The Board discussed the principle that 'control' should be the basis for consolidation, in particular the extent to which risks and rewards (including reputational risk) should be considered when assessing control of an entity. The staff recommended that:
- control, defined to require a reporting entity to have power and the ability to benefit from that power, be retained as the only basis for consolidation.
- the final standard should include exposure to risks and rewards as an indicator of control such that, the greater a reporting entity's exposure to risks and rewards from its involvement with an entity, the greater the incentive for the reporting entity to obtain rights sufficient to give it the power to direct the activities of that entity.
A Board member questioned whether this recommendation was operational and proposed a structured transaction in which he suggested that power was surrendered but all the risks and rewards were retained. Several Board members and senior staff challenged this hypothetical transaction, suggesting that it was unrealistic to expect an entity to accept all risks and rewards without retaining some power. The original Board member remained unconvinced, but was willing to work with the staff to develop guidance that might satisfy his concerns.
The Board agreed that 'reputational risk' was not a factor that indicated 'control', but was a factor to consider whether an entity was exposed to benefits: that is, reputational risk is a specific type of business risk. Board members noted that several financial institutions had stepped in to rescue structured entities citing 'reputational' reasons: these were often business decisions aimed at avoiding litigation.
The Board had an extended and inconclusive discussion of options and whether options were indicative of control. The staff stated that they would be bringing issues related to 'kick-out rights', call and put options and similar matters to the September meeting.
Power to direct the activities on an entity without a majority of the voting rights
The Board affirmed the position in the Consolidation ED that to have 'power' the reporting entity should be able to direct the activities of another entity currently. That does not mean that the mechanism that provides a reporting entity with power could not have timing delays, but it should be in place (for example, an entity might have power currently even though it might have to wait for the next shareholder meeting to enforce its will; this does not negate the presumption of power). The Board agreed that, in the absence of contra-indicative factors, a passive majority shareholder is presumed to meet the power element of the control definition.
The Board discussed the presence of power in the absence of a majority of voting rights. After a protracted debate, the Board reaffirmed the view in the ED that a 'dominant' minority shareholder might be able to satisfy the power element of the control definition, but must be able to demonstrate that this shareholding allows it to exercise that power to effect control. This determination would need to assess all facts and circumstances. In particular, the dispersion of the other shareholdings would need to be assessed. The final IFRS would provide further application guidance on this issue.
Power to direct the activities of another entity: Options and convertible instruments
The Board discussed the situations in which an unexercised option would give the holder of the option the power to direct the activities of another entity.
A bare majority of the Board preferred the Alternative View expressed in the ED: that the holder of an option over a sufficient number of voting rights that is capable of being exercised currently meets the power element of the definition of control. The Board agreed that a currently exercisable option might give the holder the power to direct the activities of an entity but other factors should be considered to assess whether there are any barriers to exercise.
A Board member noted that the fact that a conversion feature that was out-of-the-money should not be excluded from the assessment of control solely on that basis: often the exercise of such an option was cheaper than other alternatives open to the holder, such as bankruptcy or litigation.