SBS Resolution No. 2610-2018: Amending the Regulation on Classification and Valuation of Investments of Financial System Companies, Incorporating a Procedure in the SBS TUPA and Amending Other Provisions

Los Laureles Nº 214 - Lima 27 - Perú Telf. : (511)6309000 Fax: (511) 6309239

Lima, July 4, 2018

S.B.S. Resolution
No. 2610-2018

The Superintendent of Banking, Insurance and
Private Pension Fund Administrators

WHEREAS:

That numeral 13 of article 349 of the General Law of the Financial System and the Insurance System and Organic Law of the Superintendency of Banking and Insurance, Law No. 26702 and its amendments, hereinafter the General Law, states that the Superintendency has the power to issue general rules to specify the preparation, presentation and publicity of financial statements, and any other complementary information, ensuring that the real economic-financial situation of the companies under its supervision is reflected;

That numeral 1 of article 354 of the General Law provides that the Superintendency may require supervised entities to constitute provisions and reserves for assets and contingencies that entail credit and market risk, in accordance with the general rules it issues on the matter;

That numeral 2 of article 354 of the General Law provides that the Superintendency has the power to establish the methodology that allows adjusting to market value the investments made by companies;

That by SBS Resolution No. 7033-2012 of September 19, 2012 and its amending rules, the Regulation on Classification and Valuation of Investments of Financial System Companies was approved;

That by SBS Resolution No. 895-98 of September 1, 1998 and its amending rules, the Accounting Manual for Financial System Companies was approved;

That it has been considered necessary to amend the aforementioned Regulation to establish specific guidelines for the evaluation of impairment, as well as for the treatment of exchange differences;

That it is necessary to amend the Accounting Manual for Financial System Companies, in order to reflect the aforementioned amendments;

That by SBS Resolution No. 4906-2017 the Regulation for Market Risk Management was approved;

That it is also necessary to amend the External Audit Regulation approved by SBS Resolution No. 17026-2010 and its amending rules;

That, in order to gather the opinions of the general public regarding the proposed rule, the prepublication of the draft resolution was arranged on the electronic portal of this Superintendency, under the provisions of the Thirty-Second Final and Complementary Provision of the General Law and Supreme Decree No. 001-2009-JUS and its amending rules;

With the approval of the Superintendencies of Banking and Microfinance, of Risks, of Economic Studies and of Legal Advice; and,

In use of the powers conferred by numerals 7, 9 and 13 of article 349 of the General Law;

RESOLVES:

Article One.- Amend the Regulation on Classification and Valuation of Investments of Financial System Companies, approved by article one of SBS Resolution No. 7033-2012 and its amending rules, in accordance with the following:

1. Replace literal d) of article 7 "Held-to-maturity investments" in accordance with the following text:

"Article 7.- Held-to-maturity investments
(…) d) They must have risk classifications, in accordance with the following requirements:
a. Be classified by at least two local or foreign risk rating agencies. Instruments issued by Central Banks of countries whose sovereign debt receives at least the classification corresponding to the sovereign debt of Peru are excluded from this requirement. b. For instruments classified by local rating agencies, in accordance with the equivalences established in the Regulation for the Effective Equity Requirement for Credit Risk, approved by SBS Resolution No. 14354-2009 and amending rules, that the most conservative of the classifications is not lower than category BBB.
c. For instruments classified by foreign rating agencies, in accordance with the equivalences established in the Regulation for the Effective Equity Requirement for Credit Risk, approved by SBS Resolution No. 14354-2009 and amending rules, that the most conservative of the classifications is not lower than category BBB-, except for the sovereign debt of countries of the American continent, in which case it must be at least the lower of BBB- and the one corresponding to the classification received by the sovereign debt of Peru."

2. Replace literal a) of numeral 2 of article 10 "Subsequent measurement of investments" in accordance with the following text:

"Article 10.- Subsequent measurement of investments (…)
2. Available-for-sale investments
a) Valuation at fair value (or at cost)
The valuation of available-for-sale investments shall be made at fair value, in accordance with the guidelines established in article 11. Equity instruments that do not have quoted prices in active markets and whose fair value cannot be reliably estimated must be measured at cost. In the case of debt instruments, prior to valuation at fair value, companies must update accounting at amortized cost applying the effective interest rate methodology and, from the amortized cost obtained, gains and losses from the change in fair value must be recognized."

