In September 2008, Lehman Brothers, a global financial services firm and the fourth-largest investment bank in the United States, collapsed. For the past five years, Lehman Brothers had amassed a huge commercial property loan book, focusing on securitizing sub-prime debt, which left it vulnerable to downturns in real-estate values. Holding more than US$600 billion in assets, it filed for bankruptcy. The repercussions were felt around the globe, with venerable financial giants like Merrill Lynch, AIG, Freddie Mac, Fannie Mae and Royal Bank of Scotland, among other institutions, coming within a hair’s breadth of collapse themselves. Trillions of dollars were used to prevent the world banking system from collapse.
Canada wasn’t immune to the crisis. A 2012 Canadian Centre for Policy Alternatives (CCPA) report estimated that several national banks, despite claiming solvency, received $114 billion in bailout support from various government agencies, including Canada Mortgage and Housing (CMHC) as well as the Bank of Canada.
Fingers were pointed at a variety of players, institutions and policies. It was clear that existing regulatory regimes were inadequate and in need of an overhaul. This resulted in the creation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, a huge piece of financial reform legislation passed by Washington in 2010. That same year, the Basel Committee on Banking Supervision, headquartered in Switzerland, citing “excessive leverage, inadequate and low-quality capital and insufficient liquidity buffers” as some of the shortcomings that led to the crash, agreed to new Basel III global banking standards.
“The new standards present considerable challenges. They affect not just accounting but overall operations.” – Cheryl Maksymiw
In mid-2014, the International Accounting Standards Board (IASB) published International Financial Reporting Standards, or IFRS 9 – Financial Instruments. As of Jan. 1, 2018, IFRS 9 would replace the standard IAS 39 – Financial Instruments: Recognition and Measurement. A report from 2009 indicated that IAS 39, overly complicated and inadequate to the practice of proper financial management, played a role in precipitating the banking crisis in 2008. IFRS 9 was drafted at the request of the G20, the international forum for governments and central bank governors from 20 major economies, to overcome these inadequacies and prevent another banking crisis like the one in 2008.
So, how is this new, sweeping legislative landscape affecting credit unions? The immediate challenge for Canadian credit unions relates to the implementation of new IFRS 9 Financial Instruments accounting standards. The requirements, governing asset classification and measurement, impairment accounting (including expected credit losses) and hedge fund reporting, take effect at the beginning of 2018. In order to ensure they meet the new requirements, credits unions are busy undertaking adjustments of their accounting systems to ensure they are up and running smoothly in just slightly over half a year.
This, says one expert, is proving to be a challenge. “The goal is to provide financial statement readers with more relevant information,” says Abhimanyu (Abhi) Verma, a partner at KPMG, which has extensive financial cooperative sector experience. “But that requires more work.” The burden is not equally shared. For example a big-bank team of 30 accountants is better equipped to tackle specialized provisions than the small staff in a regional credit union.
Cheryl Maksymiw, an associate vice-president at SaskCentral, agrees. “The new standards present considerable challenges. They affect not just accounting but overall operations,” Maksymiw says. “That means increased compliance costs.” According to Stephen Fitzpatrick, vice-president, corporate services and CFO at the Canadian Credit Union Association (CCUA), the sector is responding to the new challenge by using a traditional tool: cooperation. “When IFRS was first implemented CCUA took a lead role,” says Fitzpatrick. “This time, the process is being driven by the centrals.”
Cooperating: an old solution to a new challenge
Paving the way was the formation in late 2015 of the IFRS 9 Readiness for Credit Unions initiative. The group, which initially included CCUA, Central 1 Credit Union, SaskCentral, Credit Union Central of Manitoba, Atlantic Central, and Concentra Financial wholesale bank and trust company is headed by consultant Kim Andres, the acting national project manager.
