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IAS 32 — Classification of mandatorily convertible instruments subject to a cap and a floor with an issuer option to convert into the maximum (fixed) number of shares

Date recorded:

The Committee received two requests on how to classify a financial instrument that is mandatorily convertible into a variable number of the issuer’s own shares, subject to a cap and a floor on the number of shares to be delivered. The issuer has the contractual right to settle the instrument at any point before maturity by delivering the maximum number of shares (fixed by the cap).

In July 2013, the IFRS Interpretations Committee tentatively decided that the existing requirements are sufficiently clear and therefore not to add this issue to its agenda. Six comment letters were received and most of them supported the agenda decision. One respondent, however, suggested adding the issue to the agenda.

Nonetheless, the project manager recommended the IFRS IC to finalise the agenda decision.

The Committee discussed that it should be assessed whether the early settlement option was substantive. The Standard is clear that clauses that are not substantive are not taken into account when deciding whether a financial instrument is an equity instrument or a financial liability.

While most of the Committee members agreed with the staff’s recommendation, some were concerned that the wording used in the tentative agenda decision might have some unintended consequences.

One Committee member was worried that the notion in the tentative agenda decision that it is not appropriate for the issuer to assess the substance of the issuer’s early settlement option solely by applying IAS 32.20(b) might implicate that this is also not appropriate for other kinds of instruments (e.g. reverse convertible bonds). It could be read from the tentative agenda decision that, for example, for reverse convertible bonds, there needs to be an assessment that goes beyond IAS 32.20(b). This is unintended in the Committee member’s view.

Another Committee member said that the wording should reflect that it is required in IAS 32.20(b) that the share-settlement option substantially exceeds the value of the cash-settlement option while in the current issue it may not always be the case that the fixed settlement option substantially exceeds the variable settlement option and that therefore there needs to be more analysis, e.g. how big the difference between both options is.

The Committee discussed in detail which parts of the tentative agenda decision should be deleted. It was discussed whether economic compulsion should play a role in classification. However, this was rejected by most Committee members, although economic compulsion might be substantive.

The Committee concluded that it supports to follow the staff’s recommendation but – in general – should be less detailed in the agenda decision to avoid unintended consequences.

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