EY European IFRS banking conference...Agenda and speakers ÈFriday, 7 June 2019 Page 1 EY European...

EY European IFRS banking conferenceMinds made for transforming financial services

Friday, 7 June 2019

Agenda and speakers — Friday, 7 June 2019

EY European IFRS banking conferencePage 1

08:30-09:00 Registration

09:00-09:15 Introduction — Michiel van der Lof, EY

09:15-09:45 International Accounting Standards Board (IASB) update — Sue Lloyd, IASB

09:45-10:30 Challenges related to Interbank offer rates (IBOR) — Tony Clifford, EY and Fiona Thomson, Goldman Sachs

10:30-11:00 Break

11:00-11:45 IFRS 9 — What did banks disclose? — Laure Guegan, EY with Tony Clifford, EY and Fabio Fabiani, EY

11:45-12.15 Finance function of the future — Francois Rossouw, EY and Ladislas Tyl, EY

12:15-12:45 Supervisory update — Nic van der Ende, European Banking Authority

12:45-13:45 Lunch

13:45-14:15 Integrated reporting and climate risk — Doug Johnston, EY and Rebecca Self, HSBC

14:15-14:45 IFRS hot topics and accounting in the digital age — Marek Walendowski, EY and Jane Hurworth, EY

14:45-15:15 Break

15:15-15:45 The macro environment and related accounting and reporting impacts — Mark Gregory, EY

15:45-16:15 Inside Brussels — David Doyle, EY

16:15-16:30 Closing comments — Michiel van der Lof, EY

16:30 Drinks reception

The views expressed in this presentation are those of the presenter, not necessarily

those of the International Accounting Standards Board or the IFRS Foundation.

Copyright © 2019 IFRS Foundation. All rights reserved.

IFRS® Foundation

IASB Update

Sue Lloyd

Vice-chair, International Accounting Standards Board

June 2019

3What I will cover

• IBOR reform

• Dynamic Risk Management

• Financial Instruments with Characteristics of Equity

• Recent Interpretations Committee activities

• Primary Financial Statements

• Amendments to IFRS 17

IFRS® Foundation

IBOR reform

5Background

What are IBORs?

What led to the reform?

Potential effects?

Interest rate benchmarks such as interbank offer rates (IBORs) play an

important role in global financial markets. They index a wide variety of

financial products worth trillions of dollars, ranging from mortgages to

derivatives.

Market developments have undermined the reliability of existing

benchmarks. The FSB has recommended reforms. Some jurisdictions

have made progress towards replacing existing benchmarks with nearly

risk-free rates (RFRs).

This has, in turn, led to uncertainty about the future of existing interest

rate benchmarks. Such uncertainties have some market implications

which may also affect entities’ financial reporting.

6Two-phase project

Pre-replacement issuesPhase I

• Issues affecting financial reporting

before the replacement of an

existing benchmark with RFR.

The Board identified two groups of accounting issues:

The Exposure Draft addresses Phase I issues only

Replacement issuesPhase II

• Issues that might affect financial

reporting when an existing

benchmark is replaced with RFR.

The pre-replacement issues are more urgent because they may affect financial reporting

before the reform is enacted and can be addressed without knowing details of RFR.

Therefore, the Board decided to address these issues as a priority.

7Phase I – why the Board is proposing amendments

Uncertainties around timing and

amount of designated future cash flows may

affect some hedge accounting

requirements.

Entities could be required to

discontinue hedge accounting. Entities

may also not be able to designate new relationships.

Discontinuation of hedge accounting solely due to such uncertainties could

produce information that

would not be useful to users of financial

statements.

The Board decided to propose

amending some hedge accounting

requirements during this period

of uncertainty.

Uncertainties arising

from the reform

Potential effects on

financial reporting

What is the

Board’s view?As a result…

Find out more

8Which issues are addressed?

• Reform creates uncertainty about timing/ amount of future cash flows based on IBOR.

• How to consider uncertainty when assessing if future IBOR cash flows are highly probable?

Highly probable requirement

• IFRS 9 requires the existence of an economic relationship; and IAS 39 expectation of offsetting between hedged item and hedging instrument.

• How to consider uncertainties from reform?

Prospective assessments

• If the hedged item is a risk component, then it must be separately identifiable.

• Reform may impact market structure and therefore ability to identify a risk component.

Risk components

Other hedge accounting requirements would not be changed

Until uncertainty is

resolved assume cash

flows based on

interest benchmark do

not change

Separately identifiable

required only at

inception

9Timeline and next steps

Mandatory

effective date

ED

published

Phase I

JAN

2020

Q4

2019JUN

2019

MAY

2019

Comment

period ends

Publish final Phase I

amendments

Proposed effective date

Annual periods beginning on or after 1 January 2020. Earlier application is permitted. The comment

period and effective date reflects the urgency of this issue.

10Phase II – replacement issues

The staff is currently assessing the potential issues arising in Phase II.

At the time of the Board’s discussions leading to the Exposure Draft, the

specific conditions and details of the replacement RFR have yet to be

finalised.

Therefore, the Board decided to monitor developments in this area and assess

the potential implications as more information becomes available.

Examples of issues raised by stakeholders include:

• Derecognition vs. modification: whether the amended contract should be accounted for as a

modified, derecognised or ‘continuing’ financial instrument and any resulting effects on the effective

interest rate.

• Change in hedge documentation: whether amending hedge documentation to reflect RFR as the

new hedged risk would trigger discontinuation of hedge accounting and resulting effect.

• Non-FI-related implications: whether IBOR reform will impact areas such as lease accounting,

insurance, intangible assets, etc.

IFRS® Foundation

Dynamic Risk Management

12Dynamic Risk Management (DRM)

• Improve information regarding interest rate risk management and how interest rate risk management activities affect the entity’s current and future economic resources

Objective

• Recognition, measurement and presentation aspects of the core model tentatively agreed by the Board

Work completed

• July 2019 – Discuss operational simplifications, disclosure and demonstrate the completed core model

• 2nd Half 2019 – Outreach on core model

Next Steps

13Dynamic Risk Management (DRM)

At this juncture the Board has decided not to issue a formal due process document

Outreach will involve discussions with relevant stakeholders based on tentative decisions to date to obtain feedback on those decisions

The Board will consider the specifics of outreach in the coming months

Based on feedback received, the Board will determine next steps

Outreach

IFRS® Foundation

Financial Instruments with Characteristics of Equity

(FICE)

15FICE—Project Overview

• IAS 32 Financial Instruments: Presentation works well for most financial instruments, but presents challenges for some complex financial instruments

• limited information available to investors about equity instruments other than ordinary shares

• no clear rationale for classification

Problem identified

• articulate classification principles—clear rationale

• propose additional information through presentation and disclosure

Board’s proposals—Discussion Paper 2018

16

Financial Instruments with Characteristics of Equity–Feedback received

• Board’s proposals perceived as a fundamental change from IAS 32 for reasons including:

- use of new terminology that would require significant efforts to assess potential effects and to implement if they were to be finalised

- classification changes for particular types of financial instruments

• General support for:- retaining a binary distinction between liabilities and equity

- standard-setting to address known practice issues but mixed views on how

- disclosure proposals, with particular support from investors

• Concerns about the ‘amount feature’ used in the classification proposals and the attribution proposals for equity instruments

Key themes emerging from feedback received

17FICE—Timeline

June 2018

Discussion paper

published

March 2019

High level summary of

feedback received

Currently

Detailed analysis of feedback received

H2 2019

Decide project direction

IFRS® Foundation

Interpretations Committee activities

19

Recent agenda decisions that may be relevant to banking sector

Agenda decisions finalised in March

2019

Credit Enhancement in

the Measurement of ECL

(IFRS 9)

Curing of a credit

impaired financial asset

(IFRS 9)

Application of the Highly

Probable Requirement

(IFRS 9 and IAS 39)

Customer’s Right to

Receive Access to the

Supplier’s Software

Hosted on the Cloud

(IAS 38)

20Curing of a credit-impaired financial asset

A credit-impaired financial asset subsequently

cures (ie paid in full or no longer credit-impaired)

Interest

(GCA)

Interest

(Amortised

cost)

Difference

when

curing

Question

How should an entity present the difference?

Interest revenueReversal of

impairment lossor

Gross

Carrying

Amount

(GCA)

Expected

Credit

loss

(ECL)

Amortised

cost- =

For credit impaired

financial assets, interest

revenue is calculated on

the amortised cost.

Interest revenue calculated on

gross carrying amount.

21Presentation of interest revenue

IAS 1 requirement to present separately interest revenue

calculated using effective interest method

Assets measured at amortised cost

Assets measured at fair value through OCI

9

22Sufficient time for implementing agenda decision

Explanatory

material in agenda

decisions provide

new information

Entities may

determine they need

to change their

accounting policy

The Board expects companies to be entitled to sufficient

time to implement changes in accounting policy that result

from an agenda decision.

Board’s view

New information from agenda decisions

Some changes

require significant

time to implement

New rubric in

IFRIC update

How the Board and the Committee

are trying to help?

More information on our website:

ifrs.org

Feature: Agenda

Decisions- time is

of the essence

IFRS® Foundation

Primary Financial Statements

24Primary Financial Statements

Agenda Consultation

identified project as a priority

2015 Dec 2016

Board discussions on

topics in project scopePublish

Exposure DraftBoard decision

on project scope

Objective:

targeted improvements to the primary financial statements

with a focus on the structure of statement(s) of financial performance

2017–2019

25Stakeholder feedback and key tentative Board decisions

Introduce defined subtotals in

the statement(s) of financial

performance

Introduce requirements to

improve disaggregation

Introduce disclosure of

Management Performance

Measures

Preparers

Non-GAAP measures can provide

useful information, but transparency

needs to be improved

I need flexibility to tell my company’s

story

There is insufficient disaggregation in

financial statements

Statements of financial

performance are not sufficiently

comparable between different

companiesInvestors

Investors

Investors

26

PFS—introducing defined subtotals in P&L (example for general corporates)

26Revenue 16,500

Changes in inventories of finished goods and work in progress (1,000)

Raw material and consumables used (6,000)

Employee benefits expense (4,000)

Impairment of property, plant and equipment (500)

Depreciation expense (1,200)

Amortisation expense (800)

Operating profit 3,000

Share of profit of integral associates and JVs 500

Operating profit and share of profit or loss of integral associates and JVs 3,500

Changes in the fair value of financial assets 250

Dividend income 50

Share of profit of non-integral associates and JVs 100

Profit before financing and income tax 3,900

Interest income from cash and cash equivalents 100

Expenses from financing activities (1000)

Unwinding of discount on pension liabilities and provisions (100)

Profit before tax 2,900

Operating

Investing

Financing

27PFS—P&L classification for financial entities

Example: bank with multiple business

activities, including investing and customer

financing activities.

