The war in Ukraine is a humanitarian crisis and our hearts go out to the tens of millions of people whose lives have been devastated by this. Along with many major geopolitical events, it has some serious IFRS 9 implications, most obviously on all exposures to Russia and Ukraine, but it also impacts Europe and much further afield too.
IFRS 9 requires us to measure Expected Credit Losses (ECLs) on many financial assets. This requires us to measure the risk today and transform this to an expected loss by overlaying the impacts of macroeconomic forecast scenarios. For many companies’ assets, the risk today and the forecasts will have changed since the outbreak of the war and may continue to change along with major developments. Volatility itself increases credit risk. General economic forecasts that are already under pressure to recognise the risk of rising inflation must be further adjusted to reflect these risks. In addition, there is a myriad of considerations that may be specific to an entity.
What impact can we expect?
Looking at the impact in a little more detail, the most obvious and severe is on assets located in, or exposures to, Russia and Ukraine.
Moody’s Investor Services has downgraded the credit rating of Russia from Baa3 (investment grade) to deep into sub-investment grade indicating a high risk of default. Before these events, Ukraine had a sub-investment grade rating. Ukraine has been downgraded further and placed on a watchlist for further downgrades. Investments in government bonds and funds held in banks in these countries are immediately impacted. Any amounts owing from these countries including trade receivables and loans, need to incorporate the impact of sovereign rating downgrades and how this reflects the risk of repatriation of these funds as well as the ability of the counterparty to pay. Forecast scenarios for Russia or Ukraine have been fundamentally impacted.
The imposition of sanctions on Russia in combination with other pressures not to be doing business there has significantly impacted the risk of many entities, as have the wild swings in commodity prices and currencies.
There is a myriad of credit risk considerations that may be specific to an entity, such as:
- Exposure to fixed price sales contracts and variable input costs, which may now be experiencing major input cost spikes due to market price dislocation. Examples may include grain or fertilizer and plastic feedstock inputs.
- Windfall profits or major hedging or trading losses due to wild swings in some markets.
- Companies selling commodities may appear to be very profitable, but may not be able to collect the cash or may have a single large exposure to a sanctioned company.
- Entities subject to consumer boycott or backlash for not exiting Russian operations.
- Companies, or their major customers, experiencing major supply chain disruptions.
- Counterparties who are politically connected or who have a large exposure to a party that is.
- Counterparties who may experience a liquidity crisis.
It is important at a time like this to peel back the layers of the onion and delve into counterparties a little more deeply to reveal their credit risk, which could even, in some cases, be materially lower.
How to take these into account.
As always, compliance with IFRS 9 is dependent on having the right tools and the latest relevant information. In times of sudden shocks, internal historical data will not be sufficient. Any assessments of today’s risk based on historical financial information (to support judgmental assessment or to drive credit models) require adjustment.
You need to be able to measure where we are in the credit cycle and how this has changed in recent days. Market derived measures of credit risk, provided by several vendors, are quickest to reflect these changes in risk.
Economic forecast scenarios require frequent updates to incorporate the new information. Using the right tools to measure credit risk, where measurements are up to date and incorporate the latest credit cycle adjustments and macroeconomic forecast adjustments, is now essential.
Covid 19 has already taught us that shocks to the economy are real. As any risk manager will tell you, once in lifetime events seem to happen many times in their lifetime. Having access to the right tools and information eliminates the effort and uncertainty of adjusting ECL measurement methodologies and obtaining acceptance of these by risk committees and auditors.
i9 Partners provides Expected Credit Loss (ECL) calculations for IFRS 9 through the use of leading tools and credit intelligence. We cover all classes of financial assets with solutions for auditors, smaller companies to large corporates, public sector entities and smaller financial institutions. We remove the pain of IFRS 9 compliance through access to a range of world class credit models to calculate ECL’s and our network of multi-disciplinary partners. Our depth of credit, IFRS and technology skills is unique in the marketplace.
