Instruction No. 07/2016 of August 8 on the Effective Interest Rate Method for Financial Instruments

INSTRUCTION NO. 07/2016 of August 8 SUBJECT: EFFECTIVE INTEREST RATE METHOD IN THE RECOGNITION OF INCOME AND EXPENSES OF FINANCIAL INSTRUMENTS

Given the need to establish a set of procedures for the application of the effective interest rate method for the recognition of income and expenses associated with financial instruments, within the framework of the provisions established in Notice No. 06/2016 of June 22, regarding the general principles to be observed by banking financial institutions in the full adoption of International Accounting Standards/International Financial Reporting Standards.

Considering that this Instruction does not intend to make any interpretations of International Accounting Standards/International Financial Reporting Standards, as these are developed exclusively by the IFRS Interpretations Committee and issued by the International Accounting Standards Board (IASB).

In accordance with the combined provisions of Article 21 and Article 51, both of Law No. 16/10 of July 15 – Law of the Bank of Angola, and Article 93 of Law No. 12/15 of June 17 – Law of the Bases of Financial Institutions.

HEREBY DETERMINES:

1. Object This Instruction establishes the procedures to be observed by Banking Financial Institutions in the application of the effective interest rate method in the recognition of income and expenses associated with financial instruments, as provided for by International Accounting Standard 39 – Financial Instruments: Recognition and Measurement, hereinafter abbreviated as IAS 39.

2. Scope This Instruction applies to Banking Financial Institutions under the supervision of the Bank of Angola, under the terms and conditions provided for 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 are understood:

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 favorable 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 the institution's own equity 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.

3.2 Available-for-sale financial assets: non-derivative financial assets that are designated as available for sale or that are not classified as: a) loans and receivables; b) held-to-maturity investments, or; c) financial assets at fair value through profit or loss.

3.3 Amortized cost: the amount at which the financial asset or financial liability is measured at initial recognition, less any principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount, and less any reduction, directly or through the use of a valuation allowance, for impairment or uncollectibility.

3.4 Transaction costs: incremental costs that are directly attributable to the acquisition, issue, or disposal of a financial asset or financial liability.

3.5 Derivative: a financial instrument for which the following characteristics are cumulatively met: a) its value changes in response to changes in an 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 one of the parties to the contract; b) no initial net investment is required 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.

3.6 Loans and receivables: non-derivative financial assets with fixed or determinable payments that are not quoted in an active market and that are not: a) those that the institution intends to sell immediately or in the near term, which will be classified as held for trading, and those that the institution, after initial recognition, designates at fair value through profit or loss; b) those that the institution, after initial recognition, designates as available for sale, or; c) those with respect to which the holder may not recover substantially all of its initial investment, for reasons other than credit deterioration, which will be classified as available for sale.

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

3.8 Held-to-maturity investments: non-derivative financial assets with fixed or determinable payments and fixed maturity that an institution has the positive intention and ability to hold to maturity that are not: a) those that the institution designates at initial recognition at fair value through profit or loss; b) those that the institution designates as available for sale; and c) those that meet the definition of loans and receivables.

3.9 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.

3.10 Effective interest rate method: the method of calculating the amortized cost of a financial asset or financial liability (or group of financial assets or financial liabilities), and of allocating interest income or expense over the relevant period.

3.11 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 unfavorable 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 equity instruments of the said institution do not include instruments that are themselves contracts for the future receipt or delivery of the institution's own equity instruments.

3.12 Effective interest rate: the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability.

4. Application of the effective interest rate method Institutions must use the effective interest rate method in the following financial instruments: 4.1 Loans and receivables; 4.2 Held-to-maturity investments; 4.3 Available-for-sale financial assets, with respect to income and/or expenses for interest or similar items; and 4.4 All financial liabilities that are not: a) financial liabilities at fair value through profit or loss; b) financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies; c) financial guarantee contracts that are not covered by International Financial Reporting Standard 4 – Insurance Contracts; and d) commitments that provide a loan at a below-market interest rate.

5. Calculation of the effective interest rate 5.1 In calculating the effective interest rate, Institutions must: a) estimate cash flows considering all contractual terms of the financial instrument, including, among others, prepayment conditions, call options, and put options, but must not take into account future credit losses; b) include all fees that are an integral part of the effective interest rate as described in paragraph 7 of this Instruction, transaction costs, and all other premiums or discounts encompassed by the effective interest rate.

5.2 For the purposes of the foregoing, Institutions must calculate the effective interest rate of financial instruments according to the following formula:

FC0 = FC1/(1+TJE)^1 + FC2/(1+TJE)^2 + FC3/(1+TJE)^3 + ... + FCn/(1+TJE)^n

Where: 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, the contractual cash flows over the entire contractual term of the financial instrument, or group of financial instruments, must be used.

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

6. Review of payment or receipt estimates 6.1. In reviewing estimates of payments or receipts, Institutions must adjust the carrying amount of the financial asset or liability or group of financial instruments to reflect the actual and revised estimated cash flows. The carrying amount is recalculated by updating future estimated cash flows at the original effective interest rate of the financial instrument, or according to the revised effective interest rate calculated in accordance with paragraph 92 of IAS 39, when applicable.

6.2. With respect to Angolan Treasury obligations with variable nominal value indexed, without prejudice to the provisions of the previous point, Institutions must 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.

7. Eligible income and expenses 7.1. The eligibility of income and expenses depends on the underlying purpose/objective of those income and expenses and the accounting 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.

