Sam Hobbs, CPA
Sam ensures the Clearwater solution is in compliance with applicable regulatory guidelines. Since joining Clearwater in 2013, Sam has worked closely with industry experts, client services team leads, and the Clearwater development team to implement enhancements and new features to ensure the Clearwater system remains best-in-class.
Prior to joining Clearwater, Sam was an audit manager at PwC in Atlanta. He worked closely with clients in the insurance, investment management, and real estate industries as a member of the financial services group.
Sam is a certified public accountant and has a bachelor’s in accounting from Brigham Young University.
Sam is an avid golfer. He especially enjoys the outdoors and spending time with his wife and four boys.
With a few short months before IFRS 9 is implemented, investment accountants face several impending challenges: adjusting to changes to classification of measurement, updates to fair value through profit and loss (FVPL), a new solely payments of principal and interest (SPPI) test, and changes to impairment methodology.
Here’s what you need to know if your organization plans to adopt IFRS 9 in 2018.
IFRS 9 will change how securities are classified. Financial instruments must pass SPPI and business model tests, discussed in further detail below, to be classified as fair value through other comprehensive income (FVOCI) or amortized cost. As a result, more financial instruments are expected to be classified as FVPL, the new residual category.
The business model test is based on how organizations manage assets and report performance. It also reflects how groups of assets are managed together to meet an objective and determines the intent of holding a security.
Two types of business models will be used with IFRS 9: the “hold-to-collect” business model and the “hold-to-collect-and-sell” business model.
The hold-to-collect business model dictates that while companies do not have to hold all instruments to maturity, sales or transfers should be infrequent and insignificant.
The hold-to-collect-and-sell business model addresses that many investments are hold-to-collect but could be sold at an amount representing unpaid principal and interest on the principal amount outstanding. The hold-to-collect-and-sell business model helps manage liquidity needs, maintain a yield, match assets to liabilities, and more.
The new SPPI test requires professionals to determine if cash flows only consist of principal and interest. Principal is defined by the fair value of a financial asset at initial recognition, which can change over time. Interest is the compensation for time value of money and credit risk, which can also include consideration for basic lending risks like liquidity and costs. Most commonly held securities are likely to pass this test, but complex or non-traditional vehicles may require more consideration.
Contractual features that introduce exposure to risks or volatility in the contractual cash flows unrelated to a basic lending arrangement, such as exposure to changes in equity or commodity prices, do not give rise to contractual cash flows that are SPPI.
For example, convertible bonds, inverse floaters, and profit participating loans will not meet the SPPI condition. Additionally, some embedded derivatives may also not meet the SPPI condition.
Currently, originations can report an entire portfolio of equity instruments as FVOCI. Under IFRS 9, all equities held for trading must be classified as FVPL. However a lot-by-lot irrevocable election can be made to classify equities as FVOCI. If this is the case, OCI cannot be recycled to profit and loss when sold.
IFRS 9 will fundamentally change how companies view and respond to impairment. The existing incurred loss model based on IAS 39 was criticized for delaying the recognition of losses, inconsistent with how businesses and risk are managed, and difficult to understand and apply.
IFRS 9’s new impairment methodology requires the recognition of an allowance for FVOCI or amortized cost securities (debt-like assets are not measured at FVPL) at purchase based on probabilities, time value of money, and reasonable and supportable information on past events, current conditions, and forecasts of future economic conditions. This method asks companies to take a forward-looking approach to assessing impairments rather than resolving impairment issues after they have already occurred.
Before buyers decide on an allowance, they must bucket the security into three stages based on deterioration in credit quality, as depicted in the chart below.
While this methodology encourages a more proactive and forward-looking approach, it will require additional review and analysis. Identifying such things as probabilities of default and expected losses can be challenging. Automated investment accounting solutions can help alleviate the burden of cumbersome additional requirements.
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