Office of the Superintendent of Financial Institutions
The Office of the Superintendent of Financial Institutions (OSFI) is issuing the final guideline on IFRS 9 Financial Instruments and Disclosures. The guideline provides guidance to Federally Regulated Entities (FREsFootnote 1) on the application of International Financial Reporting Standard 9 Financial Instruments (IFRS 9).
In July 2014, the International Accounting Standards Board (IASB) finalised its project to improve the accounting for financial instruments with the publication of IFRS 9. This new accounting standard replaces the International Accounting Standard 39 (IAS 39) and will be effective for annual periods beginning on or after January 1, 2018Footnote 2.
The Basel Committee on Banking Supervision (BCBS) also issued regulatory guidance to guide banks and their supervisors in implementing the expected credit loss framework of IFRS 9 through its Guidance on Credit Risk and Accounting for Expected Credit Losses issued on December 18, 2015.
IFRS 9 is an improvement to the previous standard and has led OSFI to consider changes to our own related prudential expectations. The proposals contained in the guideline have been tailored to the size, nature and complexity of FREs. For example, more detailed requirements for the application of the IFRS 9 expected credit loss framework are proposed for banks that are systemically important in Canada based on the recent guidance issued by the BCBS. By contrast the proposals for other deposit-taking institutions are more tailored for the size, nature and complexity of those institutions.
In addition to new guidance on expected credit losses, OSFI proposes, the following seven guidelines be revised or replaced and consolidated into a single IFRS 9 Financial Instruments and Disclosures guideline.
The Guideline incorporates several revisions resulting from comments received during the public consultation process, which began in March 2016. The attached table (Annex) summarizes material comments received from stakeholders and provides an explanation of how they have been addressed. We thank all those who participated in the consultation process.
Question on the guideline should be sent by email to Renée Chen, Director, Accounting Policy Division (Renee.Chen@osfi-bsif.gc.ca) or through industry associations.
Comments from respondents
The use of financial statements for regulatory purposes
One respondent noted the primary purpose of GAAP financial statements is to provide investors and creditors with decision-useful information for investment and lending activities rather than as a suitable basis for regulatory capital purposes. Adjustments to financial statements to assess regulatory capital should be outside the GAAP framework. Limitations to accounting options and practical expedients, expansion of IFRS requirements, and the use of permissive and restrictive language will place Canadian Federally Regulated Entities (FREs) at a competitive disadvantage to their global peers.
On the other hand, another respondent appreciated the fact that section 2.1 of the draft guideline is consistent with the Basel Committee’s guidance and noted that consistency with the Basel guidance is appropriate in the Canadian context.
Three respondents supported OSFI’s inclusion of guidance that was tailored to the nature, size, complexity and risk-profile specific to standardized deposit-taking institutions.
The legislation governing FREsFootnote 3 requires that the financial statements be prepared in accordance with generally accepted accounting principles (GAAP), the primary source of which is the CPA Canada Handbook, except as otherwise specified by OSFI. Through its authority, OSFI may specify additional accounting guidance or additional disclosure, or require that a specific accounting option within an applicable accounting standard be followed. OSFI makes these specifications in rare situations where there is a strong prudential need for additional accounting guidance for FREs.
OSFI has chosen to rely as much as possible on accounting information prepared in accordance with GAAP when it sets capital requirements in its industry-wide guidance. This reliance-based approach enables OSFI to leverage the high-quality information contained in FREs’ financial statements that have undergone rigorous internal governance and external audit processes. It also promotes a more transparent process surrounding OSFI’s prudential requirements while reducing regulatory burden on FREs from having to carry two sets of books: one for public reporting purposes and another for the regulator.
Section 2.1 sets out supervisory guidance on accounting for expected credit losses. Representatives of the International Accounting Standards Board have been provided with the opportunity to comment on the Basel Committee’s Guidance on Credit Risk and Accounting for Expected Credit Losses which section 2.1 reproduces and have not identified any aspects of the Basel Committee’s guidance that would prevent a bank from meeting the impairment requirements of IFRS 9.
Reference to IFRS as issued by IASB
OSFI’s reference to FREs’ financial statements prepared in accordance with IFRS as issued by the IASB should be amended to include the reference to Canadian GAAP as set out in the CPA Canada Handbook – Accounting.
