Financial instruments with characteristics of equity

Date recorded:

Project Plan (Agenda Paper 5)

At the October 2019 Board meeting, the Board discussed the project plan for the FICE project. In particular, the Board discussed the practice issues that it could address in the scope of the project and an indicative project timeline outlining the expected commencement of Board deliberations on each issue.

The objective of this paper was to begin the Board’s discussion on the classification of financial instruments that will or may be settled in the issuer’s own equity instruments (both derivative and non-derivative instruments). In particular, the staff explored as part of this discussion what clarifications could be made to the underlying principle of the fixed-for-fixed condition.

In the paper, the staff examine the current requirements in IAS 32 as well as the history of the development of the fixed-for-fixed condition. The staff then analyse practice questions arising in this regard and propose clarifications to the principle underlying the fixed-for-fixed condition including an explanation of how those clarifications would be applied. Based on that, the staff conclude with a preliminary view.

Staff preliminary view

At a future meeting, the staff plan to recommend adding clarifications to the requirements in IAS 32:16 to explain the rationale of the fixed-for-fixed condition and provide guidance on how it should be applied. At this stage, the staff are considering the following clarifications:

  • a) A derivative on own equity that meets the fixed-for-fixed condition should have a fair value on the settlement date (settlement value) that is:
    • i) affected only by fluctuations in the price of the underlying equity instruments (exposed to equity price risk); and
    • ii) not affected by fluctuations in other variables that the holder of the underlying equity instruments would not be exposed to (not exposed to other risks).
  • b) If a derivative is subject to any adjustments to the amount of cash or another financial asset, or the number of own equity instruments, the adjustments would not preclude the derivative from meeting the fixed-for-fixed condition if the adjustments:
    • i) preserve the relative economic interests of the derivative holder and the underlying equity instrument holder (‘preservation adjustments’); or
    • ii) compensate the issuer for the fact that the derivative will be settled at a future date (‘passage of time adjustments’).

No decisions were asked at this meeting.

Board discussion

The Board agreed with the staff’s analysis that the proposed clarifications in IAS 32:16 should be considered from the perspective of the issuer of the instrument given that the obligations lie with the issuer. However, that the exceptions described in this paper should be considered from the perspective of the derivative holder. A Board member suggestion to remove the word ‘only’ from paragraph (a) i. of the proposed clarifications to result in the desired outcome of the proposals was generally supported. Another Board member suggested that the fundamental principle for the fixed-for-fixed criterion should be “adjustments that favour the derivative holder at the expense of the underlying equity holders which go beyond the purposes of a ‘preservation adjustment’ or a ‘passage of time’ adjustment.” However, the staff mentioned that there may be situations where this is not the case and would therefore not use this definition as a fundamental principle but rather as a starting point in assessing whether an instrument meets the fixed-for-fixed criterion. The Board asked the staff to clarify that if there is a possibility that the issuer would have to give away more value to the derivative holder, one would have to consider whether these are preservation adjustments or passage of time adjustments. A Board member was concerned that preservation adjustments as described in this paper could be interpreted as an exhaustive list and suggested that additional guidance should be provided about preservation adjustments.

No decisions were made.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.