Extract from statement(s) of financial performance

Interest income* X

Interest expense (X)

Net interest income X

Fee and commission income X

Fee and commission expense (X)

Net fee and commission income X

Net trading income X

Net investment income X

Credit impairment losses (X)

Employee benefit expenses (X)

General and administrative expenses (X)

Operating profit X

Share of profit of integral associates and joint ventures X

Operating profit and share of profit of integral associates and JVs X

Share of profit of non-integral associates and joint ventures X

Unwinding of discount on pension liabilities (X)

Profit before tax X *Interest revenue calculated using the effective interest

method would be presented separately (IAS 1.82(a)(i))

all expenses from financing activities

in operating profit, rather than below

‘profit before financing and tax’

income (expenses) from investments

made in the course of the entity’s main

business activity are included in

operating profit.

entity does not present ‘profit before

financing and income tax’ subtotal

28

Disclosure in the notes of measures of profit not defined by IFRS Standards

Management performance measures (MPMs)

Same measure must be

used in public

communications with

users outside financial

statements

Accompanied by disclosures to enhance transparency, in a single note

—including a reconciliation of the MPM(s) to the most directly comparable subtotal

or total specified by IFRS Standards (see next slide)

In management’s view

complements IFRS-

defined totals or subtotals

in communicating an

entity’s performance

Must faithfully

represent the financial

performance of the

entity to the users

IFRS® Foundation

IFRS 17 Insurance Contracts

30Easing IFRS 17 implementation

Simplified balance sheet presentation

Allocation of acquisition costs

to expected contract renewals

Attribution of profit to service relating

to investment activities

Extension of risk mitigation option

Additional scope exclusions

Deferral of the effective date by

one year

Reduced accounting

mismatches for reinsurance

Additional transition reliefs

Business combinations

Risk mitigation—transition date

Risk mitigation—fair value approach

Loans

Credit cards

IFRS 17

IFRS 9

31Loans that transfer insurance risk

• A loan contract that transfers

significant insurance risk is an

insurance contract that contains both a

loan and an insurance component

• Applying IFRS 4 some entities

separate the loans in such contracts

and apply IFRS 9 to those loans

• IFRS 17 does not permit the

continuation of this practice

• Entities need to apply IFRS 17 to the

loan contract in its entirety

• An entity would be permitted to apply

either IFRS 17 or IFRS 9 to ‘insurance

contracts that provide insurance

coverage only for the settlement of the

policyholder’s obligation created by the

contract’

• The choice would be made portfolio by

portfolio, using the IFRS 17 definition

of a portfolio

Concerns and implementation

challenges expressedIASB’s response

Proposal in the forthcoming

Exposure Draft

32Credit cards that provide insurance

• Some credit card contracts provide

insurance coverage—for purchases

made using the credit card—for free or

for a fixed fee

• Entities that today account for those

credit card contracts applying IFRS 9

would need to change the accounting

when IFRS 17 is effective, shortly after

having incurred costs to comply with

IFRS 9

• An entity would not apply IFRS 17 to

credit card contracts for which the fee

charged to the customer does not

reflect an assessment of the insurance

risk associated with that individual

customer

• The entity would apply other relevant

IFRS Standards (eg IFRS 9, IFRS 15

or IAS 37)

Concerns and implementation

challenges expressedIASB’s response

Proposal in the forthcoming

Exposure Draft

33Timeline

May 2017

IFRS 17

issued

Mid-2019

Expected

Exposure Draft of

proposed

amendments to

IFRS 17

January

2022

IFRS 17 is

effective

Mid-2020

Expected

finalisation of

amendments to

IFRS 17

Nov 2018-

April 2019

Board decided to

amend IFRS 17

to aid

implementation

Get involved

@IFRSFoundation

IFRS Foundation

International Accounting Standards Board

IFRS Foundation

IFRS Foundation

Join our team: go.ifrs.org/careers

Find out more: www.ifrs.org

Follow us:

34

EY European IFRS banking conference

Challenges related to Interbank offer rates (IBOR)

Tony CliffordPartner, Ernst & Young LLP

Fiona ThomsonManaging Director,International Head of Accounting Policy, Goldman Sachs International

Page 35

LIBOR and its impact, by the numbers

SOURCE: ISDA, “IBOR Global Benchmark Survey 2018 Transition Roadmap” (data as of 2014)

benchmark tenor most widely referenced, by volume

3m

year after which the FCA will no longer compel panel banks to submit to LIBOR

2021year LIBOR was introduced

1986

total outstanding notional of USD LIBOR and EURIBOR exposures ($150T for each rate) globally

$300Ttotal outstanding notional of IBOR exposures across markets and currencies

$370TNotional Interest Rate Derivatives trading volume linked to LIBOR in 2018

$150T

portion of syndicated loans in the US market (~$3.4T in outstanding volumes) that reference USD LIBOR

97%Time (GMT) at which LIBOR is normally published for each currency and tenor combination on every business day

11:55am

LIBOR TRANSITION OVERVIEW

LIBOR is expected to be phased out over the next 2-3 years

▪ Despite recent efforts to reform existing LIBOR benchmarks, international regulatory bodies are promoting new interest rate benchmarks (i.e. Alternative Risk Free Rates), due to a number of factors:

– Limitations in the relevance of LIBOR as a benchmark rate (e.g., it is based on expert judgment rather than actual transactions)

– Questions around the sustainability and stability of LIBOR in stressed market conditions, given the lack of an active and highly liquid underlying market

– Instances of LIBOR manipulation in the 2008 financial crisis and the 2012 LIBOR scandal

▪ As announced in July 2017 by Andrew Bailey, Chief Executive of the UK Financial Conduct Authority (FCA), banks will no longer be compelled to submit rates that are currently used to calculate LIBOR after year-end 2021

▪ In July 2018, Andrew Bailey further reiterated the likelihood of LIBOR discontinuation and the need for market preparedness for the transition

▪ Additionally, several regulators across the globe have continued to state the importance of the transition


SOURCE: FCA, “The future of LIBOR,” speech by Andrew Bailey at Bloomberg London, 27 July 2017 (https://www.fca.org.uk/news/speeches/the-future-of-libor); FCA, “Interest rate benchmark reform: transition to a world without LIBOR,” speech by Andrew Bailey, 12 July 2018 (https://www.fca.org.uk/news/speeches/interest-rate-benchmark-reform-transition-world-without-libor)

“Let me immediately remind firms of their responsibility […] It is therefore an imperative that we take preparations for 2021 seriously.”

Megan Butler, Executive Director of Supervision –Investment, Wholesale and Specialists at the FCA

“Every firm that has exposure to LIBOR needs to prepare now for the risk—indeed, the likelihood—that LIBOR will cease in the near future.”Michael Held, Executive Vice President and General Counsel,

Federal Reserve Bank of New York

The identified Alternative Risk-free Rates (RFRs)

CharacteristicsJurisdiction Working Group Alternative RFR

Rate administration

Secured vs. Unsecured First publication

UKWorking Group on Sterling Risk-Free Reference Rates

Reformed Sterling Overnight Index Average (SONIA)

Bank of England Unsecured 23 April 2018

USAlternative Reference Rates Committee

Secured Overnight Financing Rate (SOFR)

Federal Reserve Bank of New York

Secured 3 April 2018

Europe Working Group on Risk-Free Reference Rates for the Euro Area

Euro Short-Term Rate (€STR)

European Central Bank

Unsecured Anticipated October 2019

SwitzerlandThe National Working Group on CHF Reference Rates

Swiss Average Rate Overnight (SARON)

SIX Swiss Exchange Secured Already published prior to 2018

JapanStudy Group on Risk-Free Reference Rates

Tokyo Overnight Average Rate (TONAR)

Bank of Japan Unsecured Already published prior to 2018


SOURCE: ISDA, “IBOR Global Transition Roadmap,” 1 February 2018 (https://www.isda.org/a/g2hEE/IBOR-Global-Transition-Roadmap-2018.pdf)

Section

1 Overview of Exposure Draft proposals

2 Initial views on Exposure Draft

3 Phase two issue to be addressed

Contents


Assume that the interest rate is not altered as a result of IBOR reform, so forecast cash flows remain highly probable

Assume that the interest rate is not altered as a result of IBOR reform, so amounts can remain deferred

Assume that the interest rate on which hedged cash flows (contractual or non-contractually specified) are based are not altered as a result of IBOR reform

Overview of phase one Exposure Draft proposals one


All hedging relationships of interest rate risk that are affected by interest rate benchmark reform

Highly probable requirement for cash flow hedges (CFH)

2

Reclassification of the amount in the CFH reserve to profit and loss (P&L)

3

Assessment of effectiveness and economic relationship

4

Proposal Description

Scope of relief1

Earlier of when the uncertainty ends, the hedging relationship is discontinued, the entire amount accumulated in CFH reserve is recycled, cash flow uncertainty is no longer present

1 January 2020, earlier application permitted, applies retrospectively

Overview of phase one Exposure Draft proposals one (cont’d)


Requirement that the hedged risk is separately identifiable and applied only at the inception of the hedging relationship

End of application6

Effective date7

Comment letter period closes on 17 June 2019, so respondents need to formulate their views quickly.

Proposal Description

Designation of a component of an item as a hedged item

5

Page 41

Initial views on Exposure Draft (ED)


The ED provides workable solutions to phase one issues, but some of the drafting needs to be clarified.

Guidance could be clearerDesignating a component

2

Proposal Comments

Include cross-currency swaps in scope of reliefScope of relief1

For portfolio hedges, clarify when relief would end

Does uncertainty end only when the spread over risk free rates is set?

Drafting not clear

Relief needed from IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

Initial views on Exposure Draft (cont’d)


Consider requesting relief from 80-125 test during transition, including when hedging instrument is amended before hedged item

Clarify examples of timing difference Basis for Conclusions (BC) 40, BC41

End of relief5

Retrospective application

6

Disclosure7

Proposal Comments

Risk of failing effectiveness test

4

Phase two issues to be addressed


Issue Description

How (and when) to recognize the differenceFair value (FV) hedge valuation difference

3

Have to apply the 10% test? Is it a substantive amendment? Modification or derecognition

4

When to release and how

Impact of transition to RFRs on hedge designation

Release of CFH reserve2

Hedge de andre-designation

1

Whether to recognize as change to EIR or continue to use original EIREffective interest rate (EIR)

5

Leases, insurance, first-time adoption, small and medium enterprises (SMEs)

Other interactions6

A global implementation programme:what’s involved?

