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5. Conclusions and Suggestions
IAS39 will be replaced by IFRS9 due to the complexity of implementation. The aim of IFRS 9 is to simplify the standard. However, the application to insurance company would be more complex while implement IFRS4 Phase II simultaneously.
The drivers of assets allocation strategies include 1) liability profile and trends, 2) current global market environment, 3) regulatory constraints, and 4) capital requirement. After adopting IFRS9, the challenges to insurance companies are not only the economic profit or losses but also the “paper” performance represented to the shareholders.
Under current accounting standard, insurance company could change the accounting policy to avoid or mitigate the fluctuation in profit or losses or the capital in certain economic events, however, the IFRS 9 do not permit to change the accounting policy due to the global market environment change, unless the company change its business model as well.
Insurance companies do not use simple debt instruments to match insurance liabilities. The assets strategies involve risk diversification, including interest rate, foreign exchange rate, and duration geographic/country and so on. Therefore, the hedge cost should be considered as well. However, the business model approach does not consider the impact of the risk diversification.
IFRS 9 should be applied retrospectively, the level of volatility in financial results caused by accounting mismatches and changes in economic circumstance will be highly related to the interaction with the structure and measurement of insure liabilities. The market environment
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is dynamic, and the management could only make decision on the business model and choose the accounting policy based on the view of the financial market.
IFRS 9 and IFRS4 phase II may take a number of years to be complete; Figure 11 is the road map for implementation.
Data source: Ernst & Young, March 2012
Figure 11: IFRS9 and IFRS 4 Phase II Implementation Roadmap
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References
PwC, 2010, Practical guide to IFRS-IFRS9,”Financial instruments”
Tamsin Abbey, Deloitte, November 2013 ,IFRS 4 Phase 2 Practical Implications
Deloitte, December 2012, IFRS in Focus / IASB issues proposal for limited amendments to IFRS 9
Deloitte, August 2012, IFRS9 Classification and Measurement Are you lost?
Deloitte, January 2012, Facing the challenge/ Business implication of IFRS 4,9 and Solvency II for insurers
Deloitte, 2008, IFRS in Real Estate
Ernst & Young, March 2014, IASB makes use OCI optional and confirms unlocking of the Contractual Service Margin
Ernst & Young, March 2013, IFRS Outlook, Insights on IFRS for Executives and Audit Committees
Ernst &Young, November, 2012, The IASB proposes limited amendments to IFRS9 classification and measurement model
Ernst &Young 1, January 2012, IFRS9: New mandatory effective date and transition disclosures
Ernst &Young 2, January 2012, Facing the challenge Business implications for IFRS 4, 9 and
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Solvency II for insurers
Ernst & Young, March 2012, Limited improvements to IFRS classification and measurement /The impact for insurance and next steps,
Ernst & Young, May 2012, Financial Instruments: classification and measurement — the GAAP differences continue to narrow
Ernst &Young, July, 2011, Measure by measure Synchronising IFRS 9 and IFRS 4 Phase II for Insurers
Ernst &Young, November 2009, IASB publishes IFRS9: Phase 1 of new standard to replace IAS 39
European Financial reporting Advisory Group, 17 June 2013, Classification and measurement of financial assets results of the field test conducted by EFRAG,ANC,ASCG,FRC and OIC
R. Venkata, November 2009, Salient differences between IAS 39 and IFRS 9
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Appendixes
1. Extracts prospectus of MBS
The bonds, and interest thereon, are not guaranteed by the United States and do not constitute a debt or obligation of the United States or of the agency or instrumentality thereof other than Fannie Mae.
Certain Securities Terms
A. Title: step rate bonds due August 24,2023 B. Form: Fed book-entry securities
C. Specified PaymentCurrncy i. Interest: USD
ii. Principal: USD
D. Issue date: August 24, 2011 E. Matunity date: August 24, 2023
Amount payable on matunity date: 100% of principal amount F. Subject to redemption prior to maturity date
In whole or in part, at our option on the 24th of each Febuary, August and November commencing Febaury 24, 2012 at a redemption price of 100% of the principal amount redeemed, pls accured interest thereon to the date of redemption.
