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October 19, 2018

During his keynote speech at the Banco de Espana in Madrid, ESMA Chair Steven Maijoor discussed the implementation and enforcement of IFRS 9 standard from the perspective of securities markets regulators. He addressed three issues related to the expected credit loss (ECL) model: quantitative impact of IFRS 9; transparency and understandability of the ECL model by investors; and role of auditors and supervisory cooperation.

In its annual European Common Enforcement Priorities for 2018 year-end, ESMA focuses on some of the application issues of IFRS 9. The focus will be on the need for transparency and disclosures on the assumptions of ECL models and on the key judgments made. Based on the average reported quantitative impact in the financial statements, the introduction of IFRS 9 as of January 01, 2018 had, in most countries, a lower quantitative impact than originally expected. However, the widely reported headline figure of the impact on regulatory capital across the industry might not give the entire picture. Given the complexity of modeling and the role of judgment in determining some of the assumptions used in the ECL calculation, it cannot be excluded that new inconsistencies in the implementation of the provisioning are arising in practice. 

He then highlighted that multiple scenarios need to be reflected in the ECL modeling, given the non-linear nature of credit losses in response to a deteriorating economic outlook. In this context, he discussed that the last report of the Joint Committee of ESAs on risk and vulnerabilities in the EU financial system identifies repricing of risk premia and potential increase of interest rates as key factors that could negatively affect financial institutions. Thus, it is important that all relevant risks identified are reflected in ECL models. While discussing the transparency and understandability of the ECL model, he highlighted the importance of disclosing material assumptions and judgments made in estimating ECL and emphasized that banks should disclose their approach to setting the criteria for identifying the significant increase in credit risk for material portfolios. He also mentioned that banks should explain how they are taking into account forward-looking information in determining the ECL and that there is a need to disclose information on the multiple scenarios capturing the non-linear nature of the credit losses under the downturn scenario.

He commented on the scope of the involvement of auditors and supervisors in assessing the ECL model and emphasized the need for close cooperation between supervisors in assessing the implementation of IFRS 9, as highlighted in the 2017 report of ESRB. Supervisors need to step up their efforts in capacity building and gain experience in assessing ECL models. The new ECL model poses challenges for both banking supervisors and accounting enforcers within their respective remits. Accounting enforcers are developing their expertise to scrutinize more complex ECL models used in the financial statements. He believes that communication, cooperation, exchange of information as well as practical experience between accounting enforcers and banking supervisors need to be further reinforced to reflect the increased complexity of the ECL models. This is essential to ensure high quality, consistent implementation of IFRS 9.

Related Link: Speech (PDF)

Keywords: Europe, EU, Accounting, Banking, Securities, IFRS 9, Expected Credit Loss, Credit Risk, Disclosures, ESMA

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