Auditor's report

Report on the audit of the financial statements

Opinion

In our opinion the financial statements present fairly, in all material respects, the financial position of the European Bank for Reconstruction and Development (the Bank) at 31 December 2016 and its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB).

 

We have audited the financial statements of the Bank, which comprise:

  • the income statement
  • the statement of comprehensive income
  • the balance sheet
  • the statement of changes in equity
  • the statement of cash flows
  • the statement of accounting policies
  • the risk management disclosures
  • the related notes 1 to 31.

 

The financial reporting framework that has been applied in their preparation is applicable law and IFRS as issued by the IASB.

 

Basis for opinion

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the auditor’s responsibilities for the audit of the financial statements section of our report.

 

We are independent of the Bank in accordance with the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants (IESBA Code) together with the ethical requirements that are relevant to our audit of the financial statements in the United Kingdom, and we have fulfilled our other ethical responsibilities in accordance with these requirements and the IESBA Code.

 

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

 

Summary of our audit approach

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with ISAs. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.

 

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgement, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Bank’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Bank’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

Key audit matters

The key audit matters that we identified in the current year were:

• valuation of illiquid equity investments and associated derivatives

• loan impairment and provisioning: portfolio and specific provisions.

Materiality

 

The materiality that we used in the current year was €109 million which was determined on the basis of 0.75% of shareholders’ equity of €14.6 billion as disclosed in the balance sheet and statement of changes in equity.

Scoping

Our audit was performed on the Bank’s legal entity.

Key audit matters

Key audit matters are those matters that, in our professional judgement, were of most significance in our audit of the financial statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.

 

 

 

Description

 

The Bank holds a €3.5 billion portfolio of illiquid equities and an associated €0.5 billion portfolio of level 3 derivatives. The process of assessing the fair value of an illiquid equity investment involves a high degree of subjectivity and, accordingly, the Bank has defined a set of valuation principles and rules by which valuations are performed, governed and reviewed.

 

In general there is a lack of comparable market transactions in the Bank’s countries of operations for such investments and associated derivatives, as well as a number of assumptions inherent in the valuation methodologies that are subjective and sensitive to methodology choice and inputs. As a consequence we identified a key risk of material misstatement in the financial statements in respect of these valuations given that the fair values of both can fall within a relatively wide valuation range.

 

Management has assessed the sensitivity of the portfolio by considering reasonably possible alternative assumptions in the individual equity and associated derivative valuations, as disclosed within risk management note F at page 54 in the financial statements. The relevant accounting policy is disclosed in note B at page 20, and further details in notes 5, 14 and 17 to the financial statements.

 

How the scope of our audit responded to the risk

We completed the following procedures in relation to the valuation of illiquid equity investments and associated derivatives:

 

• We tested management controls in place over the valuation process.

This involved gaining an understanding of the Bank’s valuation

methodology and the processes and procedures to ensure this

methodology is consistently applied over the portfolio with

appropriate management review and challenge.

 

• We independently reperformed the valuation for a sample of illiquid

equity investments as well as for a sample of associated derivatives

to assess the appropriateness of the valuation methodologies

applied by the Bank (for example earnings multiples or net asset

values) and independently challenged against observable external

data and tested the inputs and adjustments applied in order to

recalculate the valuations.

 

• We have reviewed the exit proceeds achieved on the sale of equity

investments against the carrying value of those assets as a “back

test” to consider the reasonableness of the Bank’s valuations both

during the current year as well as in prior periods.

 

• To consider the existence and completeness of the illiquid

equities and associated derivatives populations:

• owe considered the level of trading of listed equities

and challenged whether these investments had been

appropriately classified as liquid or illiquid

• owe agreed a sample of equity investments to shareholding

certificates and custody statements

• owe reviewed the relevant equity shareholding certificates from

our sample to ensure any associated derivatives listed were

correctly recorded by the Bank.

 

• We reviewed publicly available information in relation to the Bank as well as Bank committee minutes for indications of exits or disbursements around year-end.

 

Key observations

We concluded that the Bank’s valuation of illiquid equities and associated derivatives is appropriate and is towards the middle of our acceptable range.

 

 

 

 

Description

There are significant provisions recognised by the Bank with respect to loans. Provisions for loan impairment are split between incurred but not recognised (“IBNR”) or portfolio provisions (referred to by the Bank as “general portfolio provisions”) of €279 million, and individually assessed specific provisions of €765 million.

 

With regards to general portfolio provisions, management use a model to calculate IBNR losses based on a Board approved provisioning policy. This provisioning model uses inputs such as probability of default (“PD”), loss given default (“LGD”) and emergence period that involve considerable management judgement due to the often bespoke nature of the underlying loans. As a result, we identified a key risk of material misstatement over the IBNR provisioning model.

Individually assessed specific provisions are based on the net present value of expected cash flows to be received on a loan once it has been classified as impaired by the Bank.

 

In determining the level of specific provisions there are judgements and estimates made by management which involve a level of subjectivity and as a consequence we identify this area as a key risk of material misstatement in the financial statements.

