IFRS 9 Challenges and Solutions

©Copyright BOND PRICING AGENCY MALAYSIA SDN.BHD. - All rights reserved.
Bond Pricing Agency Malaysia
IFRS 9 : Accounting Meets Risk Management
Challenges and Solutions for Fixed Income Instruments
©Copyright BOND PRICING AGENCY MALAYSIA SDN.BHD - All rights reserved.
Presented by Mohd Shaharul Zain
Chief Business Officer, BPAM

Content
1. Introduction to IFRS 9
2. The Expected Credit Loss Model
3. Data Sources
4. Conclusion and Summary

Content
1. Introduction to IFRS 9

Phase 1: Classification and measurement of financial assets and liabilities
Fair Valuation for fixed income instruments (unchanged from IAS 39 / FRS 139)
 IFRS 9 “Financial Instruments” : The replacement of IAS 39 released on 24 July 2014.
 Implementation on 1st January 2018
Key Modules:
Phase 2 : Impairment Methodology – The Expected Loss Model
Phase 3 : Hedge Accounting
1.1 IFRS 9 : Introduction

Determine Business
Model
Treatment of Books
AMORTISATION
(HTM Book)
IMPAIRMENT
PROVISIONING VIA
EXPECTED CREDIT
LOSS MODEL
Fair Value Through
Profit & Loss
(Trading Book)
Mark to Market
FAIR VALUE
THROUGH OTHER
COMPREHENSIVE
INCOME
(AFS Book)
IMPAIRMENT
PROVISIONING VIA
EXPECTED CREDIT
LOSS MODEL
1.2 IFRS 9 : New Classification and Treatment

1.3 IFRS 9 : Implications
IAS 39 does not evaluate events after the reporting date. On the other hand, ECL looks 12
months beyond the reporting date to evaluate deterioration in credit risk, not other forms of risk
(eg interest rate risk)
To avoid the problem of provisioning “too little too late” as seen during the Subprime and Euro
Debt Crisis. Insufficient provisioning and their sudden realisation led to shocks on financial
institutions balance sheets
IAS 39 : Incurred Loss Model
IFRS 9: Expected Credit Loss Model

1.4 IFRS 9 : Implications
Overall, the implementation of IFRS 9 will be a major challenge for everyone holding bonds,
sukuk, commercial papers and bills.
Large amounts of data sets will be required to evaluate the various asset classes affected. This
is less a problem for entities with well developed risk databases compared to those lacking
such infrastructure
The new numbers reported under IFRS 9 may lead of significant impact in P&L volatility as well
as Basel III compliance for capital regulated entities
The new method of classification based on the business model of the entity. could have a large
impact on financial performance as assets will need to be measured differently

Content
2. The Expected Credit Loss Model

EVALUATING PERFORMANCE
Is there a “significant increase in credit risk’ since initial recognition?
USE IAS 39 / MFRS 139 TRIGGERS AS
“LOSS EVENT” INDICATORS
Disappearance of
Active Market
Downgrade of
Credit Rating
Decline of Fair
Value below
Amortised Cost
Local or National
economic
conditions that
correlate to the
assets in the group
The lender -
granting the
borrower a
concession that the
lender would not
otherwise consider
Significant financial
difficulty of the
issuer
“It may not be possible to identify a single, discreet event that caused the impairment.
Rather the combined effects of several events may cause the impairment”
2.1 IFRS 9 : The Expected Credit Loss Model

2.2 IAS 39 / MFRS 139 : Key Excerpts
Para 59
A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is
objective evidence of impairment as a result of one or more events that occurred after the initial recognition of
the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial
asset or group of financial assets that can be reliably estimated.
It may not be possible to identify a single, discrete event that caused the impairment. Rather the combined effect of
several events may have caused the impairment. Objective evidence that a financial asset or group of assets is impaired includes
observable data that comes to the attention of the holder of the asset about the following loss events:
a. significant financial difficulty of the issuer or obligor;
b. a breach of contract, such as a default or delinquency in interest or principal payments;
c. the lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower a
concession that the lender would not otherwise consider;
d. it becoming probable that the borrower will enter bankruptcy or other financial reorganisation;
e. the disappearance of an active market for that financial asset because of financial difficulties; or
f. observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of
financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the
individual financial assets in the group, including:
g. (i) adverse changes in the payment status of borrowers in the group or
(ii) national or local economic conditions that correlate with defaults on the assets in the group

