2 Basis of preparation and changes to accounting policies

Basis of preparation

The consolidated annual accounts as at December 31, 2017 are prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU). These 2018 consolidated interim accounts have been prepared in accordance with IAS 34 Interim Financial Reporting.

The accounting policies, presentation and methods of computation are consistent with those applied in the preparation of FMO’s consolidated financial statements for the year ended December 31, 2017, except for the adoption of new standards, interpretations and amendments effective as of January 1, 2018. The consolidated interim accounts do not include all the information and disclosures that are required for the consolidated annual accounts, and should be read in conjunction with FMO’s consolidated annual accounts as at December 31, 2017.

This is the first set of accounts where IFRS 9 Financial Instruments has been applied. As required by IAS 34, the nature and effect of these changes are disclosed below.

Group accounting and consolidation

The company accounts of FMO and the company accounts of the subsidiaries Nuevo Banco Comercial Holding B.V., Asia Participations B.V., FMO Investment Management B.V., FMO Medu II Investment Trust Ltd., Equis DFI Feeder L.P. and Nedlinx B.V. are consolidated in these interim accounts.

The activities of Nuevo Banco Comercial Holding B.V., Asia Participations B.V., FMO Medu II Investment Trust Ltd. and Equis DFI Feeder L.P. consist of providing equity capital to companies in developing countries. FMO Investment Management B.V. carries out portfolio management activities for third party investment funds, which are invested in FMO’s transactions in emerging and developing markets. Nedlinx B.V. is incorporated to finance Dutch companies with activities in developing countries. FMO has a 63% stake in Equis DFI Feeder L.P. and all other subsidiaries are 100% owned by FMO.

Foreign currency translation

FMO uses the euro as the unit for presenting its annual accounts and interim reports. All amounts are denominated in thousands of euros unless stated otherwise.

Adoption of new standards, interpretations and amendments

The following standards, amendments to published standards and interpretations were adopted in the current year.

IFRS 9 Financial Instruments

In July 2014, the IASB issued the final version of IFRS 9 Financial Instruments, which reflects all phases of the financial instruments project and replaces IAS 39 Financial Instruments: Recognition and Measurement and all previous versions of IFRS 9. The standard introduces new requirements for classification and measurement, impairment, and hedge accounting. EU has endorsed IFRS 9 in November 2016. IFRS 9 is effective for annual periods beginning on or after January 1, 2018, with early application permitted. Retrospective application is required, but comparative information is not compulsory.

FMO has applied IFRS 9 as issued in July 2014 and endorsed by the EU in November 2016. For FMO the effective date of application is from 1 January 2018. Starting from 2016 FMO set up a multidisciplinary implementation team with members from Risk Management, Finance and other operational teams to prepare for IFRS 9 implementation. All the required changes have been implemented successfully as of January 2018.

The following table and the accompanying notes set out the impact on financial assets and liabilities on adopting IFRS 9. Furthermore reference is made to the original measurement categories under IAS 39 and the new measurement categories under IFRS 9 for each class of FMO’s financial assets and liabilities.

The following table summarizes the impact of the adoption of IFRS 9 on the opening balance of FMO’s equity at January 1, 2018.

• a The reclassification of interest-bearing securities from AFS to amortized cost has resulted in a release of the AFS reserve of €3,566 with a deferred tax impact of €897.
• b The available for sale reserve of €385,984 with a deferred tax impact of €6,040 related to the equity investments that were reclassified from AFS to FVPL has been transferred to the other reserves as per January 1, 2018.
• c The available for sale reserve of €20,819 with a deferred tax impact of €2,745 has been transferred to the fair value reserve.
• d The changes related to the reclassification of financial assets from amortized cost to FVPL, the recognition of the ECL and the correction of the accrued income were recorded in other reserves, which had a deferred tax impact of €5,589.

Classification and measurement of financial assets and financial liabilities

From a classification and measurement perspective, the new standard requires all financial assets, except for equity
instruments and derivatives, to be assessed based on a combination of the entity’s business model for managing the assets
and the instruments’ contractual cash flow characteristics. IFRS 9 also requires that derivatives embedded in host contracts where the host is a financial asset in the scope of IFRS 9 are not separated. Instead, the hybrid financial instrument as a whole is assessed for classification.

The IAS 39 measurement categories are replaced by: Fair Value through Profit or Loss (FVPL), Fair Value through Other Comprehensive Income (FVOCI), and amortized cost (AC).