 

These include matters such as the valuation of illiquid collateral as well as the identification and assessment of potential indicators of impairment.

 

Management disclose information about credit risk in note A of the risk management section, as well as the relevant accounting estimates for portfolio and specific provisions in note C on pages 25 and 26, and further details in notes 10 and 15 to the financial statements.

 

How the scope of our audit responded to the risk

In order to challenge the IBNR provision we:

• assessed the model for compliance with IFRS

• assessed the sensitivity of the model to reasonable levels of change in key variables and

considered whether any more reliable estimate might result from changing the variables

accordingly

• tested back to relevant internal and external data that the correct PD and LGD inputs had been

applied for a sample of loans included within the provisioning model

• tested the completeness of the loan population included within the model by reconciling to the

ledger and tracing to recent cash movements in the facility balances

• reperformed the model to check its mathematical accuracy.

 

In order to challenge the specific provision balance we:

• examined the controls in place over the credit assessment process for banking loans to ensure

they had been designed and implemented correctly and had operated effectively throughout

the year

• reviewed a sample of impaired loans to determine whether a loss event could be identified for

these loans and to assess the appropriateness of the specific level of provisions applied. We

reviewed both the assumptions used in relation to cash flows and the input data supporting the

provision calculations.

• considered the completeness of the specifically impaired loans population by reviewing a

sample of unimpaired loans to determine whether a loss event could be identified for these

loans which would require an impairment.

• reviewed whether there were any new impairments in January 2017 to challenge whether the

impairment assessment is reflective of loss events that should have been assessed as a

2016 provision.

 

Key observations

Overall, we concluded that the level of provisioning is appropriate and is towards the more prudent end of our acceptable range.

Valuation of illiquid equity investments and associated derivative

Loan impairment and provisioning: portfolio and specific provisions

Our application of materiality

We define materiality as the magnitude of misstatement in the financial statements that makes it probable that the economic decisions of a reasonably knowledgeable person would be changed or influenced. We use materiality both in planning the scope of our audit work and in evaluating the results of our work.

Based on our professional judgement, we determined materiality for the financial statements as a whole as follows:

 

Materiality

 

€109 million

 

Basis for determining materiality

The materiality was determined on the basis of 0.75% of shareholders’ equity of €14.6 billion as disclosed in the balance sheet and statement of changes in equity.

 

Rationale for the benchmark applied

Materiality has been based on shareholder equity given our assessment of this being the most stable metric, and the most applicable to the operation of the Bank.

 

 

 

 

 

We agreed with the Audit Committee that we would report to the committee all audit differences in excess of €5 million (2015: €5 million), as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds. We also report to the Audit Committee on disclosure matters that we identified when assessing the overall presentation of the financial statements.

 

An overview of the scope of our audit

Our audit was performed on the Bank legal entity given there were no consolidated entities as at 31 December 2016.

 

Other information

The President is responsible for the other information. The other information comprises the highlights, financial results and additional reporting and disclosures sections of the Financial Report for the year ended 31 December 2016. Our opinion on the financial statements does not cover the other information and we do not express any form of assurance conclusion thereon.

 

In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or whether our knowledge obtained in the audit or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact.

We have nothing to report in this regard.

 

Responsibilities of the President for the financial statements

The President is responsible for the preparation and fair presentation of the financial statements in accordance with IFRS as issued by the IASB, and for such internal control as the President determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

 

In preparing the financial statements, the President is responsible for assessing the Bank’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the President either intends to liquidate the Bank or to cease operations, or has no realistic alternative but to do so.

 

The President is also responsible for overseeing the Bank’s financial reporting process.

Auditor’s responsibilities for the audit of the financial statements

Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.

 

As part of an audit in accordance with ISAs, we exercise professional judgement and maintain professional scepticism throughout the audit. We also:

 

  • identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
  • obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Bank’s internal control.
  • evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by the President.
  • conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Bank’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained to the date of our auditor’s report. However, future events or conditions may cause the Bank to cease to continue as a going concern.
  • evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation.

 

We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

 

We also provide those charged with governance with a statement that we have complied with the relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to have a bearing on our independence, and where applicable, related safeguards.

 

From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.

 

 

 

 

 

 

 

 

Matters on which we are required to report by exception

 

We are required to report to you if, in our opinion:

  • we have not received all the information and explanations we require for our audit
  • proper accounting records have not been kept.

We have nothing to report in connection with these matters

 

Other matters

This report, including the opinion, has been prepared for, and only for, the Board of Governors as a body in accordance with Article 24 of the Agreement Establishing the Bank dated 29 May 1990, and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come, save where expressly agreed by our prior consent in writing.

 

 

 

 

 

 

 

 

For and on behalf of Deloitte LLP

Chartered Accountants

London, United Kingdom

8 March 2017

REPORTING INDEPENDENT AUDITOR'S REPORT TO THE GOVERNORS OF THE EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT

Independent auditor’s report to the Governors of the European Bank for Reconstruction and Development

Report on other legal and regulatory requirements

European Bank for Reconstruction and Development

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