The role of the Finance function


IFRS 9What did banks disclose?

Laure Guegan Partner, Ernst & Young et Associés

Tony Clifford

Fabio FabianiPartners, Ernst & Young LLP

Page 47

IFRS 9 Financial Instruments: what did banks disclose?

► What do IFRS 9 disclosures tell us?

► An analysis of a sample of 18 European banks

► A focus on UK banks: have more detailed disclosures improved comparability?

► Insight from the Taskforce on Disclosures about Expected Credit Losses (DECL)


What do IFRS 9 disclosures tell us?


► The (complex) IFRS 9 story

► IFRS 7 Financial Instruments: Disclosures requires some disclosures by class of financial instruments (movement table, maximum exposure and collateral)

► For the rest, an entity shall consider how much detail to disclose, how much emphasis to place on different aspects of the disclosure requirements, the appropriate level of aggregation or disaggregation, and whether users of financial statements need additional explanations to evaluate the quantitative information disclosed (IFRS 7 Financial Instruments: Disclosures, § 35D)

Page 49

CoverageStage

allocationStage credit

qualityForwardlooking

Movements and trends

Expectedcredit loss

(ECL)

1 2 3 4 5 6

Can we make sense of the full picture?


SICR: Significant Increase in Credit Risk PD: Probability of DefaultPOCI: Purchased or Originated Credit Impaired LGD: Loss Given DefaultEAD: Exposure at Default

CoverageStage

allocation

Stage credit quality

Forwardlooking


ECL

1 2 3 4 5 6

Practice-based differences

Scenarios,Weights,Overlays

SICR, modelsWrite-off,

forward-looking

IFRS 9 application

Models: PD, LGD, EAD,

Life

SICR triggers, Default, PD models,

Write-off, POCI

Can we make sense of the full picture?

Risk-based differences

PD bandsDelinquency

Loan to value

Customers, products, geographies, business

segments

Sensitivity to economic

factors

Changes in risk,new loans, disposals

Business mixGrowth

Risk-management


CoverageStage

allocation

Stage credit quality

Forwardlooking


ECL

1 2 3 4 5 6

Practice-based differences

Scenarios,Weights,Overlays

SICR, modelsWrite-off,

forward-looking

IFRS 9 application

Models: PD, LGD, EAD,

Life

SICR triggers, Default, PD models,

Write-off, POCI

How do stage allocation and coverage ratios compare?


0.8%

0.6%

2.0%

1.5%

1.1%

1.9%

2.8%

1.5%1.6%

4.3%

4.4%

2.6%

3.2%

0.7%0.8%

0.2%

0.6% 0.8%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

-

200

400

600

800

1,000

UK 1 UK 2 UK 3 UK 4 UK 5 FR 1 FR 2 FR 3 FR 4 IT 1 IT 2 SP 1 SP 2 NL 1 NL 2 CH 1 DE 1 DE 2

Loans to customers : stage allocation and total coverage ratio

Stage 1 Stage 2 Stage 3 Total coverage ratio

USD GBP GBP USD GBP EUR EUR EUR EUR EUR EUR EUR EUR EUR EUR USD EUR EUR

Based on public information (2018 Annual reports)

The scope may differ for some banks

Billions (in ReportingCurrency)

Exposure Coverageratios

How do stage allocation and coverage ratios compare?


Source: Based on public information (2018 Annual reports)

The scope may differ for some banks

6%5%

13%

6%

8%8%

10%

5%

9%

7%

10%

6%

8%

6%

5%

4%

5%

4%

1% 1%

3%

2%

2%3%

4%

3%

3%

6%

7%

4%

4%

2%2%

1%

1%

1%

0%

10%

20%

30%

40%

50%

60%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

UK 1 UK 2 UK 3 UK 4 UK 5 FR 1 FR 2 FR 3 FR 4 IT 1 IT 2 SP 1 SP 2 NL 1 NL 2 CH 1 D 1 D 2

Stage 2 and 3 proportions and coverage ratios

Stage 2% in total exposure Stage 3% in total exposure Coverage rate stage 2 Coverage rate stage 3

Are we comparing apples and oranges?

► Outside the UK, banks rarely show stage 1 and 2 allocation at a detailed level

► Retail and non-retail seems a basic split, yet only half of the banks provide it

► Further detail on customers or products is rare and heterogeneous

► A few banks also allocate exposures by countries and regions or business segments

► ECL is not always provided with the same level of detail

► Scope of instruments varies (measurement categories and on / off balance-sheet)

► Many disclosures on credit risk without stage 1 and 2 split


How detailed are banks on stage 1 and 2 allocation?

UK Bank 1


Non-retail

Retail

Retail

Non-retail

Commercial real estate

Residential mortgages

Business segments

First lien residential mortgages

Interest only

Affordability

Credit cards

Second lien residential mortgages

Motor vehicle

Other

Country or region

Stage 1and 2 split only available for

loans to customers

Loans to customers

Corp or non-bank Financial Institutions (FI)

Industries

Geographies

Renegotiated


How detailed are banks on stage one and two allocation?


Comparison of banks on 4 axis: retail, non-retail, geographies, business segments

Based on public information (2018 Annual reports)

UK 1 UK 2 UK 3 UK 4 UK 5

The rest of the sample show Stage 1 / 2 split at the level of « loans to customers » only

FR 1 FR 3 SP 1 NL 2 CH 1 DE 1

Can we compare the credit quality of stage 1 and 2? Credit risk rating grades

► All banks provide an analysis of stage 1 and 2 by PD bands or risk rating ranges

► However, the formats vary significantly:

► Number and size of PD bands (from three to eight)

► Use of rating bands is difficult to compare with PD bands

► Products are rarely differentiated

► ECL or coverage ratio is rarely provided

► Can we compare stage allocation for a given PD band?

► Can we compare average or median PD of stage 1 and stage 2?


Can we compare stage 1 and 2 allocation for a given PD band?

Page 58 EY European IFRS banking conference


PD bands varyand do not allow comparisons of stage allocation for a given PD range.

Total loans

Retail / Non Retail

Products

GranularityPD % UK 1 UK 2 UK 3 UK 4 UK 5 FR 1 FR 2 FR 3 IT 1 SP 2 NL 1 NL 2 CH 1 D 1 D 2

0,01 0,01 0,00 0,01

0,02 0,02 0,02 0,02

0,03 0,02

0,04 0,04 0,03 0,04

0,05 0,05 0,05

0,07

0,08 0,08

0,10 0,10

0,15 0,12 0,11 0,11 0,13 0,12 0,11

0,20

0,25 0,25

0,30 0,30

0,40 0,38 0,39 0,37

0,50 0,50 0,43 0,50 0,48 0,46 0,5 0,50

0,60 0,60 0,58

0,70 0,68

1,00

2,00 1,50 2,00 2,16 1,37 1,94 1,77

3,00 2,35 2,22 2,10 2,27

4,00 3,22 3,10

5,00 5,00 4,50

6,00

7,00

8,00 8,60 7,93 7,57

10,00 9,35

11,00 10,61 10,22

12,00 11,35 11,67

16,00 14,00 15,75

17,00 17,22

18,00 17,80

20,00 20,00 20,00 20,00 19,97

21,00 20,67 20,20

22,00 21,81 21,21

30,00 29,58

50,00

100

Can we compare median PD of stage 1 and 2?



Stage 1median PD

Stage 2median PD

PD % UK 1 UK 2 UK 3 UK 4 UK 5 FR 1 FR 2 FR 3 IT 1 SP 2 NL 1 NL 2 CH 1 D 1 D 2

0,01 0,01 0,00 0,01

0,02 0,02 0,02 0,02

0,03 0,02

0,04 0,04 0,03 0,04

0,05 0,05 0,05

0,07

0,08 0,08

0,10 0,10

0,15 0,12 0,11 0,11 0,13 0,12 0,11

0,20

0,25 0,25

0,30 0,30

0,40 0,38 0,39 0,37

0,50 0,50 0,43 0,50 0,48 0,46 0,5 0,50

0,60 0,60 0,58

0,70 0,68

1,00

2,00 1,50 2,00 2,16 1,37 1,94 1,77

3,00 2,35 2,22 2,10 2,27

4,00 3,22 3,10

5,00 5,00 4,50

6,00

7,00

8,00 8,60 7,93 7,57

10,00 9,35

11,00 10,61 10,22

12,00 11,35 11,67

16,00 14,00 15,75

17,00 17,22

18,00 17,80

20,00 20,00 20,00 20,00 19,97

21,00 20,67 20,20

22,00 21,81 21,21

30,00 29,58

50,00

100

0.3

2.9

6.7

1.8

4

0.36

4.1

0.3

0.3

6.4

1.4

0.08

0.2

5.3

0.2

7.1

0.33

6.1

0.11

0.4

8.6

0.45

5.5

0.33

1.65

0.37

6.39

2.3

0.34

4.3

Can we compare the credit quality of stage 2 assets? Delinquency status

Page 60

DPD status of stage 2 exposures (in % of total stage 2)



R: Retail / NR: Non-Retail

0%

5%

10%

15%

20%

25%

30%

35%

UK Bank 1 R NR UK Bank 2 R NR UK Bank 3 R NR UK Bank 4 R NR UK Bank 5 R NR French B 1 R NR Spanish B 2 Italian B 1 Italian B 2

dd > 90 days 30 < dd ≤ 90 days dd ≤ 30 days Not past due

UK Bank 1

Can we compare the credit quality of stage 2 across banks? Overview of credit quality disclosures


PD bands andrating grades

ECL

CorporateNon-bank First lien Other personal

Commercial real estateOther corporateResidential mortgageThree regions for each

Delinquency

Non-retail products

Retail products

Geographies

Business segments

PD bands

Delinquency

Loan to value

35 cuts

Loan to value

PersonalCorporate, Non-bank FI

ECL provided for loans to customers

(x 8 PD bands)


Can we compare the credit quality of stage one and two? Overview of credit quality disclosures

Comparison of banks on the four axis: retail, non-retail, geographies, business segments



Comparison of banks on the 4 axis: ECL, PD bands, delinquency, Loan to Value

UK 1 UK 2 UK 3 UK 4 UK 5 FR 1 FR 2 FR 3

IT 1 IT 2 SP 2 NL 1 NL 2 CH 1 DE 1 DE 2

What did movements over 2018 look like ?


