MPS - IFRS 9 Financial Instruments V1)

Objectives
• Describe the key concepts addressed by IFRS 9

• Categorize financial assets and financial liabilities according to the requirements of
IFRS 9 Financial Instruments

IFRS 9
• Identify triggers that may be indicators of impairment of financial assets
• Identify hedging instruments and hedging strategies and apply hedge accounting
• Describe the derecognition criteria for financial assets
© 2022 Monte dei Paschi di Siena 1
IFRS 9 and IAS 39 Financial instruments in the Banking industry (assets)
▪ The IASB published the final version of IFRS 9 Financial Instruments in More than 90% of
assets/liablities are in the
July 2014 scope of IFRS 9 (evidenced
▪ IFRS 9 endorsed by EU on 22 November 2016 in yellow)
▪ Effective date on 1 of January, 2018

▪ IFRS 9 replaces IAS 39
© 2022 Monte dei Paschi di Siena 2 © 2022 Monte dei Paschi di Siena 3
Financial instruments in the Banking industry (liabilities) Financial instruments in the Banking industry (P&L)
Most of items of P&L are

affected by IFRS9 (evidenced
in yellow)
IFRS 9 Classification and Measurement
Overview
IFRS 9 contains 3 main measurement categories for financial assets, as illustrated below:
Principal measurement categories
Fair Value through Other

Fair Value through Profit or
Amortized Cost (i.e. AC) Comprehensive Income (i.e.
Classification
Loss (i.e. FVTPL)
FVOCI)
■ Although the permissible measurement categories for financial assets appear to be similar to IAS 39, the criteria for
classification into the appropriate measurement category are significantly different
■ According to IFRS 9.4.1.1, the assessment as to how an asset should be classified is made on the basis of both the
entity’s business model for managing the financial asset and the contractual cash flow characteristics of the
financial asset (i.e. “SPPI test”)
■ A financial asset shall be measured at amortized cost if it is held within a business model whose objective is to hold
financial assets in order to collect contractual cash flows and its contractual terms give rise on specified dates to cash
flows that are Solely Payments of Principal and Interest (SPPI) on the principal amount outstanding

Financial assets - Decision tree Fair Value Through Profit and Loss (FVTPL)
Financial asset in the scope of IFRS 9 • Three Subcategories
Are the asset's contractual Is the business model's Yes

1. Held for Trading
Is the asset an equity
No No
Is the asset a derivative
No Has the entity elected No Yes
the irrevocable FVTPL cash flows solely payments objective to hold to collect
investment? instrument?
option? of principal and interest? contractual cash flows? 2. Designation upon initial recognition
Yes Yes Yes No No
3. FVTPL mandatory (i.e. failure of SPPI test)
Yes
Is it held for trading? Is the business model's
No objective achieved both by • Held for Trading
collecting contractual cash
–
No flows and by selling
financial assets? Not an election (required)
Has the entity elected
the irrevocable OCI
option? No
Yes
– Classified as trading if any of the following:
Yes
• Acquired or incurred for purpose of selling or repurchasing in near term
FVOCI FVOCI
(equity instruments)
FVTPL
(debt instruments)
AC • On initial recognition, part of portfolio for which there is evidence of a recent actual
▪ Dividends generally recognised in ▪ Interest revenue, credit impairment pattern of short-term profit-taking
P&L Changes in fair value recognised in and foreign exchange gains or losses
▪ Interest revenue credit
▪ Changes in fair value recognised
in OCI
P&L
▪ Interest revenue, dividends and
recognised in P&L (in the same
manner as for amortized cost assets)
impairment and foreign exchange • Derivative, including bifurcated embedded derivatives
gains or losses recognised in P&L
▪ No reclassification of gains and foreign exchange gains or losses ▪ Other gains and losses recognised in
losses to P&L on derecognition recognised in P&L OCI
▪ On derecognition, gain and losses
recognised in P&L
– Exceptions: Designated and effective hedging instruments, financial guarantee contracts
and no impairment recognised in ▪ On derecognition, gains and ▪ On derecognition, cumulative gains
P&L losses recognised in P&L and losses in OCI reclassified to P&L
▪ No impairment recognised
© 2022 Monte dei Paschi di Siena SPPI test Business Model Assessment 8 © 2022 Monte dei Paschi di Siena 9
IFRS 9 Classification and Measurement No No

Financial asset in the scope of IFRS 9
No Has the entity elected No

Are the asset's contractual
Yes Is the business model's Yes

Equity instruments – Overview Equity instruments – OCI option

Is the asset an equity Is the asset a cash flows solely Is the asset an equity Is the asset a cash flows solely
the irrevocable FVTPL objective to hold to collect the irrevocable FVTPL objective to hold to collect
investment? derivative instrument? payments of principal and investment? derivative instrument? payments of principal and
option? contractual cash flows? option? contractual cash flows?
interest? interest?
Yes Yes Yes No No Yes Yes Yes No No
Yes Yes
Is it held for trading? Is the business model's Is it held for trading? Is the business model's
No objective achieved both by No objective achieved both by
collecting contractual cash collecting contractual cash
No flows and by selling No flows and by selling
financial assets? financial assets?
Has the entity elected Has the entity elected
the irrevocable OCI Yes the irrevocable OCI Yes
option? No option? No
Yes Yes
FVOCI FVOCI FVOCI FVOCI

