IFRS 9 Financial Instruments—Credit enhancement in ECL measurement (Agenda Paper 6)

Background

The Committee received a submission asking about the effect of a credit enhancement on the measurement of expected credit losses (ECL) when applying the impairment requirements of IFRS 9 Financial Instruments. IFRS 9:B5.5.55 requires the inclusion of cash flows expected from collateral and other credit enhancements in the measurement of ECL if the credit enhancements are part of the contractual terms and are not recognised separately by the entity. The submitter asked whether the cash flows expected from a financial guarantee contract or any other credit enhancement that is integral to the contractual terms of a loan can be included in the measurement of ECL if the credit enhancement would otherwise be required to be separately recognised (for example the lender obtained a guarantee from a guarantor).

Staff analysis

The staff are of the view that for the cash flows expected from a credit enhancement to be included in the measurement of ECL, the credit enhancement is required to be both: (a) part of the contractual terms; and (b) not recognised separately by the entity. Therefore, if a credit enhancement is required to be recognised separately by IFRS Standards, an entity cannot include the cash flows expected from it in the measurement of ECL, even if the credit enhancement is judged to be integral to the contractual terms of the loan.

Staff recommendation

The staff did not recommend to add this matter to its standard-setting agenda because it is considered that the requirements in IFRS 9 provide an adequate basis for an entity to determine whether to include the cash flows expected from a credit enhancement in the measurement of ECL in the fact pattern described in the submission. Instead, the staff recommended that the Committee publish an agenda decision that outlines the relevant requirements set out in IFRS 9.

Discussion

Most of the Committee members agreed with the staff analysis and conclusion. However, some of the Committee members pointed out that requirements in paragraph B5.5.55 of IFRS 9 is not clear whether the credit enhancement has not been recognised separately by the entity or is required to be separately recognised under other IFRS Standards. They also recalled the discussion points in the Impairment TRG ('ITG') meeting that if the credit enhancement is accounted for separately, it shall not be included in the measurement of ECL to avoid double accounting. The Chair has stressed that the ITG meeting has discussed in a quite different context that the protection provided from credit enhancement is from a legal perspective, which is outside the contract, i.e. not part of the contract. On the other hand, some Committee members said they do not understand the difference between the terms "part of contractual terms" and "integral to the contractual terms".  The Chair explained that the ITG focused on whether or not the sale of collateral held or other credit enhancements are integral to the contractual terms. The Committee members suggested the wording in the tentative Agenda Decision should be more explanatory. Therefore, the Committee members suggested the Agenda Decision to change to "the Committee concluded that if the credit enhancement is to be required to be recognised separately by an IFRS Standard, an entity cannot include the cash expected to be received in the measurement of ECL." The Chair had further pointed out that IFRS9:B5.5.55 of IFRS 9 does not provide any relief from other standard requirements to recognise assets from credit enhancement.

The Committee decided, by a majority of votes, not to add this matter to the Committee's standard-setting agenda but to publish an Agenda Decision.

In terms of the wording in the Agenda Decision, the Chair suggested to remove all references to "integral", change to conform with paragraph B5.5.55 of IFRS 9 that credit enhancement is part of the contractual terms and not recognised separately by the entity and add the sentence of "it does not provide any relief from the requirement to account for the credit enhancement in the IFRS Standards". The Committee decided, by a majority of votes, to adopt the wording in the Agenda Decision subject to above changes.