Amendments to the Classification and Measurement of Financial Instruments

Date recorded:

Contractually linked instruments—sweep issue (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), including clarifying the scope and unique characteristics of contractually linked instruments (CLIs). In September 2022, the IASB tentatively decided that the unique characteristics of a CLI structure are the use of multiple CLIs with non-recourse features that establishes the prioritisation of payments through a waterfall payment structure and creates concentrations of credit risk resulting in a disproportionate allocation of losses between investors in the event of cash flow shortfalls.

However, after the tentative decision in September 2022, stakeholders asked how the non-recourse and CLI requirements are applied when there are only two debt instruments, and the borrower/sponsor (sponsor) of a special purpose entity (SPE) holds the junior debt instrument. 

SPEs are used to obtain a loan from a bank that is secured by specified assets of the sponsor. Even though the loan is made to the SPE, the bank negotiates the contractual terms with the sponsor. These structures can be set up such that the lender has recourse to the sponsor and therefore will not be a CLI. Alternatively, the sponsors investments in the SPE could be in the form of equity and again the structure will not be a CLI as there are no ‘multiple contractually linked instruments.’

However, if the sponsors investment in the SPE is a debt instrument, the structure might be considered a CLI, as it has multiple contractually linked instruments (senior and junior debt instruments), the debt could have non-recourse features, and there might be a waterfall payment structure.

The staff believe these lending arrangements are distinct from investments in CLIs as the ultimate counterparty to the lending bank is the sponsor. From the sponsor’s perspective, the SPE will be consolidated, resulting in the junior debt instrument being eliminated and the financing provided by the bank as the only debt instrument outstanding. The staff therefore believe that the debt instrument held by the sponsor does not constitute a separate debt instrument or ‘tranche’ when assessing whether a particular structure is within the scope of the CLI requirements.

Staff recommendation

The staff recommended clarifying that when determining whether a transaction is in the scope of the CLI requirements, an entity excludes any instruments held by the sponsor that has transferred the underlying assets to the issuer.

The staff asked the IASB if they agree with their recommendation.

IASB discussion

IASB members agreed with the staff analysis.

The paper discussed that if the sponsor is required or has the option to either increase its debt or equity investment then this could be indicative that the investor has recourse. An IASB member asked what the staff’s intention was with this element and whether it would be built into the description of ‘non-recourse’. The staff noted that they would like to provide more clarity on this and will build it into the standard or the Basis for Conclusions (BC). However, it was noted that if the investor has the option to increase debt or equity, this may not necessarily be considered recourse.

IASB decision

11 out of 11 voted in favour of the staff’s recommendations.

Accounting policy choice for derecognition of financial liabilities (Agenda Paper 16B)

In October 2022, the IASB considered possible standard-setting options for applying the derecognition requirements in IFRS 9 to the settlement of a financial asset or a financial liability via electronic cash transfers. The IASB tentatively decided to develop an accounting policy choice to allow an entity to derecognise a financial liability before it delivers cash on the settlement date when specified criteria are met.

The purpose of this paper was to further develop the criteria and scope of such an accounting policy choice.

Staff recommendation

To improve the consistent application of the requirements in IFRS 9, the staff recommend clarifying that an entity applies settlement date accounting when recognising and derecognising financial assets (except for regular way transactions) and financial liabilities.

With regards to the accounting alternative for derecognising a financial liability before settlement date, the staff recommended refining the criteria to require:

  • An entity to have no ability to withdraw, stop or cancel an electronic payment instruction
  • The entity to have lost the practical ability to access the cash as a result of the electronic payment instruction and
  • The settlement risk associated with the electronic payment instruction to be insignificant. For this to be the case, the payment system used must have the following characteristics: the period between the payment initiation date and settlement date is relatively short and is standardised for the particular payment system concerned and completion of the payment instruction follows a standard administrative process so that the debtor has reasonable assurance that the transfer will be completed, and the cash will be delivered to the creditor

The staff also continue to be of the opinion that the scope of an accounting alternative must be deliberately limited to particular types of transactions such as electronic payment systems that meet the specified criteria without otherwise changing the general derecognition requirements in IFRS 9.

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

IASB discussion

A few IASB members did not agree with the limitation to particular types of transactions. However, they believed that from a practical standpoint this might not have a significant impact.

In the paper, the staff note that the requirement to apply settlement date accounting when recognising and derecognising financial assets and financial liabilities is within IFRS 9. However, there is widespread diversity in practice. Therefore, the staff intend to clarify this point in IFRS 9. The staff confirmed that this clarification will be within the standard or the application guidance.

The paper also noted that the staff do not believe that the refinements noted could apply to receivables. IASB members did not agree with this point. However, the paper and the clarifications specifically relate to financial liabilities.

IASB members asked the staff to ensure that the background to this project is provided in the BC to ensure it is clear as to why these clarifications are being provided and how the IASB have reached their conclusion.

The staff asked the IASB if they agree that the same transition requirements being used for these clarifications as for the rest of the ED. IASB members requested that the staff include this as a question in the ED. IASB members noted that this could have significant impacts on corporates and therefore based on the responses may consider a different effective date for this clarification.

IASB decision

11 out of 11 voted in favour of the staff’s recommendations.

Due process steps (Agenda Paper 16C)

In October 2022, the IASB expanded the scope of its maintenance project for proposed narrow-scope amendments to IFRS 9 and IFRS 7. The IASB tentatively decided on the following amendments:

  • Clarification of:
    • The term ‘basic lending arrangement’ and how it applies to the assessment of whether a financial asset’s contractual cash flows are solely payments of principal and interest (SPPI)
    • How to apply the SPPI assessment to financial assets with contractual terms that change the timing or amount of contractual cash flows
    • The term ‘non-recourse’ and factors to consider when performing the SPPI assessment on financial assets with non-recourse features
    • The scope of the requirements relating to CLIs and the nature of eligible instruments in the underlying pool
  • Transition requirements for these clarifying amendments
  • Additional disclosure requirements for financial instruments with contractual terms that could change the timing or amount of contractual cash flows
  • Amendments to IFRS 7 for equity instruments to which the other comprehensive income (OCI) presentation option is applied, i.e. disclosure at the end of the reporting period of the aggregated fair value of such equity investments and of changes in the fair value of such equity investments recognised in OCI during the period
  • Amendments to permit an accounting policy choice that allows an entity to derecognise a financial liability before it delivers cash on the settlement date when specified criteria are met (subject to the IASB agreeing with the staff recommendation in Agenda Paper 16B)

The staff asked the IASB if they agree with the staff recommendation to have a comment period of 120 days for the Exposure Draft (ED).

The staff asked if any of the IASB members dissent from the publication of the ED.

The staff asked for permission to begin the process for balloting the ED.

IASB discussion

One IASB member requested reducing the comment period from 120 days to 90 days, given the feedback regarding the urgency around accounting for ESG loans. However, overall the IASB and the staff concluded that given the number of different issues in the ED and the fact that it is not specifically about ESG loans the comment period should stay at 120 days.

IASB decision

11 out of 11 voted in favour of the comment period of 120 days and gave permission to begin the balloting process. No IASB members indicated that they plan to dissent from the publication.

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