“Our goals are to provide credit unions with information and coordinate a national approach that minimizes duplication of efforts and the sharing of resources to better address common issues.” – Kim Andres
Andres today leads a team of 60 credit union and central volunteers from across the country who staff a series of task forces that are exploring ways to facilitate IFRS 9 compliance. “Our goals are to provide credit unions with information and coordinate a national approach that minimizes duplication of efforts and the sharing of resources to better address common issues,” says Andres. “Ultimately this creates efficiencies and reduces costs throughout the system.” Participants in the readiness initiative have been busy. Stakeholder meetings, teleconference and webinars have been conducted across the country and implementation working guides related to three major IFRS 9 areas have been hammered out. In addition, a “tool kit” related to financial statements notes and disclosures was just released.
The coordination of the process by Andres and her team was complex. They pulled together four working groups, three subgroups, a project team as well as steering and administrative committees. One of their first moves was to hire KPMG consultants to provide technical expertise, assist the various groups and facilitate overall process.
Maksymiw, of SaskCentral, who is part of the steering committee, says that the preparations will help many credit unions overcome the pre-IFRS 9 jitters. “Many credit unions don’t have the resources and large accounting teams they need to easily handle the transition,” said Maksymiw, who cites process changes, data requirements, as well as IT infrastructure and personnel training as key costs member credit unions must assume. “We are doing everything we can to help. We recently invited individual credit unions to participate in conference calls to exchange ideas. The reaction was very good.”
Changes affect credit unions differently
Complicating matters is the fact that not all the IFRS 9 changes affect credit unions equally. For example, classification and measurement guidelines, which are now driven by cash flow characteristics and the business models in which the assets are held, should be more straightforward to implement for credit unions that have narrow client bases. Conversely, the relaxation of hedge fund reporting requirements, which provide institutions flexibility regarding valuations of certain assets, particularly non-fungible items such as derivatives, will be more relevant to larger players.
One area that requires special attention is asset impairment. During the financial crisis, the delayed recognition of credit losses on loans and other financial instruments was identified as a weakness in existing accounting standards. IFRS 9 mandates a new, expected loss impairment model that requires more timely recognition of expected credit losses. According to Maksymiw, credit unions currently use an incurred loss model. The new, far more burdensome methodology includes forward-looking impairment models, which require different data sets, including the monitoring of macro indicators.
To help streamline the process, the national readiness initiative commissioned Central 1 to develop a national solution to help facilitate loan impairment accounting. According to Peter Liao, a Central 1 spokesperson, the new IFRS 9 National Reporting & Analytics Platform enables credit unions to achieve economies of scale by sharing costs associated with defining, building and maintaining a software solution that incorporates future revisions.
The new software as a service (SaaS) platform, which Liao’s team has been demonstrating to Canadian centrals and their credit union affiliates during this annual general meeting season, facilitates exible data modelling. This enables more realistic and relevant loan loss estimates. The solution offers several advantages. For one, it enables accounting stakeholders to create “what if” scenarios related to how loan portfolios would be affected by changes in interest rates, housing prices, local and national economies and a variety of other macro-economic and forward-looking indicators.
“Strategic risks exist for financial institutions at all levels and appropriate safeguards are critical.” – Phil Braginetz
The platform also introduces some standardization in the way credit unions conduct impairment accounting. This provides a degree of certainty to financial professionals, who may feel uncomfortable using proprietary solutions developed in silos. It also makes it easier for professionals to collaborate on technical issues and to maintain their skills if they progress to other credit unions as their careers advance.
Simulations that produce reports related to projected loan losses and financial disclosure reconciliations will run in as little as a few minutes. Users will be able to filter loan portfolio variables to get a better understanding of expected loss results at both the branch and loan level. Central 1 is producing the new solution on a cost-recovery model basis. Fees will fund platform upgrades.
Participating credit unions will have to do initial implementation groundwork to identify and gather the needed data sets from their various banking platforms, loan origination systems and manual files. However, the new platform is expected to reduce lifetime ownership costs, such as staffing and specialized expertise and infrastructure, which are associated with developing and maintaining proprietary solutions. ◊