A financial asset is measured at amortized cost if it meets both of the following conditions and is not designated as at FVPL:

• it is held within a business model whose objective is to hold assets to collect contractual cash flows; and

• its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest (SPPI) on the principal amount outstanding.

A debt instrument is measured at FVOCI only if it meets both of the following conditions and is not designated as at FVPL:

• it is held within a business model whose objective is achieved by both collecting contractual cashflows and selling financial assets; and

• its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

For equity investments that are not held for trading an irrevocable election exists (on an instrument-by-instrument basis) to present subsequent changes in fair value in OCI.

All financial assets not classified as measured at amortized cost or FVOCI as described above are measured at FVPL. In addition, on initial recognition FMO may irrevocably designate a financial asset that otherwise meets the requirements to be measured at amortized cost or at FVOCI as at FVPL if doing so eliminates or significantly reduces an accounting mismatch that would otherwise arise.

A financial asset is initially measured at fair value plus, for an item not at FVPL, transaction costs that are directly attributable to its acquisition.

For FMO the following accounting policies apply to the subsequent measurement of its financial assets:

IFRS 9 largely retains the existing requirements in IAS 39 for the classification and measurement of financial liabilities. The adoption of IFRS 9 has not had a significant effect on FMO’s accounting policies related to financial liabilities.

Impact of IFRS 9 on the classification and measurement of financial assets

FMO has made an assessment of the objective of the business model in which a financial asset is held at a portfolio level because this best reflects the way the business is managed and information is provided to management. The information that is considered includes:

• how the performance of the portfolio is evaluated and reported to management of FMO;

• the risks that affect the performance of the business model (and the financial assets held within that business model) and how those risks are managed;

• the frequency, volume and timing of sales in prior periods, the reasons for such sales and expectations about future sales activity. However, information about sales activity is not considered in isolation, but as part of an overall assessment of how FMO’s stated objective for managing the financial assets is achieved and how cash flows are realized.

For the purpose of the contractual cash flow assessment, related to solely payments of principal and interest (SPPI), ‘principal’ is defined as the fair value of the financial asset on initial recognition.‘Interest’ is defined as consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs (e.g. liquidity risk and administrative costs), as well as a profit margin. In assessing whether the contractual cash flows are solely payments of principal and interest, FMO has considered the contractual terms of the instrument. This includes assessing whether the financial asset contains a contractual term that could change the timing or amount of contractual cash flows such that it would not meet this condition. In making the assessment, FMO has considered among others:

• Contingent events that would change the amount and timing of cash flows – e.g. prepayment and extension features, loans with performance related cashflows;

• Features that modify the consideration for the time value of money – e.g. regulated interest rates, periodic reset of interest rates;

• Loans with convertibility and prepayment features;

• Terms that limit FMO’s claim to cash flows from specified assets – e.g. non-recourse assets;

• Contractually linked instruments.

Impairment

IFRS 9 also fundamentally changes the loan loss impairment methodology. The standard replaces IAS 39’s incurred loss approach with a forward-looking expected loss (ECL) approach. FMO estimates allowance for expected losses for the following financial assets:

• Banks;

• Interest-bearing securities;

• Loans to the private sector and loans guaranteed by the State;

• Loan commitments and financial guarantee contracts issued.

ECL measurement

IFRS 9 ECL reflects an unbiased, probability-weighted estimate based on either loss expectations resulting from default events over a maximum 12-month period from the reporting date or over the remaining life of a financial instrument. The method used to calculate the ECL is based on the following principal factors: probability of default (PD) which is based on Moody's PD term structure, loss given default (LGD), exposure at default (EAD) and a correction factor for current and expected future conditions (macro-economic factor).

Impairment stages

FMO groups its loans into Stage 1, Stage 2 and Stage 3, based on the applied impairment methodology, as described below:

Stage 1 – Performing loans: when loans are first recognized, an allowance is recognized based on 12-month expected credit losses.

Stage 2 – Underperforming loans: when a loan shows a significant increase in credit risk, an allowance is recorded for the lifetime expected credit loss.

Stage 3 – Credit-impaired loans: a lifetime expected credit loss is recognized for these loans. In addition, in Stage 3, interest income is accrued on the amortized cost of the loan net of allowances.

Significant increase in credit risk

IFRS 9 requires financial assets to be classified in Stage 2 when their credit risk has increased significantly since their initial recognition. For these assets, a loss allowance needs to be recognized based on their lifetime ECLs. FMO considers whether there has been a significant increase in credit risk of an asset by comparing the lifetime probability of default upon initial recognition of the asset against the risk of a default occurring on the asset as at the end of each reporting period. This assessment is based on either one of the following items:

• The change in internal credit risk grade with a certain number of notches compared to the internal rating at origination;

• The fact that the financial asset is 30 days past due, unless there is reasonable and supportable information that there is no increase in credit risk since origination;

• The application of forbearance.

