Instruction No. 13/2019 of 28 August

INSTRUCTION NO. 13/2019 of 28 August SUBJECT: FINANCIAL SYSTEM − Effective Interest Rate Method in the Recognition of Income and Expenses of Financial Instruments

Considering the entry into force on 1 January 2018 of International Financial Reporting Standard 9 – Financial Instruments, which replaces International Accounting Standard 39 – Financial Instruments: Recognition and Measurement. Given the need to revise Instruction No. 07/2016 of 08 August, regarding the effective interest rate method in the recognition of income and expenses of financial instruments; Considering that this Instruction does not intend to make any interpretations of International Accounting Standards/International Financial Reporting Standards, which are issued by the International Accounting Standards Board (IASB) and developed exclusively by the IFRS Interpretations Committee. Under the combined provisions of Article 21 and Article 51, both of Law No. 16/10 of 15 July – Law of the National Bank of Angola, and Article 93 of Law No. 12/15 of 17 June – Law of the Bases of Financial Institutions.

DETERMINES:

1. Objective This Instruction establishes the procedures that Banking Financial Institutions must observe in applying the effective interest rate method in the recognition of income and expenses associated with financial instruments, as provided in International Financial Reporting Standard 9 – Financial Instruments, hereinafter abbreviated as IFRS 9.

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2. Scope This Instruction applies to Banking Financial Institutions under the supervision of the National Bank of Angola, under the terms and conditions provided in the Law of the Bases of Financial Institutions, hereinafter abbreviated as Institutions.

3. Definitions Without prejudice to the definitions established in the Law of the Bases of Financial Institutions, for the purposes of this Instruction, the following shall be understood as: 3.1 Financial asset, any asset that is: a) Cash; b) An equity instrument of another entity; c) A contractual right: i. to receive cash or another financial asset from another entity; or, ii. to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the Institution. d) A contract that will or may be settled in the Institution's own equity instruments and that is: i. a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the Institution's own equity instruments. For this purpose, the Institution's own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of such instruments; or ii. a non-derivative for which the Institution is or may be obliged to receive a variable number of the Institution's own equity instruments.

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3.2 Financial asset with credit impairment: a financial asset for which one or more events that have a negative impact on the estimated future cash flows for that financial asset have occurred. Indicators that a financial asset is in credit impairment include observable data regarding the following events: a) Significant financial difficulty of the issuer or borrower; b) Breach of contract, such as a default or delinquency; c) The lender(s), for economic or contractual reasons related to the borrower's financial difficulties, having granted concessions to the borrower that they would not otherwise have granted; d) It becomes likely that the borrower will enter bankruptcy or other financial/reorganization process and/or operational; e) The disappearance of an active market for that financial asset due to financial difficulties; or f) The acquisition or creation of a financial asset at a significant discount that reflects incurred credit losses.

3.3 Financial assets acquired or originated with credit impairment: financial assets acquired or originated that are in credit impairment at the time of initial recognition.

3.4 Contract assets: rights specified by International Financial Reporting Standard 15 – Revenue from Contracts with Customers, which are accounted for in accordance with IFRS 9 for the purposes of recognizing and measuring gains or losses from impairment.

3.5 Financial guarantee contract: a contract that requires the issuer to make specified payments to reimburse the holder for a loss incurred because a specified debtor fails to make payment when due, in accordance with the initial or modified terms of a debt instrument.

3.6 Amortised cost: the amount at which a financial asset or financial liability is measured at initial recognition, minus capital repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount, and, for financial assets, adjusted for any loss allowance.

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3.7 Transaction costs: incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. An incremental cost is one that would not have been incurred if the entity had not acquired, issued or disposed of the financial instrument.

3.8 Derivative: a financial instrument or other contract within the scope of IFRS 9 for which both of the following characteristics apply: a) Its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided that, in the case of a non-financial variable, the variable is not specific to a party to the contract; b) It requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and c) It is settled at a future date.

3.9 Gains or losses resulting from modification: the amount resulting from adjusting the gross carrying amount of a financial asset to reflect renegotiated or modified contractual cash flows.

3.10 Financial instrument: any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.

3.11 Fair value: the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

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3.12 Effective interest method: the method used to calculate the amortised cost of a financial asset or financial liability and to allocate and recognise interest income or interest expense over the relevant period.

3.13 Financial liability: any liability that is: a) A contractual obligation: i. to deliver cash or another financial asset to another entity; or ii. to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the Institution. b) A contract that will or may be settled in the Institution's own equity instruments and that is: i. a non-derivative for which the Institution is or may be obliged to deliver a variable number of the Institution's own equity instruments; or ii. a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the Institution's own equity instruments. For this purpose, the Institution's own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of such instruments.

3.14 Credit loss: the difference between all contractual cash flows that are due to an Institution in accordance with the contract and all cash flows that the Institution expects to receive, discounted at (i) the original effective interest rate, or (ii) the credit-adjusted effective interest rate for financial assets acquired or originated with credit impairment.

