Time For Action On AASB 9 – Financial Instruments
AASB 9 was primarily developed in response to the lessons learned from the Global Financial Crisis (GFC). Some blame for the GFC was directed at the complexity and valuation of financial instruments and the delayed recognition of credit losses (primarily relating to residential housing loans in the USA).
Part of the response from regulators has been to establish a single new standard that seeks to standardise classification and fair value of financial assets, simplify hedge accounting and introduce a new forward looking approach to impairment.
Head In The Sand?
Despite the standard being available for early adoption for a number of years, and with a mandatory implementation date of 1 January, 2018 fast approaching, it has been surprising to see many reporting entities still with their heads firmly buried in the sand when it comes to assessing and understanding the potentially significant changes required under this new standard.
All reporting entities should have already formed some opinion as to the impacts on their operations and made appropriate comments in their financial statements in recent years. We are now in the final year of AASB 139 and the first comparative period under AASB 9, so the regulators will be expecting to see significantly more fulsome commentary in the upcoming reporting period on the assessed impacts of AASB 9.
ASIC Are Watching…
ASIC have highlighted that these disclosures will receive a high level of focus in the upcoming reporting period and it will not be acceptable to simply state that there will be no or immaterial impact to the entity which is currently a common conclusion.
Who Is Most Impacted?
Clearly some industries will be more impacted than others. The impact on most SMEs is limited to changes in accounting policy and disclosures relating to financial assets designation and impairment process. The largest operational impact will be on our clients in the financial services sector specifically relating to the approach to impairment - not surprising given the standard was developed to address perceived shortfalls in banks provisioning methodologies.
The re-design of the provisioning model from an ‘incurred loss’ model to an ‘expected loss’ model will require earlier recognition of impairment. The 12 month expected credit loss for performing assets and lifetime expected credit loss for non-performing assets will need to be captured upfront. The expected credit loss (ECL) model is expected to be unbiased, probability weighted amount determined from the evaluation of range of possible outcomes.
The Next Steps
The practical reality is that Authorised Deposit-taking Institutions (ADIs) will need to develop new systems and process in order to be compliant with the ECL’s data, calculation and economic forecasting requirements.
A number of models and provisioning solutions are commercially available, however for the smaller ADIs, who are price sensitive, these options are impractical.
Most ADIs have a significant volume of quality data that can be used. The challenge is knowing how to use this data effectively and streamlining processes to collate the appropriate information. By using this data and incorporating economic forecast and trend analysis based on a range of industry parameters, they should be able to pragmatically deal with the new requirements.
If good quality is used effectively, the model used to calculate the ECL does not necessarily need to be complex and expensive. We have already seen some good examples of low cost, in-house developed models that are fit for purpose and achieve the same desired results.