Financial instruments with characteristics of equity

Date recorded:

Financial Instruments with Characteristics of Equity research project- Agenda paper 5

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) Alternative settlement outcomes within the control of the entity – 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


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

The Board has 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 has been developing an approach (labelled Gamma, see discussion in February 2016), which distinguishes claims based on a combination of these features and would lead to outcomes broadly aligned with IAS 32. In September 2016, the Board discussed approaches to applying the separate presentation requirements to derivatives on ‘own equity’ that are neither completely independent nor solely dependent on the residual amount, as well as disclosures of financial instruments with characteristics of equity.

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

Financial Instruments with Characteristics of Equity research project - Alternative settlement outcomes within the control of the entity - Agenda paper 5B


This paper discussed whether economic compulsion should be considered when classifying as liability or equity claims that grant the issuer the right to choose between two settlement alternatives. The paper looked at some issues that have come to the Board or Interpretations Committee, such as a convertible bond that is convertible into a fixed number of shares at the issuer’s option (‘a reverse CB’). The paper assessed whether economic incentives can be so persuasive that an instrument should be classified in a particular way. The paper assumed that there are no legal or regulatory barriers to consider so that the discussion can focus solely on economic compulsion.

Staff analysis

View A—economic incentives should not be considered. This is consistent with the IAS 32 principle of classifying as equity those claims where the entity has an unconditional right to avoid transferring cash or other financial assets based on an assessment of the entity’s contractual rights and obligations. In response to the counterintuitive point raised by the proponents of view B, the Staff believes that the existing guidance in IAS 32.20 covers cases where the cash alternative is structurally always favourable to the equity settlement alternative from the issuer’s perspective: IAS 32.20 requires such claims to be classified as a financial liability.

View B— economic incentives should be considered. Although this is inconsistent with IAS 32’s underlying principles, the Staff notes that some parties continue to believe that it is counterintuitive to classify as equity a reverse CB that is highly likely to be settled in cash (e.g. when the fair value of the share settlement alternative significantly exceeds that of the cash alternative), and vice versa for a CB that is convertible at the holder’s option. Furthermore, the Conceptual Framework ED proposes that an entity has an obligation to transfer an economic resource if the entity has no practical ability to avoid the transfer, an example of which is if any action to avoid the transfer would have economic consequences significantly more adverse than the transfer itself (the interpretation of ‘practical ability to avoid’ will be redeliberated at a future Board meeting), potentially supporting a view that a sufficiently favourable liability settlement outcome as compared to the equity alternative might establish a financial liability. However, this view begs the following questions:

  1. How significant does an economic incentive need to be for the entity to be ‘economically compelled’ to transfer economic resources?
  2. When should the assessment of economic compulsion be performed and how often, if at all, should it be reassessed, bearing in mind the significance of the economic incentive will change in response to market changes?
  3. Should the assessment be made based on the economic conditions existing at assessment date, or should it take into account expected future changes to those economic conditions?
  4. Should economic incentives also be considered for the classification of claims where the holder of the instrument has the choice of settlement?

Staff recommendation

The Staff recommended view A.


The Board approved the Staff recommendation.

The Board strongly supported the analyses in the agenda paper. They acknowledged that it would be complex and judgemental if one were to apply the ‘no practical ability to avoid’ concept in classifying a claim (i.e. view B). One Board member gave the example of an entity that had historically declared dividends might run the risk of not having any equity in the statement of financial position under view B. Furthermore, some Board members believed that reassessments must be done under view B and this might lead to flip-flopping between equity and liability classification which was not ideal.

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