FVTPL AC FVTPL AC
(equity instruments) (debt instruments) (equity instruments) (debt instruments)
The assessment to conduct under IFRS 9 on equity instruments can be synthetically summarized in
the following steps Under IFRS 9, FVOCI election:
▪ Is available for all investments in equity instruments in the scope of IFRS 9 that
Steps of analysis are not held for trading
1 OCI option ▪ Determines a different accounting treatment compared to the FVOCI category
▪ Verify whether the instrument under analysis meets the for debt instruments as:
Definition of
definition of equity instrument provided by IAS 32.11 “An equity − The impairment requirements in IFRS 9 are not applicable
instrument is any contract that evidences a residual interest in − All foreign exchange differences are recognized in OCI
the instrument the assets of an entity after deducting all of its liabilities” − Amounts recognized in OCI are never reclassified to profit or loss even
upon disposal/ derecognition
− Only dividend income is recognized in profit or loss
2
▪ Verify whether the equity instrument meets the definition of held
Held for for trading provided by IFRS 9 - Appendix A
▪ Accordingly, an equity instrument is held for trading if it is
trading acquired principally for the purpose of selling it in the near term
definition or on initial recognition it is part of a portfolio for which there is
evidence of a recent actual pattern of short term profit taking According to the definition provided by IFRS 9, FVOCI election is:
▪ Irrevocable: de-designation is not permitted
▪ Made at inception: at the date of initial application (i.e. DIA) or at the date of acquisition
3
▪ In case of equity instruments not held for trading, decide
whether the OCI option has to be adopted
OCI option * ▪ Formalize within a policy the condition for the OCI option
election


Derivative instruments Fair Value option for financial assets

interest? interest?
Yes Yes
Yes Yes

FVTPL AC FVTPL AC
The assessment to conduct under IFRS 9 on derivative instruments can be performed in the following
step Standard requirements Observations
“[…] an entity may, at initial recognition, irrevocably ▪ Any financial asset that is managed on a fair value basis is
Steps of analysis
designate a financial asset as measured at fair value through mandatorily measured at FVTPL under IFRS 9 due to its
profit or loss if doing so eliminates or significantly reduces business model
[…] an ‘accounting mismatch’ […]” (IFRS 9.4.1.5) ▪ Under IFRS 9 embedded derivatives are not separated
▪ Verify whether the instrument under analysis meets the definition from a hybrid financial asset and a hybrid contract in its
of derivative instrument provided by IFRS 9 Appendix A entirety is likely not to meet the SPPI criterion (see
▪ A derivative is a financial instrument or other contract within the following slides)
scope of IFRS 9 with all three of the following characteristics:
− its value changes in response to the change in a specified
underlying (e.g. interest rate, commodity price)
− it requires no initial net investment or an initial net
investment that is smaller than would be required for other
Definition of the types of contracts that would be expected to have a similar
instrument response to changes in market factors
− it is settled at a future date
▪ A derivative different from a financial guarantee or a designated
and effective hedging instrument meet the definition of held for
trading provided by IFRS 9 Appendix A, thus it is measured at
FVTPL
Financial asset in the scope of IFRS 9 Financial asset in the scope of IFRS 9
Are the asset's contractual Are the asset's contractual

No No No Has the entity elected No Is the business model's Yes No No No Has the entity elected No Is the business model's Yes
IFRS 9 Classification and Measurement IFRS 9 Classification and Measurement

cash flows solely Yes cash flows solely Yes
Is the asset an equity Is the asset a Is the asset an equity Is the asset a
interest? interest?
SPPI test – Overview SPPI test – Overview

Yes Yes
Yes Yes

FVTPL AC FVTPL AC
Examples of cash flows characteristics that potentially fail SPPI test

The contractual terms of the financial assets give rise on specified dates to cash flows that are Solely Non standard interest Clauses that modify frequency and amount of contractual cash flows
Payments of Principal and Interest on the principal amount outstanding (basic lending arrangements). rate
SPPI Test (performed at financial asset level) tests wether cash flow interests are from: Leverage Clauses that increase volatility of the cash flows (e.g, 2XEuribor6M)
Prepayment options Clauses that allow prepayment
time value of money

Term extension Clauses that allow to extend the maturity od the instrument
Credit risk
Non-recourse loan Clauses that restrict some rights of the lender
Other residual components such as:
• Profit Margin Contractually linked Cash inflow depend on underlying assets (“look through” approach
• Liquidity risk instruments required)
• administrative costs
Hybrid contracts Hybrid contracts including embedded derivatives.
Government set interest

Potentially inconsistent with time value of money
rates
IFRS 9 Classification and Measurement Financial asset in the scope of IFRS 9
1

No No No Has the entity elected No Yes Is the business model's Yes No No No Has the entity elected No Yes Is the business model's Yes
Business model assessment – Overview

interest? interest?
Business model assessment - Identify relevant / objective evidence

