The activities of the entity
The staff reminded the Board that ED10 proposed the following definition of control:
A reporting entity controls another entity when the reporting entity has the power to direct the activities of that other entity to generate returns for the reporting entity.
The Board discussed a staff recommendation that the IFRS should clarify that 'the activities' in the control definition refers to those activities of an entity that significantly affect the returns.
Several Board members expressed concerns with this clarification: some thought it too narrow and some did not think it captured common securitisation structures. One Board member noted that the Board (and staff) was often schizophrenic when using the term 'power': at the entity level, the returns were for the entity; but when layering the 'so as to benefit' criterion when assessing whether the entity should be consolidated, the returns had to benefit the owner, not the entity.
That Board member agreed that if [a parent] had both power and benefits, consolidation of the entity would be required. In addition, other Board members noted that synergies were indicative of control - an entity could not take advantage of synergies without having control of another entity - but they came after control was obtained and need not be present.
Another Board member challenged the main definition, and urged that the well-established notion of power to direct the strategic financial and operating policies of another entity should not be lost.
The Board accepted the staff recommendation without a vote.
Returns for the reporting entity
The Board agreed the staff recommendation that the definition and description of 'returns' should be retained in a manner similar to that in ED10. However, the Board would clarify which returns are relevant when assessing control.
The staff recommend that the final standard should also clarify that:
- (a) to control another entity, a reporting entity must be exposed to variability of returns from its involvement with that entity. Without exposure to variability, a reporting entity is unable to benefit from any powers that it might have.
- (b) returns received in the past are not relevant when assessing control. If a reporting entity is not exposed to variability of returns in the future, it is unable to benefit from any power that it might have. In such situations, a reporting entity uses any powers that it might have solely for the benefit of others, and therefore, would be acting as an agent.
- (c) returns have the potential to be wholly positive, wholly negative or either positive or negative. Therefore, a reporting entity controls another entity if it has the power to direct the activities of that entity, and any of the following three possibilities exist:
- (i) the reporting entity's future returns from its involvement could only ever be positive (e.g. a beneficial interest holder in an entity that has bought insurance to cover all potential losses).
- (ii) the reporting entity's future returns from its involvement could only ever be negative (e.g. a reporting entity that provides a guarantee of payments to beneficial interest holders when assets default).
- (iii) the reporting entity's future returns from its involvement could be either positive or negative (e.g. an equity shareholder in an entity)
A Board member was concerned about the use of 'variability in returns' and the opportunities for defeasance trusts and similar structures to be used once again to achieve off-balance sheet treatment for items. The staff acknowledged the potential difficulty, but was trying to avoid too definitive guidance.
Power to direct: protective and participating rights
The Board discussed a staff recommendation that the IFRS characterise 'power' as follows:
- Power refers to a reporting entity's current ability to enforce its will in directing the activities of an entity that significantly affect the returns. A reporting entity has that current ability if a mechanism is in place that ensures that the reporting entity has substantive decision-making rights that mean that it can enforce its will in directing the activities that matter as and when decisions are required to be taken or the reporting entity would like decisions to be taken.
- Power need not be exercised.
- Power need not be absolute.
- Power is assessed on the basis of current facts and circumstances.
A Board member noted that 'current ability' would be the tension point and that the staff's proposed wording would not resolve the tension that exists. The staff responded that much of that tension concerns the effect of options, a topic that would be addressed later.
The Board did not object to this clarification, subject to its forthcoming discussion of options.
Rights of a reporting entity
The Board discussed whether to:
- add guidance discussing participating rights as follows:
- participating rights are rights that, if held by one party, are sufficient to give that party the ability to enforce its will in directing the activities of an entity that significantly affect the returns. If their exercise requires agreement by more than one party, participating rights prevent other parties from controlling the entity to which they relate.
- participating rights must be substantive
- rights that are exercisable only when specified circumstances arise or events happen are participating rights in some circumstances and protective rights in others
- include the guidance on protective rights included in B1 and B2 of ED10
A Board member thought that the discussion focussed too much on rights and omitted any discussion of obligations - if an entity has rights it must have obligations to another entity.
In addition, Board members were concerned that some of the discussion of operational barriers to exercising an entity's rights to exercise control over another might have significant unintended consequences for entities in administration/ bankruptcy protection and urged the staff to investigate this further.
Subject to other minor clarifications, the staff recommendations were agreed.
The staff prefaced this discussion by noting that they did not want to change the definition of 'joint control'. Rather, this discussion was about situations in which multiple parties had decision-making authority over the activities of an entity. In particular, the discussion focussed on situations in which entities have discrete and unilateral power over bundles of activities (sometimes called 'silos').
The Board agreed the staff recommendation that when two or more parties have discrete decision-making authority over the activities of an entity, the party that has the ability to direct the activities that most significantly affect the returns meets the power element of the control definition.
In doing so, several Board members expressed grave concern about how the discussion of shared power (the Consolidation IFRS) and joint control (the Joint Activities IFRS) were explained and distinguished, given that the expected release date of the two IFRSs were different and that the forerunner could not refer to conclusions in an IFRS that was not yet balloted: it could only refer to existing IFRS. The staff acknowledged that the two standards were not scheduled to be released at the same time and noted the concern raised.
Involvement in the design of a structured entity
The Board discussed a staff recommendation that the IFRS clarify that understanding the purpose and design of an entity was an important factor to consider when assessing control of that entity, and that involvement in the design of an entity is not, in isolation, sufficient to conclude that the reporting entity controlled that entity. The staff's intention was that involvement in the design of a structured entity was indicative but not determinative of control.
Board members were uncomfortable with the recommendation as drafted. Control of the risks and benefits was often the more crucial assessment to be made. It was necessary to understand the entity's purpose and who controls those policies.
The Board agreed that, in assessing control of any entity, including a structured entity, a full understanding of all relevant facts and circumstances was necessary. This could include who designed the structure and why, the source of assets and financing, as well as who controls the operating policies and which entity has the risks and benefits.
The staff agreed to rework its proposals and return at a subsequent Board meeting.
Continuous assessment of control
With little discussion, the Board affirmed that a reporting entity should assess control continuously and that the IFRS should clarify the application of that requirement.