Financial instruments with characteristics of equity

Date recorded:

The purpose of this session was to continue discussions on the Financial Instruments with Characteristics of Equity (FICE) project. The staff presented the following agenda papers:

  • a. Summary of discussions to date — Agenda paper 5A
  • b. Exception in Paragraphs 16A–16D of IAS 32 — Agenda paper 5B

The Board was asked to comment on the staff analysis and their recommendations.

Financial Instruments with Characteristics of Equity research project — Summary of discussions to date — Agenda paper 5A

Recap

The research phase of this project involved evaluating potential ways to improve the classification of liabilities and equity, and the related presentation and disclosure requirements. 

The Board explored the features to distinguish liabilities and equity: (i) the type of economic resources required to settle the claim; (ii) the timing of the transfer; (iii) the amount required to be transferred; and (iv) the priority of the claim relative to other claims. 

The Board had been developing an approach (labelled Gamma, see discussion in February 2016), which distinguished claims based on a combination of these features and would lead to outcomes broadly aligned with IAS 32. In October 2016, the Board tentatively decided that economic incentives that might influence the issuer's decision to exercise its rights should not be considered when classifying a claim as either a liability or equity.

Appendix A summarised three approaches and Appendix B summarised classification outcomes for some simple instruments under the proposed approaches.

Financial Instruments with Characteristics of Equity research project — Exception in Paragraphs 16A–16D of IAS 32 — Agenda paper 5B

Background

This paper considered whether the exceptions set out in IAS 32.16A and 16B (as well as 16C and 16D) (the ‘Puttables Exception’) should be retained given the classification and presentation requirements of the Gamma approach.

Staff analysis

Alternative 1 – Removing the Puttables Exception

Under the Gamma approach, a claim would be classified as a liability if (i) it required an entity to transfer economic resources at particular points in time other than at liquidation, (ii) for an amount that was not solely dependent on the residual amount. Accordingly, puttable instruments covered by IAS 32.16A and 16B would meet the definition of a liability under the Gamma approach because they could be put back to the issuing entity for economic resources at any time before liquidation. Furthermore, such instruments might not qualify for separate presentation under Gamma because IAS 32.16A(e) only required the settlement amount of such instruments to have a substantial dependency on the key drivers of residual amount, whereas Gamma required sole dependence on the residual amount for separate presentation.

The Staff further noted that the Gamma approach would address only some, but not all, of the concerns that led to the Puttables Exception in the first place.

The above analysis would apply equally to instruments covered by IAS 32.16C and 16D.

Alternative 2 — Retaining the Puttables Exception

Retaining the Puttables Exception would arguably address the concerns that led to their development in the first place. In addition, the Staff suggested keeping the related disclosure requirements in IAS 1.136A which addressed some of the shortcomings of the Puttables Exception, as well as to extend the IAS 1 disclosure requirements to instruments covered by IAS 32.16C and 16D.

Staff recommendation

The Staff intended to ask the Board whether it had any preference for retaining or removing the Puttables Exception. The Staff further recommended that the planned Discussion Paper (DP) ask the stakeholders about the prevalence of the application of the Puttables Exception in practice.

Discussion

The Board tentatively agreed not to remove the Puttables Exception subject to consultation to be put forth in the DP.

The Board started off with mixed views on whether the exception should be retained and whether consultation on the matter was needed. The discussion went along the following lines.

Given the tentative decision to date that Gamma was the preferred proposed approach to the liability/equity classification, the DP should fully expose its upsides and downsides, by noting that although Gamma might solve a number of problems that the Board had identified in the past, it did not solve all, with the issues that led to the Puttables Exception being one of them. Accordingly, constituents should be consulted on whether an exception was warranted in this case to achieve the desired outcome. Against that, it was submitted that any (good) new model should minimise the number of exceptions; however, a number of Board members noted that the aim of the FICE project was not to revamp the fundamentals of IAS 32 but rather to reinforce the underlying rationale of liability/equity classification that already existed in IAS 32 and to deal with practice issues. Removing the Puttables Exception would be inconsistent with either of those objectives. Furthermore, given that it was known that the Puttables Exception had pervasive application in certain jurisdictions (Germany), a number of Board members believed that it would be ineffective and inefficient to re-consult on this issue when constitutuents had already spent so much resource on it not so long ago and the Board expected that any tentative suggestion of removing the Puttables Exception would likely be met with fierce opposition and would lead to unnecessary unease and uproar for those affected. As the Puttables Exception was a ready-made solution to the identified issues, it was suggested that it should be retained.

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