3.15 Expected credit losses: a weighted average of credit losses with the respective risk of a default occurring as the weighting factors.

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3.16 Loss allowance: (i) expected credit losses on financial assets measured at amortised cost, lease receivables and contract assets, (ii) cumulative impairment for financial assets measured at fair value through other comprehensive income and (iii) expected credit losses on loan commitment and financial guarantee contracts.

3.17 Gross carrying amount of a financial asset: the amortised cost of a financial asset, before adjusting for any loss allowance.

3.18 Effective interest rate: the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or to the amortised cost of a financial liability.

3.19 Credit-adjusted effective interest rate: the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument to the amortised cost of a financial asset acquired or originated with credit impairment.

4. Application of the effective interest rate method 4.1 Institutions shall use the effective interest rate method for the following financial instruments: a) Financial assets measured at amortised cost; b) Debt instruments measured at fair value through other comprehensive income, with respect to interest income and/or expenses or similar; c) All financial liabilities that are not: i. financial liabilities at fair value through profit or loss, including derivatives that are financial liabilities; ii. financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies; iii. financial guarantee contracts that are not within the scope of International Financial Reporting Standard 4 – Insurance Contracts; iv. loan commitments to provide a loan at a below-market interest rate; and, v. contingent consideration recognised by an acquirer in a business combination to which International Financial Reporting Standard 3 – Business Combinations applies. Such contingent consideration shall be subsequently measured at fair value, with changes recognised in profit or loss.

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4.2 Institutions shall calculate interest income using the effective interest rate method. To do so, they shall apply the effective interest rate to the gross carrying amount of a financial asset, except in the following situations: a) Financial assets acquired or originated with credit impairment. In these situations, Institutions shall apply the credit-adjusted effective interest rate to the amortised cost of the financial asset resulting from initial recognition; and b) Financial assets that do not fall under the previous sub-paragraph, but subsequently become financial assets in credit impairment. In these situations, Institutions shall apply the effective interest rate to the amortised cost of the financial asset in subsequent reporting periods.

4.3 Institutions that, in a given reporting period, calculate interest income by applying the effective interest rate method to the amortised cost of a financial asset with reference to the provision in sub-paragraph b) of the previous point of this section, shall, in subsequent reporting periods, calculate interest income by applying the effective interest rate to the gross carrying amount, if the credit risk associated with the financial instrument improves, such that the financial asset ceases to be in credit impairment and this improvement can be objectively related to an event occurring after the application of the requirements described in sub-paragraph b) of the previous point of this section, of which an example is an improvement in the borrower/issuer's credit rating.

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5. Calculation of the effective interest rate 5.1 In calculating the effective interest rate, Institutions shall: a) Estimate expected cash flows, considering all contractual terms of the financial instrument, such as prepayment and call or put options, but shall not consider expected credit losses; and, b) Include all fees that are an integral part of the effective interest rate as described in section 8 of this Instruction, transaction costs and all other premiums or discounts falling within the effective interest rate.

5.2 For the purposes of the preceding point, Institutions shall calculate the effective interest rate of financial instruments according to the following formula: CA0 = FC1/(1+TJE)^1 + FC2/(1+TJE)^2 + FC3/(1+TJE)^3 + ... + FCn/(1+TJE)^n Where: CA0 - corresponds to the amortised cost of the financial instrument at the time of initial recognition; FC - is the cash flow attributable to each period; TJE - is the effective interest rate.

5.3 In exceptional situations where Institutions cannot reliably estimate the cash flows or the expected life of a financial instrument, or group of financial instruments, contractual cash flows over the entire contractual term of the financial instrument, or group of financial instruments, shall be used.

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5.4 Institutions shall update the effective interest rate of variable rate financial instruments at the time of reindexation to market rates.

6. Calculation of the credit-adjusted effective interest rate 6.1 In calculating the credit-adjusted effective interest rate, Institutions shall: a) Estimate expected cash flows considering all contractual terms of the financial instrument, such as prepayment and call or put options, as well as expected credit losses; and b) Include all fees that are an integral part of the effective interest rate, as described in section 8 of this Instruction, transaction costs and all other premiums or discounts falling within the effective interest rate.

6.2 For the purposes of the preceding point, Institutions shall calculate the credit-adjusted effective interest rate of financial instruments according to the following formula: CA0 = FC1/(1+TJEAC)^1 + FC2/(1+TJEAC)^2 + FC3/(1+TJEAC)^3 + … + FCn/(1+TJEAC)^n Where: CA0 - corresponds to the amortised cost of the financial instrument at the time of initial recognition; FC - is the cash flow attributable to each period (which includes consideration of future credit losses); TJEAC - is the credit-adjusted effective interest rate.

6.3 In exceptional situations where Institutions cannot reliably estimate the cash flows or the remaining life of a financial instrument, or group of financial instruments, contractual cash flows over the entire contractual term of the financial instrument, or group of financial instruments, shall be used.

