Reviewing(the(modeling(for( IFRS9(to(add(value(for(regulators,( - PowerPoint PPT Presentation

Reviewing(the(modeling(for( IFRS9(to(add(value(for(regulators,( banks(and(their(shareholders Brandon(Davies Board(Director

Board(Directors(Personal(Risk • The(time(has(come(to(implement(IFRS9. • I(propose(to(take(a(“boards(eye”(view(of(this(process. • The(board(signs(off(on(the(accuracy(of(the(companies( accounts(for(which(they(are(legally(responsible. • The(board(is(responsible(for(steering(market( expectations(with(respect(to(a(companies(financial( performance(through(earnings(announcements( (usually(quarterly). • For(banks(in(particular,(because(provisions(have(such(a( large(effect(on(earnings(and(potentially(capital,(the( accuracy(of(IFRS9(based(provisions(represent(an( enormous(potential(liability.(((

Board(Directors(Personal(Risk • Regarding(board(directors(potential(jeopardy,(the( BoE(states(that: o “(The(new(legislation(introduces(powers(that(enable(us( to(impose(sanctions(on(senior(managers(at(a(bank(that( fails(to(keep(within(the(rules.(We(will(be(able(to(take( action(against(the(senior(manager(responsible(for(the( area(where(a(failure(occurred(if(he(or(she(cannot( demonstrate(that(they(took(reasonable(steps(to(avoid(or( stop(the(problem.” and o “Criminal(prosecutions(can(be(bought(against(senior( managers,(if(their(companies(fail,(and(their(conduct(fell( significantly(below(what(could(be(“reasonably(expected” (“Irresponsible(conduct(carries(consequences(in(British( finance”(Andrew(Bailey,(Deputy(Governor(for(Prudential( Regulation(at(the(BoE(– FT(23/2/2015)

Board(Directors(Personal(Risk They(are(required(to(give(a(“Longer(Term(Viability(Statement”. • o Confirming(that: “Directors*should*state*whether,*taking*account*of*the*company’s* ! current*position*and*principal*risks,*they*have*a*reasonable* expectation*that*the*company*will*be*able*to*continue*in* operation*and*meets*its*liabilities*as*they*fall*due*over*the*period* of*their*assessment,*drawing*attention*to*any*qualifications*or* assumptions*as*necessary*(Code*Provision*C.2.2) Bank(boards(will(need(to(consider(very(carefully(what(period( • of(assessment(they(wish(to(choose(when(making(their(long( term(viability(statement.( Some(77%(of(UK(companies(have(put(this(statement(along( • with(the(”Robust(Assessment(of(Principal(Risks”(disclosure( into(the(Strategic(Report(to(gain(the(“safe(harbour”(cover.(

Board(Directors(Personal(Risk When(we(look(at(financial(reporting(for(UK(companies(the(UK(Companies( • Act(from(October(2014(requires(UK(companies(– whether(listed(or( unlisted(– to(prepare(a(Strategic(Report(in(place(of(the(current(business( review. The(Financial(Reporting(Council(guidance(on(the(Strategic(Report( states(that(one(objective(of(the(report(is: “ to*provide*information*on*the*entity*and*insight*into*its*main*objectives*and*strategies,* ! and*the*principal*risks*it*faces ”(another(is(“ to*compliment,*supplement*and*provide* context*for*the*related*financial*statements ”.((UK(Companies(Act(2006,(amendment( 2014)( Bank(boards(are(required(by(the(PRA(to(have(a(strategy(document(outlining(the( • companies(business(model(and(strategic(plan.(Bank(boards(will(need(to(ensure( alignment(between(the(Companies(Act(requirement(and(PRA/(FCA(requirements( which(should(not(differ(in(any(material(respects. Section(463(of(the(Companies(Act(provides(a(“safe(harbor”(for(disclosures(in(the( • Strategic(Report(unless(deliberately(untrue(or(misleading(or(is(recklessly(made((or( deliberately(conceals(a(material(fact.( Could(IFRS(provisions(be(put(here? •

Board(Directors(Personal(Risk The(importance(of(the(Strategic(Report(is(further(attested(to(by(its(link(to( • the(requirement(by(boards(to(make(a(statement(to(the(effect(that(the( report(and(accounts(are(“Fair,(Balanced(and(Understandable”. o Their(obligation(is(to(confirm(that: “The*board*confirms*that*the*annual*report*and*accounts,*taken*as*a*whole,*is*fair,* ! balanced*and*understandable*and*provides*the*information*necessary*for*shareholders* to*assess*the*performance,*strategy*and*business*model*of*the*company.”*(UK*Corporate* Governance*Code*2013) Bank(boards(will(especially(need(to(consider(how(the(direct(link(of(the(accounts(to( • the(strategy(and(business(model(of(the(bank(is(to(be(achieved.(One(facet(of(such( reporting(would(be(to(look(at(the(segmental(reporting(in(the(accounts.( There(is(also(a(need(to(ensure(there(is(no(discrepancy(between(the(business(as( • described(in(the(narrative(at(the(front(of(the(report(and(accounts(and(the( performance(as(described(by(the(financial(accounts(at(the(back(of(the(report(and( accounts.( What(happens(if(the(IFRS9(credit(provisions(prove(not(to(be(accurate?( •

