Investment Entities Amendments – an investment entity subsidiary that also provides investment-related services

The agenda paper for this slot provided an analysis of the comment letters received on the proposal to amend IFRS 10 in relation to the accounting for an investment entity subsidiary that also provides investment-related services. The Senior Technical Manager introduced the agenda paper, and asked the IASB members whether they agreed with the staff recommendations in the agenda paper.

An IASB member noted that he agreed with the overall direction of the staff, but expressed concern with respect to the lack of guidance on what to do in circumstances where an entity had dual-purpose subsidiaries that were both investment entities and provided investment services. He added that this left people in doubt as to what to do in such circumstances.

The Senior Technical Manager responded and noted that in the case of a dual-purpose subsidiary that qualified as an investment entity but also provided some investor-related services, it could be made very clear that fair value measurement would be required. However, she noted in the case where a dual-purpose subsidiary did not qualify as an investment entity (as the level of investment activity was lower), the IASB could provide assistance through working on the wording in the existing paragraph in Appendix B that talked about business purpose and the intention of the types of subsidiaries they would expect would be consolidated.

Another IASB member expressed disappointment that an exemption to consolidation that had been difficult for the IASB to give (because of its belief in consolidation) had sort of backfired in the sense that people were now saying that the exemption provided less useful information. She noted that a lot of the decision for allowing fair value measurement for all investment entity subsidiaries was based on comments received at the time about the potential complexities for preparers if they would be required to consolidate investment entity subsidiaries. She further noted that she believed it would be very difficult at this stage for the IASB to reverse that decision, in part because the IASB had not asked a broad enough question or received feedback from a broad enough range of people, and that in the circumstances, clarification of the existing guidance was the best approach.

Another IASB member noted that, for the reasons articulated by the previous IASB member, he accepted (not supported) the staff recommendations. He noted the concerns expressed by some respondents that the proposed amendments would result in a loss of information of a number of items including borrowings for those entities measured at fair value. He noted that the agenda paper referred to the July 2012 IASB Update that discussed the disclosures that were introduced into IFRS 12 [paragraphs 19A through G], which focused on information about interests in unconsolidated subsidiaries (investment entities). He noted that paragraph 19D required disclosure of the nature and extent of any significant restrictions resulting from borrowing arrangements, but did not state that the actual borrowing arrangements needed to be disclosed, and asked the staff whether this clarification could be made to make it explicit that the borrowing arrangements were required to be disclosed as well as the nature and extent of restrictions resulting from the borrowing arrangements.

A further IASB member noted that there were two issues associated with investment entity subsidiaries – the first related to borrowings, and loss of information, and the second related to the accounting treatment of investment-related services expenses. He noted that he did not believe the IASB could do anything in relation to the borrowings issue outside of requiring certain disclosures. However, he noted he was concerned about the accounting for the investment-related services expenses as under the proposed guidance, if an entity took an investment entity subsidiary and reorganised it into two separate companies – one holding the investments and the other providing investment-related services, it would result in different accounting, as under the reorganized structure, the investment-related services expenses would need to be consolidated. He further cited concerns around expense ratios and the like being distorted as a result of different accounting for investment-related services expenses under different structures. He noted that if the IASB agreed with the staff recommendation, it would effectively force people to go to non-GAAP measures or to restructure. He questioned why the principle that already existed, that required investments to be fair valued and fees and services to be reported as an expense [when they were in a separate subsidiary] could not be applied when the investments and expenses were in the same entity.

The Director of Implementation Activities noted that to go down this route would require providing guidance to help dual-purpose entities distinguish when it was appropriate to consolidate. The IASB member responded and noted that guidance already existed that if a subsidiary provided investment-related services, it should be consolidated; and questioned why this guidance could not be expanded to state that if those services were incorporated in an investment entity subsidiary, they should be stripped out and presented in the financial statements as expenses.

