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Investment Entities

Date recorded:

The Boards were presented with a summary of the feedback received on their respective proposals on investment entities. No decisions were made by the Boards during this session.

The majority of IASB constituents were supportive of the proposal to provide an exception from consolidation for investment entities citing various reasons including 1) that investment entities manage their investments on a fair value basis and use fair value information to evaluate their performance regardless of whether the investment represents a 1%, 20%, 50% or 100% interest in the investee, 2) fair value is the most relevant and useful information for investors of investment entities and 3) that US GAAP and other local GAAPs have historically contained specialised accounting for investment-type entities which included an exception from consolidation and such guidance has worked well in these jurisdictions. However, a minority of IASB constituents disagreed with the proposals arguing that an exception for consolidation should not be provided for any controlled investee and raised concerns with the introduction of industry-specific guidance into IFRSs. FASB constituents supported the FASB’s proposals to retain and clarify its existing investment company guidance for similar reason to those of IASB constituents including developing converged guidance with the IASB with respect to investment entities.

With respect to the proposed criteria for identifying an investment entity, IASB constituents had mixed views on the approach to be used. The IASB and FASB exposure drafts utilised an entity-based approach with specific criteria required to be met in order to qualify as an investment entity. Certain IASB constituents suggested alternative approaches including a principles-based entity level approach, an asset-based approach and a fair value option. The constituents supporting a principles-based approach suggested that certain of the proposed criteria could be combined (eg, the nature of investment activities, business purpose and fair value management criteria) in developing an overarching principle. They suggested that the other criteria could be used as either mandatory criteria or as indicators which would not be mandatory but rather used in an overall assessment.  Other IASB constituents suggested an asset-based approach where an entity would determine whether a controlled investment should be consolidated or measured at fair value based on the nature and characteristics of each individual controlled investment. And finally other IASB constituents recommended that entities qualifying as investment entities are provided an irrevocable option to measure their controlled investments at fair value as they asserted that certain of the criteria already included implicit options (eg, the fair value management criteria).  Certain FASB constituents also had concerns with the proposed approach suggesting either a qualitative assessment considering all of the criteria to determine whether an entity is an investment entity or a principles-based approach with certain criteria required to be met with other criteria used as indicators. The staffs then discussed the specific comments received on each of the six proposed criteria.

With regard to controlling interest in other investment entities, the IASB and FASB proposals differed with the IASB proposing to measure controlled investment entities at fair value while the FASB would require consolidation of another investment entity. The IASB did not ask a specific question on this issue in its proposals but the comments received were generally supportive of the IASB’s proposed approach.  FASB constituents generally supported a feeder fund not consolidating its interest in a master fund but several respondents requested that master fund financial statements be included in the financial statements of the feeder fund. However, for a fund of funds structure, most FASB constituents stated that controlling financial interest in another investment company should be measured at fair value rather than applying consolidation and supported the IASB approach.

With respect to the accounting by non-investment entity parents of an investment entity, the IASB and FASB proposals again differed with the IASB prohibiting retention of fair value accounting and instead requiring non-investment entity parents to consolidate all controlled investments including those controlled through an investment entity. The FASB proposal retains the existing US GAAP practice of retaining the specialised accounting applied by an investment company subsidiary in the consolidated financial statements of a parent. The majority of IASB constituents favoured the US GAAP approach with user feedback generally mirroring overall feedback.  The arguments stated for preference for the FASB proposals included that 1) fair value accounting used by an investment entity subsidiary continues to be relevant at a non-investment entity parent level, 2) the cost savings and benefits of more relevant reporting would be lost if an investment entity subsidiary is controlled by a non-investment entity parent and 3) the retention of fair value accounting used by an investment entity subsidiary for its investment assets would be consistent with the IASB’s proposed accounting by a non-investment entity parent for interests in associates and joint ventures.  Almost all FASB constituents also supported the retention of specialised accounting proposed by the FASB.

One IASB member noted that it seems there are three primary issues that the Boards will need to address.  Those areas are defining the appropriate scope for investment entities, establishing the appropriate accounting for those entities and finally addressing the accounting for the rollup of investment entities. He noted that the Boards were basically converged on the scope criteria. On the accounting by investment entities, he noted the FASB had more specific guidance while the IASB proposals strictly scoped controlled investments from consolidation and referred to IFRS 9 for other investments; he stated a preference for clarifying that the investments would be measured at fair value through profit or loss so that entities would not attempt to utilise the fair value through other comprehensive income measurement for equity securities.  He also noted that constituents strongly supported the FASB approach to rollup and therefore the Boards would need to work on attempting to converge their positions.

Another IASB member noted that one of the first issues the Boards would need to address is whether they want the investment entity exception to be a principle or whether the exception should be defined by specific criteria. The staff responded that several constituents had raised this issue and suggested utilising certain of the criteria in developing a principle.

One IASB member raised an issue with the constituent feedback on the rollup and suggested the staff perform analysis of whether banks could utilise the investment entity concept to circumvent the offsetting requirements and effectively get net reporting through use of fair value. However, the staff noted that retention of fair value doesn’t result in a net fair value of the investment being recognised but consolidation where assets are recognised at fair value while liabilities are typically recognised at amortised cost.

Another IASB member stated a preference for limiting the scope of the project to focusing solely on whether investment entities should consolidate controlled investments and then what the accounting should be for non-investment entity parents required to consolidate investment entities.  Given the pending adoption of IFRS 10 he cautioned against bringing ancillary topics in to the discussions such as IAS 40, IAS 28 and disclosures which he felt would lengthen the timing of this project.

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