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Financial Instruments Puttable at Fair Value

Date recorded:

Based on issues raised in the comment letters the Board continued its discussion on the Exposure Draft Financial Instruments Puttable at Fair Value and Obligations arising on Liquidation (ED).

The discussion focussed on the basic characteristics (principles) underlying the ED.

The staff outlined that an instrument addressed in the ED:

  • a. has a residual interest in that entity throughout the life of the instrument, and
  • b. participates fully in the performance of the entity throughout the life of the instrument.

In this context the Board raised the question what fair value is being referenced to in the ED; the fair value of the instrument or the fair value of the entity.

After a thorough discussion there seemed to be a consensus that the fair value referenced to in the ED should be the fair value of the instrument and that this fair value does not necessarily reflect the pro-rata share of the fair value of the entity. It was noted that in many cases in an 'ongoing business' (that is, not a limited life entity at the point of liquidation) the fair value of the instrument is determined based on a formula. The fair value of the entity is not determined or not determinable since the instruments are not listed. Accordingly, the 'formula value' is the only relevant market value to determine fair value.

The Board pointed out that in case the fair value of the instrument differs from the pro-rata share of the fair value of the entity the instrument does not participate fully in the performance of the entity and therefore characteristic b) would not be fulfilled. One Board member noted that the initial wording was discussed in relation to limited life entities only.

The Board decided to stick with the basic characteristics but to improve the wording in the ED; in particular to clarify the fair value implications discussed at this meeting. Senior staff noted that in summary the ED should make clear for the instruments in question that 'absent the put we have an equity instrument'.

In addition the Board agreed the following:

  • Partnership interests Personal guarantees by partners (either general or limited) should be disregarded for classification purposes and with regard to the ranking among the holders of the most residual class of instrument. Such personal guarantees should be considered to be separate contractual arrangements.
  • Presence of non-puttable instruments The Board decided to maintain the criteria set out in the ED relating to the presence of non-puttable instruments, i.e. one feature of being most residual is that if an instrument is puttable at fair value, then all other instruments in that class must also be puttable.
  • Minority interests The Board agreed to maintain the guidance in AG 29A of the ED with regard to the treatment of minority interest at consolidation level.
  • Identification of issue price for old instruments / transition guidance To be discussed at the June 2007 meeting.

The staff was directed to redraft the ED accordingly for discussion at a future meeting.

Correction list for hyphenation

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