The Senior Technical Manager noted that this approach was suggested in some of the comment letters received, and that the comment letters provided evidence that different approaches were being taken in dealing with investment and services components. She also noted that diversity in practice was beginning to be seen and that the IASB needed to do something to prevent this diversity from increasing. She further expressed concerns about the precedent the IASB might be setting by unwinding some of the decisions that had been made in the original amendments to IFRS 10. She noted that if the IASB was seen to be making changes to fundamental decisions in the early stages of implementation, it could make it difficult for people to implement other new standards if they thought they might have a moving target to apply.

The Technical Manager noted that introducing guidance that required dual-purpose subsidiaries to apply a 'dual-model' of consolidation would be very difficult guidance to draft. She noted that a lot of blocker funds and fund-of-funds structures would want to argue that they themselves were providing investment-related services by, for example, providing tax benefits, or certain investment expertise, and accordingly, it would be difficult to introduce this approach while simultaneously confirming that blocker funds and fund-of-funds that qualified as investment entities should be measured at fair value.

The IASB member pointed out that blocker funds did not typically have employees, and it was entities that had employees managing investments and providing services that were not shown as an expense in the parent company’s financial statements that was the concern.

The Senior Technical Manager noted that another issue that came up in comment letters in relation to this 'dual-model' consolidation approach was around the level of services that would need to be provided within a dual-purpose entity before they were significant enough to be stripped out. She noted that there was a range of views on this, and that this would be another complexity that would need to be considered if the IASB was to go down the route of allowing this type of split treatment.

The Executive Technical Director acknowledged that it was not ideal to have a situation where two economically identical structures gave different accounting answers based on how they were set up; however, he noted that he felt very uncomfortable with drafting part-consolidation guidance on the fly in such a limited timeframe.

An IASB member suggested, as a compromise, requiring dual-purpose entities to provide some disclosures about the related expenses where services were material.

Another IASB member highlighted the fact that an entity only qualified as an investment entity when its main purpose was to invest solely for capital appreciation and/or investment income, and that accordingly, if other types of income and expense were significant enough to the entity, it questioned whether an entity was even an investment entity. A further IASB member responded noting that the expenses incurred in managing certain types of investments could be quite high, and that it did not follow that an investment entity was not an investment entity because a lot of time and effort was spent on managing the investments. He added that the reason why this issue arose was because the investment management services were material, and whether they were rolled into the fair value change or removed from the fair value change and shown as expenses changed the financial statements. The IASB member acknowledged that he accepted that if the IASB wanted to do a quick amendment to clarify these issues, agreement was required in the current meeting. However, he questioned whether the IASB would look into this issue again.

The Director of Implementation Activities noted that there would be a post implementation review of IFRS 10, and that he expected this issue would feature in the post implementation review.

Ten IASB members agreed with the staff recommendations in the agenda paper to:

1. Confirm that an investment entity should measure at fair value all of its subsidiaries that are themselves investment entities;
2. Make clear that the requirement for an investment entity to consolidate a subsidiary, instead of measuring it at fair value, applies only to those subsidiaries that support the investment entity parent’s investment activities as an extension of the operations of the investment entity parent and are not themselves classified as investment entities; and
3. Clarify the IASB's reasoning for its decisions, as outlined in the Basis for Conclusions on the 2014 ED, through amendments to the application paragraphs in Appendix B of IFRS 10, which relate to the business purpose of an investment entity, and in the related paragraphs of the Basis for Conclusions on IFRS 10.

Application of the equity method by a non-investment entity investor to an investment entity investee

The next agenda paper provided a summary of the responses received in relation to the application of the equity method by a non-investment entity investor to an investment entity investee. The Senior Technical Manager introduced the agenda paper and asked the IASB members whether they agreed with the staff recommendations set out in the agenda paper.

