The effective interest rate (EIR) is the rate that exactly discounts the future cash payments or receipts estimated over the expected life of the financial instrument or, when appropriate, over a shorter period, to obtain the net book value for the financial asset or financial liability. Financial assets Classification and valuation of financial assets Non-derivative financial assets (debt or equity instruments) are classified on the balance sheet in accounting categories that determine their accounting treatment and their subsequent valuation method. The criteria for classifying and evaluating financial assets depends on the nature of the financial asset, whether it is qualified as: - debt instruments (i.e. loans and fixed or determinable income securities); or - an equity instrument (e.g. shares). These financial assets are classified in one of three categories: - financial assets at fair value through profit or loss; - financial assets at amortised cost (debt instruments only); - financial assets at fair value through equity (recyclable for debt instruments, non-recyclable for equity instruments). Debt instruments The classification and valuation of a debt instrument depends on the combination of two criteria: the business model defined at portfolio level and the analysis of the contractual terms determined by debt instrument, unless the fair value option is used. The three business models: The business model reflects the strategy applied by CFM Indosuez Wealth Group for the management of its financial assets in order to achieve its objectives. The business model is specified for a portfolio of assets and does not constitute a case-by-case intention for an isolated financial asset. There are three business models: • The Hold to Collect model, the objective of which is to receive contractual cash flows over the lifetime of the assets. This business model does not necessarily involve holding all the assets until they mature, however the sale of such assets is strictly regulated; • The Hold to Collect and Sell model, the objective of which is to both collect the contractual cash flows and sell the financial asset. The selling of financial assets and the collecting of cash are both essential in this business model ; and • The Other/Sell model, the main objective of which is to sell the assets. This concerns, in particular, portfolios where the aim is to collect cash flows via sales, portfolios whose performance is assessed based on fair value and portfolios of financial assets held for trading. When management’s strategy for managing financial assets does not correspond to either the collect model or the collect and sell model, these financial assets are classified in a portfolio whose management model is other/sell. Contractual characteristics (“Solely Payments of Principal & Interests” or SPPI test): SPPI testing combines a set of criteria, examined cumulatively, to establish whether contractual cash flows match the characteristics of simple financing (principal repayments and interest payments on the remaining amount of principal due). The test is met when the financing gives entitlement only to repayment of the principal and when the payment of interest received reflects the time value of money, the credit risk associated with the instrument, the other costs and risks of a conventional loan contract and a reasonable margin, regardless of whether the interest rate is fixed or variable. In a simple loan agreement, interest is the consideration for the cost of time, the price of credit and liquidity risk over the period, and other components related to the cost of carrying the asset (e.g. administrative costs). In some cases, when this form of qualitative analysis does not allow a conclusion to be drawn, quantitative analysis (or Benchmark testing) is carried out. This additional analysis consists of comparing the contractual cash flows of the asset under review with the cash flows of a benchmark asset. If the difference between the cash flows of the financial asset and the benchmark asset is considered immaterial, the asset is deemed to be simple financing. Moreover, a specific analysis is conducted when the financial asset is issued by special purpose entities establishing a differentiated order of payment among the holders of the financial assets by contractually linking multiple instruments and creating concentrations of credit risk (“tranches”). Each tranche is assigned a rank of subordination that specifies the order of distribution of the cash flows generated by the structured entity. In this case, the SPPI test requires an analysis of the characteristics of contractual cash flows of the asset concerned and underlying assets according to the “look-through” approach and the credit risk borne by the tranches subscribed, compared to the credit risk of the underlying assets. The method of accounting for debt instruments resulting from determining the business model and performing the SPPI test can be presented in the form of the following diagram: CFM Indosuez Wealth Management 70
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