7.2. For the calculation of the effective interest rate, Institutions must consider as eligible income: a) fees received related to the acquisition or creation of a financial asset that is not classified at fair value through profit or loss, in accordance with IAS 39, namely: i. remuneration for activities, such as the assessment of the borrower's financial condition, including the opening fee for a credit operation; ii. assessment of the collateral received; iii. negotiation of the terms of the financial instrument; iv. preparation and processing of documents; and v. completion/formalization of the transaction. b) fees received for the commitment to grant credit, outside the scope of IAS 39, if it is probable that the institution will grant the credit; c) fees received on the issuance of financial liabilities measured at amortized cost; and d) fees received for granting a credit at a rate lower than the market interest rate.

7.3. Without prejudice to the provisions of points 1 and 2 of number 7 of this Instruction, other income and expenses may be considered eligible with prior authorization from the Bank of Angola.

8. Ineligible income and expenses 8.1 Institutions must not include in the calculation of the effective interest rate of the respective financial instrument the following types of income: a) Fees received associated with services provided, namely: i. fees for the commitment to grant credit, if it is not probable that it will occur; and ii. fees for investment management. b) Fees associated with the execution of a significant act, namely: i. fee on the allocation of shares to a client; ii. arrangement fees for financing between a borrower and an investor, where the institution does not assume the role of borrower and/or investor; and iii. syndication fees for financing received by an institution that arranges a syndicated financing and does not retain part of the financing for itself, or retains part of the financing at the same effective interest rate and with a comparable level of risk taken to that taken by other participants.

9. Recognition period 9.1 Institutions must recognize in profit or loss any fees, transaction costs, and other premiums or discounts included in the calculation of the effective interest rate over the life of the financial instrument or a shorter period, as described in point 2 of number 9 of this Instruction.

9.2 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 instrument, the appropriate recognition period in profit or loss must be the period until the next reindexation date.

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

10. Accounting 10.1 Revisions of estimates of income and expenses, referred to in number 6 of this Instruction, must be recognized as: a) income or expense 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 category of fair value through profit or loss or available-for-sale financial assets, to the category of loans and receivables and, subsequently, as a result of an expectation of increased recoverability of future cash flows from that financial asset, there is an upward revision of estimates relating to those same cash flows.

10.2 Eligible fees must be: a) deferred and recognized as an adjustment to the effective interest rate together with related transaction costs; in the case of fees defined in letter a) of point 2 of number 7 of this Instruction; b) deferred and recognized as an adjustment to the effective interest rate of the financial instrument together with related transaction costs, in the case of fees defined in letter b) of point 2 of number 7 of this Instruction. In situations where the commitment expires without the institution granting the credit operation, the fee is recognized as revenue; c) deferred and recognized as an adjustment to the effective interest rate of the financial instrument together with related transaction costs, in the case of fees defined in letter c) of point 2 of number 7 of this Instruction; d) recognized gradually in profit or loss, in the case of fees defined in letter d) of point 2 of number 7 of this Instruction.

10.3 Ineligible fees must be: a) recognized as revenue gradually in profit or loss as services are provided, in the case of fees defined in letter a) of point 1 of number 8 of this Instruction; and b) recognized as revenue when the significant act has been completed, in the case of fees defined in letter b) of point 1 of number 8 of this Instruction.

10.4 Without prejudice to the provisions of the previous points of this number, income and expenses associated with a financial instrument measured at fair value through profit or loss must be recognized in profit or loss when the financial instrument is initially recognized.

11. Information system 11.1 Institutions must ensure the adequate parametrization of their information systems in the application of the effective interest rate method provided for in this Instruction.

11.2 For the purposes of the foregoing, Institutions must ensure the traceability of changes in information systems, and must also have periodic monitoring mechanisms that ensure the performance of reviews and updates of information systems in this matter, whenever applicable.

12. Documentation 12.1 Institutions must formally document the policy for the recognition of income and expenses associated with financial instruments, which must be approved by the governing body and ensure that this policy remains adequate at all times.

12.2 For the purposes of the foregoing, Institutions must ensure the existence of mechanisms and procedures to analyze the nature of income and expenses and proceed with their accounting recognition in accordance with the provisions of this Instruction.

13. Transitional provisions 13.1 Institutions that comply with at least one of the criteria provided for in number 2 of Article 5 of Notice No. 06/2016, of June 22, regarding the full adoption of International Accounting Standards/International Financial Reporting Standards, must be in compliance with the provisions of this Instruction from the 2016 fiscal year, inclusive.

13.2 Institutions that are not in the conditions provided for in the previous point must observe the provisions of number 3 of Article 5 of Notice No. 06/2016, of June 22, regarding the full adoption of International Accounting Standards/International Financial Reporting Standards.

14. Final provisions 14.1 This Instruction does not dispense with the consultation of International Accounting Standards/International Financial Reporting Standards or International Accounting Standards/International Financial Reporting Standards, hereinafter abbreviated as IAS/IFRS.

14.2 Whenever there are discrepancies between this Instruction and the IAS/IFRS, the standards issued by the IASB shall prevail.

15. Doubts and omissions Doubts and omissions arising in the interpretation and application of this Instruction will be resolved by the Bank of Angola.

16. Revocation All regulations contrary to the provisions of this Instruction are hereby revoked.

17. Entry into force This Instruction enters into force on the date of its publication.

PUBLISH Luanda, August 8, 2016

THE GOVERNOR VALTER FILIPE DUARTE DA SILVA