Yes Yes
Yes Yes

FVTPL AC FVTPL AC
The Business Model Assessment to conduct under IFRS 9 can be synthetically summarized in the “An entity’s business model refers to how an entity manages its financial assets in order to generate cash flows.
following macro-steps That is, the entity’s business model determines whether cash flows will result from collecting contractual cash
flows, selling financial assets or both.” (IFRS 9.B4.1.2A)
Steps of analysis
The standard provides the following example of relevant and objective evidence to identify for assessing the
1 business model:
▪ Enhance documentation of the relevant business
Identify relevant objectives and operating policies ▪ An entity considers frequency, volume and timing of sales in prior periods, the reasons for such sales, and
and objective ▪ Establish processes and controls over gathering and its expectations about future sales activity
evidence assessing relevant and objective evidence, to support Sales activities (see ▪ Information about sales is not considered in isolation but as part of a holistic assessment of how the entity’s
the assessment on an ongoing basis IFRS 9.B4.1.2B) objective is achieved and cash flows are realized
▪ Information about past sales has to be considered taking into account the conditions that existed at that
time as compared to current conditions
2 Performance
Define each ▪ How the performance of the business model (and the financial assets held within that business model) are
evaluation (see IFRS
▪ Specify within a policy the characteristics that drivers evaluated and reported to the entity’s key management personnel
business model 9.B4.1.2C)
above identified assume in each business model
criterion
Risks managed (see ▪ Risks that affect the performance of the business model (and the financial assets held within that business
IFRS 9.B4.1.2C) model) and the way those risks are managed
3
▪ Perform an adequate segregation of portfolios to Management
Identify ▪ How managers of the business are compensated (e.g. whether the compensation is based on the
identify groups of financial assets managed together compensation (see
portfolios/ fair value of the assets managed or the contractual cash flows collected)
to achieve a particular business objective IFRS 9.B4.1.2C)
subportfolios for
▪ Apply to each group the rules defined in the previous
the assessment ▪ No “bright-lines” for assessing the impact of sales activity – i.e. no definition of
steps Observation
significance and frequency of sales
IFRS 9 Classification and Measurement 2 2
Financial asset in the scope of IFRS 9 Financial asset in the scope of IFRS 9

No No No Has the entity elected No Yes Is the business model's Yes No No No Has the entity elected No Yes Is the business model's Yes
Business model assessment - Held-to-collect

interest? interest?
Yes Yes
Business model assessment - Both held to collect and for sale

Yes Yes No No Yes Yes No No
Yes Yes
Yes Yes

FVTPL AC FVTPL AC
“Financial assets that are held within a business model whose objective is to hold assets in order to collect contractual cash flows are “[…] In this type of business model, the entity’s key management personnel have made a decision that both collecting contractual
managed to realize cash flows by collecting contractual payments over the life of the instrument […]” (IFRS 9.B4.1.2C) cash flows and selling financial assets are integral to achieving the objective of the business model. There are various objectives that
Relevant and objective evidence within a held-to-collect business model show the following characteristics: may be consistent with this type of business model. For example, the objective of the business model may be to manage everyday
liquidity needs, to maintain a particular interest yield profile or to match the duration of the financial assets to the duration of the
liabilities that those assets are funding […]” (IFRS 9.B4.1.4A)
IFRS 9.B4.1.3A-B give the following examples of sales that may be consistent with the HTC business Relevant and objective evidence within a held-to-collect business model show the following characteristics
model:
▪ Sales infrequent (even if significant in value) or insignificant in value both individually and in
aggregate (even if frequent)
▪ Sales take place close to the maturity of the financial asset and the proceeds from the sales According to IFRS 9.B4.1.4B:
approximate the collection of the remaining contractual cash flows ▪ Compared to a HTC criterion, this business model will typically involve greater frequency and value
Sales activities ▪ Sales due to an increase in the credit risk of a financial asset irrespective of their frequency and Sales activities of sales
value: ▪ However, there is no threshold for the frequency or value of sales that must occur in this business
− This is the case of a sale of a financial asset which no longer meets the credit criteria model
specified in the entity’s documented investment policy (the increase in credit risk may be
demonstrated in other ways, in absence of such a policy)
Sales made in managing concentrations of credit risk do not represent an exemption ▪ For example, performance is evaluated based on the overall return generated by a portfolio held to
Performance
An entity need not hold all of these assets until maturity collect contractual cash flows and, when an opportunity arises, sold to re-invest the cash in financial
evaluation
assets with a higher return
Performance ▪ For example, reports to management focus on the credit quality and contractual returns; fair value is
evaluation considered from a liquidity perspective
Risks managed ▪ Risks managed are for example credit risk, interest yield risk, liquidity risk
Risks managed ▪ Credit risk affects the performance of the business model as credit quality is relevant to the entity’s ability to
collect contractual cash flows
Management ▪ With regard to the example above, compensation in based on the overall return generated by the
Management compensation portfolio
▪ Compensation in based on the credit quality and contractual returns
compensation
2