The legislation governing FREs requires that the financial statements be prepared in accordance with generally accepted accounting principles, the primary source of which is the CPA Canada Handbook, except as otherwise specified by OSFI. The AcSB has adopted IFRS as the accounting standards to be used by publicly accountable enterprises. All FREs are considered publicly accountable enterprises.
For clarity, OSFI will amend the reference to IFRS and align with the legislative requirements governing FREs.
Need for guidance on the use of the Fair Value Option
Two respondents believe FREs have robust fair value processes to reliably fair value mortgages and loans.
Although existing fair value processes meet accounting requirements, OSFI does not consider estimates of fair values of mortgages and loans to be sufficiently reliable for prudential capital purposes in the case of deposit-taking institutions given those loans do not have observable market inputs and represent very large exposures for many deposit-taking institutions. Thus, OSFI is of the view that in the case of deposit-taking institutions these loans should be measured at amortized cost and should be subject to the expected credit loss requirements in IFRS 9 to measure impairment.
In the case of life insurers, OSFI has similar concerns about the reliability of fair values from a prudential perspective but recognizes that it needs to balance this concern against the fact that these mortgages and loans are less material in the case of life insurers as well as the fact that the asset-liability matching business model of life insurers will likely require them to use Fair Value through Other Comprehensive Income (FVOCI) for their assets supporting policyholder liabilities. If the business model results in life insurers classifying mortgages and loans at FVOCI, OSFI is willing to allow them to use the Fair value Option (FVO) to reclassify these mortgages and loans from FVOCI to Fair Valued through Profit and Loss. Therefore OSFI has made an exception for the mortgages and loans on life insurers’ financial statements that would otherwise have been classified as FVOCI. OSFI plans to promote greater confidence in the fair valuation practices of life insurers by reviewing their fair value practices and developing a capital solution to address any quality of capital issues for loans measured at fair value.
Revisit IFRS 9 Guideline when IFRS 4 Phase II is finalized
A life insurers’ business model for assets supporting insurance contract liabilities could lead to a classification of amortized cost. While there is no accounting mismatch under the Canadian Asset Liability Method (CALM), there could be a mismatch on adoption of IFRS 4 Phase II. A respondent asked OSFI to revisit the IFRS 9 Financial Instruments and Disclosures Guideline again when the forthcoming Insurance Contracts standard is finalized.
In developing the draft IFRS 9 Guideline, OSFI considered the IASB’s tentative decisions on IFRS 4 Phase II as of February 2016 (based on their Summary of effect of redeliberations on the ED). The IFRS 9 Guideline was drafted with the intent for being applicable to life insurers both under CALM and the forthcoming Insurance Contracts standard.
As part of OSFI’s ongoing monitoring of impacts of new or revised IFRSs to its guidelines and supervisory practices, when the IASB publishes the revised Insurance Contracts standard, OSFI will assess whether any amendments would be needed for the IFRS 9 Financial Instruments and Disclosures Guideline.
Pre-notification requirements in Chapter 2
Some respondents requested that OSFI clarify the pre-notification requirements in sections 2.1 and 2.2. While commentators agreed that it is appropriate to advise OSFI of significant changes in ECL methodology, some commented that routine adjustments that are within the institution’s methodology should not be subject to pre-notification.
Clarification has been reflected in the final guideline to explain OSFI is less likely to review routine adjustments that result in material changes to the ECL allowance level; however the decision will be subject to the discretion of the lead supervisor.
Pre-notification is an effective communication tool that ensures OSFI is aware of material changes before they occur. The approach encourages sound credit risk management practices, by allowing supervisors a first line of sight on the appropriateness of a DTI’s allowance methodology and adequacy of its allowances.
30-days-past-due rebuttable presumption
A respondent requested that OSFI clarify expectation of “thorough analysis” under the more than 30 days past due rebuttable presumption in section 2.1 and 2.2, paragraphs 143 and 14 respectively.
OSFI is of the view that delinquency is a lagging indicator of significant increases in credit risk and that banks should have credit risk assessment and management processes that detects significant increases in credit risk before exposures become past due or delinquent.