Coverageratios

Exposure


0%

1%

2%

3%

4%

5%

6%

7%

-

200

400

600

800

1,000

1,200

UK 1 UK 2 UK 3 UK 4 UK 5 FR 1 FR 2 FR 3 FR 4 IT 1 IT 2 SP 1 NL 1 NL 2 CH 1 DE 1 DE 2

Changes in size of loan book and total coverage ratio in 2018

Exposure Jan 2018 Exposure Dec 2018 Total coverage Jan 2018 Total coverage Dec 2018

Billions(in ReportingCurrency)

USD GBP GBP USD GBP EUR EUR EUR EUR EUR EUR EUR EUR EUR USD EUR EUR

What did movements over 2018 look like? (cont’d)



7%

6%

8%

5%

15%

13%

7%

6%

8% 8%

6%

8%

11%10%

5% 5%

11%

9% 9%

7%

11%

10%

7%

6%7%

6%

5%5%

5%

4%4%

5%

4% 4%

1%

1%

1%

1%

3%

3%

3%

2%

4%

2%

3%

3%

4%

4%

4%

3%

3%

3%

8%

6%

10%

7%

4%

4%

2%2% 2%

2%

1%

1%

1% 1%

0%

5%

10%

15%

20%

Allocation of Exposures in Stage two and three in January and December 2018

% of exposures in stage 2

% of exposures in stage 3

ECL movement table

► Diversity in line items description and granularity

► Many banks don’t disclose the movements in gross carrying amounts (8/18)

► Stage movements


6 lines (or 3 lines and 3 columns)

Stage 1 to 2

Stage 1 to 3

Stage 2 to 1

Stage 3 to 1

Stage 2 to 3

Stage 3 to 2

3 lines

Net transfers in Stage 1 (from / to Stage 2/3)

Net transfers in Stage 2 (from / to Stage 1/3)

Net transfers in Stage 3 (from / to Stage 1/2)4

0

1

1

4

4

5

2

3

1

4

2

5

2

9

13

ECL transfers (P/L neutral)

ECL only

Carrying Amount + ECL

Net transfers

Carrying amount only

ECL only

Carrying amount + ECL

Gross transfers

Total sample of banks

UK Other

Stage movements reflects the sensitivity of SICR triggers

Migration of loans gross exposure in 2018


For two banks information includes debt securities and bonds.

Stage 1(91.9%)

Stage 2(6.7%)

Stage 3(1.4%)

3.1%

8.8%

5.2%

63%5.7%

0.2%

UK banks (4)

Europeanbanks (4) Stage 1

(85.7%)Stage 2(8.4%)

Stage 3(5.9%)

1.6%

4.6%

8.8%

39.3%

4.9%

0.4%

► Over 60% of stage 2 healed to stage 1, 5.2% entered stage 3.

► Over 11% of the value of stage 3 cured.

► 40% of stage 2 healed to stage one, 8.8% entered stage three.

► Only 6% of the value of stage 3 cured.


0.2%

UK

banks (4)

Can we assess the effect of banks’ SICR triggers?


► Information is mainly qualitative

► PD thresholds are rarely quantified and difficult to compare

► Banks don’t provide sensitivity analysis for SICR thresholds

Qualitative triggers

DPD

Forbearance

Watchlist

Bureau or external rating

Monitoring processes

4

5

6

6

2

5

7

12

Qualified PD threshold…

Qualified rating denotching

Use of lifetime PD threshold

Use of 12m PD threshold

All Banks in population

PD Thresholds

UK Non-UK

(PD x X or PD + Y)

Can we assess the effect of banks’ SICR triggers?

► Two UK banks split stage 2 based on SICR triggers

69%

30%

1%

UK Bank 3 – stage 2 decomposition by SICR triggers

quantitative test qualitative test 30 DPD backstop

48%

15%

21%

1%

2% 2%11%

UK Bank 5 - Stage 2 decompositionby SICR triggers (retail)

PD movement PD persistence

Event - Adverse credit bureau Event - Forbearance

Event - Customers in collection DPD > 30

Other



ECL movement table – other movements



Gd Bk UK 1 UK 2 UK 3 UK 4 UK 5 FR 1 FR 2 FR 3 FR 4 IT 1 IT 2 SP 1 SP 2 NED 1 NED 2 SW 1 GER 1 GER 2

Change of risk inputs X X X X X X X X X X X X X X

New loans X X X X X x X X X X X X

Repayments X X

Disposals X X X X

Write-offs X X X X X X X X X X X X X X X X

Modifications X X X X X X

Changes in models X X X X X X X X X X

Unwind of discount X X X

FX movements X X X X

Others (*) X X X X X X X X X X X X X X X X X X

XX X X

X xX

XX

X

X X X XX X X

► Diversity in line items description and granularity

► Limited explanations

► Portfolios with material movements

► Interaction with the charge to the income statement

► Disposals / write-off (business as usual vs. « one off »)

Forward-looking modeling: how much did banks disclose?

Page 70

6

5

6

5

5

6

3

2

3

3

8

12

0 2 4 6 8 10 12 14 16 18

Sensitivity analysis

More than 10parameters

Macroeconomicparameters

Scenario weights

Number of scenarios

Total sample of banks

Forward-looking disclosures

UK Non-UK



Conclusion

► Understanding and comparing stories is challenging

► Key metrics are still to be defined

► Analytics are out of reach

► Improved and homogeneous granularity is a priority

► Retail / non-retail at a minimum

► Country / product for significant porfolios

► More harmonized formats would improve clarity and comparability

► Scope of instruments

► Organization of the disclosures

► Terminology


IFRS 9 disclosures

The UK perspective

Overview of the UK Retail portfolios

2.7%

0.7% 0.5% 1.0%0.3% 0.2% 0.2%

0.5%

8.6%

2.4% 2.4%

6.9%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

Barclays HSBC Lloyds RBS

UK Retail lending coverage ratios

Total Retail Mortgage lending Other retail



UK Bank 5UK Bank 3 UK Bank 1 UK Bank 2

Focus on UK mortgages

1.00%

12.10%

4.70%

9.20%

7.10%

0.80%1.60% 0.50% 1.70% 2.20%

5.30%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

HSBC Barclays LloydsStatutory

LloydsUnderlying

RBS

UK mortgage portfolio

Stage 2 Stage 3 POCI

% of portfolio



1.7%0.5%

1.3%

2.7% 2.2%

0.5%

11%

14.2%14.7%

18.2%

8.5%

Coverage

UK Bank 5UK Bank 3 UK Bank 1 UK Bank 2 – Statutory

UK Bank 2 – Other

UK Bank 2 – Underlying

A UK perspective : forward-looking assumptions

Upside 2 Upside 1 BaseDown-side 1

Down-side 2

Down-side 3

Overlay

UK Bank 1 — 10% 50% 30% 5% 5% $410mn

UK Bank 2 — 30% 30% 30% 10% — N/A

UK Bank 3 9% 24% 41% 23% 3% — £150mn

UK Bank 5 12.8% 17% 30% 25.6% 14.6% — £101mn

UK bank 6 5% 15% 40% 30% 10% — N/A

UK bank 4Simple average across 50 scenarios modelled under Monte Carlo

simulation



One bank model the wholesale portfolio using a Monte Carlo simulation

A UK perspective: forward-looking assumptions



UK 6

UK 5

UK 1

UK 2

UK 3

UK 6

UK 5

UK 1

UK 2

UK 3

UK 6

UK 5

UK 1

UK 2

UK 6

UK 5

UK 2

UK 1

A UK perspective: forward-looking assumptions and ECL build

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Barclays - Mortgages Barclays - Other HSBC - UK Lloyds - Mortgages Lloyds - Other

Forward-looking – ECL build

Base case Effect of MES Overlays Other



UK Bank 3 — mortgages UK Bank 3 — other UK Bank 1 — other UK Bank 2 — mortgages UK Bank 2 — other

(MES: Multiple economic scenarios)


Finance function of the future

Francois Rossouw Director, Ernst & Young LLP

Ladislas Tyl Partner, Ernst & Young et Associés

The ‘new normal’ has changed


Stakeholders

Forward looking Non-financial information

Trusted

Location

Skills

Technology

Chief Value Officer

Compliance

Cognition

Control

CostReal-time

Self service

Future workforce

Outsource

Automation

Finance function of the future EMEA CFO survey 2019

Page 79

Driving transformation


People and talent management

Increase finance function’s attractiveness, new ways ofworking and transform the finance team profile

Invest time and budgetin IT integration andnew technologies

Build new services tocreate alternative revenue streams andoffset costs

Make the CFO roleevolve as a businesspartner and designnew missions

Foster better use of data to amplify the strategist and catalyst roles of finance

Scale the finance organization, converge with risk and setup strategic partnership

Digital andIT revolution

New services

Businesspartner

Data

1

2

3

4

5

6Real-time

AutomatedStraight-through

Advanced analysis

Forward looking

Predictive

Self serviceBehaviour based

Efficient

Upgradingoperating model

1 How well equipped is your finance function to deliver against the organizational strategic priorities?

Driving revenue growth

Implementing organizational transformation

Driving cost

efficiency

Efficient management

of capital

Risk management

Regulatory changes

Organization priority

Low

Fin

an

ce

fu

ncti

on

ab

ilit

y

High

Medium

Low

What changes to the industry will have the largest impact on your finance function?

2

10%

50%

20%

50%

78%

30%

30%

80%

40%

11%

60%

20%

0%

10%

11%

0% 20% 40% 60% 80% 100%

Refining / changing theBusiness Model

Rapid development of newproducts

Products that leveragedynamic real time data about

clients / customers

Regulator demand for moretimely and comprehensive

data

Introduction of newtechnologies

Low Medium High

A change in focus


Medium High

Refining or changing the business model

Products that leverage dynamic real-time data about

clients or customers

Source: Finance function of the future EMEA CFO survey 2019

4What are the top three ways your finance function provides value to your organization’s end customers or clients?

Looking ahead five years from now, what finance capabilities will be critical to meeting the demands of your organization

Improve regulator

relationships

3 1

Reduce the cost of business

Produce scenario and profitability

analysis

2

0 2 4 6 8 10

Investor relations

Agile implementatuion ofregulatory changes

Corporate reporting

Strategic risk management

Incorporating non-financial data

An agile Finance Function able torespond to business

Sophisticated planning andforecasting

Big Data and advanced analytics

A shift in capabilities


3

Page 82

Big data and advanced analytics

An agile finance function able to respond to business


Regulatory change focused


65

Less Same More

Strategy development and strategic decision making

Reporting of financial data

Providing financial analysis and insights

Reporting of non-financial data

Monitoring and risk-assessment of the financial reporting control environment

Implementing strategic initiatives

Implementing regulatory and accounting change

People management

What are your top operational risks within the finance function and how do these impact the organization as a whole?