IFRS 9 Classification and Measurement No No No Has the entity elected No
Financial liabilities - Decision tree

Is the asset an equity Is the asset a cash flows solely
the irrevocable FVTPL objective to hold to collect
investment? derivative instrument? payments of principal and
option? contractual cash flows?
interest?
Yes Yes Yes No No
Business model assessment - Other business models Is it held for trading?
No
Has the entity elected

the irrevocable OCI
Yes
No
No
Is the business model's
objective achieved both by
collecting contractual cash
flows and by selling
financial assets?
Yes
option?
Yes
FVOCI FVOCI
FVTPL AC
(equity instruments) (debt instruments)
“Financial assets are measured at fair value through profit or loss if they are not held within a business model whose objective is to Is the instrument a derivative or
hold assets to collect contractual cash flows or within a business model whose objective is achieved by both collecting contractual Yes
financial liability that is held for
cash flows and selling financial assets […]” (IFRS 9.B4.1.5) trading?
Relevant and objective evidence within a held-to-collect business model show the following characteristics:
No Would split Yes FVTPL
presentation of changes
Is it designated under the fair value Yes due to credit risk create
FV changes not due to credit
According to IFRS 9.B4.1.5-6 one business model that results in measurement at fair value option*? or enlarge an
risk
through profit or loss is one in which: accounting mismatch in
Sales activities No
▪ The entity manages the financial assets with the objective of realizing cash flows through the sale P&L?
of the assets; such an objective will typically result in active buying and selling No
▪ The portfolio meets the definition of held for trading FV changes due to credit
risk FVOCI
Does it contain a separable
embedded derivative(s)?
Performance ▪ The entity is primarily focused on fair value information to make decisions and performance is
evaluation evaluated on a fair value basis Yes
Separate the host and
the embedded
Risks managed ▪ For example, market risk derivative(s)
No
Management Host Derivative(s)

▪ Compensation is calculated on a fair value basis
compensation
* IFRS 9 retains the option in IAS 39 to designate irrevocably on initial recognition a financial
AC liability as at FVTPL
IFRS 9 Classification and Measurement Is the instrument a derivative or financial Yes

liability that is held for trading?
No Yes
FVTPL
Financial liabilities – Own credit risk

Would split presentation of
Yes changes due to credit risk
Is it designated under the fair value
create or enlarge an
option*?
accounting mismatch in FV changes not due to credit risk
P&L? No
No
FV changes due to credit risk FVOCI

Does it contain a separable embedded
derivative(s)?
Yes
Separate the host

and the embedded
derivative(s)
No
Host Derivative(s)
AC
Under IFRS 9.5.7.7, fair value changes on financial liabilities designated under the fair value
option are presented as follow:
▪ The amount of change in the fair value that is attributable to changes in the credit risk of
the liability is presented in OCI
Own credit
risk ▪ The remaining amount of change in the fair value is presented in profit or loss
Amounts presented in OCI are never reclassified to profit or loss. However, an entity may
transfer the cumulative gain or loss within equity (see IFRS 9.B5.7.9)
Financial Assets–Impairment
IFRS 9 Impairment Model IFRS 9 Impairment Model
Scope Expected Credit Losses - Significant Credit Deterioration (PD Threshold Method)
Asset Quality and Bucket Allocations are largely disconnected

Scope (= population of impairment under IFRS 9)
PD-Threshold Definition
▪ Debt instruments (e.g. Loans, debt securities, trade receivables) measured at amortized cost (AC) in accordance with (Non-investment grade) “Credit-impaired” Stage 1 1yr EL Notion
IFRS9 classification rules Stage 2 Lifetime EL

Ft0 Ft1 Notion
Stage 3
“Assets with low credit risk”
▪ Debt instruments that are measured at fair value through other comprehensive income (FVOCI) in accordance with
IFRS9 classification rules Loan X at origination
Et0 Et1 Xt0 (t0)
Loan X at the end of the

Xt1
▪ Loan commitments issued that are not measured at fair value through profit or loss (FVTPL) Ct0 Ct1 Dt0 Dt1 first period (t1)
Bt0 Bt1 Insignificant deterioration
▪ Financial guarantee contracts to which IFRS 9 applies and that are not accounted at FVTPL At0 Significant deterioration
At1
Investment Grade Non Investment Grade Default PD

▪ Lease receivables in the scope of IFRS 16 Leases
■ Asset quality and bucket allocation are largely disconnected. This is inconsistent with the PD-based risk management view.
– Bucket 1 contains loans from all risk classes except ‘credit-impaired’ loans.
– Loans with identical PDs can be in buckets 1 and 2.
▪ Contract assets in the scope of IFRS 15
– Loans in bucket 1 may have higher PD than loans in bucket 2.
■ The model is symmetrical: once transfer criteria are no longer fulfilled, loans are transfered back to bucket 1.
■ 12-month expected credit losses would be recognised for all newly originated or purchased instruments except credit impaired, which go to bucket 3.