3. Replace literal c) of numeral 2 of article 10 "Subsequent measurement of investments" in accordance with the following text:

"Article 10.- Subsequent measurement of investments (...)
2. Available-for-sale investments
(…) c) Impairment losses.
When one or more of the investment instruments classified as available-for-sale investments have suffered an impairment of value, in accordance with the provisions of article 12, the loss must be recognized in the result for the year. The amount of the impairment loss of debt instruments shall be calculated as the difference between their amortized cost and their fair value determined in accordance with article 11 of the Regulation, less any impairment loss previously recognized in the result for the year or previous years. In the case of equity instruments, the amount of the impairment loss shall be calculated as the difference between their acquisition cost and their fair value determined in accordance with article 11 of the Regulation, less any impairment loss previously recognized in the result for the year or previous years. In equity instruments not traded in an active market that are measured at cost, the amount of the impairment loss shall be calculated as the difference between their acquisition cost and the present value of the expected future cash flows, discounted at the market rate of return for other similar securities. The methodology and assumptions used to estimate the flows must be reviewed periodically by the company itself and the respective control bodies. In estimating impairment of equity instruments, it must be taken into consideration that the book value must not exceed the proportional share in the accounting equity of the investee. The amount of the loss that has previously been recognized in Other Comprehensive Income must be reclassified to the result for the year."

4. Replace literal d) of numeral 2 of article 10 "Subsequent measurement of investments" in accordance with the following text:

"Article 10.- Subsequent measurement of investments (...)
2. Available-for-sale investments
(...) d) Reversal of impairment losses
Impairment losses recognized in the result for the year or previous years corresponding to investment in debt instruments shall be reversed through the result for the year, provided that the increase in the fair value of said instrument can be associated, proven and objectively, with a favorable event occurring after the loss. Companies must document all objective evidence of the subsequent favorable event that justifies the increase in the value of the instrument, which must be available to this Superintendency. Impairment losses recognized in the result for the year or previous years corresponding to investment in equity instruments shall not be reversed through the result for the year, but through Other Comprehensive Income. In the case of equity instruments measured at cost, impairment losses may not be reversed."

5. Replace literal b) of numeral 3 of article 10 "Subsequent measurement of investments" in accordance with the following text:

"Article 10.- Subsequent measurement of investments (...)
3. Held-to-maturity investments
(...) b) Impairment losses
When one or more of the investment instruments classified as held-to-maturity investments have suffered an impairment of value, in accordance with the provisions of article 12, the loss must be recognized in the result for the year.
The amount of the impairment loss shall be calculated as the difference between its book value (amortized cost) at the time the impairment is determined and the present value of the future cash flows expected to be recovered given the risk conditions that have been identified, discounted at the original effective interest rate (purchase IRR) if it is an investment instrument with a fixed rate, or the effective interest rate in force for the period (the rate at the date to which the financial statements refer), determined according to the contract, if it is an investment instrument with a variable rate. The book amount of the instrument shall be reduced and the amount of the loss shall be recognized in the result for the period. The methodology and assumptions used to estimate the flows must be reviewed periodically by the company itself and the respective control bodies. In addition, the company may not recognize an impairment amount less than the difference between the amortized cost and the fair value at the evaluation date."

6. Replace article 12 "Evaluation of evidence of impairment" in accordance with the following text:

"Article 12.- Evaluation of evidence of impairment Companies shall evaluate, at the date of preparation of quarterly financial statements, whether there is evidence that an instrument classified as available-for-sale investment, held-to-maturity investment, investments in subsidiaries, associates and interests in joint ventures, records an impairment of value. It is considered that there is an impairment of value if there is objective evidence of impairment as a consequence of an event that has occurred after the initial recognition of the investment instrument and said event, causing the loss, has an impact on the future cash flows of the instrument that can be reliably estimated. The accounting record of the impairment and its reversal must follow the guidelines established in article 10 of this Regulation. The identification and quantification of the impairment of value must be in charge of the Risk Unit. The results of the impairment analysis must be collected in a Report, which must be brought to the attention of the Risk Committee or whoever performs said function, and be available to the Superintendency. For the purposes of the impairment evaluation, the following shall be taken into account:
a) Instruments classified as available-for-sale investment and held-to-maturity investment The identification of impairment for instruments classified as available-for-sale investments and held-to-maturity investments shall be carried out by applying the "Standard Methodology for the Identification of Impairment of Value of Available-for-Sale Investments and Held-to-Maturity Investments", which is detailed in the Annex that forms part of this rule. If a company wishes to apply a more sophisticated impairment identification methodology different from the methodology of the referred Annex, it must request prior authorization from this Superintendency, submitting the following documentation:
i) Authorization request signed by the General Manager. ii) Internal methodology for identifying impairment of value. iii) "Report supporting the impairment identification methodology", which must contain, at a minimum, the following:

• Detail of the qualitative and quantitative criteria for identifying the impairment of value of available-for-sale investments and held-to-maturity investments.
• Support for the choice of each criterion.
• Sources of information to collect the qualitative or quantitative criteria.
• Justification for the use of the methodology (reasons why the proposed methodology is considered to identify impairment of value more precisely).
• Other aspects relevant to the impairment methodology.
  iv) Copy of the minutes of the Risk Committee where the approval of the methodology indicated in point ii is recorded.
  Any update, modification or change that the entity wishes to make to the methodology authorized by this Superintendency must also be authorized prior to its application. For this, the company must attach the following documentation:
  i) Authorization request signed by the General Manager. ii) Update, modification or changes in the internal methodology for identifying impairment of value. iii) "Report supporting the update, modification or changes in the impairment identification methodology", which must contain, at a minimum, the following:
• Detail of the modifications in the qualitative and quantitative criteria for identifying the impairment of value of available-for-sale investments and held-to-maturity investments.
• Support for the modification of each criterion.
• Sources of information to collect the qualitative or quantitative criteria that have been modified.
• Justification for the modification of the methodology (reasons why the changes in the methodology are considered to serve to identify impairment of value more precisely).
• Other relevant aspects referred to the modifications in the impairment methodology.
  iv) Copy of the minutes of the Risk Committee where the approval of the methodology indicated in point ii is recorded.
  The Risk Unit shall be responsible for documenting the impairment evaluation under the standard methodology or the methodology that has been authorized by the Superintendency. b) Investments in subsidiaries, associates and interests in joint ventures The company must evaluate whether there is any indication that a subsidiary, associate and interest in joint ventures may have been impaired, considering the guidelines established in IAS 36. Companies must document the aforementioned evaluation and have said support available to the Superintendency."

7. Replace article 13 "Exchange difference" in accordance with the following text:

"Article 13.- Exchange difference
In the case of investments at fair value with changes in results, gains or losses from exchange differences shall be recognized in the result for the year.
In the case of available-for-sale investments, gains or losses from exchange differences related to the amortized cost of debt instruments shall affect the result for the year, provided they are not instruments used for hedging purposes. For this purpose, the following procedure shall be followed:

• First, the difference must be determined between:
  i. The amortized cost in national currency at the reporting date, using the closing accounting exchange rate; and,
  ii. The amortized cost of the previous period using the closing exchange rate of said period, plus interest accrued from the previous reporting date to the reporting date, using the average or closing exchange rate of the period, minus interest collected from the previous reporting date to the reporting date, using the exchange rate of the transaction date.
  Said difference must be recognized as a gain or loss from exchange difference, in result for the year accounts.
• Second, the fair value of the investment at the reporting date must be determined and expressed in national currency at the closing accounting exchange rate, where the difference between the fair value in national currency and the amortized cost in national currency (resulting from the adjustment in the previous point) at the reporting date must be recognized as a gain or loss from fluctuation of value, as appropriate, in equity accounts (unrealized gain or loss), presented in other comprehensive income.
  In the case of equity instruments classified in the available-for-sale investments category, gains or losses from exchange differences shall be presented in other comprehensive income, recorded in equity accounts, provided they are not hedging operations. In the case of investment instruments classified as held-to-maturity investments, gains or losses from exchange differences shall be recognized in the result for the year, provided they are not hedging operations. In the case of investments in subsidiaries, associates and interests in joint ventures, the guidelines established in IAS 21 "The Effects of Changes in Foreign Exchange Rates" shall be applied. In all cases described, the recording of gains or losses from exchange differences of operations for hedging purposes shall be made in accordance with the provisions on the matter issued by the Superintendency."

8. Amend the Fourth final and complementary provision, in accordance with the following:

"Fourth.- Requirement of impairment adjustments and additional provisions When, in the opinion of the Superintendency, there is any distortion in the calculation of the valuation of investments or operations under the scope of this Regulation, the company shall be required to justify the calculations made or proceed to make the impairment adjustments or constitute additional provisions."

9. Replace the name of the Annex "Standard Methodology for the Identification of Impairment of Value of Financial Instruments" with "Standard Methodology for the Identification of Impairment of Value of Available-for-Sale Investments and Held-to-Maturity Investments".