Para 60
The disappearance of an active market because an entity’s financial instruments are no longer publicly traded is not
evidence of impairment.
A downgrade of an entity’s credit rating is not, of itself, evidence of impairment, although it may be evidence of
impairment when considered with other available information.
A decline in the fair value of a financial asset below its cost or amortised cost is not necessarily evidence of impairment
(for example, a decline in the fair value of an investment in a debt instrument that results from an increase in the risk-
free interest rate).
Para 61
…..objective evidence of impairment…also includes information about significant changes with an adverse effect that
have taken place in the technological, market, economic or legal environment in which the issuer operates…
Para 62
….an entity uses its experienced judgement to adjust observable data for a group of financial assets to reflect current
circumstances …..The use of reasonable estimates is an essential part of the preparation of financial statements and
does not undermine their reliability

AG84
Impairment of a financial asset carried at amortised cost is measured using the financial instrument’s original effective
interest rate…..As a practical expedient, a creditor may measure impairment of a financial asset carried at amortised
cost on the basis of an instrument’s fair value using an observable market price
AG86
The process for estimating the amount of an impairment loss may result either in a single amount or in a range of
possible amounts. In the latter case, the entity recognises an impairment loss equal to the best estimate within the range
taking into account all relevant information available before the financial statements are issued about conditions existing
at the end of the reporting period
AG 87
…. financial assets are grouped on the basis of similar credit risk characteristics that are indicative of the debtors’ ability
to pay all amounts due according to the contractual terms (for example, on the basis of a credit risk evaluation or
grading process that considers asset type, industry, geographical location, collateral type, past-due status and other
relevant factors).
AG89
Future cash flows in a group of financial assets …..are estimated on the basis of historical loss experience for assets
with credit risk characteristics similar to those in the group
reasonable estimates is an essential part of the preparation of financial statements and does not undermine their
reliability

IAS 39 / MFRS 139 LOSS EVENT TRIGGERS
(RELEVANT TO FIXED INCOME INSTRUMENTS)
Disappearance
of Active Market
Downgrade of
Credit Rating
Decline of Fair
Value below
Amortised Cost
Local or National
economic
conditions that
correlate to the
assets in the
group
The
lender….granting
the borrower a
concession that
the lender would
not otherwise
consider
Significant
financial difficulty
of the issuer
OBSERVABLE DATA FROM BOND MARKET
Trades/Liquidity
Score -
Compared to
whole market /
peers)
Credit Rating –
Actions during
period
Probability of
default and
migrations –
Rating agency
data
Prices and Yields
– Compared to
peers
Index
Performance –
Credit class vs
general market
trends
BIR – Notch
differential /
period
2.5 IFRS 9 : Application to Fixed Income

Content
3. Data Sources

Trigger: Disappearance
of Active Market
 Evaluate if there is an
active market
 Compare liquidity
relative to the market as
a whole and other
similar bonds
 Consider turnover ratio
 Source: BPAM Bond
Transparency Tool
.
LIQUID
ILLIQUID
1
5
No. of Trades
Total
Trades
Turnover Ratio
Trade Recency
Trade
Frequency
Trade Turnover
SCORING
3.1 Data Sources : Liquidity Scores and Trade Data

Trigger: Downgrade of Credit
Rating
 Ratings performance since
recognition are an important
source of information, but
may be lagging
 Source: BondStream
Para 60
A downgrade of an entity’s credit rating is not, of
itself, evidence of impairment, although it may
be evidence of impairment when considered
with other available information.
3.2 Data Sources : Credit Ratings