LLPs and interest revenues calculation methodology Transfer criteria
Different calculation methodologies apply to both LLP and interest revenue, depending on which Stage an exposure is
classified in:
❖ Selection of transfer criteria and indicators are required (e.g. types of downgrades and
where the boundary of low risk lies)
Stage Stage Stage
1 2 3 ❖ Transfer criteria should incorporate information about past events, current conditions
and reasonable and supportable forecasts of future events and economic conditions at
12 months expected the end of the reporting period
Lifetime expected credit loss What
credit loss ❖ More than 30 days past due rebuttable presumption to serve as a backstop, to identify
deterioration
Loss financial instruments that have experienced significant increase in credit risk, if no other
▪ Expected shortfalls in ▪ Expected shortfalls in contractual cash flows in credit forward looking, borrower-specific information available
Allowance contractual cash flows taking into account the potential for default over quality is
taking into account only the the remaining lifetime of the instrument ❖ Assessment based on the change in the risk of a default occurring in the next 12 months
potential for default in the considered permitted unless a lifetime assessment is necessary
next 12 months ‘significant’?
❖ Assessment of significant increase in credit risk on an individual vs portfolio basis
❖ Assessment of significant increase in credit risk by establishing initial maximum credit
Net interest rate risk for homogenous portfolios at origination and compare against the credit risk of
Gross interest rate method
method those portfolios at the end of reporting period
Interest ▪ EIR calculated on contractual cash flows ▪ EIR calculated on ❖ Assessment could be performed at counterparty level if the objectives of the expected
revenues ▪ Applied to the Gross Carrying Amount**
contractual cash flows* loss model can be met
▪ Applied to the Net
Carrying Amount** Observation
The term "significant increase" is not defined in IFRS 9. Determinig whether there has been a significant increase in credit risk is one of
(*) For purchased – originated credit impaired assets, the credit-adjusted EIR (i.e. the EIR calculated on the contractual cash flows NET of initial loss expectations) is used instead of the EIR the most critical and difficult judgement areas in the model. Entities will need to decide how they will define this key term in the context
(**) See below for further details
of their instruments

Information used for the assessment Low credit risk
The following non-exhaustive list of information may be relevant in assessing changes in credit risk (IFRS 9. B5.5.17):
As an exception from the general requirements, an entity may assume that the criterion for recognising lifetime expected
credit losse is not met if the credit risk on the financial instrument is low at the reporting date.
a) significant changes in internal price indicators of credit risk as a result of a change in credit risk since inception, including, but not
limited to the credit spread that would result if a particular financial instrument or similar financial instrument with the same terms and the If a financial instrument is determined to have low credit risk at the reporting date an entity
same counterparty were newly originated or issued at the reporting date. may assume that the credit risk of the financial instrument has not increased significantly since initial recognition.
b) other changes in the rates or terms of an existing financial instrument that would be significantly different if the instrument was
newly originated or issued at the reporting date (such as more stringent covenants, increased amounts of collateral or guarantees, or higher
income coverage) because of changes in the credit risk of the financial instrument since initial recognition.
c) significant changes in external market indicators of credit risk for a particular financial instrument or similar financial instruments with IFRS 9 states that the credit risk is low if (IFRS 9.B5.5.22):
the same expected life. ❖ The instrument has a low credit risk of default;
d) an actual or expected significant change in the financial instrument’s external credit rating.
❖ The borrower has a strong capacity to meet its contractual cash flow obligations in the near term;
e) an actual or expected internal credit rating downgrade for the borrower or decrease in behavioural scoring used to assess credit risk
internally. Internal credit ratings and internal behavioural scoring are more reliable when they are mapped to external ratings or supported Low credit risk ❖ Adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce
by default studies. the borrower's ability to fulfil its obligations
f) existing or forecast adverse changes in business, financial or economic conditions that are expected to cause a significant change in the
borrower’s ability to meet its debt obligations, such as an actual or expected increase in interest rates or an actual or expected significant The low credit risk notion is not a bright-line trigger for lifetime ECL
increase in unemployment rates.
g) an actual or expected significant change in the operating results of the borrower. Examples include actual or expected declining
revenues or margins, increasing operating risks, working capital deficiencies, decreasing asset quality, increased balance sheet leverage, Observation
liquidity, management problems or changes in the scope of business or organisational structure (such as the discontinuance of a segment of
the business) that results in a significant change in the borrower’s ability to meet its debt obligations. IFRS 9 states that the financial instrument with an external rating of "investment grade" is an example of an instrument that may be
h) significant increases in credit risk on other financial instruments of the same borrower considered to have low credit risk (IFRS 9.B5.5.23)
i) an actual or expected significant adverse change in the regulatory, economic, or technological environment of the borrower that
results in a significant change in the borrower’s ability to meet its debt obligations, such as a decline in the demand for the borrower’s sales However an external rating is a lagging indicator, as it does not reflects events that occur or other relevant information that become
product because of a shift in technology. avaible after the rating agency last updated its rating. In addition, the definition used by a ratings agency may not be consistent with the
j) … definition of default used by the entity.
Therefore, in order to conclude that an instrument with an external rating equivalent to "investment grade" has low credit risk, the entity
will need to consider whether there is evidence of an increase in credit risk that is not yet reflected in the rating.
IFRS 9 Impairment Model
The expected credit loss concept 12-months EL calculation
The probability-weighted estimate of credit losses (ie the present value of all cash
Expected credit losses
shortfalls) over the expected life of the financial instrument (IFRS 9.B5.5.28) ■ EAD –Exposure at Default
■ Cash and undrawn credit lines
IFRS 9 requirements
■ LGD - Loss Given Default

