Ind AS 109, the Indian counterpart of IFRS 9, has been mandatory for most large NBFCs since 2018 and applies to Category II AIFs with significant debt portfolios through the financial reporting obligations of their fund vehicles. The standard is not new. The implementation problems are not new either — they recur, with remarkable consistency, across the portfolios we review.
This note is not an introduction to Ind AS 109. It assumes familiarity with the standard’s three-stage expected credit loss model, the business model assessment, and the SPPI (solely payments of principal and interest) test. What it covers is where implementation goes wrong in practice, and why those failures matter beyond the accounting.
The ECL model in practice: what gets shortcut
The Expected Credit Loss model under Ind AS 109 requires funds to estimate credit losses across three stages based on whether credit risk has increased significantly since origination. The standard is explicit that ECL estimates must be forward-looking, probability-weighted, and incorporate reasonable and supportable macroeconomic information.
In practice, the most common shortcut is using historical loss rates as a proxy for expected losses, without forward adjustment. A private credit AIF with a three-year history of near-zero defaults applies a near-zero ECL to its current portfolio — a portfolio that may have been originated in a different macroeconomic environment, at different leverage levels, or with weaker covenant packages than the historical book.
This is not a conservative valuation. It is a stale one. The standard explicitly requires that ECL reflect current conditions and forward expectations, not just historical experience. Auditors who are increasingly familiar with IFRS 9 enforcement actions in Europe are raising exactly this challenge with Indian fund audits.
The second shortcut is staging that does not move. Stage 1 instruments accumulate in portfolios even when the underlying issuer’s credit profile has materially deteriorated — because reclassification to Stage 2 (significant increase in credit risk) requires a positive determination that the practitioner is reluctant to make. Stage 2 triggers a higher lifetime ECL provision. Staying in Stage 1 requires only a 12-month ECL. The economic reality — that the issuer’s creditworthiness has declined — does not force the reclassification; it requires a documented judgement call that the finance team must be willing to make.
The SPPI test: where structured instruments fail
The SPPI test determines whether a financial asset can be classified at amortised cost (AC) or fair value through other comprehensive income (FVOCI). If an instrument fails SPPI, it must be measured at fair value through profit and loss (FVTPL) — which can produce significant P&L volatility.
For straightforward bullet NCDs or term loans, SPPI is typically satisfied. For structured private credit instruments — those with variable coupons tied to benchmarks, step-up features linked to credit events, equity conversion rights, or returns linked to the issuer’s financial performance — SPPI analysis is material and frequently done incorrectly.
The most common error is classifying an instrument at amortised cost on the basis that its coupon is variable but benchmark-linked, without analysing whether the benchmark linkage produces cash flows that are solely payments of principal and interest. The IFRS Interpretations Committee has been explicit that leveraged variable-rate features, non-standard benchmark adjustments, and certain performance-linked elements fail SPPI regardless of how they are documented.
Indian private credit NCDs with profit-participation features, ratchet returns, or coupon resets tied to the borrower’s EBITDA performance fail SPPI. They must be measured at FVTPL. Funds that have classified them at AC are misstating their financial position — and their auditors are increasingly catching this.
Business model assessment: the fund-level complication
Ind AS 109’s business model assessment asks whether a portfolio is held to collect contractual cash flows (AC), held both to collect and to sell (FVOCI), or held primarily for trading (FVTPL). The assessment is made at a portfolio level, not instrument by instrument.
For closed-ended Category II AIFs, the business model is typically "hold to collect" — loans are made and held until maturity, consistent with AC measurement. But this assessment is undermined when the fund:
- Regularly sells instruments before maturity to manage liquidity or rebalance the portfolio
- Demonstrates a pattern of secondary sales in its track record
- Has LP redemption features that effectively require liquidity management inconsistent with a pure hold-to-collect model
Where the AIF has sold more than an "infrequent" proportion of instruments before maturity, the business model may not support AC classification. The standard is not prescriptive on what "infrequent" means numerically, which creates documentation risk — a fund that believes its sales are infrequent, but has not documented that judgement clearly, faces an audit challenge when the facts are examined.
Modification accounting: the restructuring problem
When a private credit borrower restructures — extending maturity, deferring coupon payments, adjusting covenant terms — Ind AS 109 requires an assessment of whether the restructuring constitutes a modification or an extinguishment and re-origination of the instrument.
If the restructured terms are substantially different from the original terms, the old instrument is deemed extinguished and a new instrument is recognised — which forces an immediate gain or loss on derecognition. If the terms are not substantially different, a modification is recognised with the difference between the original carrying amount and the present value of the revised cash flows taken to P&L.
In both cases, the practical problem is that restructurings in Indian private credit often have bespoke terms — fee waivers, equity sweeteners, extended moratoriums — that require instrument-by-instrument analysis to assess the Ind AS 109 treatment. Applying a blanket policy ("all restructurings are modifications, not extinguishments") without instrument-level analysis is not defensible on audit.
The modification also interacts with ECL staging. A restructured instrument is generally a Stage 3 indicator regardless of the fund’s assessment of ultimate recovery — the credit-impaired classification follows from the restructuring fact, not from loss projections.
Why this matters beyond accounting compliance
The practical stakes of Ind AS 109 implementation extend beyond financial statement accuracy.
LP reporting. Category II AIF LP packs that include Ind AS 109-based financial statements but incorrectly apply ECL or SPPI are giving LPs a view of portfolio performance that does not reflect the accounting standard the fund claims to apply. Sophisticated LPs — increasingly the norm for any fund above ₹500 crore — will notice.
SEBI valuations. SEBI’s AIF valuation framework for NAV computation and SEBI’s accounting framework are distinct, but they interact. An instrument that must be marked at FVTPL under Ind AS 109 but is being carried at AC in the NAV calculation creates a reconciliation that investment managers must explain to auditors, LPs, and regulators.
Due diligence for secondary sales. Funds that are acquiring secondary interests in existing AIF portfolios perform accounting due diligence. An acquiring fund that discovers material Ind AS 109 misapplication post-signing faces a valuation dispute and potential indemnity claim.
The practical fix
The Ind AS 109 gaps that cause audit friction are not conceptually difficult. They require:
- SPPI analysis on every instrument at origination, documented and retained in the investment file
- Business model documentation at portfolio level, reviewed annually and when the fund’s selling behaviour changes
- An ECL staging review process that is outcome-independent — which means someone other than the investment team is making the staging call
- Forward-looking ECL adjustment methodology that is documented, not assumed to be zero
- Modification accounting policy that requires instrument-level analysis, not portfolio-level blanket treatment
None of this requires a separate system. It requires discipline, documentation, and — for the ECL staging call in particular — independence from the investment team that has an economic interest in the staging outcome.
Independent valuation is the natural governance mechanism for that independence. It is not the only mechanism, but it is the most credible one.
For a review of your fund’s Ind AS 109 implementation, ECL model, or instrument-level SPPI analysis, get in touch.