G. Interest catgory: step rate securities H. Interest
i. Frequency of interest payment: semiannully
ii. Interest payment dates: the 24th of each February and August
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iii. First interest payment date: Feruary 24,2012
iv. The interest ate on the outstanding principal amount will be as follows:
2. Extracts Prospectus of CDO A. Series number: 533
Tranche number: 1 B. Interest basis: fixed rate
Provided that the fixed rate will be subject to adjustment in accordance with special condition (D) (5)
Interest will cease to accrue on the notes as from the schedule maturity and no further interest will be payable on the notes in respect of any period after schedule maturity date, whether or not the schedule maturity date is postpone until the extended maturity date (see special condition F)
C. Redemption/Payment basis: Condition 10.1 (schedule redemption) is applicable to the notes
D. Change of interest or redemption/payment basis: the fixed rate will be subject to adjustment in accordance with special condition (D)(5)
E. Alternative Quotations
Upon receipt of a Substitution Information Notice by the Portfolio Manager in accordance with sub-paragraph (2) above, the Portfolio Manager will within the Alternative Quotation Window attempt to obtain from Eligible Dealers (which shall include the Determination Agent or one or more of its Affiliates) firm quotations in respect of both the Removed Reference Entity and any New Reference Entity, in each case, as specified in the relevant Substitution Request (each such quotation, an
"Alternative Quotation"). Any such Alternative Quotation in relation to a Removed
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Reference Entity (which shall be expressed as a percentage per annum (the
"Alternative Offer Spread")) or any such Alternative Quotation in relation to any New Reference Entity (which shall be expressed as a percentage per annum (the
"Alternative Bid Spread")) shall be requested promptly upon receipt of the Substitution Information Notice from the Determination Agent and obtained on the basis that that the Eligible Dealer will enter into a single name physically settled credit default swap with the CDS Counterparty documented on market standard terms as at such time (including, if appropriate, an Applicable 2003 Master Confirmation) and any non standard trading terms agreed between the Determination Agent and the Portfolio Manager under paragraph 2(i) above) referencing any New Reference Entity or, as the case may be, the Removed Reference Entity where:
(i) the CDS Counterparty is buyer of credit protection if the quotation is requested in relation to the Removed Reference Entity or the CDS Counterparty is seller of credit protection if the quotation is requested in relation to any New Reference Entity;
(ii) the floating rate payer calculation amount of such credit default swap is equal to
(iii) the Substitution Quotation Amount applicable to the Removed Reference Entity or, as the case may be, the New Reference Entity, in each case as specified in the relevant Substitution Information Notice;
and
(iv) the period to the scheduled termination date of such credit default swap is the period to the Scheduled Maturity Date;
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such swap, an "Alternative Quotation Swap".
For the avoidance of doubt, the quotation given either by the Determination Agent or an Affiliate or, as the case may be, an Eligible Dealer in respect of a New Reference Entity shall be a bid side quotation (the most favourable of any quotation given, being the "Bid Spread") and the quotation given in respect of a Removed Reference Entity shall be an offer side quotation (the most favourable of any quotation given, the "Offer Spread").
F. Credit events:
i. Conditions to settlement
(i) At any time after the Determination Agent has determined in its sole and absolute discretion that an applicable Credit Event has occurred in relation to a Reference Entity, the Determination Agent may during the Notice Delivery Period give a Credit Event Notice and a Notice of Publicly Available Information to the Issuer, which shall constitute satisfaction of the Conditions to Settlement. The Credit Events applicable to each Reference Entity comprising the Reference Portfolio will be the market standard Credit Events applicable to such Reference Entity (determined, if appropriate, in accordance with the Applicable 2003 Master Confirmation) as of the date on which such Reference Entity was included in the Reference Portfolio, as determined by the Determination Agent in its sole and absolute discretion. The Issuer shall promptly notify the Noteholders in accordance with Condition 19 (Notices) of the satisfaction of the Conditions to Settlement.
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(ii) In relation to a Credit Event that is a Restructuring the Determination Agent may deliver multiple Credit Event Notices with respect to such Restructuring Credit Event, each such Credit Event Notice setting forth the Reference Entity Notional Amount to which such Credit Event Notice applies (the "Exercise Amount") (which shall be (A) no greater than the Reference Entity Notional Amount of such Reference Entity and (B) in a minimum amount equal to 1,000,000 units of the currency in which the Reference Entity Notional Amount is denominated or an integral multiple thereof).
G. Determination of Loss Amount
i. On each occasion that a Credit Event occurs with respect to a Reference Entity and all the Conditions to Settlement have been satisfied with respect to such Credit Event, (a) the Determination Agent will determine the Loss Amount, the Loss Settlement Amount, and the Loss Settlement Percentage, (b) the Reference Entity shall, on the relevant Loss Settlement Date (subject to Condition (D)(1)
ii. be removed from the Reference Portfolio and the Reference Portfolio Notional Amount shall be reduced by an amount equal to the Reference Entity Notional Amount of such Reference Entity, and (c) the Reference Portfolio Ledger shall be amended accordingly.
