IFRS 9:

the changes and IT challenges in store

The IFRS standard for accounting for financial instruments is changing. The new standard IFRS 9 will be succeeding the existing IAS 39. Not only does this mean that investment management organisations have to change their financial report­ing in the future. For large parts of the investment management industry, the transition also requires a conversion of holding categories and of accounting values. This article addresses the IT aspects of these conversion projects.

by Arne E. Jørgensen,Domain Manager for accounting, SimCorp

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In 2009, the International Ac­counting Standards Board (IASB) embarked on a three-phase project to replace the current standard for financial instruments, IAS 39, with a completely new standard, which has been given the name IFRS 9. The three phases are:

• the first, ‘Financial Instruments: Classification and Measurement’, was published in its final version in November 2009. Due to the review comments on the accounting for lia­bilities, the update of the rules for liabilities was spun off as a fourth phase of the project, ‘Phase 1A’;

• the second, ‘Financial Instruments: Amortisation and Impairment’, was sent out for public comment in No­vember 2009, with a deadline for comments set for 30 June 2010;

• the third, ‘Financial Instruments: Hedge Accounting’, is expected to be sent out for public comment in the second half of 2010.

Although the introduction of IFRS 9 primarily is a business and procedural project, each phase also poses its spe­cific challenges to IT systems and to IT project capabilities.

Organisations that have never used cat­egories other than the fair value cate­gory would probably consider them­selves very fortunate. They do not have to change or convert anything, provided their accounting policies and business models remain unchanged.

PHASE 1; ‘FINANCIAL INSTRU­MENTS: CLASSIFICATION AND MEASUREMENT’

LEGAL FRAMEWORK

The timetable for IFRS 9 Phase 1 is that early adoption was permitted already for 2009 and that the standard will be mandatory for accounting periods start­ing on or after 1 January 2013. How­ever, in spite of the original time pres­sure put on the IASB to act fast, so far very few legislative and supervisory au­thorities have actually approved the use of IFRS 9 Phase 1 within their jurisdic­tion. The status of the EU endorsement process is just one example.

PROJECT FRAMEWORK

The lack of legislative progress is worry­ing project planners, both on the busi­ness side and on the IT side, who are concerned that political pressure may result in last-minute modifications of the standard. Such uncertainty often causes decision-makers to delay the project start, which may result in a ‘ketchup’ effect where many projects will be starting at the same time, with a much shorter timeframe and in compe­tition for internal and external resources.

IFRS 9 Phase 1 primarily entails a re­structuring and reduction of the hold­ing categories compared to IAS 39, most significantly abolishing the IAS 39 ‘Available For Sale’ category.

From an IT perspective, it is fortunate that the technical tools required for the new holding categories already were used by the old. The tools, such as am­ortisation and fair value adjustment, will simply be applied in new contexts.

CONVERSION PROJECT

The decision concerning what from the old categories goes where in the new is a business decision, but may need IT sup­port for ad-hoc analyses and data ex­tracts. Determining the initial values to use in the new categories is also prima­rily a business task, which may also need some ad-hoc IT support.

The crucial question from an IT per­spective is how the IFRS 9 categories and values are going to be implemented. Two approaches come to mind: a period of parallel accounting or a ‘big-bang’ conversion.

The ‘big-bang’ conversion, where all assets and liabili­ties are transferred from one of the old categories to one of the new categories on the date of transition, requires very careful plan­ning and an extensive test phase. There is no second chance if business is to resume the next day. The process must include an update of the booked values according to the IFRS 9 transition rules.

The construction of comparable IFRS 9 figures for previous years to use in the first two IFRS 9 reports will primarily be a manual task for the business side of the organisation, unless the conversion takes place under the (very) early adop­tion rules.

Accounting in parallel for IAS 39 and IFRS 9 for a period of time is less vulnerable to mistakes. The IAS 39 figures will still be present in an un­changed fashion and the IAS 39 results will be the official financial results for one or two reporting period before switching over.

