Deloitte Touche Tohmatsu Limited is pleased to respond to the International Accounting Standards Board’s (“the IASB”) IFRS Accounting Standard Exposure Draft, Financial Instruments with Characteristics of Equity (“the ED”).

We welcome the IASB’s efforts to improve the requirements for classification and disclosure of financial instruments with characteristics of equity. We welcome the efforts to reduce the existing diversity in the application of IAS 32. However, we have concerns that in several areas the proposed amendments may lead to new interpretation issues. In our detailed comments, we provide suggestions to minimise new interpretative issues and avoid fundamental changes in the classification of liabilities and equity where we consider that current practice is appropriate.

A significant proportion of questions that arise from applying IAS 32 is in respect of the fixed-for-fixed criteria. We welcome the explicit inclusion of the concepts of preservation and passage-of-time adjustments when applying the criteria. However, we believe the criteria we are concerned that the criteria used have been defined too narrowly such that many adjustments, which we believe should pass the criteria, will instead fail them.

As previously expressed in our comment letter to the discussion paper Financial Instruments with Characteristics of Equity, we believe that derivatives over own equity should be measured at fair value through profit or loss. This approach would avoid the issues associated with the gross obligation accounting. Whilst we acknowledge that the amendments proposed in the ED will reduce divergence in practice, many of the issues arising from the gross obligation accounting will remain. If the IASB retains this approach, we strongly believe that gains and losses from remeasuring obligations to purchase an entity’s own equity instruments at a future market price should be recognised in equity. The proposal that such gains and losses be recognised in profit or loss does not faithfully represent the economics of the transaction because arrangements in which the redemption price reflects the future market price of the underlying equity instruments result in an exchange of cash and equity of equal value.

In addition, we do not believe that financial liabilities with contingent cash flows should be measured ignoring the probability and estimated timing of occurrence of the contingent event. In our view this approach is conceptually flawed and fails to capture the economic substance of the related instruments, and therefore we believe that it would be more appropriate to measure such financial liabilities applying IFRS 9.

We support the proposal to clarify the effect of laws and regulations on the classification of financial instruments. However, we are concerned that some interpretation questions remain and we have suggested how these may be addressed through examples in the Illustrative Examples and Application guidance.

We welcome the introduction of disclosures of the terms and conditions of financial instruments containing characteristics of equity. Developments in financial engineering have led to an increasing sophistication and complexity of financial instruments which are not fully apparent from the amounts recognised in the financial statements. Disclosure of terms and conditions can help users better understand the economics of such instruments.

However, several other proposed disclosures are, in our view, not necessary and may not lead to meaningful information for the users. Specifically, we have concerns about the introduction of extensive disclosures of the nature and priority of claims on liquidation, particularly in the context of consolidated financial statements. The aggregation and ranking of claims on liquidity is unlikely to be meaningful when they involve claims on various legal entities within the consolidated group. Further, whilst we support disclosure of information on the dilutive effect of financial instruments, we believe it would be more proportionate to require this information to be disclosed only for entities that are required to apply IAS 33 Earnings Per Share. For entities not required to apply IAS 33 disclosure of the terms and conditions of financial instruments containing characteristics of equity should be sufficient.

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