Time spent relative to five years ago

Manual processes and controls

Poor technology and infrastructure

Key person dependencies

Data qualityMulti-location of finance function


Regulatory reporting focused


65 What are your top three operational risks within the finance function and how do these impact the organization as a whole?

Currently spend enough time





Too little Enough Too much








People management

Page 84


Shifting towards strategy and insight


65 What are your top three operational risks within the finance function and how do these impact the organization as a whole?

Time spent in five years relative to today





Less Same More








People management


Overcoming barriers


What are the barriers to transforming your finance function?

Do you have the right finance capabilities?

Legacy technology and

systems complexity

Investment required

Finance skills

Skills shortage

Other priorities

Capacity to change

Disagree Neutral Agree

Right mix of capabilities to meet the demands of our future strategic priorities

Access and ownership of the right technology, systems and or data analytics to meet the demands of our future strategic priorities

Ownership or access to the right quality of data in a timely manner to meet the demands of our future strategic priorities

Capacity or capability to meet the data demands of regulators

Page 86

87


Enabled by technology


Blockchain

Robotic Process Automation

Rationalisation of Regulatory Reporting systems

Implementing new / uprgading existing ERP systems

Artificial Intelligence (including machine learning)

Cloud and SaaS

Big data technologies

Advanced Data Analytics and Forecasting

Least

How critical are the following to enable your future finance function?

Most

Page 87

9

Robotic process automation (RPA)

Advanced data analytics and forecasting

Cloud and Software as a Service (SaaS)

Artificial intelligence (including machine learning)

Implementing new or enterprise resource planning (ERP) systems

Rationalization of regulatory reporting systems


Enabled by technology (cont’d)


Blockchain

Robotic Process Automation

Rationalisation of Regulatory Reporting systems

Implementing new / uprgading existing ERP systems

Artificial Intelligence (including machine learning)

Cloud and SaaS

Big data technologies

Advanced Data Analytics and Forecasting

Least

How critical are the following to enable your future finance function?

Most

No

a

cti

vit

y

Inve

stig

ati

ng

No

t p

rog

ress

ing

Imp

lem

en

tati

on

Bu

sin

ess

as

usu

al (B

AU

)

Page 88

9

RPA

Advanced data analytics and forecasting

Cloud and SaaS

Artificial intelligence (including machine learning)

Implementing new or enterprise resource planning (ERP) systems

Rationalization of regulatory reporting systems


Transforming skills


Low High

Improving ability to manage offshoring, shared services andoutsourcing

Developing deep technical skills in key areas of risk, such asregulatory and cyber

Improving digital technology skills in areas such as RPA,Cloud and SaaS

Improving regulatory knowledge to keep abreast of anuncertain and changing environment

Building understanding of ethical decision-making in support of your organisation’s purpose and reputation

Developing a wider Finance Function leadership team toassume delegated CFO responsibilities

Building skills in predictive and prescriptive analytics

Improving commercial knowledge and understanding tobetter partner with the Business

Challenge in attracting and retaining talent

Banking experience

Technology and

analytics skills

RewardRegulatory knowledge

Looking ahead five years from now, how important will the following people and skills initiatives be for your finance function?

Finance skills

Career paths

1110

Improving digital technology skills in areas such as RPA, cloud and SaaS

Developing a wider finance function leadership team to assume delegated CFO responsibilities

Improving commercial knowledge and understanding to better partner with the business


Supervisory Update

EY’s European IFRS banking conference, 7 June 2019

Nic van der Ende

(views expressed here may not necessarily reflect those of De Nederlandsche Bank, EBA, ECB, BCBS or BIS)

Agenda

• Experiences with ECL over 2018

• EBA’s Priorities 2019 Accounting

• Prudential topics related to provisions

• Other prudential topics

91

Experiences with ECL over 2018

Coverage ratio by non-impaired / impaired

92

Average

impaired

Average non-

impaired

France 55% 0,46%

UK 33% 0,50%

Canada 28% 0,43%


Total coverage ratio

93

Range from Range to

France 1,6% 2,9%

UK 0,3% 2,0%

Canada 4,8% 10,3%


• Residual shortfall as per 1 January 2018

94


Canada: Lacks probability weights No disclosure of probability weights

Inconsistent approach to calculating ECL sensitivity to FLI.

France: Lack of available data

No link between qualitative and quantitative information, no explanation between stage 3 exposures/Stage 3 coverage ratio and write off policies

No impact on the sensitivity of ECL to FLI

No link between SICR criteria or coverage ratio and credit risk analysis, no explanations on movements of the period

FR banks don’t disclose in their FS granular breakdowns of exposures (by portfolios, rating grades or geographical area) except one.

2 FR banks out of 4 have adjusted their Pillar 3 report following the implementation of IFRS 9

UK: Lack of consistency Inconsistency of disclosure across banks

Challenging to compare inputs for MES

95

EBA’s priorities 2019 Accounting

• IFRS9:

• Monitoring implementation IFRS9 (including qualitative aspects)

• Monitoring use of IFRS9 transitional arrangements

• Monitoring quantitative impact of ECL through indicators

• Monitoring effects for EBAs GL CRAECL

• Interaction ECL with prudential requirements

• Accounting standard setting projects

• Dynamic risk management (core model)

• IBOR

• FICE

• Regulatory products & advise to the EC

• IFRS9 benchmarking exercise

96

Prudential topics related to provisions

Regulatory treatment of ECL

Extant situation maintains (IRB: excess/shortfall, SA: specific/general)

Collecting data for longer term analysis

Massive disposal of NPLs (article 500 CRR2)

If disposal is >20% of portfolio

Then disregard loss on disposal when assessing LGD

Prudential backstop (article 47a, 47b, 47c CRR2)

Into force as of 26 April 2019

Forward looking

Calender for unsecured and secured loans (see next slide)

Formula:

prud minimum -/- acc prov -/- IRB shortfall -/- POCI prov -/- ‘write-off’ prov

8

Calender minimum loss coverage

Calender Unsecured CRR Unsecured SSM Secured

immovable CRR

Secured

movable CRR

Secured SSM

Year 1 0 0 0

Year 2 0 0 0

Year 3 35% 100% 25% 25%

Year 4 100% 35% 35%

Year 5 55% 55%

Year 6 70% 80%

Year 7 80% 100%

Year 8 85% 100%

Year 9 100%

Year 10

98

Other prudential topics

Treatment of software

Mandate in CRR2 for EBA to provide advise to EC

Until future revision of CRR extant situation remains

Accounting and capital aspects (joint effort at EBA)

Sustainable Finance

Climate change consequences for prudential framework

Credit risk

Operational risk

ESG data

Recording requirements for banks

Risk management inclusion

Disclosures

99


Integrated reporting and climate risk

Rebecca SelfChief Financial Officer (CFO), Sustainable Finance, HSBC

Doug JohnstonPartner, Ernst & Young LLP

Despite clear evidence of climate risk, many businesses have not adapted adequately


While there is enormous operational and financial risk to the economy, businesses have been slow to develop an effective response

CNN Business

Regulatory bodies are beginning to consider climate risk, making change even more pressing


The discussion paper seeks input on four areas:

► Climate change and pensions

► Enabling competition and market growth for green finance

► Ensuring disclosures provide adequate information to investors on the financial impacts of climate change

► The scope for a new requirement for financial services firms to report publicly on climate risk management

Financial Conduct Authority (FCA)

Consultation paper on integrating sustainability risks into Markets in Financial Instruments Directive (MiFID) II:

► Environmental, social and corporate governance (ESG) considerations in the advisory process and portfolio management should not lead to mis-selling practices

► ESG preferences should be taken into account when identifying potential target markets

► Adequate product governance arrangements to ensure the products and services are compatible with customers' ESG preferences

► Information about clients' ESG preferences must be collected

European Securities and Markets Authority (ESMA)

Draft supervisory statement on climate risk management:

► Embed the consideration of financial risks from climate change in their governance arrangements

► Incorporate the financial risks from climate change into existing risk management practice

► Use (long-term) scenario analysis to inform strategy setting and risk assessment and identification

► Develop an approach to disclosure on the financial risks from climate change

Bank of England (BoE)

The Task Force on Climate-related Financial Disclosures (TCFD) recommendations are a framework for assessing climate-related risks and opportunities


Governance

Strategy

Risk management

Metrics and

targets

Core elements of the TCFD recommendations

The organization’s governance framework for climate-related risks and opportunities

The actual and potential impacts of climate-related risks and opportunities associated with the organization's businesses, strategy and financial planning

The processes used by the organization to identify, assess and manage climate-related risks

Strategy

Risk management

Governance

Metrics andtargets

The metrics and targets used to assess and manage relevant climate-related risks and opportunities

The TCFD was founded to provide consistent, high-level guidance to assessing and disclosing climate-related risks and opportunities, using forward-looking and scenario-based analysis. You can find the report here.

https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-2017-TCFD-Report-11052018.pdf

Climate change risk requires a response from all parts of a business, including finance, strategy and risk management


Strategic planning risk management

Financial impact

Balance sheet Cash flow statement Income statement

OpportunitiesRisks

Policy and legal

Technology

Market

Reputation

Acute

Chronic

Physical risks

Transition risks Opportunities

Market

Reputation

Revenues

Expenditures

Resource efficiency

Energy source

Products or services

Markets

Resilience

EY climate risk disclosure barometer — how are industries performing against the TCFD recommendations?


EY teams have developed the Climate risk disclosure barometer to provide an annual snapshot of the uptake of the TCFD recommendations across highly impacted sectors. This provides analysis of current corporate disclosures to compare the high-risk sectors listed in the recommendations against each proposed TCFD disclosure.

Coverage Quality

Source: EY climate risk disclosure barometer 2019 *Overall scoring results do not include companies from within these non-key TCFD sectors

PUBLIC

Author: Rebecca Self

Chief Financial Officer – Sustainable Finance

Sustainable Finance

107

Environmental

• We strive to manage sustainability risk, principally via the

implementation of our policies put in place to protect the

environment, society and supporting customers through the

transition to the low-carbon economy

• Our sustainability risk policies cover sensitive sectors

Social

• This covers our customers, employees and areas of operations

which could impact people, such as human rights

• Products are designed with customers in mind, with regular

feedback monitored

• Our approach to approach to diversity and inclusion looks to

increase and leverage diversity of thought to drive greater

innovation, better identify and manage risks, enhance

collaboration, and improve workforce agility

• As part of HSBC’s ongoing focus on improving gender balance in

senior leadership, by the end of 2020 we are aiming for 30+% of

our senior leadership to be female

Governance

• Full details of Corporate Governance may be found in our

Annual Report

• Financial crime risk management is important to protect our

customers, our communities and the integrity of the financial

system

• We continue to strengthen and significantly invest in our ability

to prevent, detect and respond to the ever-increasing threat of

cyber attacks

HSBC’s ESG ProfileActivity highlights

More than 240 of our largest suppliers have

accepted our Ethical and Environmental Code of

Conduct.