An IASB member noted that she agreed with the staff recommendation to require the same treatment for interests in both associates and joint ventures. She observed that the IASB had received a lot of feedback on the decision not to allow joint venturers to roll up the fair value, both expressing scepticism about the IASB’s original assumption with respect to the ability of a joint venturer to obtain the required accounting information, and concerns about creating differences depending on why the equity method was being applied. She noted that with respect to question 2 in the agenda paper, she agreed with providing relief [option 2b]. She further noted that she believed the way this was phrased in the final amendments was very important. She noted that the words “enable to retain” helped to eliminate the concern expressed that the amendment would force an investment entity associate (or joint venture) that did not measure its subsidiaries at fair value because it did not apply IFRS, to determine the fair value of those entities in order to apply the equity method. She noted that using the wording “enable to retain” confirmed that this option was not mandatory. With respect to question 3, she noted that she favoured giving permission to roll up the fair value into the non-investment entity parent rather than restricting it only to situations where it was determined to be impracticable to unwind. She noted that she preferred leaving it to entities to determine their accounting policy, and further noted that allowing entities the option could eliminate situations where there was different accounting across a portfolio as unwinding was considered impracticable for some investments and not for others. She concluded, noting that she agreed with the staff recommendations set out in paragraph 1, paragraph 2b and providing entities with an option with no restrictions in respect of question 3.

Another IASB member noted that when the IASB had discussed the investment entity exemption several years previously, and whether or not to roll up the fair value into the non-investment entity parent, the IASB had a preference for fair value to be retained at the parent entity level, but decided not to go down this route because of structuring risks. However, he observed that structuring risks were less of an issue with associates and joint ventures as the parent did not control these entities. He noted that he favoured allowing the rolling up the fair value, and further noted that requiring different accounting for non-investment entity parents and investment entity parents was not practical. He further noted that in some cases it could be impossible for the non-investment entity parent to unwind the fair value accounting of a joint venture, as it relied on the other investor sharing the cost of obtaining the information or giving permission for the joint venture to provide that information, which it may not be willing to do, particularly if that other investor was itself an investment entity. He observed that the same could also be true for investments in associates, noting that investors in associates do not have the power to enforce the unwinding of the fair value, as significant influence is not control. He concluded that he agreed with the IASB member who had spoken previously, that the IASB needed to provide relief.

The Chairman questioned whether the aforementioned views represented the general opinion of all IASB members.

One IASB member noted that this was not his view. He noted that, based on what he had seen in practice, even in situations where an entity did not have control, either unilaterally or jointly, when it had significant influence it was almost always the case that the financial information needed to unwind fair value accounting could be obtained. Accordingly, he pointed out that control issues and the ability to access information were totally different things, and that it really came down to a question of the cost of obtaining the information. He noted that he believed the IASB should make relief available only for situations where it was impracticable to obtain the information necessary to unwind the fair value measurement.

Another IASB member highlighted the fact that significant influence was not just determined by the percentage of equity owned, but also by an entity’s ability to assert significant influence, noting that in situations where financial information that met the entity’s needs could not be obtained, it brought into question whether or not the entity actually had significant influence. She further confirmed what the previous IASB member was saying was that conclusions in respect of practicability were more cost/benefit driven than control driven, as the latter questioned the validity of the significant influence determination in situations where the financial information could not be obtained.

A further IASB member noted that in practice, an entity might have significant influence, but may not be able to obtain the information due to timing of availability of information, for example, in situations where there were differences in the timing of period end closings or fiscal quarters between investor and investee.

All IASB members agreed with the staff recommendation to require the same treatment for interests in both associates and joint ventures.

All IASB members agreed to provide relief to a non-investment-entity investor by enabling the investor to retain, when applying the equity method, the fair value measurement applied by an investment entity associate or joint venture to its interests in subsidiaries.

Having agreed to provide relief, thirteen of the fourteen IASB members agreed with the staff recommendation to make relief available as a choice.

Exemption from preparing consolidated financial statements

The agenda paper for this slot provided analysis of the comment letters received on the proposal to amend IFRS 10 in relation to the exemption from preparing consolidated financial statements. The Technical Manager introduced the agenda paper and asked the IASB members whether they agreed with the staff recommendation to proceed with the amendments to IFRS 10 and to add further changes to IFRS 10 and IFRS 12, as set out in paragraph 42 of the agenda paper.

