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Consolidation

Date recorded:

Control through voting rights

Both Boards agreed that, when assessing control of entities controlled through voting rights, in the absence of other arrangements, a reporting entity that holds more than half of the voting rights in an entity meets the power element of the control definition.

The Boards also decided that a reporting entity with less than half of the voting rights in an entity that has the legal or contractual ability to direct those activities of the entity that significantly affect the returns meets the power element of the control definition.

The real point of the discussion was whether an entity with less than half of the voting rights meets, in absence of other contractual arrangements, the power element of the control definition. Different opinions were expressed by various Board members in this respect.

Some Board members preferred the 'contractual view' that assumed that in such situation the reporting entity would not meet the power element of the control definition without the contractual ability to direct the activities of the entity. Supporters of this view were particularly concerned with the possibility of change of assessment from one period to another resulting in frequent consolidation and de-consolidation. In addition, they expressed their concerns that consolidation in these circumstances would lead to multiple reporting issues, mainly related to a significant increase in Non-controlling interest (NCI) balances in the financial statements and would confuse the users which assets are available to which shareholders.

Other Board members preferred the 'dominant shareholder' approach (based on holding significantly more voting rights than any other party as well as wide dispersion of the other shareholders). In response to the proponents of the contractual view these Board members argued that this approach better depicted economic reality. They were of the view that this approach would not lead to frequent changes of consolidation/de-consolidation as this did not reflect economic reality. They cited the experience from some countries where similar changes were adopted and these changes led to decrease in structuring opportunities for entities. In addition, some of these Board members believed that this approach was conceptually sounder as it was in line with the definition of an asset.

In response to the concerns that the 'dominant shareholder approach' would not be practicable they argued that usually it is very clear from the individual facts and circumstances who was in control. These members also believed that large NCI balances in the financial statements depicted economic reality and disclosures would address the concerns raised in that respect.

In the following discussion, two particular modification of the 'dominant shareholder approach' were discussed. Some, mainly IASB members supported the 'pure' view that would not require the dominant shareholder to demonstrate that it actually directed the activities significantly affecting returns. These Board members were of the view that the ability was sufficient to qualify for the consolidation and this ability did not have to be exercised.

Other Board members believed that the definition of the dominant shareholder should be strengthened to include evidence of actual exercise of the power element. They noted that the power element should not be assessed only in the short term but should be perpetuated.

On voting, both Boards supported the 'dominant shareholders approach' (IASB unanimously, FASB 3:2), with majority of the IASB members in the pure dominant shareholders view. On the other hand, the FASB narrowly supported the dominant shareholders view based on the need for additional evidence of exercise of control. The Boards noted that the differences between these two approaches should not be insurmountable as it related only to a narrow subset of cases.

Options and convertible instruments

The Boards briefly discussed the effects of options and convertible instruments on the overall control model developed. Most Board members agreed that options and convertibles were used in many different situations. They noted that these instruments were often used in structuring and expressed their view that these instruments were evidence of power; nonetheless, they differed whether these instruments should be currently exercisable.

Finally, the Boards agreed that options and convertible instruments should be considered when assessing power. In this assessment, the entity should consider all facts and circumstances not limited to these instruments and their impact on voting rights.

Kick-out rights

The Boards continued their discussion with considering the role of kick-out rights in determining which entity should consolidate another entity and whether kick-out rights should be considered in determining whether a reporting entity was agent or principal.

Although the Boards discussed this issue separately, they agreed that assessment of kick-out rights was dependent on all the economic and contractual facts and circumstances and that it was only one of the factors to be consider when deciding whether to consolidate an entity.

In general, two views were shared by the Board. The first view ('View 1') was based on the guidance in FASB Statement No. 167 that limits the consideration of kick-out rights in the power analysis to situations in which only a single entity had a unilateral ability to remove the decision maker.

On the other hand, the second view ('View 2') would not limit the consideration of kick -out right to these situations but would include all the relevant facts, thus in effect allowing kick-out rights held by more than one party to be considered in determining which reporting entity had the power over another entity.

Some Board members felt uncomfortable to consider this issue in isolation as they did not believe that holding of substantive kick-out rights would necessarily lead to consolidation of an entity by holder of these rights. Other Board members were of the view that they would support 'View 2' if the shareholders having these kick-out rights were organised, but would otherwise prefer 'View 1'.

One IASB member suggested that the reporting entity should consider what the incentive is for shareholders to exercise these kick-out rights and include these considerations in the power analysis.

One FASB member suggested that the whole power and benefit analysis has to be performed to consider the agency relationship. Finally, most of the Board members agreed that decision on which view to support really depended on analysis of control through voting rights already discussed (i.e. which of the views is consistent with the dominant shareholder view). The Board thus asked the staff to provide additional analysis of these considerations for the next Board meeting.

In an indicative vote, majority of the IASB members preferred 'View 2', whereas majority of the FASB members supported 'View 1'.

Agency Relationships

The Boards very briefly discussed the issue of agency relationship. This was an initial session on the topic, no decisions were taken.

From the discussion it was clear that the Boards would prefer the view in which the overall relationship was considered, including, but not limited, to the range of decision made and latitude in decision making, kick-out rights as well as benefits (e.g. amount of fees and overall fee structure, other interests, guarantees). In addition, most of the Board members suggested that this analysis should include also explicit consideration of the fee variability (to consider whether the fees varied in the same way or differently with the other investors) as well as any disproportionate exposure to losses below the most senior investors.

Most of the Board members did not support the view that would be based solely on the significant variability of returns from its involvement in the entity.

In the subsequent discussion, some Board members suggested that the staff considered in its analysis also the following factors with particular impact on the fund managers: consequences of the consolidation of funds and whether their consolidation would result in providing more useful information to investors, existence of significant leverage as well as loss recoupment.

The staff would provide its additional analysis at the next joint meeting in February. At that meeting the Boards would also consider application of the consolidation guidance to investment companies.

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