3. IAS 32 paragraphs 16A and 16B or paragraphs 16C and16D
16A A puttable financial instrument includes a contractual obligation for the issuer to repurchase or redeem that instrument for cash or another financial asset on exercise of the put.
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As an exception to the definition of a financial liability, an instrument that includes such an obligation is classified as an equity instrument if it has all the following features:
(a) It entitles the holder to a pro rata share of the entity’s net assets in the event of the entity’s liquidation. The entity’s net assets are those assets that remain after educting all other claims on its assets. A pro rata share is determined by:
(i) dividing the entity’s net assets on liquidation into units of equal amount; and (ii) multiplying that amount by the number of the units held by the financial
instrument holder.
(b) The instrument is in the class of instruments that is subordinate to all other classes of instruments. To be in such a class the instrument:
(i) has no priority over other claims to the assets of the entity on liquidation, and (ii) does not need to be converted into another instrument before it is in the class
of instruments that is subordinate to all other classes of instruments.
(c) All financial instruments in the class of instruments that is subordinate to all other classes of instruments have identical features. For example, they must all be puttable, and the formula or other method used to calculate the repurchase or redemption price is the same for all instruments in that class.
(d) Apart from the contractual obligation for the issuer to repurchase or redeem the instrument for cash or another financial asset, the instrument does not include any contractual obligation to deliver cash or another financial asset to another entity, or to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity, and it is not a contract that will or may be settled in the entity’s own equity instruments as set out in subparagraph (b) of the definition of a financial liability.
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(e) The total expected cash flows attributable to the instrument over the life of the instrument are based substantially on the profit or loss, the change in the recognized net assets or the change in the fair value of the recognized and unrecognized net assets of the entity over the life of the instrument (excluding any effects of the instrument).
16B For an instrument to be classified as an equity instrument, in addition to the instrument having all the above features, the issuer must have no other financial instrument or contract that has:
(a) total cash flows based substantially on the profit or loss, the change in the recognized net assets or the change in the fair value of the recognized and unrecognized net assets of the entity (excluding any effects of such instrument or contract) and
(b) the effect of substantially restricting or fixing the residual return to the puttable instrument holders. For the purposes of applying this condition, the entity shall not consider non-financial contracts with a holder of an instrument described in paragraph 16A that have contractual terms and conditions that are similar to the contractual terms and conditions of an equivalent contract that might occur between a non-instrument holder and the issuing entity. If the entity cannot determine that this condition is met, it shall not classify the puttable instrument as an equity instrument.
Instruments, or components of instruments, that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation
16C Some financial instruments include a contractual obligation for the issuing entity to deliver to another entity a pro rata share of its net assets only on liquidation. The obligation arises because liquidation either is certain to occur and outside the control of the entity (for
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example, a limited life entity) or is uncertain to occur but is at the option of the instrument holder. As an exception to the definition of a financial liability, an instrument that includes such an obligation is classified as an equity instrument if it has all the following features:
(a) It entitles the holder to a pro rata share of the entity’s net assets in the event of the entity’s liquidation. The entity’s net assets are those assets that remain after deducting all other claims on its assets. A pro rata share is determined by:
(i) dividing the net assets of the entity on liquidation into units of equal amount;
and
(ii) multiplying that amount by the number of the units held by the financial instrument holder.
(b) The instrument is in the class of instruments that is subordinate to all other classes of instruments. To be in such a class the instrument:
(i) has no priority over other claims to the assets of the entity on liquidation, and (ii) does not need to be converted into another instrument before it is in the class
of instruments that is subordinate to all other classes of instruments.
(c) All financial instruments in the class of instruments that is subordinate to all other classes of instruments must have an identical contractual obligation for the issuing entity to deliver a pro rata share of its net assets on liquidation.
16D For an instrument to be classified as an equity instrument, in addition to the instrument having all the above features, the issuer must have no other financial instrument or contract that has:
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(a) total cash flows based substantially on the profit or loss, the change in the recognized net assets or the change in the fair value of the recognized and unrecognized net assets of the entity (excluding any effects of such instrument or contract) and
(b) the effect of substantially restricting or fixing the residual return to the instrument holders.
For the purposes of applying this condition, the entity shall not consider non-financial contracts with a holder of an instrument described in paragraph 16C that have contractual terms and conditions that are similar to the contractual terms and conditions of an equivalent contract that might occur between a non-instrument holder and the issuing entity. If the entity cannot determine that this condition is met, it shall not classify the instrument as an equity instrument.