This site uses cookies to provide you with a more responsive and personalised service. By using this site you agree to our use of cookies. Please read our cookie notice for more information on the cookies we use and how to delete or block them.
The full functionality of our site is not supported on your browser version, or you may have 'compatibility mode' selected. Please turn off compatibility mode, upgrade your browser to at least Internet Explorer 9, or try using another browser such as Google Chrome or Mozilla Firefox.

Financial instruments with characteristics of equity

Date recorded:

Cover note (Agenda Paper 5)

The staff presented agenda papers 5A-5C, which have been refined based on feedback provided by the Board in the February 2021 meeting. The purpose of these papers is to enable the Board to make its decisions on the objectives and principles of the disclosure requirements and disclosures required to meet these objectives.

Terms and conditions disclosures (Agenda Paper 5A)

This paper sets out further refinements to the proposals on the terms and conditions disclosures.

The staff recommended, that for financial instruments with characteristics of both debt and equity, an entity would be required to disclose information about key terms and conditions that enables users of the financial statements to better understand:

  • (a) The nature, amount, timing and uncertainties of cash flows arising from these financial instruments issued
  • (b) Information about the financial instrument’s characteristics that do not affect its classification as equity or financial liabilities but is considered important to understand the nature of the financial instruments
  • (c) The reason for classification as financial liabilities or equity instruments, or compound instruments (e.g. why an instrument is classified as equity despite having debt-like features or why an instrument is classified as a financial liability despite having equity-like features)

To meet the above objectives, the staff recommended the following disclosures to be incorporated into IFRS 7 for financial instruments that have characteristics of both debt and equity (except for standalone derivatives):

  • (a) Debt-like features in financial instruments that are classified as equity
  • (b) Equity-like features in financial instruments that are classified as financial liabilities
  • (c) Debt-like and equity-like features that determine the classification of the financial instruments with characteristics of both debt and equity or the classification of components of compound financial instruments

The staff asked the Board whether they agree with their recommendations.

Board discussion

Overall, Board members agreed with the proposals and the main feedback points focused on the precision and clarity of the final wording.  

Another point of feedback for the staff was to be clearer on exactly what information in relation to voting rights is required. Currently, the staff have referred to ‘voting rights linked to the cash flows of the financial instruments’, however Board members felt this was too subjective and did not provide a sufficient level of guidance.

Board decision

All Board members voted in favour of the staff’s recommendation.

Disclosures—priority on liquidation (Agenda Paper 5B)

This paper set out further refinements to the proposals for priority on liquidation disclosures.

Based on research by the staff, the information needs of the users are:

  • (a) The need for greater visibility regarding the company’s capital structure
  • (b) The need to understand priority on liquidation of particular instruments to estimate the risk and return on the instruments

The staff recommended the following disclosures to be incorporated into IFRS 7 to meet the needs of the users outlined above.

  • (a) An entity would be required to disclose its capital structure disaggregated into categories to enable users of the financial statements to understand its capital structure and the quality of different categories of capital.
    • (i) In disclosing its capital structure, an entity would consider the particular combination of financial liabilities and equity instruments used to fund/finance its overall business activities and operations.
    • (ii) In disaggregating its capital structure to reflect differences in the quality of its capital, an entity would use its own judgment, including determining the terminology it uses to describe the various categories of capital but at a minimum, it would be required to categorise them in a way that distinguishes between:
      • 1. Secured and unsecured financial instruments
      • 2. Contractually subordinated and unsubordinated financial instruments
      • 3. Those issued/owing by the parent and those issued/owing by subsidiaries
  • (b) An entity would be required to provide information about priority on liquidation of financial instruments that have characteristics of both financial liabilities and equity instruments. The priority information should be provided as part of the terms and conditions disclosures and should include the following:
    • (i) Terms and conditions that indicate priority or that could lead to changes in priority (e.g. conversion features and contingent features) including when there is significant uncertainty about the application of relevant laws or regulations that could affect how priority will be determined at liquidation
    • (ii) When multiple subordination levels exist within a particular category (e.g. subordinated liabilities, perpetual instruments)
    • (iii) Describe intragroup arrangements such as guarantees that are relevant to understand the priority of material financial instruments
  • (c) An entity would provide the above information based on the carrying amounts of the instruments and if not otherwise clear, state in which line item in the statement of financial position the instruments are included.

The staff were planning on asking the Board whether they agree with their recommendations.

Board discussions

Board members wanted to understand the meaning of capital structure as it is not a defined term within IFRS Standards and believe that guidance should be provided to preparers of what this definition encompasses.  A Board member asked if they had tested the disclosure requirements for a financial institution, as there was a concern that in order to meet the requirements a significant level of disclosure would be required.

Overall, as Board members required more information, the staff decided not to ask the Board to vote on this paper and instead bring it back at a later meeting.  

Disclosures—potential dilution (Agenda Paper 5C)

This paper set out further refinements to the proposals for disclosures on potential dilution of ordinary shares. The objective of these disclosures is to enable users of financial statements to assess the potential dilution of ordinary shares arising from financial instruments that could be settled by delivering ordinary shares, for example convertible bonds and derivatives on own equity.

The staff recommended the following disclosures to be incorporated into IFRS 7, which will be required for all entities, both listed and unlisted, to meet the objectives of this paper:

  • (a) information about the maximum dilution of ordinary shares:
    • (i) Disclose the maximum number of additional ordinary shares that an entity could be required to deliver for each type of potential ordinary shares outstanding at the reporting date. Included in this number is the total number of share options outstanding (as required by IFRS 2) and the number of unvested shares to the extent it is known, at the reporting date
    • (ii) Disclose the minimum number of ordinary shares required to be repurchased
    • (iii) A narrative explanation of any significant changes in (i) and (ii) from the prior reporting period
  • (b) Disclose key terms and conditions relevant to understanding the likelihood of maximum dilution and the possibility for unknown dilution
  • (c) As a simplification, cross-refer to IFRS 2 disclosures for description of share-based payment arrangements, instead of estimating the maximum dilution, where the number of unvested shares or shares to be purchased is not yet known at the reporting date

The staff asked the Board whether they agree with their recommendations.

Board discussion

Board members requested that the term ‘committed buy back’, e.g. for when an entity is able to achieve offset to the maximum dilution, should be defined. Board members believe it should be a high bar to achieve this offset and hence should have a narrow definition.

In relation to disclosing the maximum dilution, the staff proposed to include the ‘number of unvested shares to extent it is known’ at the reporting date. However, Board members felt this could be misleading as if the amount was unknown and could be unlimited, it would be excluded. It was discussed, during the meeting, that as an alternative, for the items where there is no maximum dilution, it would be included in the disclosure table with a description stating unknown dilution. This would avoid any misunderstanding.

In determining the maximum number of additional ordinary shares, the paper allows an expedient where a company could use the current share price to estimate the maximum dilution when a variable number of shares is delivered. One Board member disagreed with the approach and said this should fall into the category of unknown dilution, but with an explanation of how it could be estimated. 

One Board member pointed out that the maximum dilution analysis included in this paper was simple to understand, however the downside of the simplicity is that it does not differentiate between the likelihood of occurrence. Therefore, a recommendation was that relevant terms and conditions should be included to allow investors to understand the likelihood of occurrence, e.g. by including strike prices.

One Board member did not support the staff’s conclusion, as they felt improvements would need to be made to the IFRS 2 disclosures, in order to support investors understanding of the numeric information provided. This was outside the scope of this project.

Board decision

12 of the 13 Board members voted in favour of the staff’s recommendation with the discussed amendments.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.