Risk Evaluation is crucial for Canadian banks, and it's closely tied to the IFRS 9 standard. This standard requires banks to embed forward-looking risk assessments in their financial condition measurement, which can be a significant change for many institutions.

Banks using the standardized approach (SA) to determine their capital requirements may need to develop new models from scratch, whereas those using the advanced internal ratings-based approach (IRB) can adjust their existing models.

The transition to the Expected Credit Loss (ECL) approach under IFRS 9 is a major undertaking, but it can also improve a bank's internal credit risk monitoring systems.

Banks must disclose their forward-looking risk assessments to external stakeholders, which can be a challenge for some institutions.

The adoption of IFRS 9 can benefit banks by improving their internal credit risk monitoring systems, but it requires a significant investment in new models.

Here's a brief comparison of the two approaches: