Guidelines on the adoption of PFRS 9

CIRCULAR NO. 708 Series of 2011

Subject: Guidelines on the adoption of PFRS 9

The Monetary Board in its Resolution No. 1844 dated 23 December 2010, approved the following guidelines governing the implementation/early adoption of Philippine Financial Reporting Standards (PFRS 9) Financial Instruments.

Section 1.  Statement of Policy

It is the policy of the Bangko Sentral ng Pilipinas (BSP) to promote fairness, transparency and accuracy in financial reporting.  It is in this light that the BSP aims to adopt all Philippine Financial Reporting Standards (PFRS) and Philippine Accounting Standards (PAS) to the greatest extent possible.

Section 2.  Classification and Measurement of Financial Assets under PFRS 9

PFRS 9 shall apply to financial assets within the scope of Philippine Accounting Standards (PAS) 39. Financial institutions (FIs) shall classify and measure financial assets in accordance with the provisions of PFRS 9 upon its initial application. FIs shall likewise observe the following guidelines in the implementation of PFRS 9:

1. Classification of financial assets.  Financial assets that are debt instruments shall be classified as subsequently measured at either amortized cost or fair value based on the (a) FI’s business model for managing financial assets, and (b) the contractual cash flow characteristics of the financial asset. Financial assets that are equity securities shall be classified at either fair value through profit or loss (FVPL) or irrevocably designated at initial recognition at fair value through other comprehensive income (DFVOCI).

2. Business model for managing financial assets.  An FI’s business model pertains to the manner by which it actually manages its business or portfolio of financial instruments.

An FI’s business model need not be assessed at the level of the FI. The business model criteria may be applied at the level of a portfolio of financial instruments (i.e., group of financial instruments that are managed together by the FI) but not on an instrument-by-instrument basis (i.e., not based on intention for each individual financial instrument). This may include, for instance, a portfolio of investments that an FI manages in order to collect contractual cash flows and another portfolio of investments that an FI manages in order to trade to realize fair value changes.

An FI’s business model for managing financial assets shall be documented and approved by the FI’s board of directors or its equivalent governing body. The documentation shall include, at a minimum, the following:

a. clearly documented policies and procedures on the specific business model for managing financial assets and for measuring/evaluating performance of those financial assets within a specific business model;

b. type and frequency of reports which shall be presented to management to measure/evaluate performance of financial instruments within a specific business model; and

c. accountable officers and their specific responsibilities with respect to the management, monitoring and evaluation of the performance of financial instruments within a specific business model.

3. Financial assets measured at fair value through profit or loss (FVPL).  A financial asset shall be measured at fair value through profit or loss, except in the following cases:

a. The financial asset is part of a hedging relationship, in which case the provisions of PAS 39 on hedge accounting shall apply;

b. The financial asset that is an equity security that is not held for trading and is irrevocably elected upon initial recognition to be measured at fair value through other comprehensive income as provided under Item No. “5”; or

c. The financial asset that is a debt instrument is measured at amortized cost as provided under Item No. “7”.

Financial assets measured at fair value through profit or loss shall consist of the following:

a. Held for Trading (HFT) financial assets as defined in PAS 39;

b. Financial assets designated at fair value through profit or loss (FA DFVPL) as defined in PFRS 9; and

c. Other financial assets mandatorily measured at fair value through profit or loss (FA MMFVPL) under PFRS 9.

Investments in hybrid securities, securities overlying securitization structures and other structured products shall be measured at FVPL, unless these meet the criteria for amortized cost measurement in accordance with PFRS 9.

Investments in credit-linked notes (CLNs) and similar structured products with embedded credit derivatives, as defined under Section 1628 of the Manual of Regulations for Banks (MORB), including those that were reclassified from HFT to Available for Sale (AFS)/Held to Maturity (HTM)/Unquoted Debt Securities Classified as Loans (UDSCL) or from AFS to HTM/UDSCL in accordance with the reclassification rules under Circular No. 626 dated 23 October 2008 and Circular No. 628 dated 31 October 2008, shall be classified and measured at FVPL upon initial application of PFRS 9.

The accounting treatment for investments in CLNs and other structured products under BSP Memorandum M-2008-10 dated 7 March 2008 and the guidelines on the reclassification of CLNs and other similar instruments that are linked to the ROP under BSP Memorandum No. M-2009-012 dated 16 April 2009 shall no longer apply to financial assets that are accounted for in accordance with PFRS 9.

4. Financial assets designated at fair value through profit or loss (DFVPL).  An FI may, at initial recognition, designate financial assets that are debt instruments as measured at fair value through profit or loss in accordance with the conditions mentioned under PFRS 9, subject to the following requirements:

a. FIs shall have in place appropriate risk management systems (including related risk management policies, procedures and controls) prior to initial application of the fair value option for a particular activity or purpose and on an ongoing basis;

b. FIs shall apply the fair value option only to instruments for which fair values can be reliably estimated; and

c. FIs shall provide BSP with supplemental information as may be necessary, to enable BSP to assess the impact of the FI’s use of the DFVPL option.

5. Equity securities designated at fair value through other comprehensive income (DFVOCI).  Financial assets that are equity securities that are not held for trading may be irrevocably elected at initial recognition by an FI to be accounted for as at fair value through other comprehensive income, subject to the conditions provided under PFRS 9.

Unrealized gains/(losses) arising from changes in fair value of investment in equity securities classified as DFVOCI, including any related foreign exchange  gains/(losses), shall be credited/(charged) to Other Comprehensive Income (OCI) under the equity section of the balance sheet: Provided, That the realized gains/(losses) on sale or derecognition of equity securities booked under the DFVOCI account shall be credited/(charged) to the “Retained Earnings – Free” account on sale/derecognition date.

6. Investments in unquoted equity securities.  Investments in unquoted equity securities shall be recorded at fair value from the date of initial application of PFRS 9. However, in limited circumstances, cost may be an appropriate measure of fair value.  For this purpose, FIs shall be guided by the provisions of PFRS 9 in making its assessment.

7. Financial assets measured at amortized cost

a. Classification criteria

Financial assets that are debt instruments, other than those that are DFVPL, which meet all of the following conditions shall be measured at amortized cost:

i. The financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows; and ii. The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

b. Hold to collect contractual cash flows (HTC) business model

In addition to those provided under PFRS 9, the following instances are, likewise, deemed inconsistent with an HTC business model; hence, should not qualify for amortized cost measurement category:

i. a portfolio of debt instruments that is managed in order to benefit from actual or expected price movements/fair value changes (e.g., changes in credit spreads, yield curve, etc.) or to lock in arbitrage profits;

ii. a portfolio of debt instruments held for market-making by an FI who is a market maker in those instruments (e.g., government securities);

iii. positions in debt instruments which arise from the execution of trade orders from customers; or

iv. a portfolio of debt instruments that is managed and evaluated on a fair value basis in accordance with a documented risk management or investment strategy as evidenced by management reports provided to senior management.

A “more than infrequent sale” of financial assets in a portfolio of debt instruments measured at amortized cost shall be assessed as to whether such sales are consistent with an HTC business model.

The following sales/derecognition of financial assets shall not be considered inconsistent with an HTC business model:

(1) sales which no longer meet the FI’s investment policy (e.g., due to downgrade in credit rating below that required by the entity’s investment policy);

(2) sales of financial assets in order to fund capital expenditures;

(3) sales of financial assets to reflect the change in expected timing of payouts;

(4) sales which are so close to maturity (e.g., less than three months) or the security’s call date that changes in the market rate of interest would not have a significant effect on the security’s fair value;

(5) sales that occur after the FI has substantially collected all of the security’s original principal through scheduled payments or prepayments.

(6) sales attributable to an isolated event that is beyond the FI's control, is non-recurring and could not have been reasonably anticipated by the FI (e.g., a run on a bank);

(7) sales attributable to a change in tax law that eliminates or significantly reduces the tax exempt status of interest on the security under the amortized cost category;

(8) sales attributable to a major combination or major disposition that necessitates the sale of securities under the amortized cost category to maintain the FI's interest  rate risk position or credit risk policy;

(9) sales attributable to a change in statutory or regulatory requirements significantly modifying either what constitutes a permissible investment or the maximum level of particular investments, thereby causing the FI to dispose a security under the amortized cost category;

(10) sales attributable to a significant increase in regulatory capital requirements that causes the FI to downsize by selling securities under the amortized cost category;

(11) sales attributable to a significant increase in the risk weights of securities under the amortized cost category used for regulatory risk-based capital purposes; and

(12) sales/derecognition attributable to the changes in the payment structure as initiated by the creditor (e.g., bond swap or exchange, options, changes in tenor and other related debt restructuring).

An FI shall clearly document in its policies and procedures the instances and the manner by which sales of financial assets under the amortized cost category would not be inconsistent with the HTC business model in accordance with PFRS 9 and the requirements of this Circular.

Any sale/derecognition of financial assets under the amortized cost category shall be documented by the FI.  The documentation shall include, at a minimum, the following information:

i. details of the financial asset sold/derecognized;

ii. gain or loss on sale/derecognition; and

iii. the specific reason/s for derecognizing the financial asset and a justification on how such sale/derecognition is consistent with the HTC business model.

c. Amortized cost of financial assets at date of initial application.  The amortized cost of financial assets that are reclassified from the fair value category (i.e., HFT, DFVPL, AFS) to the amortized cost category at the date of initial application of PFRS 9 shall be determined retrospectively (i.e., using the original acquisition cost and the original effective interest rate at the date of acquisition) in accordance with the provisions of PFRS 9, except in cases when it is “impracticable” to do so, as defined in PAS 8, in which case the fair value of the financial asset at the date of initial application of PFRS 9 shall be treated as the new amortized cost of that financial asset at the date of initial application.

The retrospective determination of amortized cost at initial application of PFRS 9 under the preceding paragraph shall, likewise, apply to financial assets accounted for under the amortized cost category under PFRS 9 that were reclassified from the HFT and AFS categories to the HTM and the UDSCL categories in accordance with the reclassification guidelines under Circular No. 626 and Circular No. 628.

In the case of financial assets reclassified from AFS to the HTM/UDSCL category under Circular Nos. 626 and 628, any remaining balance (i.e., unamortized amount) of previously recognized net unrealized gains/(losses) under the “Other Comprehensive Income - Net Unrealized Gains/(Losses) on AFS Financial Assets” account in the balance sheet that correspond to those reclassified AFS financial assets shall be closed to the appropriate accounts upon initial application of PFRS 9.

8.  Reclassification of financial assets.   Financial assets shall be reclassified when, and only when, an FI changes its business model for managing financial assets in accordance with the provisions of PFRS 9 and of this Circular. Reclassifications other than due to change in business model are not permitted.

A change in an FI’s business model is expected to be very infrequent and must be determined as a result of external and internal changes that are significant to the FI’s operations and demonstrable to external parties.  Hence, such change in business model must be approved by the FI’s board of directors or its equivalent governing body, and such fact properly documented.  The documentation, at a minimum, shall include the following information:

a. A certified true copy of the board resolution approving the change in the business model for managing financial assets;

b. The reasons for the change in the FI’s business model and how it is aligned with the objectives and strategies of the FI;

c. A description of the new business model; and

d. A qualitative description of the new business model’s implication on the FI’s financial statements. In addition to the foregoing items, the BSP may require additional documents from FIs to support the reclassification of financial assets due to change in business model.

A change in the objective of the entity’s business model must be effected before the reclassification date.