■ Forward-looking loss estimates based
on best available (internal and
The difference between the cash flows that are due to an entity in accordance with the external) information that is
Cash shortfall contract and the cash flows that the entity expects to receive (IFRS 9.B5.5.28) reasonably available, including
information about:
− past events
− current conditions
− reasonable and supportable EL = EAD  PD  LGD
forecasts of future events and
economic conditions
EL is defined as a probability- ■ PD – Probability of default
The portion of the lifetime expected credit losses and represent the lifetime cash ■
12-month weighted expected value ■ PIT (point in time)
shortfalls that will result if a default occurs in the 12 months after the reporting date Incorporation of forward-looking
expected credit losses ■ EL includes losses on both, ■
(IFRS 9.B5.5.43) information
principal and interest on a
discounted basis
General requirements:
■ Validation / backtesting required
■ Consideration of macroeconomic cycles / business forecasts**
− PIT analysis required (TTC averages not adequate)
− Consider correlations between the parameters PD, LGD and EAD
■ All assumptions must be validated (conservative assumptions are not allowed)
Lifetime expected The expected credit losses that result from cash shortfalls arising from all possible
credit losses default events over the expected life of a financial instrument (IFRS 9 Appendix A)

EL/lifetime EL calculation ECL - example
■ LGD in period t ■ EAD in period t Data Legenda

■ PIT ■ PIT Mortgage
■ Removal of downturn factor & indirect ■ Contractual + stochastic cash flows
Original amount 1.000 OB Outstandng debt
costs ■ Consideration of the regulatory requirements
Interest rate 6% BoP Beginning of Period
■ Discounting based on the EIR regarding revolving credit facilities #installments 5 EoP End of Period
IFRS 9 requirements PD Probability of Default
LGD Loss Give default
■ Forward-looking loss estimates based ▪ Discount factor NBV Net Book Value
on best available (internal and ■ IFRS 9 specifies what discount factor to be used for LLP Loan Loss Provision ECL12M=f*g*h
ECL lifetime= cashflows in column "i" discounted at 6%
external) information that is Cumulative PD each financial instrument type within the scope of
reasonably available, including IFRS 9 impairments
information about: a b=ft-1 c d e=B*6% f=b-d g=input h=input i=c-(c*g*h) l=f-ECL m=f-l n o=m/f
Conditional
− past events Installment Impairment
(forward) PD #installments OD BoP Capital Interest OD EoP PD cum LGD Net cash flows NBV EoP LLP Coverage
− current conditions T amount loss
− reasonable and supportable
forecasts of future events and
EL =  [ PD
t =1
t  (1 − CPDt −1 )]  LGDt  EADt  Dt Stage 1 (ECL 12 M)
Stage 2 (ECL Life time)
1
2
1.000
857
203
203
143
152
60
51
857
705
1%
1%
45%
45%
202,10
202,10
853
524
4 -
181 -
4
185,09
0,4%
25,7%
economic conditions 3 705 203 161 42 545 5% 45% 198,44 357
■ EL is defined as a probability- ■ Marginal PD in period t 4 545 203 170 33 374 8% 45% 195,70 183
weighted expected value ■ PIT 5 374 203 181 22 194 10% 45% 193,87 -
■ Incorporation of forward-looking
■ EL includes losses on both,
principal and interest on a information
discounted basis
General requirements:
■ Validation / backtesting required
■ Consideration of macroeconomic cycles / business forecasts
− PIT analysis required (TTC averages not adequate)
− Consider correlations between the parameters PD, LGD and EAD
■ All assumptions must be validated (conservative assumptions are not allowed)

EL/12 months vs lifetime
Hedge Accounting
Exposure Identification & Hedge Accounting Models Fair Value Hedge (cont’d)
Exposure?
Measurement of derivative
E
A
Change in fair value R
Fair
Cash Net N
Value
Flow Investment
Measurement of hedged item I
Offsetting gain or loss N
• Exposure to changes in FV • Exposure to changes in cash • Consolidated financial attributable to risk being hedged
flows statements
G
• Affects earnings
• Recorded fixed rate assets • Affects earnings in future S
and liabilities periods
• Firm commitment • Recorded floating rate assets
and liabilities Net effect — ineffectiveness will be seen in the P&L
• Forecasted transactions
• Fx firm commitment
Hedging Instruments—Permitted Designation Hedging Instruments—Nonpermitted Designation
• In its entirety or some proportion thereof. • Non-permitted designation of hedging instruments:

