RULES

Abu Dhabi 2019 | FINANCE | FOCUS: IFRS 9 STANDARDS

Along with the 5% VAT, this year ushered in another regulatory update affecting businesses in Abu Dhabi and the UAE.

Though it may sound like an accounting cavil, understanding how and why the IFRS 9 may impact businesses in the Emirate should concern players well beyond the financial sector. On January 1, 2018, the implementation of International Financial Reporting Standards (IFRS) 9 marked a paradigm shift for banks worldwide. Although it is likely to have minimal impact on Abu Dhabi banks, thanks to their relatively good earning capacity and conservative approach to provisioning, its implications on the wider business environment should not be underestimated. Surely, the updated accounting standard will impact the entire financial services industry, from banks with global exposure to community banks and specialist lenders. However, the impact of IFRS 9 reaches well beyond accounting.

As far as banks are concerned, the most important part of IFRS 9 in Abu Dhabi is the new forward-looking expected credit loss (ECL) impairment methodology for their loan books and other debt-security portfolios, which are currently measured at amortized cost. The ECL model requires banks to calculate and book provisions for loan losses on all debt instruments, including credit commitments not yet disbursed, based on expectations of default over the life of the instrument. Banks will be obligated to invest and develop their IT platforms, data warehouses, and probabilities of default models, and develop ECL engines to enable them to measure their forward-looking expectations.

Within the scope of financial assets and liabilities, equity investments originally classified as held-for-trading under the former regulation will now be accounted at fair value through profit or loss or at fair value through other comprehensive income. Margins trading receivables, guarantee deposits with markets, due from securities investments, and cash and cash equivalents—previously under loans and receivables—will now fall under amortized cost voice.

The standard also instructs banks to begin calculating ECL from the first instance of credit commitment, raising the debatable question of how sensible it is to book losses on day one of granting a credit commitment. What the standard aims to address is that no credit decision is based on zero risk, but is the result of a calculated one. Financial assets like short-term placements between banks, as well as government and corporate bonds, will now also be subject to ECL calculation. The main issue arising from this is that banks will now be required to book provisions for locally issued government bonds, mainly foreign currency bonds, whereas previously this was never the case. However, banks will not be the only players to bear the impact of the new accounting standard. IFRS 9 will require changes in systems and processes, impacting multiple internal functions and business lines and requiring collaborative efforts across organizations to meet its requirements.

Though Abu Dhabi is arguably the most sophisticated market in the MENA region, the established dynamics of western markets may still not be fully applicable in the UAE. Indeed, as part of impairment provisioning under IFRS 9, companies will have to identify relevant macroeconomic variables for their businesses, study them for historical trends and impact, establish their relationship with historical default rates, and track them for available forecasts in order to estimate expected losses. For this reason, analysts consider IFRS 9 in some ways much simpler than its predecessor, IAS 39. It is principle-based and logical rather than rule-based. It enables accounting to reflect the nature of the financial asset, the company's business model, and its risk management practice on financial statements.

IFRS 9 is an accounting policy change in line with the International Accounting Standards Board and regulators, but it also creates business-wide challenges for organizations in the increasingly dynamic Abu Dhabi market. At a time of heavy financial restructuring, businesses in the Emirate will have the uneasy task of matching a Middle Eastern culture in many aspects with a standard modeled on Western institutions.