HSBC is a signatory to or has expressed public

support for: ▪ The Global Sullivan Principles

▪ The OECD Guidelines for Multinational Enterprises

▪ The UN Global Compact

▪ The UN Principles for Responsible Investment

▪ The UN Principles for Sustainable Insurance

▪ The UN Sustainable Development Goals

▪ Paris Agreement and Taskforce on Climate-related Financial

Disclosures (TCFD)

PUBLIC

23.6% 24.5% 25.4% 26.8% 28.2%

0%

20%

40%

60%

80%

100%

2014 2015 2016 2017 2018

Female share of senior leadership headcount

at HSBC 2014-2018

http://www.hsbc.com/our-approach/sustainability/finance

http://www.hsbc.com/-/media/hsbc-com/citizenship/our-values/pdfs/150930-hsbc-statement-on-human-rights.pdf

http://www.hsbc.com/our-approach/diversity-and-inclusion

http://www.hsbc.com/investor-relations/group-results-and-reporting/annual-report

http://www.hsbc.com/our-approach/risk-and-responsibility/financial-crime-risk

108PUBLIC

▪ Climate change represents an

urgent and irreversible threat to

human society, as recognised

by the almost 200 countries

that have signed the 2015

Paris Agreement on climate

change.

▪ An estimated USD90 trillion of

investment is needed in new

green infrastructure over the

next 15 years – double the

current annual rate of

spending – just to keep the

global temperature increase

below two degrees.

▪ Major injections of capital are

needed to pay for more

efficient and less carbon-

intensive technologies and

infrastructure, to reduce the

carbon footprint of established

companies and industries, and

to cover the costs of climate

adaptation.

HSBC’s Commitments

Source 100% of our

electricity from

renewables sources by

2030 (90% by 2025)

Reduce our exposure to

thermal coal and actively

manage the transition for

other high carbon sectors

Adopt recommendations

of Task Force on Climate-

related Financial

Disclosures (TCFD)

Provide USD100bn of

sustainable financing and

investment by 2025

▪ Provide USD 100bn of financing/investment to develop clean energy, lower-

carbon technologies, and projects that contribute to the delivery of the Paris

Agreement and the UN Sustainable Development Goals

▪ Lead the development of sustainable capital markets, support corporate and

institutional clients in managing risks and promote sustainable investment

products for retail and private banking clients

▪ Use direct investment and direct purchases via PPAs and similar mechanisms

that directly help the financing of new renewable electricity assets.

▪ Collaborate with RE100, governments and regulators to open up renewable

energy markets where PPAs or similar are not currently available

▪ Reduce electricity per FTE by 20% by 2020

▪ Discontinue financing of new thermal coal mines (including new customers

dependent on it) and new coal-fired power plants in developed countries and

continuously reinforce lending criteria in developing countries

▪ Engage with clients in high carbon sectors to influence their transition

strategies

▪ Continuously review our risk policies on low carbon technologies▪ Report according to governance/ strategy/ risk management recommendations

of the task force

▪ Engage with academia/ industry associations/ civil society networks to support

robust climate scenario analysis to price transition and physical risk.

▪ Promote uptake of these recommendations across our global network

Lead and shape the

debate around

sustainable finance and

investment

▪ Establish a Centre of Sustainable Finance to provide thought leadership about

climate change and the role of the financial services sector.

▪ Promote the development of industry-wide definitions, standards, tools and

metrics to enhance market analysis of ESG issues and impacts.

Context

HSBC’s ESG ProfileHSBC’s commitments to support the transition to a low carbon economy

109

HSBC’s ESG Profile

▪ HSBC is fully committed to its own sustainability approach and compliance with the sustainability commitments that we have made in

the public domain

▪ HSBC recognises that we have responsibilities not only towards our customers, employees and shareholders, but also the countries and

communities in which we operate. This means understanding and managing the impact we have on society and the environment, and

investing in the future of our employees and the communities we serve

▪ HSBC Group Sustainability’s mandate is to ensure that the business translates this recognition into practice.

Spotlight on Sustainability Risk Policies

Mining and Energy

▪ We issued an updated mining and metals

policy in 2016, providing more details on

human rights issues in the sector

▪ We issued an updated Energy Sector

Policy in 2018, restricting finance for new

coal-fired power plants (with some time-

bound exceptions in developing markets)

and specific sensitive areas

Palm oil

§ In 2017 our Agriculture commodities

policy was updated to include a “No

Deforestation, No Peat and No

Exploitation” commitment

§ Since launching our first Forestry policy

in 2004, we have been recognised as a

leader by Forest 500 ranking, an

independent analysis of companies,

investors and governments on their

commitment to preventing deforestation,

an analysis carried out by a UK-based

think tank

Climate Change

§ In addition a statement on climate change

and our approach is available on our

website

§ HSBC expects to respond to the Financial

Stability Board Task Force on Climate-

related Financial Disclosures in our 2017

Annual Report and Accounts

PUBLIC

110


Taskforce for climate-related Financial Disclosures

Strategy

Risk

Management

Metrics and

Targets

Governance

▪ Describe the board’s oversight of climate-related risks and opportunities.

▪ Describe management’s role in assessing and managing climate-related

risks and opportunities.

▪ Describe the climate-related risks and opportunities the organization has

identified over the short, medium and long term.

▪ Describe the impact of climate-related risks and opportunities on the

organization’s businesses, strategy and financial planning.

▪ Describe the resilience of the organization’s strategy, taking into

consideration different climate-related scenarios, incl a 2°C or lower scenario.

▪ Describe the organization’s processes for identifying and assessing climate

related risks.

▪ Describe the organization’s processes for managing climate-related risks.

▪ Describe how processes for identifying, assessing and managing climate

related risks are integrated into the organization’s overall risk management.

▪ Disclose the metrics used by the organization to assess climate-related risks

and opportunities in line with its strategy and risk management process.

▪ Disclose Scope 1, Scope 2 and, if appropriate, Scope 3 greenhouse gas

(GHG) emissions and the related risks.

▪ Describe the targets used by the organization to manage climate-related

risks and opportunities and performance against targets.

TCFD recommendations

✓ Two years of TCFD

disclosures published in

the Annual Report.

✓ Qualitative disclosure on

Governance, Strategy, and

Risk Management topics.

✓ Approach to transition risk

published in April 2018

ESG Update

✓ Quantitative data on

impacted industry sectors

published using a

materiality based

approach

Next steps

✓ Engage with academia,

industry associations and

civil society networks to

support robust scenario

analysis to price transition

and physical risk

✓ Develop transition metrics

and disclosures

2017 and 2018 disclosure

PUBLIC

111

HSBC’s TCFD 2018 disclosure

PUBLIC

112


▪ Proceeds from the issuance of bonds which comply with the SDG Bond Framework will be used in defined Eligible Sectors relating to

the SDGs as specified, further information on governance, reporting and indicative portfolio is provided on the following pages

▪ The defined Eligible Sectors under the HSBC SDG Framework are:

Key features of HSBC’s SDG Bond & Framework

The HSBC SDG Framework is an example of our strategic commitment to sustainability and

support for our customers and clients in this important area

PUBLIC

113 PUBLIC

IFRS hot topics and accounting in the digital age

Marek WalendowskiDirector, Ernst & Young LLP

Jane HurworthAssociate Partner, Ernst & Young LLP


Agenda

Measurement of equity investments in start-up entities

4 Crypto-assets5Changes to operating IT infrastructure3

Impact of IFRS 16 leases on the banking sector2

IFRS 7 hedge accounting disclosures1


Diversity in banks’ hedging approaches

16 banks considered in the benchmark exercise (all applying IAS 39 hedge accounting requirements)

Five UK

Two French, Two German,

Two Dutch, Two Canadian

One Swiss, One Italian, One Finnish

16

10

6

16

10

3

11

0 2 4 6 8 10 12 14 16 18

FV - Micro IRR

FV - Macro IRR

FV - EU-Carve out IRR

CFH - Interest rate risk (IRR)

CFH - Forex (FX)

Cash flow hedge (CFH) - Equity risk on cash settled SBP

Net investment hedges (NIH)


Number of banks disclosing type of hedge relationship

Overview findings

Single note44%

Single note plus reference to other section for

further information 12%

Single note plus reliance

on other section 44%

► Disclosure of risk management strategy

Yes75%

No25%

► Is change in FV of the hedged item and the hedging instrument separately disclosed?

► High levels of compliance with IFRS 7 financial instruments: disclosures requirements across the sample

► Majority of disclosures provided within single hedge accounting note

► Some utilization of risk management report and statement of comprehensive income

► Mostly explicit compliance with quantitative requirements

► Improved description of hedge accounting arrangements, but some ‘boiler plate’ information remains


Disclosure of hedge ratio and risk components

0

2

4

6

8

10

12

14

Not disclosed Specified Highly specified

Hedge ratio Designation of risk component How risk component relates to entire fair value change


Nu

mb

er

of

ba

nks

Disclosures of ineffectiveness

Boiler plate31%

Some specificity

44%

Highly specific25%

► Some banks provide a detailed comprehensive overview of the sources of ineffectiveness separately for each individual hedge program

► Other banks provide some level of detail, however it is not broken down for each individual hedge program

► A few banks list rather generic sources of ineffectiveness without providing details about the reasons for ineffectiveness

► Ineffectiveness is generally reported within trading income

► Description of sources of ineffectiveness

1

11

3

1

0 5 10 15

Net interest income

Line item which includes trading

Other line item

Separate line on the face of theSOCI

► Presentiation of ineffectiveness in Statement of Comprehensive Income (SOCI)


Disclosures regarding the amount, timing and uncertainty of future cash flows

Yes62%

No38%

Disclosed if static or dynamic hedge is applied?

Disclosure requirement for static hedges fulfilled?

Met62%

Not met38%

Is the average price disclosed in a fair value hedge?

Disclosure requirement for dynamic hedges fulfilled?