• A single hedging instrument may be designated as hedge of more – No bifurcation of derivatives (except separation of option’s intrinsic
than one type of risk. value and premium on forward)
• Two or more derivatives may be jointly designated as hedging – Designation of portions of time not permitted
instrument.
Hedge Designation Hedge Documentation
• Only external derivatives can be designated as hedging instruments • Formal documentation is required at the inception of the hedge
(not other assets/liabilities except for foreign currency risk). relationship and must include:
• Only external assets/liabilities or transactions can be designated as – Identification of the hedging instrument and the hedged item or
hedged items (intragroup forecasted transactions can under certain transaction
circumstances be hedged items in the consolidated financial – The nature of the risk being hedged
statements).
– The risk management objective/strategy
• If hedged item = portfolio of assets/liabilities:
– How effectiveness will be assessed
– Change in FV of each individual asset/liability must be approximately
proportional to change in FV of portfolio
– e.g., for the hedged risk, if the portfolio increases 10%, each individual item
should be expected to increase 8% - 12.5%
Hedge Effectiveness Monitoring Hedge Effectiveness
• Effectiveness—The ability to generate offsetting changes in fair value • If ineffective, entire hedge does not qualify for hedge accounting.
or cash flows. – Hedge activity recorded prior to failure is not impacted.
• Prospective expectation of highly effective hedge relationship: • Even effective, some ineffectiveness occurs unless 100% effective.
– At inception, and
– Ineffective portion recorded in P&L.
– At least at each reporting date.
• Retrospectively analyze actual effectiveness results:
– Effectiveness.
– Assess historic effectiveness (either periodic or cumulative, depending on
policy).
– Determine if the effectiveness is expected to continue (prospective test).
Assessment vs. Measurement Fair value hedge (example)

Bank orignates a loan with a fixed rate of 4% but its liabilites are indexed to a benchmark interest rate (e.g Euribor)
Risk management objective: riduce interest rate risk
• Expectation (assessment) of high effectiveness differs from the

Then the Bank enters into a derivative transaction with a counterparty in order to swap fixed payment of the loan with variable
payments
After 1 year interest rate increase
measurement of ineffectiveness. T0
accounting entries BS P&L
Loan classified at AC (amortised cost) DR CR A E/L C R
• Assessment of effectiveness: Nominal value

Fix rate
Fair Value t0
100
4%
100
loan (BS)
swap (BS)
100
0
100 cash outflow (BS)
0 cash (BS)
loan
cash outflow
Swap
100
-100
0
0 0
Embedded
Fair Value t1 91 100 100 0 0 0 0 loss of value
– Can hedge accounting be applied? of 9
T1 (without hedge accounting)

accounting entries BS P&L
• Prospective vs. Retrospective Cash inflow (BS)

DR
4
CR
4 Interest income (P&L) loan
A
100
E/L
4
C R
4 Interest income
cash outflow -100
cash inflow 4
• Measurement of ineffectiveness: 4 4 4 4 0 4 loss of

value
almost
T1 (with hedge accounting)
fully offset
– P/L impact
SWAP accounting entries BS P&L
by
Notional value 100 DR CR A E/L C R
Pay leg (fixed rate) 4% Hedge effect (P&L) 9 9 loan (BS) loan 91 5 Profit Hedge effect 9 10 FV gain (swap)
Receive leg (variable rate) Euribor 3M+3% Cash inflow (BS) 4 4 Interest income (P&L) cash outflow -100 4 Loan Interest income
Fair Value t0 0 swap (BS) 10 10 FV gain (P&L) swap 10 swap interest income/expense
• Based on actual results. Fair Value t1 10 Swap net cashflow 0
23
0 Interest income (P&L)
23
Cash inflow 4
5 5 9 14
• Ineffectiveness may indicate that high effectiveness can no longer be 5 Profit
expected.
Cashflow hedge (example)
Derecognition of a
Financial Asset
Derecognition Decision Tree Derecognition Decision Tree
STEP #1: Consolidate all subsidiaries (including SPEs) pursuant to IFRS 10
Recognize a Secured Borrowing

to the Extent of the Consideration
STEP #2: Determine whether derecognition analysis is applied to a portion or Previous Received
an entire financial asset Slide
YES Derecognise the

STEP #3: Have the rights to the cash flows from the asset expired?
Asset
YES Continue to
NO STEP #7: Has the entity retained substantially all the risks and rewards of Recognize the
ownership? Transferred Asset
STEP #4: Has the entity transferred the contractual rights to the cash flows of
the asset? NO
YES NO
STEP #8: Has the entity retained control over the NO Derecognize the
STEP #5: Has the entity assumed a contractual obligation to pay the cash NO Continue to Transferred Asset
transferred asset?
flows of the asset to a third party Recognize the and Recognize G/L
Transferred Asset YES
YES
STEP #9: Continue to recognize the transferred asset to the extent of
STEP #6: Has the entity transferred substantially all the risks and rewards of YES
Derecognize the continuing involvement
ownership?
NO Transferred Asset
and Recognize G/L
Next
slide
Derecognition (example) Derecognition (example)

