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Financial Instruments – Classification of Instruments Denominated in a Foreign Currency

Date recorded:

IAS 32 Financial Instruments: Disclosure and Presentation establishes principles for classifying financial instruments. IAS 32.22 states that a contract that will be settled by the entity by delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash or another financial asset is an equity instrument. On the other hand, IAS 32.24 states that a contract that will be settled by the entity delivering or receiving a fixed number of its own equity instruments in exchange for a variable amount of cash or another financial asset is a financial asset or financial liability.

The issue discussed by the Board concerns the classification of the written option in a convertible bond denominated in a foreign currency (that is, a currency other than the functional currency of the entity issuing the bond). Such a bond allows the holder to convert the bond into a fixed number of the entity's equity instruments in exchange for a fixed amount of foreign currency.

Although the issue has been raised in the context of a convertible bond it applies equally to freestanding instruments i.e. to all contracts entered into by an entity to exchange a fixed number of own shares for a fixed amount of cash that is denominated in a foreign currency. Such contracts can be simple forward agreements or options on own equity. Consequently, the implications of the issue go beyond just convertible bonds.

The majority of Board members were sympathetic to the fact that convertible bonds that are 'genuinely' issued in a foreign currency because investors operate in that foreign currency should be allowed the equity treatment. The Board was however, concerned about providing an exception as this would have to be restricted sufficiently in order to avoid structuring opportunities. Board members also indicated that the question of whether equity has a currency (that is, as equity is a residual item, is it subject to normal functional currency considerations) should be answered but that this would be addressed in the Liability / Equity project. The Board agreed to explore an amendment to IAS 32 but wanted to understand better the potential structuring opportunities that could arise before proceeding.

The Board indicated that should it decide to allow equity classification that it should be made clear that the foreign currency exposure could not be hedged under IAS 39 as there is no profit or loss impact on the equity item.

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