Financial instruments with characteristics of equity (FICE)

Date recorded:

Cover Note (Agenda Paper 5)

The staff presented three agenda papers to the Board which sets out proposed amendments to IAS 32 and asks for tentative decisions from the Board.

The staff plan to bring their analysis and recommendations on the classification of financial instruments that are subject to shareholders’ discretion to a future meeting.

Contingent settlement provisions: compound financial instruments (Agenda Paper 5A)

The staff recommended that the Board proposes the following amendments to IAS 32 for financial instruments with contingent settlement provisions as described by paragraph 25 of IAS 32:

  • To clarify some financial instruments with contingent settlement provisions may be compound instruments:
    • Require the compound instrument requirements in paragraph 28 to be applied before any specific classification requirements in IAS 32
    • Add a reference to a ‘liability component’ to paragraph 25 of IAS 32
  • To clarify the measurement requirements for the liability component of a compound financial instrument with contingent settlement provisions that could require immediate settlement in a way that it would be a financial liability upon a contingent event occurring:
    • Incorporate the statements about measurement in paragraph BC12 of the Basis for Conclusions on IAS 32 (full amount of the conditional obligation for instruments with contingent settlement provisions) into the requirements in IAS 32
    • Require the ‘full amount of the conditional obligation’ to be defined as the amount repayable assuming the earliest possible repayment date, i.e. immediate repayment for financial instruments where the contingent event could occur immediately
    • Require that the financial liability is accounted for consistently both for classification and measurement purposes irrespective of whether settlement depends on the holder of the instrument or an event outside the control of both parties
  • To clarify that payments at the discretion of the issuer are recognised in equity even though all the proceeds are initially allocated to the liability component:
    • Clarify that a compound instrument with a zero-value equity component is still a compound instrument with a liability and an equity component
    • Clarify that the requirement on dividends paid on compound instruments in paragraph AG37 of IAS 32 applies even if the equity component is initially measured at zero.

The staff asked the Board if they agree with their recommendations.

Board discussion

Board members agreed with the analysis in the staff’s paper and found that it was logical to follow and helpful. Many Board members said they are keen to see the presentation and disclosures in a future meeting.

Board decision

12 Board members voted in favour of the staff’s recommendation.

Contingent settlement provisions: the meaning of ‘liquidation’ and ‘non-genuine’ (Agenda Paper 5B)

The staff recommended that the Board proposes that the following amendments to IAS 32:

Liquidation:

Specify that the term ‘liquidation’ in paragraph 25(b) of IAS 32, refers to when an entity has started the process to permanently cease to trade. This clarification would be consistent with the Conceptual Framework and IAS 1. Clarifying the term ‘liquidation’ would improve the consistency in classification of financial instruments that contain obligations that arise on events that may seem similar to, but are not, liquidation. Doing so would help reduce diversity in practice. Classifying those financial instruments as financial liabilities would provide users of the financial statements with useful information about the entity’s exposure to liquidity risk and its potential cash outflows in liquidation.

The staff asked the Board if they agree with the potential clarification.

Non-genuine:

Specify that the assessment of whether a contractual term is ‘not genuine’ in paragraph 25(a) of IAS 32, is not purely a probability-based assessment. This would clarify that entities are required to apply judgement based on the specific facts and circumstances and the specific terms and conditions of the financial instrument. The staff do not recommend providing further clarification on how to do the assessment or expand or narrow the definition of ‘non-genuine’ to address the various circumstances that could arise in practice.

The staff asked the Board if they agree with the potential clarification.

Board discussion

Overall, Board members agreed with the staff recommendation but provided feedback on the wording used in the amendment to ensure it is interpreted correctly.

For liquidation, the words ‘an entity has started the process’ might be too specific in relation to the point in time the process starts, rather than focusing on payments that will only be required as part of the liquidation process, once you have irrevocably committed to the wind up.

The Board also mentioned that ‘cease to trade’ might be misinterpreted and it might be better to say ‘cease trading and operations’.

For the non-genuine description, Board members highlighted that in practice judgement needs to be applied however it is generally applied sensibly. The wording could be adjusted slightly to say ‘the probability based assessment is not determinative’ rather than ‘is not purely a probability assessment’. Board members highlighted that non-genuine is less about the likelihood of an event occurring but more about the nature of the event, i.e. the event is highly abnormal or unimaginable. A small number of Board members pointed out that on translation the current wording might be misunderstood and requested that some examples are added to provide guidance on the interpretation. The staff said that they are cautious to add an example, as in general this concept is applied sensibly in practice.

Board decision

12 Board members voted in favour of the staff’s recommendation.

The effects of laws on contractual terms (Agenda Paper 5C)

This paper considered the question as to whether and if so, to what extent, an entity would be required to consider the effect of applicable laws in classifying financial instruments as financial liabilities or equity instruments.

The staff recommended that the Board proposes amendments to IAS 32 to require an entity to consider the following effects of applicable laws when classifying financial instruments as financial liabilities or equity:

  • For terms that are explicitly stated in the contract, only the terms that give rise to rights and obligations that are in addition to, or more specific than, those established by applicable law would be considered. In other words, if a legal obligation exists irrespective of whether it is explicitly included in the contract, an entity would not consider such an obligation when classifying financial instruments
  • The effects of applicable laws that prohibit the enforceability of a contractual right or a contractual obligation

The staff recommended the Board require an entity not to separate a single obligation into two liabilities i.e. a financial and a non-financial liability when applying the above recommendation.

The staff highlighted that legal rights and obligations that an entity does not take into account for classification purposes would still need to be accounted for. Other accounting standards (other than IAS 32) may be applicable.

Based on feedback from stakeholders the staff do not expect that applying the principles discussed in this paper would result in significant changes in how financial instruments are classified.

The staff plan to analyse the need for any additional disclosures once the Board completes its deliberations on the classification topics. Potential disclosures in this area could include for example, disclosures of legal requirements that could affect the timing and amount of future cash flows of financial instruments issued by an entity even if they do not affect their classification. The staff plan to analyse further whether additional disclosures would be beneficial and present this analysis at a future meeting.

The staff asked if the Board if they agree with their recommendations.

Board Discussion

Overall, Board members agreed with the staff’s recommendation but made suggestions in relation to the wording and suggestions of key clarification points to include in the amendments.

For example, for the following staff recommendation ‘not to separate a single obligation into two liabilities’, Board members suggested that the wording should be ‘not to separate a term into two components’.

In addition, in the sentence ‘The effects of applicable laws that prohibit the enforceability of a contractual right or a contractual obligation’ the Board suggested to use the word ‘prevent’ rather the ‘prohibit’.

Board decision

12 Board members voted in favour of the staff’s recommendation.

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.