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6.4 Institutions shall update the credit-adjusted effective interest rate of variable rate financial instruments at the time of reindexation to market rates.

7. Revision of estimates of payments or receipts 7.1 When the contractual cash flows of a financial asset are renegotiated or otherwise modified and the renegotiation or modification does not result in the derecognition of the financial asset, Institutions shall recalculate the gross carrying amount of the financial asset and recognise a gain or loss on modification in the statement of profit or loss. The gross carrying amount of the financial asset shall correspond to the present value of the renegotiated or modified contractual cash flows. Institutions shall discount the renegotiated or modified contractual cash flows at the original effective interest rate of the financial asset (or at the credit-adjusted effective interest rate for financial assets acquired or originated with credit impairment) or, where applicable, at the revised effective interest rate calculated in accordance with paragraph 6.5.10 of IFRS 9.

7.2 In revising estimates of payments or receipts (excluding situations provided for in the previous point and changes in estimates of expected credit losses), Institutions shall adjust the gross carrying amount of a financial asset or the amortised cost of a financial liability (or group of financial instruments) so as to reflect the actual and revised estimated contractual cash flows. The gross carrying amount of a financial asset or the amortised cost of a financial liability is recalculated by updating the estimated future contractual cash flows at the original effective interest rate of the financial instrument (or at the credit-adjusted effective interest rate for financial assets acquired or originated with credit impairment) or, where applicable, at the revised effective interest rate calculated in accordance with paragraph 6.5.10 of IFRS 9.

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7.3 With regard to Angolan Treasury Bonds with variable nominal value indexed, without prejudice to the provision in the previous point, Institutions shall update future cash flows based on the nominal value of the instrument at the reporting date, without making any estimate of the future variation of the indexed variable, with the effective interest rate being revised and adjusted according to the new estimated cash flows.

8. Eligible income and expenses 8.1 The eligibility of income and expenses depends on the underlying purpose/objective of those income and expenses and on the measurement basis of the financial instrument in question. The denomination of these income and expenses may not be indicative of the nature and substance of the services provided.

8.2 For the calculation of the effective interest rate, Institutions shall consider as eligible income: a) Fees received in connection with the acquisition or creation of a financial asset that is not classified at fair value through profit or loss in accordance with IFRS 9, namely: i. remuneration for activities such as assessing the financial condition of the borrower, which includes the fee for opening a credit operation; ii. assessment and registration of received guarantees; iii. pledges and other guarantee agreements; iv. negotiation of the terms of the financial instrument; v. preparation and processing of documents; and vi. completion/formalisation of the transaction. b) Fees received for the commitment to originate a loan when the loan commitment is not measured at fair value through profit or loss and it is probable that a specific loan contract will be entered into; and c) Origination fees paid on the issuance of financial liabilities measured at amortised cost.

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8.3 Without prejudice to the provisions in points 8.1 and 8.2 of section 8 of this Instruction, other income and expenses may be considered eligible with prior authorisation from the National Bank of Angola.

9. Ineligible income and expenses 9.1 Institutions shall not include in the calculation of the effective interest rate of their respective financial instruments the following types of income: a) Fees received associated with services provided, namely: i. fees charged for the financial service of a loan; ii. fees for investment management. b) Fees for the commitment to originate a loan when the loan commitment is not measured at fair value through profit or loss and it is unlikely that a specific loan contract will be entered into; and c) Syndication fees of financing received by an Institution that organises the structuring of a loan and does not retain any part of the loan for itself, or in which it retains a part at the same effective interest rate and with a comparable risk level taken to the risk level taken by other participants.

10. Recognition period 10.1 Institutions shall recognise in profit or loss any fees, transaction costs and other premiums or discounts included in the calculation of the effective interest rate over the expected life of the financial instrument or a shorter period, as described in point 10.2 of section 10 of this Instruction.

10.2 When the variable to which fees, transaction costs, premiums or discounts relate is subject to reindexation to market rates before the expected maturity of the financial instrument, the appropriate recognition period in profit or loss shall be the period up to the next reindexation date.

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10.3 Whenever the premium or discount results from a change in the credit spread over the variable rate specified in the financial instrument, or other variables that are not reset according to market rates, the premium or discount shall be amortised over the expected life of the financial instrument.

11. Accounting 11.1 Revisions of estimates of income and expenses, referred to in section 7 of this Instruction, shall be recognised as: a) Income or expenses in profit or loss; b) Adjustment of the effective interest rate from the date of the new estimate, whenever Institutions reclassify a financial asset from the fair value through profit or loss measurement category to the amortised cost measurement category or to the fair value through other comprehensive income measurement category.

11.2 Eligible fees shall be: a) Deferred and recognised as an adjustment to the effective interest rate together with related transaction costs, in the case of fees defined in sub-paragraphs a) and c) of point 8.2 of section 8 of this Instruction; and b) Deferred and recognised as u