10. Replace the Annex named "Standard Methodology for the Identification of Impairment of Value of Available-for-Sale Investments and Held-to-Maturity Investments", in accordance with the following:

"ANNEX
STANDARD METHODOLOGY FOR THE IDENTIFICATION OF IMPAIRMENT OF VALUE OF AVAILABLE-FOR-SALE INVESTMENTS AND HELD-TO-MATURITY INVESTMENTS Companies must apply the methodology quarterly, on the occasion of the preparation of their quarterly financial statements, to all debt and equity instruments classified in the categories of available-for-sale investments and held-to-maturity investments.
I. Debt instruments
Companies must evaluate, for the entire portfolio of debt instruments subject to impairment, the occurrence of the following situations:

1. Weakening in the financial situation or financial ratios of the issuer and its economic group.
2. Downgrade in any of the credit classifications of the instrument or the issuer, by at least two (02) "notches", from the moment the instrument was acquired; where a "notch" corresponds to the minimum difference between two risk ratings within the same rating scale.
3. Interruption of transactions or of an active market for the financial asset, due to financial difficulties of the issuer.
4. Observable data indicate that since the initial recognition of a group of financial assets with characteristics similar to the evaluated instrument, there is a measurable decrease in their estimated future cash flows, even if it cannot yet be identified with individual financial assets of the group.
5. Decrease in value due to regulatory changes (tax, regulatory or other governmental).
6. Significant decrease in fair value below its amortized cost. It shall be considered a significant decrease if the fair value at the closing date has decreased by at least 40% below its amortized cost at said date.
7. Prolonged decrease in fair value. It shall be considered a prolonged decrease if the fair value at the closing date has decreased by at least 20% compared to the amortized cost of twelve (12) months earlier and, the fair value at the closing date of each month during the previous twelve (12) month period, has always remained below the amortized cost corresponding to the closing date of each month.
   The fair value to be used for the purposes of evaluating criteria 6 and 7 is that considered for the valuation of available-for-sale debt instruments, in accordance with the criteria established in article 11 of this Regulation, regardless of the accounting classification of the debt instrument. However, if the decrease in the fair value of the debt instrument is entirely a consequence of an increase in the risk-free interest rate, this decrease should not be considered as an indication of impairment. If at least two (2) of the situations described above are met, it shall be considered that impairment exists and, consequently, the company must determine the amount

Los Laureles No. 214 - Lima 27 - Peru Tel.: (511)6309000 Fax: (511) 6309239

of any impairment loss in accordance with the provisions of article 10 of the Regulation.

If at least two (2) of the situations described above have not occurred, it will be sufficient for any of the following specific situations to be present to consider that impairment exists:

1. Breach of contractual clauses, such as interruption in the payment of interest or principal.
2. Renegotiation of the contractual conditions of the instrument due to legal factors or financial problems linked to the issuer.
3. Evidence that the issuer is in a process of forced restructuring or bankruptcy.
4. When the risk classification of an instrument that was classified as investment grade is reduced to a classification that falls below investment grade.

The company must determine the amount of any impairment loss in accordance with the provisions of article 10 of the Regulation.

II. Equity instruments

Companies must evaluate, for equity-representing instruments subject to impairment, the occurrence of the following situations:

1. When the risk classification of a debt instrument of the issuer that was classified as investment grade is reduced to a classification that falls below investment grade.
2. Significant changes have occurred in the technological, market, economic or legal environment in which the issuer operates, which may have adverse effects on the recovery of the investment.
3. Weakening in the financial situation or financial ratios of the issuer and its economic group.
4. Interruption of transactions or of an active market for the financial asset, due to financial difficulties of the issuer.
5. Observable data indicate that since initial recognition of a group of financial assets similar to the instrument evaluated, there is a measurable decrease in its estimated future cash flows, even if it cannot yet be identified with individual financial assets of the group.
6. Decrease in value due to regulatory changes (tax, regulatory or other governmental).

If at least two (2) of the situations described are met, it will be considered that impairment exists and, consequently, the company must determine the amount of any impairment loss in accordance with the provisions of article 10 of the Regulation.

If at least two (2) of the situations described above have not occurred, it will be sufficient for any of the following specific situations to be present to consider that impairment exists:

1. Significant decrease in fair value below its acquisition cost. It will be considered a significant decrease if the fair value at the closing date has decreased by at least 40% below its cost value.
   As cost value or acquisition cost, the initial cost will always be taken as reference, regardless of whether an impairment loss has previously been recognized for the equity instrument analyzed.
2. Prolonged decrease in fair value. It will be considered a prolonged decrease if the fair value at the closing date has decreased by at least 20% compared to the fair value twelve (12) months earlier and, the fair value at the closing date of each month during the twelve (12) month period prior, has always remained below the acquisition cost.
3. Breach of statutory provisions by the issuer, related to the payment of dividends.
4. Evidence that the issuer is in a process of forced restructuring or bankruptcy.

The fair value to be used for the purpose of evaluating the situations indicated in numerals 1) and 2), is the fair value considered for the valuation of equity instruments available for sale, in accordance with guidelines established in article 11.