Yes44%

No56%

Met67%

Not met33%


Disclosure of the initial impact of IFRS 16 leases

► Most banks applied IFRS 16 leases using the modified retrospective approach, with the Right of Use (RoU) asset equal to the lease liability, and only few adjusted the measurement of the RoU-asset

► The extent of disclosure provided by banks varied across the industry

► Vast majority provided the description of initial measurement principles, but only some commented on the type of discount rates used, explained subsequent measurement and other key judgements

► The quantitative impact from initial application of IFRS 16 varied across the industry

Estimated impact of IFRS 16 on the common equity tier (CET) 1 ratio*

-0.25%

-0.20%

-0.15%

-0.10%

-0.05%

0.00%

Bank 8 Bank 13 Bank 14 Bank 15 Bank 16 Bank 7 Bank 12 Bank 11 Bank 17 Bank 6 Bank 5 Bank 10 Bank 18 Bank 4 Bank 2 Bank 1 Bank 3 Bank 9

Page 121

*Based on the data from the banks’ 2018 annual reports


Current IFRS 16 discussion topics

► In June, the International Financial Reporting Standards Interpretations Committee (IFRS IC) is expected to discuss the following IFRS 16 questions:

► EMSA’s request to clarify lessee’s determination of the enforceable lease period and useful life leasehold improvement where:

► The lease does not have a specified term and continues until one party terminates it

► Neither party incurs contractual termination costs upon exercising their right to exit

► Lessee constructed non-removable leasehold improvements which would need to be dismantled upon contract termination

► ESMA noted diversity in practice of applying IFRS 16 due to lack of explicit guidance

Lease term and useful life of leasehold improvements

► IFRS IC was asked whether a lessee’s incremental borrowing rate must reflect the interest rate in a loan with both:

► Similar maturity to the lease

► Similar payment profile to the lease payments

Lessee’s incremental borrowing rate


Changes to IT operating infrastructure

► Banks historically relied on asset-driven IT infrastructure and operating models

► Current technological advancements change this traditional operating model and often raise questions about the appropriateness of accounting practices in a new, more digital world

► Common areas of focus include:

► Assessment of the appropriateness of assets’ useful lives

► Accounting for flexible third-party cloud computing solutions

► Approach to capitalization of costs

Cloud computing

Robotics Mobile Big data


Proposed changes to the capital treatment of software

► Capital Requirements Directive (CRD) V or Capital Requirements Regulation (CRR) 2 introduces changes to the regulatory capital treatment of capitalized software recognized as intangible assets under IFRS

► Prudently valued software assets, whose value is not negatively affected by resolution, insolvency or liquidation will be excluded from the scope of deduction from the CET1 capital

► The European Banking Authority (EBA) has been tasked to specify the application guidance, which is expected in late 2019 or early 2020

► Changes to regulatory capital treatment will likely result in additional scrutiny of capitalized balances

► Existing processes and controls may require enhancing


Cloud computing

► Cloud computing is generally referred to as on-demand availability of IT resources including data storage, computing power or software, without direct active management by the user.

Overview of cloud service models

SaaS

Networking

Storage

Server

Database

Developer tools

Operating system

Data

Applications

Networking

Storage

Server

Database

Developer tools

Operating system

Data

Applications

Networking

Storage

Server

Database

Developer tools

Operating system

Data

Applications

Networking

Storage

Server

Database

Developer tools

Operating system

Data

Applications

On-premise IaaS PaaS

Third-party managedYou manage

► Wide range of technological solutions commonly referred to as cloud requires careful consideration of the scope and unique characteristics of each contract.

► Depending on the level of reliance on the third party vendor, we distinguish between:

► Infrastructure as a Service (IaaS)

► Platform as a Service (PaaS)

► Software as a Service (SaaS)

► Accounting conclusions focus on identifiability, control, and assessment of future economic benefits.

► In March 2019, IFRIC concluded that a contract that conveys only the right to receive access to software in the future is a service, not a lease.


How agile impacts cost capitalization processes

Analysis

Coding

Testing

Construction RetrospectiveSprint planning

Agile project approach

Waterfall project approach

Product backlog

QA

Shippable product

Quality assurance

Weekly sprints

User stories

Feedback on sprint activities

Expense Capitalize Expense

Design

DeploymentResearch

Development

► Common questions in accounting for internally developed intangible assets include:

► At which point in time the threshold for meeting the asset recognition criteria is met?

► Is software always one unit of account?

► When to start the amortization of the asset(s) and what is their useful life?

► How to distinguish development work from further research relating to new functionalities?

► Complexity of those questions is magnified in an agile software development process, which allows project requirements and solutions to evolve over time.


What is agile?


Agile: project management method characterized by division of tasks into short phases of work and frequent reassessment and adaptation of plans

Key elements of agile include:

► Product backlog: full set of prioritized scope items and functionalities desired in the product

► User story: description of a software feature from an end-user perspective which defines what they want and why

► Epic: group of user stories with a common objective

► Sprint: repeatable work cycle during which work is completed and made ready for review

Agile

How agile impacts cost capitalization processes

► Accounting standards have not changed and there is no specific interpretive guidance for agile

► While organizations still rely on detailed time tracking by development teams, some implemented an estimation-based approach to agile projects, which distinguish two phases:

► Project planning documentation, including budget and timeline an overall business case is approved for feasibility.

► Once the teams are established, their overall labor costs create the pool of cost with capitalization potential.

► Individual user stories in the backlog are reviewed to determine the treatment of costs, leading to an estimated capitalization ratio per project, epic and a user story.

► The backlog and user story categorization is reviewed and approved by an accounting function.

Preliminary phase

► During the sprints, costs are accumulated based on the time tracking systems at an epic level to flag individual user stories as capital or expense.

► Capitalization ratio is not a static measure but is reviewed and adjusted based on the backlog changes over the course of the project.

► Formal accounting oversight review takes place as part of regular change management process.

Development phase


Measurement of equity investments in start-up entities

Illustrative approach to FV measurementof equity investments1

► Banks often invest in start-up entities with potential to improve their operating model or distribution channels.

► Common types of investment include equity or convertible loans which under IFRS 9 should be measured at FV (unless investment results in significant influence or control).

► The early stage of product development, lack of liquid market, current inability to generate cash flows and uncertainty of future profitability are common challenges in determining the FV of such investments.

Are there any indicators that the cost might not be representative of fair value?

Is observable market price available?

Revalue the investment Continue with the

current measurement

Refresh inputs to initial valuation model

NoYes

Is the price deemed appropriate?

Yes

No

No

No

Is the fair value change material?

Yes

Yes No

1 Where the investor does not have significant influence or control over the investee.


Accounting for crypto-assets

► In March 2019 IFRIC discussed how IFRS standards apply to holdings of a narrow subset of crypto-assets — cryptocurrencies:

► Digital or virtual currency recorded on a distributed ledger, using cryptography for security

► Not issued by a jurisdictional authority or other party

► Holding does not give rise to a contract between the holder and another party

► IFRIC tentatively decided that an accounting model should depend on whether the asset is held for sale in the ordinary course of business:

► Apply IAS 38 unless the holding meets the definition of a financial asset or is within the scope of another standard

Cryptocurrency is not held for sale in the ordinary course of business

► Apply IAS 2 to inventories of intangible assets held for sale in the ordinary course of business

► Commodity broker-traders who buy or sell commodities for others, or on their own account, to generate profit from price fluctuations or margin measure inventories at FV less costs to sell

Cryptocurrency is held for sale in the ordinary course of business

Cryptocurrency isnot cash

Cryptocurrency is not a financial asset


Other topics

Incentives paid to

customers

Location strategy

Business combinations

Profit sharingarrangements

Share-basedcompensation

New product offerings

Jointarrangements

App-enabled services

Staff compensation

Open-end infrastructure


The macro environment and related accounting and reporting impacts

Mark Gregory

Chief Economist, Ernst & Young LLP


Macroeconomic context


Some expansions and policy positions are already long compared to history, we are moving into new territory

0

20

40

60

80

100

120

Australia US France UK SwedenGermany Japan Canada

Qu

art

ers

of

gro

wth

sin

ce la

st r

ece

ssio

n

Current Historical Average Historical Max/Min

(1)

0

1

2

3

4

5

6

7

2005 2007 2009 2011 2013 2015 2017 2019

%

US Eurozone Japan UK

Forecast

Source: ITEM Club and Haver Analytics

Advanced economies: current and pastexpansion lengths

World: policy rate

Source: Oxford Economics and Haver Analytics


Reviewing multiple economic scenarios


Overview of our process

Review of multiple economic scenarios (MESs)

1. Asset segmentation

2. Variable selection

3. Scenario development

4. Probability weightings

5. Variable forecasts

6. Credit risk modelling

7. Incorporate

into probability of default (PD)

and loss given default

(LGD)

8. Estimated credit loss

(ECL) estimation


Most common approach across Europe is three scenarios and symmetric probabilities for the upside and downside

D: downside U: upside

0

2

4

6

8

10

12

14

3 scenarios 4 scenarios 5 scenarios Additional UKeconomic

uncertaintyoverlay

Nu

mb

er

of

inst

itu

tio

ns

0

1

2

3

4

5

6

7

8

9

10

D>U D=U D<U

Nu

mb

er

of

inst

itu

tio

ns

Source: EY analysis

Number of scenarios Distribution of probabilities

Source: EY analysis


D: downside U: upside

There is a weak correlation between the severity of the downside scenarios and their assigned probabilities

Correlation: 35.8% Correlation: 46% Correlation: (47%)

(4.5%)

(4.0%)

(3.5%)

(3.0%)

(2.5%)

(2.0%)

(1.5%)

(1.0%)

(0.5%)

0.0%

0% 10% 20% 30% 40%

Pe

ak t

o t

rou

gh

Probability (40%)

(35%)

(30%)

(25%)

(20%)

(15%)

(10%)

(5%)

0%

0% 10% 20% 30% 40%

Probability

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

0% 10% 20% 30% 40%

Probability

Source: EY analysis

UK forecasts

Gross domestic product (GDP): peak to trough recessions

House price index (HPI): peak to trough recession

Unemployment peak


Base forecasts tend to be close to consensus

Source: EY analysis and HMT

Summary of UK forecasts

GDP growth base forecasts HPI growth base forecasts Unemployment base forecasts

-

0.5

1.0

1.5

2.0

2.5

3.0

2019 2020 2021 2022 2023

HMT Average EY sample max

EY sample mean EY sample min

0

1

2

3

4

5

6

7

2019 2020 2021 2022 2023



HMT rangeHMT range

(2.0)

(1.0)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2019 2020 2021 2022 2023



a a a


Scenarios tend to vary considerably among institutions

D: downside U: upsideSource: EY analysis

Range of scenarios — 2019-2023 compound annual growth rate (CAGR)

Range of scenarios — extreme values

UK sample

Note: for the banks that had more than one downside or upside scenario we calculated the weighted average from the probabilities

2.0%2.9%

3.4%

7.7%

3.0%

4.2%

(0.3%)

1.7%

(4.1%)

1.7%

4.4%

8.7%

(6%)

(4%)

(2%)

0%

2%

4%

6%

8%

10%

Upside Downside

2.3%4.6% 3.9%

8.4%

2.1%4.2%

(3.3%)

0.7%

(17.8%)

(1.4%)

4.5%

9.5%

(20.0%)

(15.0%)

(10.0%)

(5.0%)

0.0%

5.0%

10.0%

15.0%

Upside Downside


GDP HPI Unemployment GDP HPI Unemployment

But effects are relatively benign especially for GDP


GDP downside scenarios comparison

UK sample

Note: for the banks that had more than one downside or upside scenario we calculated the weighted average from the probabilities

(5.0%)

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

Inst 1 Inst 1 Inst 2 Inst 3 Inst 4 Inst 4 Inst 5 Inst 6 Inst 7 Inst 8.1 Inst 8.2 Inst 9.1 Inst 9.2 Inst 10.1 Inst 10.2

CAGR 2019-2023 Peak to trough fall


Sensitivity of ECL estimates to MES varies considerably, and in some cases is very low

D: downside U: upsideSource: EY Analysis

Increase on ECL of using multiple scenarios instead of the base scenario — European sample

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Inst 1 Inst 2 Inst 3 Inst 4 Inst 12 +overlay

Inst 9 +overlay

Inst 5 Inst 6 Inst 7 Inst 8 Inst 9 Inst 10 Inst 11 Inst 12 Inst 13 Inst 14

Inst 2 has the most negative severe downside of UK banks.