As such, OSFI expects that a bank would not use the more-than-30-days-past-due rebuttable presumption as a primary indicator of transfer to lifetime ECL measurement. Where a bank asserts that the more-than-30-days-past-due presumption is rebuttable on the basis that there has not been a significant increase in credit risk, it is the bank’s responsibility to demonstrate to OSFI that 30 days past due is not correlated with a significant increase in credit risk and that there is no substantive relationship between such information and credit risk drivers.
Transition guidance from Standardized to A-IRB
Some respondents requested that OSFI’s IFRS 9 Guideline should provide guidance to DTIs that are in transition from being a Standardized DTI to an A-IRB DTI.
OSFI’s Implementation Note A-1, Approval of Regulatory Capital Models for Deposit-Taking Institutions, sets out the approval framework that will be used to assess a deposit-taking institution’s transition plan to use advanced approaches for regulatory capital purposes.
For deposit-taking institutions transitioning and engaged in the A-IRB approval process, OSFI will provide guidance on expectations and requirements of the IFRS 9 Guideline on a case by case basis. The approach taken will be consistent with OSFI’s Implementation Note (A-1).
Applicability of Chapter 2 to Foreign Bank Branches
A respondent requested that OSFI clarify the exemption for Foreign Bank Branches within the IFRS 9 Guideline.
In developing the draft IFRS 9 Guideline, OSFI considered the implications of requiring Foreign Bank Branches to adopt IFRS 9 ECL framework. Based on the analysis, OSFI concluded and noted in section 2 of the draft IFRS 9 Guideline that, “No supervisory impairment guidance governing the application of IFRS 9 – ECL is provided for…Foreign Bank Branches.”
Therefore, section 2 of OSFI’s IFRS 9 Guideline does not apply to Foreign Bank Branches.
Capital factors applied on loans to brokers
ECL in IFRS 9 will lead to lower carrying values and higher loan loss provisions on loans to brokers than IAS 39. Capital factors applied on loans to brokers under the Minimum Capital Test should be adjusted to account for the provision for loss that is captured under IFRS 9 when IFRS 9 is adopted. Without the related capital factor revision, there is a potential for double-counting of credit risk.
OSFI will assess the interaction between the accounting ECL and capital requirements when IFRS 9 is to be implemented by insurers. If any changes are deemed necessary, industry will be consulted before making any changes to the capital guidelines.
Early adoption of IFRS 9 by Domestic Systemically Important Banks
One respondent raised concerns with OSFI’s requirement for Domestic Systemically Important Banks (D-SIBs) to early adopt IFRS 9 beginning November 1, 2017, impairing global comparability.
OSFI published a draft Advisory Early adoption of IFRS 9 Financial Instruments for FREs with October year-ends in October 2014 for comment. The Advisory was finalized in January 2015. OSFI decided D-SIBs should early adopt IFRS 9 beginning November 1, 2017 to allow more time to smaller less systemic institutions to implement the standard. If D-SIBs do not early adopt, the December year-end FREs (which are all smaller less systemic institutions) would bear the burden and cost of having to implement IFRS 9 before the D-SIBs. Further comments regarding global comparability and other issues regarding the early adoption of IFRS 9 can be found here.
OSFI is encouraged to monitor the developments in IASB disclosure initiatives and consider the impact of prudential disclosure requirements beyond IFRS 9 in light of these activities.
OSFI will continue to monitor developments in the IASB disclosure initiatives and consider the impact of prudential disclosure requirements to FREs as part of our guidance setting process.
For the purposes of this Guideline, FREs include:
Return to footnote 1
OSFI determined that Domestic Systemically Important banks (D-SIBs) should adopt IFRS 9 for their annual period beginning on November 1, 2017. See January 2015 OSFI Advisory Early Adoption of IFRS 9 by Domestic Systemically Important Banks.
Return to footnote 2
Sections 308(4) and 840(4) of the Bank Act (BA), sections 331(4) and 887(4) of the Insurance Companies Act (ICA), section 313(4) of the Trust and Loan Companies Act (TLCA), and subsection 292(4) of the Cooperative Credit Associations Act (CCAA).
Return to footnote 3