Contractual Cash Flow Characteristics of Financial Assets (Amendments to IFRS 9)

Date recorded:

General Requirements (Agenda Paper 16A)

In May 2022, the IASB decided to start a standard-setting project to clarify particular aspects of the IFRS 9 requirements for assessing a financial asset’s contractual cash flow characteristics (i.e. the ‘solely payments of principal and interest’ (SPPI) requirements).

Most respondents to the Request for Information (RFI) Post-implementation Review of IFRS 9—Classification and Measurement expressed the view that generally the SPPI assessment is working as intended, notwithstanding a few application challenges. Many respondents asked the IASB to permit financial assets with ESG-linked features to be measured at amortised cost. However, in June 2022, the IASB agreed that specific SPPI requirements should not be developed for ESG-linked features, but clarification should be provided as application guidance on the following aspects:

  • The concept of a basic lending arrangement
  • Whether and how the nature of a contingent event (i.e. the trigger for a change in the timing or amount of contractual cash flows) is relevant to determining whether the cash flows are SPPI
  • Examples in paragraphs B4.1.13 and B4.1.14 of IFRS 9 of applying the SPPI requirements to specific fact patterns (including adding additional examples for financial assets with ESG-linked features)

This paper provided the staff’s preliminary analysis of the first two concepts outlined above.

Staff analysis

IFRS 9 uses the term ‘basic lending arrangement’ to refer to an agreement whereby the lender lends a principal amount to the borrower for a specified term. In exchange, the lender has the contractual right to receive payments of principal and interest on the principal outstanding, representing compensation for risks and costs associated with lending the principal amount outstanding to the borrower during the term of the instrument. A basic lending arrangement does not represent an investment in or exposure to particular assets or cash flows that are not SPPI. Furthermore, a basic lending arrangement does not simply refer to a lending arrangement that is common or widespread in a particular market. 

The staff think it would not be appropriate to introduce a quantitative threshold to assess whether contractual terms that changes the timing or amount of contractual cash flows are SPPI. This is because the focus of the SPPI requirements is on what the entity is being compensated for and not how much. It would be helpful, however, to include additional examples of contractual terms that change the timing or amount of contractual cash flows that would be compatible with a basic lending arrangement and contractual terms that would not be consistent with a basic lending arrangement. The staff’s recommendations for applicable examples will be discussed at a future meeting.

This paper did not ask the IASB to make decisions but welcomes any questions and comments.

IASB discussion

IASB members agreed with the staff proposals. Specifically, they agreed that the focus should be on what the entity is being compensated for and if the repayments are driven by unrelated factors then amortised cost accounting ceases to provide valuable information. IASB members agreed that the application guidance will provide assistance in this area without amending the principles in IFRS 9.

IASB members agreed that the term ‘basic lending arrangement’ should be explained to ensure it is clear what the IASB intended by this phrase, as it is too embedded in IFRS 9 to be removed completely.

Financial assets with non-recourse features and contractually linked instruments (Agenda Paper 16B)

This paper provided an analysis of the characteristics of financial assets with non-recourse features and contractually linked instruments (CLIs) to inform possible amendments to IFRS 9 to clarify the requirements relating to the assessment of the contractual cash flow characteristics of such instruments.

In the June 2022 meeting, the IASB agreed that the key areas for clarification in relation to non-recourse features and the CLI requirements are:

  • The meaning and characteristics of non-recourse features
  • The meaning and scope of instruments to which the CLI requirements are applied
  • The requirements for the underlying pool of instruments for a CLI to have SPPI cash flows

This paper focused on the meaning and characteristics of non-recourse features and CLIs.

The term ‘non-recourse’ is used in IFRS 9 to refer to a contractual feature of some financial instruments (including, but not limited to CLIs) where the lender’s claim is limited to specified assets of the borrower or the cash flows from specified assets. Non-recourse does not refer to ‘normal’ collateralised debt where the lender has a claim on the borrower and in addition, the protection of the security.

The staff believe some application questions could be resolved by explaining the difference between non-recourse and full recourse financial assets, for example, non-recourse financial assets represent a direct or indirect investment in another asset and the creditor is exposed to the performance risk of the underlying asset; whereas full recourse loans collateralised by other assets constitute a debt investment in the borrower and the lender is primarily exposed to the credit risk of the borrower. In the event of default, the lender is only exposed to the performance risk of the underlying asset to the extent that the borrower is unable to make the contractual payments of principal and interest through other means.

Feedback on the scope of CLI requirements noted that there is confusion about whether the requirements for CLIs is applicable to other structures, especially financial assets with non-recourse features. It was argued that there are different classification outcomes depending on which requirements (general SPPI requirements or the CLI requirements) are applied to a particular financial asset and it is therefore important to have clarity on the intended scope of the CLI requirements.

The staff are of the view that the scope could be clarified with additional application guidance. The IASB intended CLIs to refer to financial instruments that have non-recourse features, are contractually linked, are subject to a waterfall payment structure and create concentrations of credit risk resulting from the disproportionate reduction in contractual rights in the event of cash flow shortfalls.

The staff asked the IASB if they have any questions or comments.

IASB discussion

IASB members were positive about the paper and appreciated the history of previous IASB discussions to explain why certain decisions were made. These previous agenda papers included good explanations and guidance which have never been included in the final standards and the IASB members believed it would be useful if these could be included. Therefore, they asked the staff to ensure any good explanations are included either in the implementation guidance, basis for conclusions or application guidance.

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