Inst 3 has only 1% weight on the upside and two downsides, one of which is very severe.

Institution (Inst) 1 has a high weighting on a modest downside, and a small weighting on a very extreme downside.


In our UK sample, scenarios with a high increase in unemployment do not necessarily have high increases in ECL.

Application of credit risk models can have a significant impact on outcomes

D: downside U: upsideSource: EY Analysis

Impact on ECL1 vs. peak unemployment in downside scenarios

1 Increase on ECL of using multiple scenarios instead of the base scenario

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5%

Imp

act

on

EC

L

Unemployment peak


Variable selection may not fully reflect future risk

► Common issues found in the risk models of a sample of banks:

► Lack of interest rates in the models

► Coefficients with counterintuitive signs

► Statistical correlations that lack intuition (e.g., different transformations in the same equation)

► Short sample period

► Lack of documentation justifying modeling approach

► The lack of interest rates in the models is likely to be underestimating risk:

► Interest rates in the developed world have been relatively stable for an extended period, making it difficult to find a statistically significant relationship in the models.

► With the normalization of monetary policy, this could become an issue, as the models may not be able to forecast an increase in defaults due to the increase in interest rates.

► Using debt to income ratio, debt service ratio1 or debt gearing2 could be an alternative to incorporate interest rate in the models.

1 Debt service over disposable income.2 Interest payment from debt over disposable income.


Model comparison: differenced vs. logistical transformation — UK unemployment and default rate

Difference models seem reasonable but lack the explanatory power of nonlinear relationships


0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

Actual Logit Model

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

0.30%

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

Actual Data Differenced Model


Actual data Differenced Model Logit Model

Conclusions

1. Scenarios should include sufficient downside to test credit losses

✓ ► We expect to see consideration of a significant downside.

► Projecting forward over ten years, we expect to see a recession risk scenario.

✓

2. Scenarios and their probabilities should be produced together

► Probability weighting must depend upon the severity of the scenario.

► Historic frequency analysis is a good benchmark to the probability of a scenario.

✓

4. Credit loss models should include appropriate economic drivers

► Statistical correlations alone will not produce robust models.

► Must give consideration to which economic drivers apply to each credit product.

3. Probabilities applied to scenarios should fit with economic history

► Frequency of downsides in past data is a good test.

► Current conjuncture and identifiable risks should also be considered. ✓


Inside Brussels

Dr. David P. DoyleSenior European Financial Services Regulatory Advisor, Ernst & Young LLP


Brexit — still facing a no-deal scenario

► Dual-listed equities under MiFID II share trading obligation

► Outsourcing of critical activities to UK and EU – “empty shells”

► Back-to-back booking and third country branches

► Shape and governance: EU equivalence regime

Key no-deal issues pending for financial firms

► ESMA abandons plan to ban EU fund managers and banks from trading 14 dual-listed stocks in London, post-Brexit (29 May)

► Battle to come: ESMA insisting on remaining 27 EU dual-listed stocks be traded on EU venues

► MiFID II and MFIR exemptions allowed if the trades are:

► Non-systematic, ad-hoc, irregular and infrequent

► Carried out between eligible and professional counterparties

► Do not contribute to the price-discovery process

Dual-listed equities under MiFID II share trading obligation

► ‘Time limited (one year) and strictly conditional’ EC equivalence decision — UK central counterparties (CCPs) granted temporary recognition by ESMA: immediate implementation by end October 2019

► Central securities depositories: conditional equivalence decision for 24 months

► For over the counter (OTC) contracts: 12-month transition period to allow UK counterparties to be replaced without triggering the clearing requirement

Cleared derivatives temporary equivalence decision

ESMA and UK memoranda of understanding

► ESMA and National Competent Authorities, including BoE, agree to Memorandum of understanding (MoU): on the exchange of information in relation to the supervision of credit rating agencies (CRAs) and trade repositories (TRs)

► ESMA and FCA MoU: ‘will allow certain activities, such as fund manager outsourcing and delegation, to continue to be carried out by UK-based entities on behalf of European economic area (EEA) counterparties’.

Brussels desperately pursuing contingency measures to avoid a financial meltdown


Revised capital requirements regime — May 2019

Not the end of the Basel saga for banks

CRD V

CRR 2

► Capital output floor vs. IRBA for credit risk

► New standardized measurement approach for operational risk

► Credit valuation adjustments

► Green factor:

CRD V and CRR 2 integrates ESG and sustainability disclosures

► European Banking Authority mandated to:

a. Develop guidelines for inclusion of ESG risks in supervisory review and evaluation process(SREP) and stress-testing framework. How do banks deal with such risks?

b. Develop possible prudential regime for banks linked to environmental and climate change

Outstanding issues

► CRR 2 — application 2 years after entry into force

► CRD V — implementation 18 months after EiF

► TLAC — application with immediate effect after entry into force (EiF)

► Single resolution regulation — application 18 months after EiF

► Leverage ratio requirement of 3% for all institutions andleverage ratio buffer for all G-SII’s. Possible extension to O-SII’s in the future

► Net stable funding requirement

► New proportionate market risk framework for reporting purposes, i.e., reducing reporting and disclosure requirements and simplifying market risk and liquidity rules for small, noncomplex banks

► Requirement for third-country Global systemically important banks (G-SIB) type banks + €40bn with significant activities in the EU to have an EU intermediate parent undertaking

► New total loss absorbing capacity (TLAC) requirement for global systemically important institutions (G-SIIs)

► Enhanced minimum requirement for own funds and eligible liabilities (MREL) subordination rules for G-SIIs and other large banks

► Fundamental review of trading book (FRTB) — being reviewed by EBA, but in the interim, reporting (not capital) requirement — in two phases (i) standardized in Q1 2021, (ii) Internal model approach (IMA) in Q1 2023

► Targeted measures to cater for EU specificities

► Incentives for investments in public infrastructures

► SME factor, lower capital charges and €2.5mn loans

► Credit risk framework facilitating the disposal of nonperforming loans.

CRD V and CRR 2 timeframe for implementation or application


EC package of measures

► Establishing a unified EU classification system of sustainable economic activities (taxonomy) — eco labels

► Improving disclosure requirements on how institutional investors integrate ESG factors in their risk processes

► Creating a new category of benchmarks that will help investors compare the carbon footprint of their investments.

► Integration sustainability risks and factors into MiFID II, Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Fund Managers Directive (AIFMD).

The EU sustainability disclosure regime

The ‘E’ factor in ESG leaps to prominence in Brussels

Key regulatory initiatives

Taxonomy classification system

► Uniform criteria to determine whether an economic activity is environmentally sustainable

► Must contribute to; 1) climate change mitigation; 2) climate change adaptation; 3) sustainable use and protection of water and marine resources; 4) transition to a circular economy, waste prevention and recycling; 5) pollution prevention and control; 6) protection of healthy ecosystems

► EU parliament wants fossil fuels, nuclear energy and gas infrastructure excluded

ESG disclosures regulation

► Applicable to UCITS management companies, (Alternative Investment Fund Managers Directive) AIFMs, MiFID investment firms, insurers, institutional investors and pension funds

► Requires disclosure of:

1. The procedures financial actors have in place to integrate ESG risks into their investment and advisory process

2. The extent to which ESG risks are expected to have an impact on the returns of the product or service provided, irrespective of whether or not sustainable investment objectives are pursued

► Product specific disclosure — how products fulfill or meet ESG sustainable investment objectives

Low-carbonbenchmarks

► A climate-transition benchmark — aligning benchmark portfolio with decarbonization

► An EU Paris-aligned benchmark — linked Conference of the Parties 21 (COP21) limit of global temperature increases to 1.5° above pre-industrial levels

► All EU benchmarks to disclose whether they pursue ESG objectives and if aligned with COP21 (except foreign exchange (FOREX) and interest rate benchmarks)

European Commission


EC update on nonbinding guidelines in nonfinancial reporting directive

Disclosing not only how the climate affects your entity but also how you affect the climate — the ‘double materiality’ factor

How climate change may affect the entity's business model

The entity's due diligence, governance and control policies relating to climate-related issues, including involvement of the board and management

Climate-related policies and an assessment of the entity's development, position, performance and climate impact as a result of its policies

Climate-related risk factors that the entity has identified and a description of its risk determination and risk management processes

Supporting key performance indicators (KPIs), to be defined in the updated guidelines, including specific KPIs for the insurance and banking sectors


EC FinTech action plan — market developments overtaking pace of EU policy

Opportunities and challenges for financial institutions, but a cautious approach pursued by EU regulators

► Guidelines for sandboxes and hubs

► Fitness of regulation for new technology — common EU standards and interoperable solutions

► EC comprehensive strategy on distributed ledger technology and blockchain addressing all sectors of the economy

► Review barriers limiting information-sharing between industry actors on cyber threats

► Develop EU legislative framework for crypto assets: transparency rules on primary markets/initial coin offering (ICOs), security, investor protection – based on financial stability report (FSB) and EBA work

► Create EU financial sector cybersecurity initiative or act

Action points 2019


► EU-wide authorisation with EU passport

► Covers investment and loan-based business models

► Investment protection disclosures: risks and charges, i.e., insolvency risk to services and platforms

► Scope: crowd-funding offers up to €8m

► Immediate application

Crowdfunding platforms regulation

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