IFRS 9 Impairment post-implementation review by IASB – your involvement wanted

The International Accounting Standards Board (IASB) is undertaking a post-implementation review of the expected credit loss requirements in IFRS 9 Financial Instruments. This review is a Request For Information (RFI) focused on Impairment requirements. Comments are to be received by the end of September.

4most is discussing this with clients and industry leaders and hosting round table sessions in late August/early September, to prepare feedback for a response. If you would like to be involved please contact Phillip Dransfield on phillip.dransfield@4-most.co.uk or Thomas Hirst thomas.hirst@4-most.co.uk.

The RFI highlights certain key areas of the standard where the IASB has already gained insight from stakeholder feedback. There are 10 sections covering from general information to specific topics identified from prior advisory group discussions, and questions on disclosure requirements (and IFRS 7).

To give a little insight to some of the issues we will be considering one question asked is whether the standard can be applied consistently. Since adoption conditions have been quite volatile and introduced a great deal of uncertainty and risk for reporting firms. That has greatly tested the methods and assumptions underpinning many firms’ models and adopted approaches. At 4most, we have worked with many clients in development, validation, and application and have seen and experienced these challenges. Consistency of application across reporting firms and even within firms has been an issue. There will be a lot to unpick in thinking about how to answer this question.

It might help to look and compare the text and guidance of the Standard to an alternate approach. Banks wishing to report credit risk capital using the Internal Ratings Based (IRB) approach must adhere to a standard (capital rules) for model development and application. The capital rules provide a materially greater level of detail as to what is required for compliance in comparison to the IFRS 9 standard and guidance. Coming out of the 2008/09 financial crisis regulators and governments pointed to inconsistent application of the capital rules as a key driver of the issues causing the crisis. The response has taken a long time to develop and is still to be fully adopted but it is very evident that there is a large difference in the detail of the direction provided by the relevant authorities between the accounting and regulatory capital standards.

Despite this, when work is undertaken in firms’ modelling functions, independent validation and governance committees, firms have largely adopted a single internal standard to modelling, each requiring a thorough check of the texts to understand whether certain approaches are allowed with documentation detailing how the decisions align with the standard/regulations. Most firm’s approaches to model risk – through their frameworks, policies and standards cover a consistent approach for modelling.

With an assumed consistency in internal approaches, there is no doubt a degree of confusion – possibly lack of awareness and/or misunderstanding, as IRB models align to what is intended as a thoroughly defined granular direction on key modelling decisions – to eliminate risk weight variation between firms models, whereas for IFRS 9 models firms need to make a greater leap from modelling decisions to an understanding of what is an objective interpretation of the standard. An example of this is when discussing the definition of impaired/default where IRB has detailed guidelines, definitions, and calculations of areas such as diminished obligation, whereas IFRS 9 largely relies on a backstop position of 90 days-past-due with the rest being determined by each organisation separately (specific to impairment/default).

There are, of course, good reasons for this – IRB regulation provides a fixed formula (for risk weighted assets) which require inputs (probability of default – PD, exposure at default – EAD, and loss given default – LGD) in a specific form for the resultant calculation to be in line with expectations. Whereas IFRS 9 has a general aim of a discounted cash shortfall over the next 12 months or lifetime of the account and how to do this is largely undirected from a modelling methodology perspective.

However, firms have converged on a narrow set of modelling approaches, a two-stage discounted ECL consisting of a PD, EAD and discounted recovery in the form of LGD. Therefore, there could be opportunity for a more prescriptive standard or accompanying guidance that provides detail on expected model development requirements, if not aligned with, at least as prescriptive as credit risk capital modelling. Guidance that addresses known and material modelling and estimation issues faced by reporting firms will help strengthen the quality and robustness of application and challenge offered by those overseeing matters.

There will likely be a need to have the ability to follow alternate, more simplistic, approaches in some circumstances for smaller portfolios and lenders, and a question is asked in this regard. Such alternates could be signposted as a compliant option if rationale is given for deviating. This ‘two tier’ approach is not dissimilar to what is happening at the moment in practice, as auditors have industry best practice in mind but will accept alternates where limitations, for example, in data availability, prohibit its application.

More prescriptive technical modelling guidance would be material change in the approach to the accountancy standard and potentially raise concern in the interpretation from financial purists but, given the concern raised about consistency in the RFI, and that enhanced guidance, detail and prescription is advocated by the industry for capital reporting it would seem a viable solution – and a strengthening of standards – to ensure that the application and interpretation of IFRS 9 impairment numbers is on an equal footing across all organisations.