We assume that the amended provisions of IFRS 9 will entail adjustments in different areas of the TMS.
Source: KPMG Corporate Treasury News, Edition 47, September 2015
January 1, 2018 – the date for mandatory application of IFRS 9 – is drawing closer. It is thus scarcely surprising that more and more entities are starting to tackle this looming challenge. In the meantime, the contents of this new standard have largely become clear. In addition to professional subject matter, particular attention should be paid to implementation in the respective Treasury Management System (TMS) in use in order to exploit available functions, identify adjustment requirements and, as far as possible, avoid extra manual effort.
We assume that the amended provisions of IFRS 9 will entail adjustments in different areas of the TMS:
1 In respect of classification it is critical to decide whether and how the three categories of IFRS 9:
• AC – Amortized Cost
• FVOCI – Fair Value through Other Comprehensive Income
• FVPL – Fair Value through Profit or Loss
can be technically established and how classification criteria (business model and SPPI criterion) can be represented by the TMS. Allocation to a business model is to be made by the entity. The SPPI criterion can be reviewed using a decision tree both within and outside of the TMS. Transaction features significant for classification (e.g. instrument, business model, SPPI fulfilled or not) can be represented in the TMS (e.g. by using a portfolio structure). On this basis, a transaction can be automatically classified and the related documentation is already in place.
2 In contrast to IAS 39, IFRS 9 no longer requires separation of embedded derivatives for asset transactions. Derivative contractual components have a significant impact for the review of SSPI criterion in the classification process. If the criterion is not fulfilled (in particular, due to clauses having a derivative character), the entire contract is to be recognized at fair value. For transactions involving liabilities, IFRS 9 requires an assessment to determine whether embedded derivatives must be separated. In particular, determining the fair value of compound instruments can be extremely complex as not all information and parameters necessary to determine measurement are present in the TMS. This means that either data needs to be imported for calculation or measurement occurs outside of the TMS and the result is subsequently imported. The more complex the instruments that can currently be measured already (e.g. callable bonds, credit default swaps), the greater the probability that only minor adjustments are needed. Each entity nevertheless has to ascertain which instruments are to be traded currently or in future in order to able to define the particular necessary adjustment for potential fair value measurements.
3 For impairment, there are different scenarios concerning the TMS. If, for instance, trade receivables are solely represented in the ERP, then it is often beneficial to calculate and post impairment there. Additional representation in the TMS is then not necessary. If, however, corresponding transactions (e.g. bonds, credit lines) are also managed in the TMS, then representation in the TMS needs to be possible. Only then is there consistency between the TMS and ERP and the Treasurer has direct access to the information required pursuant to IFRS 9. At the same time, assignment of transactions to the three impairment types (three buckets) should not present an obstacle. If the TMS does not provide the corresponding functions to calculate expected loss, it must at least be possible to import the impairment calculated outside of the TMS. In determining the posting for impairment in the TMS, the relevant parameters (PD and LGD) need to be provided; this entails increased complexity for system providers and users. Irrespective of whether the actual calculation takes place inside or outside of the TMS, required postings should be generated by the TMS and be capable of being passed on to the ERP.
4 Due to the elimination of the OCI release option for non-financial hedged items and changed designation options, the logic of OCI release needs to be challenged by entities and adjusted, where necessary, in the course of hedge accounting. If net positions or aggregated exposures are designated as hedged items in cash flow hedges, the current functions of a TMS are to be assessed as to whether OCI is reclassified correctly regarding time and subject matter – doing so will require adjustments. Similar functions are required if the fair value of options or forward points of forward exchange contracts are separated and not designated in hedge accounting relationships. In this respect, the performance indicators currently available as well as the own portfolio of corresponding instruments are a good benchmark for the assessment of necessary changes.
5 Rebalancing in hedge accounting is stipulated for proxy hedges in IFRS 9 if the relationship of hedged items to hedges changes in the course of hedge effectiveness testing in such a way that an adjustment (e.g. change in the nominal amount of the derivative) is required. This adjustment occurs manually in most TMSs; subsequent posting should nevertheless occur automatically. For future postings, the price and fair value of hedges applying at the designation date and date of rebalancing are relevant to ensure that the TMS can process hedges designated at different prices and market values.
The elimination of thresholds (80%-125%) for hedge effectiveness testing is perceived to be a simplification in hedge accounting. Entities nevertheless need to define and explain what they consider to be an effective hedge relationship in the context of their risk management. Quantitative hedge effectiveness testing and its results continue to represent a good benchmark for the quality of a hedge relationship. The TMS needs to ensure that postings for IFRS 9 of quantitative hedge effectiveness testing are decoupled as determination of ineffective amounts continues to be relevant for posting using the dollar-offset approach.
In addition, the transformation is to be considered as a separate, entity-specific issue. Revised classification of financial instruments should not present a major obstacle from the technical perspective. Changes to the account structure and the related posting logic mostly require adjustments to the account determination in the TMS. This occurs either via the configuration (in the case of a reasonably flexible TMS) or via a producer-update (in the case of hard-wired logic).
In the context of hedge accounting, the transition from IAS 39 to IFRS 9 can require markedly more effort. The full history once more needs to be accurately presented in the system as this is normally a precondition for an accurate OCI release. Due to expanded options particularly for the designation of hedged items in hedge relationships (e.g. aggregated exposures or net positions as hedged items), new paths open up for risk management. These should be analyzed in advance from a professional and technical perspective in order to be able to use the resulting opportunities that materialize.
Some IFRS 9 amendments do not require any or only require limited new functions for most TMSs on the part of the producer. The adjustments required for users' existing system functions to IFRS 9 requirements should nevertheless not be underestimated. A first step is to assess existing and planned financial instruments in the portfolio to determine whether, for instance, additional measurement is required.
As with all projects, timely and detailed planning, along with relevant measures derived from this, before the effective date of January 1, 2018, will markedly reduce risks.
On October 29, 2015, KPMG will be offering a webinar titled “IFRS 9 – the Approach to Implementation in Your Treasury Management System”. The focus is on a possible project plan in which professional aspects can be appropriately combined with technical IT aspects.
Author: Karin Schmidt, Senior Manager, email@example.com
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