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Financial Instruments with Characteristics of Equity (FICE)

Date recorded:

Cover Note (Agenda Paper 5)

The purpose of Agenda Papers 5A-5D was to set out potential disclosures that could be developed as part of the FICE project. The Board was not asked to make any decisions on these papers.

The objective of Papers 5E-5F was to begin the Board’s discussion on the classification of particular financial instruments that contain obligations that arise only on liquidation of the entity. The Board was asked if it agrees with the staff’s preliminary view on this topic.

Disclosures: Outreach feedback and research findings (Agenda Paper 5A)

This paper provided background information on the disclosures part of the FICE project, summarised the additional outreach conducted with stakeholders and presented the findings from the staff’s research on regulatory disclosures provided by banks and insurers.

Board discussion

One Board member asked if the key takeaway from this paper was that it confirms that the regulatory disclosures did not contain all the information the Board are looking to include in these new disclosures and therefore it is important to continue with this project. The staff confirmed this.

Another Board member asked the staff to present, at a later point in the project, the main differences between the disclosures the Board are discussing and  the regulatory disclosures.

Potential refinements — Priority on liquidation (Agenda Paper 5B)

This paper recapped some of the key concerns raised and suggestions made by stakeholders on proposals related to disclosure of the priority of financial liabilities and equity on liquidation of the entity, either in the statement of financial position or the notes, as set out in Discussion Paper DP/2018/1 Financial Instruments with Characteristics of Equity (2018 DP). It also presented potential refinements, including an example, to address some of these concerns and suggestions and feedback from additional outreach conducted with stakeholders to discuss these potential refinements. Based on the feedback from the Board, the staff plan to analyse further aspects of the disclosures and look for ways to reduce the scope of the disclosure.

Board discussion

Board members agreed with the idea of focusing on individual entities rather than the consolidated position. However, they raised concerns around usefulness if the disclosures focused only on external claims not including intragroup claims and focused on financial instruments and not including non-financial items. A Board member raised a concern around the focus on individual entities for very complex groups as the disclosures could be onerous.

Board members agreed that the scope of this project would need to be looked at in detail. In order to scope the project, it would be important to get a better understanding from investors around how they will use this information and what information is important. This will enable the Board to work out which instruments to focus on and it would also help justify to preparers that there is real investor need for this information. Board members stressed that it is important to have a clear disclosure objective, however if there are changes to the scope or when different alternatives are explored, it would be useful to show how that would narrow or change disclosure objective.

Board members wanted to ensure replication is avoided. Regulated entities already provide a large amount of information, so it would be important to try and tie into that information as much as possible.

One Board member raised the issue of, and requested further information about, how to address uncertainty arising from legal effects and that, if different entities address it differently, it would reduce comparability between the accounts.

Potential refinements — Potential dilution (Agenda Paper 5C)

The paper recapped some of the key concerns raised and suggestions made by stakeholders on the proposals related to potential dilution of ordinary shares set out in the 2018 DP. It then presented potential refinements to address some of these concerns and suggestions. The staff also provided feedback from additional outreach conducted with stakeholders to discuss these potential refinements. Based on the feedback from the Board, the staff plan to further analyse aspects of the disclosures and plan to illustrate how to calculate the maximum number of additional ordinary shares that an entity could be required to issue to settle financial instruments outstanding at the reporting date.

Board discussion

Board members agreed that this disclosure would not replace the IAS 33 diluted earnings per share (EPS) figures and would be showing different figures. Board members did not agree that focusing the maximum dilution on financial instruments and excluding the IFRS 2 share settlement instruments would provide useful information. One reason was that for digital reporting it would be important to disclose one maximum dilution figure. Board members asked the staff to think about this further to understand how the numbers could be linked.

Potential refinements — Terms and conditions (Agenda Paper 5D)

The paper recapped some of the key concerns raised and suggestions made by stakeholders on the proposals related to the terms and conditions affecting the amount and timing of cash flows of both financial liabilities and equity instruments set out in the 2018 DP. It then presented potential refinements to address some of these concerns and suggestions. The staff also provided feedback from additional outreach conducted with stakeholders to discuss these potential refinements. Based on the feedback from the Board, the staff plan to further analyse aspects of the disclosures.

Board discussion

Board members highlighted that the scope of this disclosure should focus only on material information. In order to scope this it would be important to know what investors need to understand. The scope may need to be broader than financial instruments for which classification involves significant judgement. For example, it may need to be in relation to specific features, i.e. where a financial instrument has a term where it converts into shares or is perpetual. In terms of voting rights, Board members believe this would be too broad, but potentially a subset of particular voting rights might be useful. If the scope remains as financial instruments for which classification involves significant judgement, then guidance should be provided as to which judgements would be considered significant.

Obligations that only arise on liquidation of the entity — Background, outreach feedback and research findings (Agenda Paper 5E)

The purpose of this paper was to begin Board discussions on the classification of financial instruments that contain obligations that arise only on liquidation of the entity. Applying IAS 32:16 these would be classified as equity. Based on the 2018 DP the classification of these would change, at least in part, and would be classified as financial liabilities. Concerns were raised by issuers of and investors in these types of instruments about the potential classification change. In Agenda Paper 5F, the staff explore alternatives to address the concerns.

Obligations that only arise on liquidation of the entity — Potential solutions (Agenda Paper 5F)

The Board’s objective was to limit changes in classification to situations where there is clear evidence that a different classification would provide information that is more useful to the users of financial statements compared to the current classification. Feedback from users of financial statements showed that users reach their own conclusions about the classification of these instruments regardless of the entity’s classification in the financial statements. Equity analysts indicated that for their analyses they treat these as debt. However, as a compromise, they have said that if equity classification is retained, separate presentation of these instruments and additional disclosure in the notes would be useful. The staff believe that the information needs of users of financial statements could be met by supplementing the existing IAS 32 classification requirements with new presentation and disclosure requirements rather than changing the classification.

The staff asked the Board whether it agrees with the staff’s preliminary view that it should consider developing presentation and disclosure requirements instead of changing the classification requirements for instruments that contain obligations that only arise on liquidation.

Board discussion

Board members agreed that improved disclosure would be a better solution than changing the IAS 32 classification requirements. Different stakeholders have different views on which financial instruments are financial liabilities vs equity and therefore improving the explanation of these in the accounts would be helpful. It would be important to highlight key terms and conditions, for example coupons, currency exposure, and step up features.

Board Decisions

12 of the 13 Board members voted in favour of the staff’s preliminary view.

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