Credit-impaired financial assets

Financial assets will be included in Stage 3 when there is objective evidence that the loan is credit impaired. The criteria of such objective evidence are the same as under the current IAS 39 methodology explained in the section ‘Value adjustments on loans’ of the Accounting policies and in Note 9. Accordingly, the population is the same under both standards.

Definition of default

Under IFRS 9, FMO will consider a financial asset to be in default and therefore in Stage 3 (credit-impaired) when:

• The client is past due more than 90 days on any material credit obligation to FMO, unless FMO judges that the client is likely to pay its credit obligation to FMO; or 

• when FMO judges that the client is unlikely to pay its credit obligation to FMO.

Written-off financial assets

A write-off is made when all or part of a claim is deemed uncollectible or forgiven. Write-offs are charged against previously recorded impairments. If no impairment is recorded, the write-off is included directly in the profit and loss account under 'Impairments'.

Forward looking information

FMO incorporates forward-looking information in both the assessment of significant increase in credit risk and in the measurement of the ECL. GDP growth rates are represented as macro-economic factor in the forward-looking information. FMO has formulated a ‘base case’ scenario which represents the more likely outcome resulting from FMO’s normal financial planning and budgeting process.

Impact

FMO has determined that the application of IFRS 9’s impairment requirements at January 1, 2018 results in an additional impairment allowance as follows.

All Interest Bearing Securities (credit quality of AA+ or higher) and Banks (credit quality of BBB- or higher) are classified as Stage 1. An amount of €45 is calculated for the ECL of both asset classes as per January 1, 2018.

The following table shows the credit quality and the exposure to credit risk of the loans to the private sector at amortized cost at January 1, 2018.

The following table shows the credit quality and the exposure to credit risk of the loan commitments at January 1, 2018.

The following table shows the credit quality and the exposure to credit risk of the financial guarantees at January 1, 2018.

Changes related to hedge accounting

With respect to hedge accounting IFRS 9 allows to continue with the hedge accounting under IAS 39. FMO applies IFRS 9 in its entirety. The impact is insignificant for FMO compared to IAS 39.

Other standards adopted in 2018

IFRS 15 Revenue Contracts with Customers

In May 2014, the IASB issued IFRS 15 ‘Revenue from Contracts with Customers’. The standard is effective for annual periods beginning on or after January 1, 2018. IFRS 15 provides a principles-based approach for revenue recognition, and introduces the concept of recognizing revenue as and when the agreed performance obligations are satisfied. The standard should in principle be applied retrospectively, with certain exceptions. This standard does not have significant impact on FMO.

Amendments to IFRS 2 Share-based payment – Classification and measurements of share-based payment transactions

In June 2016, the IASB issued amendments to IFRS 2 containing the clarification and amendments of accounting for cashsettle share-based payment transactions that include a performance condition, accounting of share-based payment transactions with net settlement features and accounting for modifications of share-based payment transactions from cashsettled to equity-settled. The amendments do not have impact on FMO.

Amendments to IAS 40 Investments property – Transfers of investment property

These amendments provide guideance and include criteria for transfers of property to, or from, investment property in accordance with IAS 40. This amendment is effective for annual reporting periods beginning on or after January 1, 2018 and has no impact on FMO.

Annual Improvements 2014-2016 Cycle

Amendments regarding IFRS 1 First time adoption of IFRS, IFRS 12 Disclosure of interest in other entities and IAS 28 Investments in associates and joint ventures. These amendments mainly comprise additional guidance and clarification have no impact on FMO.

IFRIC Interpretation 22 Foreign currency transactions and advance consideration

The interpretation provides clarifications on the transaction date for the purpose of determining the exchange rate with respect to the recognition of the non-monetary prepayment asset or deferred income liability and that a date of transaction is established for each payment or receipt in case of multiple advanced payments or receipts. IFRIC 22 is effective for annual reporting periods beginning on or after January 1, 2018. The interpretation has a minor impact on FMO.

The standards issued and endorsed by the European Union, but not yet effective up to the date of issuance of FMO’s Interim Report 2018, are listed below.