The organisation can use the time to ac­quaint itself with IFRS 9, and the anal­ysis of the effects of the differences be­tween IAS 39 and IFRS 9 follows almost automatically.

Initialisation of the IFRS 9 framework can be done (for example, six months earlier) and can be repeated if necessary. The comparable IFRS 9 figures from the parallel period are automatically available.

PHASE 1A: ‘FAIR VALUE OPTION FOR FINANCIAL LIABILITIES‘

This spinoff from Phase 1 was sent out as an exposure draft in May 2010 with a very short review deadline, i.e. 16 July 2010. For a 30-page document, the deadline is probably reasonable. An in­vestment management system that can separate value changes due to changes in credit risk from the overall change in fair value will already have the technical tools to meet this challenge.

PHASE 2: ‘FINANCIAL INSTRUMENTS: AMORTISATION AND IMPAIRMENT‘

IFRS 9 Phase 2 is not finalised at this point. The final standard is expected in the second half of 2010 and the date from which it will be mandatory will be fixed in that final version. Given the comments as well as the meetings and other initiatives taken by IASB, it is al­most certain that the final standard will differ from the exposure draft on several points. The most disputed points seem to be the amortisation based on the expected cash flow and the impair­ment process.

Technically, the use of an expected cash flow means that an integrated invest­ment management system must allow for two parallel cash flows for a given bond: the contractual cash flow, which still controls the payments (until the debtor actually fails to pay), and the ex­pected cash flow for amortisation pur­poses. Two cash flows for the same bond, one of them potentially quite volatile, will probably pose an IT chal­lenge. The resemblance to the treatment of impaired securitised debts under US-GAAP’s EITF 99-20 may help in some circumstances.

Nothing about IFRS 9 Phase 2 is cer­tain for now. The final standard and any communication from IASB will be read eagerly in industry circles, both on the business side and on the IT side.

PHASE 3: ‘FINANCIAL INSTRUMENTS: HEDGE ACCOUNTING‘

The exposure draft for IFRS 9 Phase 3 is currently expected to be sent out for comment in the second half of 2010.

Given the new holding categories (Phase 1), hedge accounting will probably apply to fewer cases under IFRS 9 than under IAS 39. The discussions and the preliminary information from IASB in­dicate that the only mechanism of hedge accounting will correspond to the current cash flow hedges.

An IT system that already supports cash flow hedges will probably only have minor challenges with Phase 3, al­though the context may change.

OUTLOOK

Any organisation that currently uses the ‘Available For Sale‘ holding category under IAS 39 faces a challenging con­version project when implementing Phase 1 of IFRS 9.

There are three main challenges: the structure of the future financial report­ing; the business challenge of the actual conversion (classification and initial values); and the technical IT challenge of the actual conversion.

The technical IT conversion for IFRS 9 Phase 1 depends on a crucial choice of conversion model – a business critical ‘big-bang’ or a period of parallel ac­counting before the transition date ac­cording to both IAS 39 and IFRS 9. If asked for his opinion, the author of this article would recommend a period of parallel accounting although this presents more pressing project deadlines.

The final formulation of IFRS 9 Phase 2 is still pending at the time of writing. If the rules suggested in the exposure draft from November 2009 become standard, there will be new challenges, both for the business side and for the IT side. The participants in the investment management industry should follow de­velopment of IFRS 9 Phase 2 with the greatest interest.

Only very preliminary information is currently available regarding IFRS 9 Phase 3. What is known so far indicates that IFRS9 Phase 3 will pose smaller challenges than Phase 1 and Phase 2. We will know more by the end of the year.

Arne E. Jørgensen is domain manager for accounting in SimCorp. He holds an M.Sc. in Engineering from the Technical Uni­versity of Denmark and a Diploma in Fi­nance from Copenhagen Business School. Prior to joining SimCorp in 1988, he worked with IT development at Copenha­gen Handelsbank (now part of Danske Bank), and before that at the Danish con­sulting engineering company Carl Bro.