Trigger: Downgrade of Credit
Rating
 Ratings migration and default
studies over the years give a
probabilistic perspective on
deterioration in quality
 The BPAM Default and Rating
report covers the entire
RAM/MARC universe on a
quarterly basis
 Source: DaRT Report
3.3 Data Sources : Migration and Default Studies
AG89
Future cash flows…..are estimated on the basis of
historical loss experience for assets with credit risk
characteristics similar to those in the group

Trigger: Decline of Fair
Value below Amortised
cost
 Historical price and
yield performance
relative to peers and
the market as a whole
 Consider if declined or
increased relative to
amortised value, and
for how long (sustained
or temporary)
 Source: Bond Pricing
Service
3.4 Data Sources : Historical Price and Yield Analysis

Rating
Trigger: The
lender….granting the
borrower a concession that
the lender would not
otherwise consider….
Significant financial
difficulty of the issuer
 Captures specific risk
profile of issuer and
industry, showing market
perception of under or over
performance relative to
peers
 Source: BPAM Bond
Transparency Tool
3.5 Data Sources : Issuer Specific Yield Analysis

Trigger: Local or National
economic conditions that
correlate to the assets in the
group….information about
significant changes with an
adverse effect that have taken
place in the technological,
market, economic or legal
environment in which the
issuer operates…
 Indices provide a barometer of
macro market conditions and
can be used to determine if a
certain credit class is
underperforming relative to its
peers
 Source: TR-BPAM Index Series
3.6 Data Sources : Indices

AAA
AA
A
BBB
Bonds
Bond: A
Tenure: 1 Year
Credit Rating: AAA
BIR: BBB
Bond: B
Tenure: 5 Year
Credit Rating: AA
BIR: AAA
Bond: C
Tenure: 10 Year
Credit Rating: AA
BIR: AA
BIR Regions
Tenure
YTM-MGSSpread
Implied Ratings are a market-perceived credit rating, implied via market statistics and
calibrated via financial mathematics
Trigger: The lender….granting the
borrower a concession that the lender
would not otherwise
consider…..Significant financial difficulty
of the issuer
 Market reacts immediately to issuer
specific news, some of which may be
privileged
 Sustained negative divergence (ie IR < CR)
is a strong leading signal of possible credit
related problems
 Comparison between CR and IR thresholds
can give a theoretical range of loss values
as a guide to provisioning
 Source: BPAM Market Implied Ratings
3.7 Data Sources : Implied Ratings

Content
4. Conclusion & Summary

Data sets and statistical
values to support the
impairment provisioning
decision for fixed
income instruments
OUTPUT
Trades/Liquidity Score
Credit Rating
Evaluated Price/Yield
Index Performance
Implied Ratings
Probability of default
DATA SOURCES
Disappearance of Active
Market
Downgrade of Credit Rating
Decline of Fair Value below
Amortised Cost
Local or National economic
conditions that correlate to the
assets in the group
The lender….granting the
borrower a concession that the
lender would not otherwise
consider
Significant financial difficulty of
the issuer
KEY IMPAIRMENT
TRIGGERS
4.1 Summary

KEY DATA SETS NEEDED TO CALCULATE
EXPECTED CREDIT LOSSES:
TRIGGER DATA
PROBABILITY OF DEFAULT
LOSS GIVEN DEFAULT
CASH FLOWS
ORIGINAL EFFECTIVE INTEREST RATES
4.2 Conclusion

IT’S ALL ABOUT DATA
THE SUCCESFUL IMPLEMENTATION OF IFRS 9 IN AN ENTITY IS
FUNDAMENTALLY DEPENDENT ON THE AVAILABILITY
OF DATA THAT IS:
TIMELY
GRANULAR
ACCURATE
ACCEPTED BY THE AUDIT INDUSTRY
EFFICIENTLY FORMATTED AND DELIVERED
4.3 Conclusion

THANK YOU
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