What(Board(Directors(Need Assurance Defensibility This(is(what(stops(you(going(over(the(edge

Start(with(the(obvious • How(should(a(CRO(&(CFO(guide(the(board(to(obtain(its( backing(for(the(IFRS9(expected(loss(provisions(and(thus(the( banks(earnings? • Start(with(the(obvious. “The(future(is(not(unknown(it is(unknowable”(J.M.(Keynes(f a( treatise(on(probability. • So(any(projection(of(a(number(into(the(future(is( probabilistic(i.e.(it(consists(of(two(parts(a(number(and(an( associated(probability(of(its(occurrence.((

Start(with(the(obvious Future(numbers(are(not(congruent(with(accounting(numbers( that(have(traditionally(been(historic(and(therefore(deterministic The(Passed The(Future Deterministic(Numbers Probabilistic(Numbers

Start(with(the(Obvious • Thus(whilst(the(concept(of(an(expected(credit(loss(is( conceptually(alluring(and(in(hindsight(relatively(easy(to( calibrate,(projecting(an(expected(credit(loss(into(the(future( is(more(problematic. • Future(credit(losses(will(be(Dynamic(and(Conditional.(They( change(and(will(be(affected(by(the(general(economic( conditions(of(the(relevant(economy.(

Move(on(to(the(Accounting(Standard • IFRS9(breaks(down(into(two(main(parts; • An(operational(model(that(requires(a(great( deal(of(data(gathering(and(analytical(capability( to(establish(the(allocation(of(loans(to(three( stages:f Source(– GENPACT(Point(of(View

Move(on(to(the(Economic(Model • Whilst(the(operational(model(is(expensive(and( may(require(major(changes(to(credit(processes( and(procedures(it(is(relatively(simple(to( understand.( • The(relationship(between(the(losses(on(various( portfolios(and(their(relationship(to(major( economic(variables((output,(employment,( interest(rates,(wage(inflation(etc.)(is(vital(to( forecasting(expected(loss. • Macro(Economic(Models(are,(however,(not(easily( understood(and(their(projections(are(not(reliable.

Projections Euro-zone CPI Inflation & ECB Forecasts Estimates of Impact of Brexit on UK Economy (% y/y) (2012 – 2018) (As a % of GDP) 3.0 3.0 Loss Gain Current forecast Tim Congdon/UKIP (2012) ECB's target of Patrick Minford (2016) Past forecasts 2.5 2.5 near 2% Civitas (2004) Actual Minford & Mahambre (2005) 2.0 2.0 Institute of Directors (2000) Open Europe (2015) 1.5 1.5 NIESR (2004) IEA (2015) 1.0 1.0 Bertelsmann Stiftung (2015) CEP/LSE (2016) CBI/PwC (2016) 0.5 0.5 Oxford Economics (2016) CBI (2013) 0.0 0.0 HM Treasury (2016) LSE/CEP (2014) -0.5 -0.5 2012 2013 2014 2015 2016 2017 2018 -12 -8 -4 0 4 8 12 Sources: Various Sources: Thomson Datastream, ECB 19 The Deloitte Academy

Markets(are(no(better

Economists(Know(This

So(The(Board(Should(Know(This

Macro(Models(Do(have(Benefits They(produce(probability(distributions(and(have(credibility( (BoE(Quarterly)

Macro(Models(Do(have(Benefits • IFRS9(requires(banks((and(other(companies)(to(choose( “probability(weighted”(outturns(from(their(IFRS9( scenarios(to(calculate(their(expected(losses. • Independent(scenarios(can(at(best(only(have(highly( subjective(probabilities(associated(with(them.(They(are( little(more(than(guesswork. • But(scenarios(that(can(be(derived(from,(and(are( congruent(with,(the(paths(of(interest(rates,(output(and( employment(resulting(from(a(macro(model(are( defensible. • So(which(would(you(prefer(if(you(wanted(ASSURANCE? • Which(will(be(more(convincing(to(a(judge(and(jury?

Assurance(&(Defensibility • Assurance(is(what(board(directors(seek(from(their( executives. • But(increasingly(under(pressure(from(activist( shareholders(and(the(SMCR(they(also(seek(the( defensible.( • What(is(the(more(defensible(a(weighted(average(of(a( number(of(scenarios(to(which(either(the(executive(or( the(board((or(both)(have(ascribed(their(own( probabilities(OR • The(weighted(average(of(the(outputs(of(the(BoE( Model? • If(you(were(giving(assurance,(which(would(you(choose?

The(BoE(/(NIESR(Model • Finding(a(source(of(macro(economic(models(that(can( provide(the(required(outputs(is(not(as(difficult(as(you(might( imagine. • Indeed(the(dominant(model(in(the(UK(is(known(as(a( Dynamic(Stochastic(General(Equilibrium((DGSE)(Model(and( was(developed(by(the(National(Institute(for(Economic(and( Social(Research((NIESR).(It(is(widely(used(by(the(UK( Treasury,(the(BoE(and(many(economic(institutes. • If(you(need(similar(models(for(other(economies(the(IMF(is( an(excellent(source. • Potential(sources(of(outputs((scenarios)(based(largely(on( their(own(versions(of(this(model(are(economic(analytical( companies(such(as(Oxford(Economics,(Capital(Economics,( Lombard(Street(Research(etc.