An FI shall not effect a reclassification within the period of change in the business model.  Any reclassification of financial assets due to change in business model should take effect from the beginning of the next reporting period of the FI’s financial statements: Provided, That the change in business model shall be disclosed in the financial statements in the period of change consistent with PFRS 7 Financial Instruments: Disclosures which require among others the disclosure of an entity’s objectives, policies and processes for managing the risk from financial instruments and any changes to those objectives, policies, and procedures.

9.  Operations Manual.  An FI shall maintain an operations manual on the classification and measurement of financial assets which shall be consistent with PFRS 9 and the provisions of this Circular.

Section 3.  Early Adoption of PFRS 9

The guidance provided in this Section shall apply to FIs that early adopt PFRS 9 prior to 1 January 2013. The date of initial application of PFRS 9 is the date when the FI first applies the requirements of PFRS 9.  If the date of initial application is prior to 1 January 2011, the date of initial application can be any date between 1 January 2010 up to 31 December 2010.  If the date of early application is on or after 1 January 2011, the date of initial application must be the first day of the fiscal year or calendar year adopted by the FI (e.g., 1 January).

An FI that elects to apply PFRS 9 prior to 1 January 2013 shall observe the requirements of PFRS 9 and any amendments thereto.

FI’s shall, likewise, observe the following guidelines:

1.  Board/Senior management approval.  FIs that early adopt PFRS 9 must assess the financial statement implications of early adoption of PFRS 9 and must ensure that it has the capability to comply with the requirements of that standard, including the required disclosures in the financial statements. The early adoption of PFRS 9 must be approved by the FI’s board of directors.

2.  Inapplicability of Appendix 33 of the MORB and Appendix Q-20 of the MORNBFI.  The guidelines set forth under Appendix 33, including Annex A of Appendix 33, of the MORB and Appendix Q-20, including Annex A of Appendix Q-20, of the MORNBFI on the classification and accounting of debt and equity securities shall no longer be applicable when an FI opts to adopt PFRS 9.

3.  FRP reporting.  Banks shall report financial assets in accordance with the following guidelines on the mapping of financial assets (Annexes A and A-1) using the existing FRP template issued under Circular No. 512 dated 3 February 2006, as amended:

a. Debt securities measured at amortized cost under PFRS 9 shall be booked under the HTM account, in the case of debt securities that are quoted in an active market, or the UDSCL account, in the case of debt securities that are not quoted in an active market. The “tainting rule” for HTM securities shall no longer apply to early adopters of PFRS 9.

b. Financial assets measured at fair value through profit or loss under PFRS 9 shall be booked under the following accounts/sub-accounts.

(i)  Held for Trading (HFT) Financial Assets

The “HFT Securities” sub-account shall be used to record held for trading debt and equity securities.

The “Derivatives with Positive Fair Value Held for Trading” account shall be used to record the positive fair value of derivatives, other than those that are designated and effective hedging instruments.

The sub-account “Derivatives with Positive Fair Value Held for Trading (stand-alone derivatives)” in the FRP shall be used to record the positive fair value of stand alone derivatives, other than those that are designated and effective hedging instruments.

The sub-account “Derivatives with Positive Fair Value Held for Trading” (embedded derivatives)” in the FRP, shall be used to record the positive fair value of embedded derivatives where the host contract is a financial liability of the FI.

(ii) Financial Assets Designated at Fair Value through Profit or Loss (DFVPL).   This account shall be used to record investments in  FA DFVPL and FA MMFVPL, as follows:

FA DFVPL refers to investments in debt instruments that are designated as at fair value through profit or loss in accordance with PFRS 9.

FA MMFVPL refers to financial assets that are required to be measured at fair value through profit or loss under PFRS 9, other than those that are HFT and DFVPL.

c. The “Available for Sale (AFS) Financial Asset – Equity Securities” account shall be used to record investments in equity securities (other than those that are held for trading) that are irrevocably designated at initial recognition to be accounted for as DFVOCI in accordance with PFRS 9.  The “Other Comprehensive Income – Net Unrealized Gains/(Losses)” account under the equity section of the balance sheet shall be used to record unrealized gains/(losses) from changes in…