One IASB member noted that he agreed with the staff recommendations in the agenda paper. He observed that IOSCO and ESMA had expressed concerns with respect to a loss of information, and asked the staff for further explanation regarding these concerns. The Technical Manager responded and noted that the staff had reached out to IOSCO to fully understand their concerns, further noting that they were concerned about the loss of information of the intermediate parent, especially for the stakeholders of said entity. He noted that the staff had spoken with IOSCO about the significant increases in costs if consolidated financial statements were mandated for all intermediate parents. He noted that they had understood this point and had advised that they would monitor how the loss of information would affect stakeholders and potentially come back with comments as part of the post issuance review.

Another IASB member highlighted the fact that intermediate parents that listed debt or equity instruments in a public market would still be required to prepare consolidated financial statements [in accordance with paragraph 4a of IFRS 10], and accordingly, that the concerns were only limited to those intermediate parents that were not listed. The Director of Implementation Activities noted that some securities regulators also had a mandate for reviewing or monitoring compliance with IFRS for non-listed entities, and that some of the concerns came from those securities regulators.

Another IASB member noted that it was important that the IASB expressed [in the Basis for Conclusions] that this was not creating a further exemption, but clarifying that by following the exemption for investment entities, an entity was complying with the consolidation requirements, and that was why an intermediate entity was eligible. She noted that she raised the point because she believed the IASB had gotten caught up in the language and labels around consolidated and separate financial statements. She noted that there had been a suggestion that these financial statements could be referred to as "investment entity financial statements", but noted that she disagreed with this and that the IASB needed to look again more broadly than just in the exception to the exception situations about attaching labels. She observed that another class also existed – "individual financial statements", where an investor did not have any subsidiaries that were required to be consolidated. She suggested the IASB looked at finding a label for separate financial statements that were produced for reasons other than as separate statutory accounts, possibly as part of an Annual Improvements Project. The Director of Implementation Activities noted that the staff could certainly take that on.

Another IASB member noted that he understood the concerns with respect to loss of information, but did not believe the IASB should take this into consideration because his understanding was that securities regulators had their own very detailed, up to date disclosure requirements, and these had been heightened in recent years resulting from the financial crisis. He suggested that to address some of the concerns of regulators, the IASB could include wording in the Basis for Conclusions that the position taken would not affect regulatory requirements in different jurisdictions, and that regulators had the scope to require what information they wanted based on the legal requirements in their jurisdiction. The Technical Manager noted that the staff had addressed the concern raised with respect to the amendments conflicting with national legislation, and concluded that the exemption would not conflict with national legislation as it was not a prohibition.

All fourteen IASB members agreed with the staff recommendations in the agenda paper.

Due process considerations

The agenda paper sets out the due process steps undertaken by the IASB in completing the narrow-scope project. The Technical Maager introduced the agenda paper and asked the IASB members to respond to the five questions set out in the agenda paper.

All fourteen IASB members agreed with the proposed transition requirements and the staff’s conclusion that no specific additional relief was required for first-time adoption.

Thirteen of the fourteen IASB members agreed with a mandatory effective date of 1 January 2016 for the final amendments to IFRS 10 and IAS 28, and that earlier application should be permitted. One IASB member questioned whether the amendments would be available for application next year, and specifically whether the amendments would get endorsed in time for entities to apply the amendments next year. The Director of Implementation Activities clarified that as early adoption is permitted, effectively the amendments could be applied straightaway as the amendments are not changing requirements, but merely clarifying existing requirements.

Thirteen of the fourteen IASB members agreed that the proposed amendments to IFRS 10 and IAS 28 should be finalised without re-exposure.

Three of the fourteen IASB members noted that they needed to think further about whether or not they would dissent from the final amendments. None of the other eleven IASB members noted that they planned to dissent from the publication of the final amendments.

All IASB members confirmed that they were satisfied that all required due process steps to date that pertained to the publication of the final amendments to IFRS 10 and IAS 28 had been complied with.

No further comments were made.