The aforementioned numerals 1 and 2 are not applicable to equity instruments classified in the available-for-sale category and valued at cost due to the absence of a reliable fair value.

The company will determine the amount of any impairment loss in accordance with the provisions of article 10 of the Regulation.

This Superintendency may carry out its own analysis of the instruments that make up the investment portfolio in debt and equity instruments and determine which instruments, in its criteria, have suffered impairment and require companies to recognize it, in accordance with the provisions of article 10 of the Regulation."

Article Two.- Incorporate procedure No. 176
"Authorization to use and/or modify an internal methodology for identifying impairment of investments of financial system companies" in the Single Text of Administrative Procedures - TUPA of the Superintendency of Banking, Insurance and AFP approved by SBS Resolution No. 3082-2011 and its amending norms, in accordance with the text attached to this Resolution and published in accordance with the provisions of Supreme Decree No. 004-2008-PCM, regulation of Law No. 29091. (Institutional portal: www.sbs.gob.pe).

Article Three.- Replace article three of SBS Resolution No. 4906-2017, as follows:
"Article Three.- Replace numerals 4) and 5) in section I of Annex I "Complementary Reports in charge of External Audit Firms" of the External Audit Regulation, approved by SBS Resolution No. 17026-2010 and its amending norms, in accordance with the following text:
" I. REPORTS APPLICABLE TO THE COMPANIES INDICATED IN LITERALS A, B AND C OF ARTICLE 16 OF THE GENERAL LAW, TO THE BANK OF THE NATION, TO THE AGRICULTURAL BANK, MIVIVIENDA FUND AND THE DEVELOPMENT FINANCIAL CORPORATION (COFIDE) (…)

4) Review of compliance with management and operational requirements for operations that generate market risk. Likewise, in the review of market risk management, the following must be included:
a) Review of the existence and compliance of policies and procedures regarding the administration of market risks incurred by the company, which are duly approved by the competent body and include the aspects required by the Superintendency in its related norms; b) Review of compliance with regulatory and internal limits; c) Review of the assumptions and results of market risk measurement models, as well as models for stress tests and backtesting, if applicable; and, d) Review of the quality of the information in the regulatory annexes that are applicable.
5) Review of the management of interest rate risk in the banking book, which must contain:
a) Review of compliance with interest rate risk exposure limits; b) Review the existence of policies and procedures for the management of interest rate risk in the banking book, which are duly approved by the competent body and include the aspects required by the SBS in the related norms; and, c) Review of the annexes and reports used, cross-checking the information with the financial statements, that said information is duly approved by the competent body and presented to the Superintendency in accordance with the requirements of the related norms. (…)"

Article Four.- Replace numeral 7) in section I of Annex I "Complementary Reports in charge of External Audit Firms", approved by SBS Resolution No. 17026-2010 and its amending norms, in accordance with the following text:
" I. REPORTS APPLICABLE TO THE COMPANIES INDICATED IN LITERALS A, B AND C OF ARTICLE 16 OF THE GENERAL LAW, TO THE BANK OF THE NATION, TO THE AGRICULTURAL BANK, MIVIVIENDA FUND AND THE DEVELOPMENT FINANCIAL CORPORATION (COFIDE) (…)
7) Review of the investment portfolio, which will be carried out on the basis of a sample, and will incorporate at least the following aspects:
a) Verification of the valuation of investments in accordance with the norms established by the Superintendency; b) Review of compliance with the constitution of gains and losses due to valuation, impairment losses as well as reversals due to impairment, in accordance with current norms. For the impairment of available-for-sale and held-to-maturity investments, compliance with the methodology established or authorized by the Superintendency must be reviewed; c) Concentration of investments in economic groups and in sectors or economic activities; and, d) Review of the annexes and reports used, cross-checking the information with the financial statements, that said information is duly approved by the competent body and presented to the Superintendency in accordance with the requirements of the related norms. (…)"

Article Five.- Modify the Accounting Manual for Financial System Companies, in accordance with the attached Annex, which is published on the electronic Portal of this Superintendency (www.sbs.gob.pe), in accordance with the provisions of Supreme Decree No. 001-2009-JUS.

Article Six.- Effective date

1. This Resolution enters into force from the day following its publication in the official newspaper El Peruano in accordance with the provisions of this article.
2. Article One of this Resolution enters into force on October 1, 2018.
3. Article Five of this Resolution enters into force as of the information corresponding to the month of October 2018.

Register, communicate and publish.

SOCORRO HEYSEN ZEGARRA
Superintendent of Banking, Insurance and
Private Administrators of Pension Funds