IFRS 16 Leases

The new standard IFRS 16 ‘Leases’ has been issued in January 2016 by the IASB and requires lessees to recognize assets and liabilities for most leases. For lessors, there is little change to the existing accounting in IAS 17 Leases. The standard will be effective for annual periods beginning on or after January 1, 2019. Based on our preliminary assessment impact of this standard is limited to the building and cars we are renting/leasing.

Amendments to IFRS 9 – Prepayment Features with Negative Compensation

Under the current IFRS 9 requirements, the SPPI condition is not met if the lender has to make a settlement payment in the event of termination by the borrower. In October 2017 the IASB amended the existing requirements in IFRS 9 regarding termination rights in order to allow measurement at amortized cost (or, depending on the business model, at fair value through other comprehensive income) even in the case of negative compensation payments in case of early repayment of loans. This amendment is effective for annual reporting periods beginning on or after January 1, 2019 and does not have impact for FMO.

Other significant standards issued, but not yet endorsed by the European Union and not yet effective up to the date of issuance of FMO’s Interim Report 2018, are listed below.

IFRS 17 Insurance Contracts

IFRS 17 was issued in May 2017 and is to ensure that an entity provides relevant information that faithfully represents those contracts. This information gives a basis for users of financial statements to assess the effect that insurance contracts have on the entity’s financial position, financial performance and cashflow. The standards is expected to be effective on or after January 1, 2021. This standard does not have impact on FMO.

IFRIC Interpretation 23 – Uncertainty over Income Tax Treatments

The interpretation is to be applied to the determination of taxable profit (tax loss), tax bases, unused tax lossess, unused tax credits and tax rates, when there is uncertainty over income tax treatments under IAS 12. IFRIC 23 is effective for annual reporting periods beginning on or after January 1, 2019. The interpretation has minor impact on FMO.

Amendments to IAS 28 – Long-term Interests in Associates and Joint Ventures

The amendment clarifies that IFRS 9 to long-term interests in an associate or joint venture that form part of the net investment in the associate or joint venture but to which the equity method is not applied. Furthermore, the paragraph regarding interests in associates or joint ventures that do not constitute part of the net investment has been deleted. The amendment is expected to be effective starting from January 1, 2019. These amendments will have minor impact on FMO.

Annual Improvements 2015-2017 Cycle

Amendments regarding IFRS 3/ IFRS 11 with respect to obtaining control over a joint operation business, IAS 12 Income taxes connected to income tax consequences of dividends when a liability to par the dividend is recognized and IAS 23 Borrowing Costs that clarifies any specific borrowing remains outstanding after related assets is ready for use or sale will become part of the fund that an entity borrows generally. These amendments mainly comprise additional guidance and clarification and will have no impact on FMO.

Amendments to IAS 19 – Plan amendment, Curtailment or Settlement

In case of plan amendment, curtailment or settlement, it is now mandatory that the current service cost and the net interest for the period after the remeasurement are determined using the assumptions used for remeasurement. Also these amendments include clarification of the effect of plan amendment, curtailment or settlement on the requirements regarding the asset ceiling. This IAS 19 amendment will have a minor impact when a plan amendment occurs.

Amendments to References to the Conceptual Framework in IFRS Standards

On March 28, 2018 IASB presented the revised Conceptual Framework for Financial Reporting. The Conceptual Framework is not a standard itself but can be used as general guidance for transactions/ events where specific IFRS standards are not available. Main improvements in the revised Conceptual Framework contains the introduction of concepts for measurement and presentation & disclosures, guidance for derecognition of assets and liabilities. In addition definitions of an asset & liability and criteria for recognition have been updated. These amendments will have minor impact on FMO.

Estimates and assumptions

In preparing the condensed consolidated interim accounts in conformity with IFRS, management is required to make estimates and assumptions affected reported income, expenses, assets, liabilities and disclosure of contingent assets and liabilities. The same methods for making estimates and assumptions have been followed in the condensed consolidated interim accounts as were applied in the preparation of FMO’s consolidated annual accounts as at December 31, 2017, except for new significant judgments and key sources of estimation uncertainty related to the application of IFRS 9, which has been described above.

Segment reporting

The operating segments are reported in a manner consistent with internal reporting to FMO’s chief operating decision maker. The chief operating decision maker who is responsible for allocating resources and assessing performance of the operating segments, has been identified as the Management Board. As of January 2018 FMO has decided to present its operating segments based on servicing unit instead of strategic sector to be more aligned with internal reporting towards the Management Board. The comparative figures have been adjusted accordingly. Reference is made to Note 5 Segment Information for more details on operating segments.