• The Bank transfers Non performing loans (NPLs) to a Special Purpose Vehicle (SPV).
• GBV: 10.000 • SPV waterfall (i.e. how cash inflows from NPLs collections are used)
• NBV: 2.000 1. Legal costs relating to ongoing legal procedures
• Transfer Price: 2.000 2. SPV administrative costs and taxes certain
• SPV issues 3 asset backed securities (ABS) to fund the NPLs purchase 3. Payment of interest on senior notes
– Senior notes 4. Payment of interest on senior mezzanine notes
– Mezzanine notes 5. Repayment of principal on senior notes
– Junior notes
6. Repayment of principal on senior mezzanine notes
The notes have increasing level of subordination
7. Repayment of principal on junior notes
8. Variable return of junior notes
SPV (BS)
A L uncertain
NPLs 2.000 1.200 senior notes
600 mezzanine notes
200 junior notes
2.000 2.000
• Case 1: the Bank underwrites all notes issued by the SPV • Case 2: all notes issued by the SPV are underwritten by market investors
Notes Cash 2.000 Cash 2.000

(2.000)
Bank SPV Bank SPV Investors
NPLs
(2.000) NPLs 2.000 Notes 2.000
• Conclusion • Conclusion
• The Bank has retained substantially all the risks and rewards of ownership of the NPLs. • The Bank has transferred substantially all the risks and rewards of ownership of the NPLs.
Then the Bank continues to recognize the NPLs (but doesn’t recognize the notes) Then the Bank derecognizes the NPLs
• Case 3: The Bank underwrites 10% of the junior notes and 30% of mezzanine • If the result of the test is <=10% then the Bank derecognizes the assets
notes. The remaining notes are underwritten by market investors
• If the result of the test is >10% then there are two possible outcomes:
Cash
1. The Bank doesn’t control the assets transferred; then it derecognizes the NPLs
1.800 Cash
1.800 2. The Bank controls the assets transferred; then it recognizes a pro rata share of the
Notes
Bank 200 SPV Investors NPLs
Notes
Control is defined as the ability for the transferee to sell the asset
NPLs 1.800
2.000
• The Bank has to assess to what extent has retained the risks and rewards of
ownership of the NPLs. It compares
σNPV Notes
σNPV NPLs
• σ(NPVNotes )= variability of the net present values of the underwritten notes
• σ(NPVNPLs )= variability of the net present values of the NPLs

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Objectives

• Describe the key concepts addressed by IFRS 9

IFRS 9 Financial Instruments

© 2022 Monte dei Paschi di Siena 1

IFRS 9 and IAS 39 Financial instruments in the Banking industry (assets)

▪ Effective date on 1 of January, 2018

Most of items of P&L are

Principal measurement categories

Fair Value through Other

IFRS 9 Classification and Measurement

Financial asset in the scope of IFRS 9 • Three Subcategories

Are the asset's contractual Is the business model's Yes

IFRS 9 Classification and Measurement No No

No Has the entity elected No

No Has the entity elected No

Equity instruments – Overview Equity instruments – OCI option

FVOCI FVOCI FVOCI FVOCI

No Has the entity elected No

No Has the entity elected No

Derivative instruments Fair Value option for financial assets

FVOCI FVOCI FVOCI FVOCI

Are the asset's contractual Are the asset's contractual

IFRS 9 Classification and Measurement IFRS 9 Classification and Measurement

SPPI test – Overview SPPI test – Overview

FVOCI FVOCI FVOCI FVOCI

Examples of cash flows characteristics that potentially fail SPPI test

Prepayment options Clauses that allow prepayment

time value of money

Government set interest

IFRS 9 Classification and Measurement Financial asset in the scope of IFRS 9

IFRS 9 Classification and Measurement

Business model assessment – Overview

Business model assessment - Identify relevant / objective evidence

FVOCI FVOCI FVOCI FVOCI

Are the asset's contractual Are the asset's contractual

IFRS 9 Classification and Measurement

Business model assessment - Held-to-collect

Business model assessment - Both held to collect and for sale

FVOCI FVOCI FVOCI FVOCI

IFRS 9 Classification and Measurement

Financial liabilities - Decision tree

Business model assessment - Other business models Is it held for trading?

Has the entity elected

Management Host Derivative(s)

IFRS 9 Classification and Measurement Is the instrument a derivative or financial Yes

Financial liabilities – Own credit risk

FV changes due to credit risk FVOCI

Separate the host

Asset Quality and Bucket Allocations are largely disconnected

IFRS9 classification rules Stage 2 Lifetime EL

Loan X at the end of the

Bt0 Bt1 Insignificant deterioration

Investment Grade Non Investment Grade Default PD

IFRS 9 Impairment Model IFRS 9 Impairment Model

IFRS 9 Impairment Model IFRS 9 Impairment Model

■ LGD - Loss Given Default

IFRS 9 Impairment Model IFRS 9 Impairment Model

■ LGD in period t ■ EAD in period t Data Legenda

IFRS 9 Impairment Model

Hedging Instruments—Permitted Designation Hedging Instruments—Nonpermitted Designation

• In its entirety or some proportion thereof. • Non-permitted designation of hedging instruments:

Hedge Designation Hedge Documentation

Assessment vs. Measurement Fair value hedge (example)