absorb the first losses and to receive any residual return from the investee. One of the equity investors who
holds 30% of the equity is also the asset manager. The investee uses its proceeds to purchase a portfolio of
financial assets, exposing the investee to the credit risk associated with the possible default of principal and
interest payments of the assets. The transaction is marketed to the debt investor as an investment with minimal
exposure to the credit risk associated with the possible default of the assets in the portfolio because of the
nature of these assets and because the equity tranche is designed to absorb the first losses of the investee.
Consolidated financial statements 383
The returns of the investee are significantly affected by the management of the investee’s asset portfolio,
which includes decisions about the selection, acquisition and disposal of the assets within portfolio guidelines
and the management upon default of any portfolio assets. All those activities are managed by the asset
manager until defaults reach a specified proportion of the portfolio value (i.e. when the value of the portfolio
is such that the equity tranche of the investee has been consumed). From that time, a third-party trustee
manages the assets according to the instructions of the debt investor. Managing the investee’s asset portfolio
is the relevant activity of the investee. The asset manager has the ability to direct the relevant activities until
defaulted assets reach the specified proportion of the portfolio value; the debt investor has the ability to direct
the relevant activities when the value of defaulted assets surpasses that specified proportion of the portfolio
value. The asset manager and the debt investor each need to determine whether they are able to direct the
activities that most significantly affect the investee’s returns, including considering the purpose and design
of the investee as well as each party’s exposure to variability of returns.
Example 6.6 below illustrates a structured entity in which there is more than one
activity that affects the investee’s returns.
Example 6.6:
Identifying relevant activities in a structured entity
A structured entity buys dollar-denominated assets, issues euro-denominated notes, and hedges the cash flow
differences through currency and interest rate swaps. The activities that affect the structured entity’s returns include:
• sourcing the assets from the market;
• determining the types of assets that are purchased;
• deciding how the structure is hedged; and
• managing the assets in the event of default.
If each of these activities is managed by different investors (e.g. one investor manages the assets in the event
of default, but a different investor determines the types of assets that are purchased), it is necessary to
determine which activity most significantly affects the structured entity’s returns.
When there are multiple activities that significantly affect an investee’s returns, but
those activities are all directed by the same investor(s) (which is frequently the case
when those activities are directed by voting rights), it is not necessary to determine
which activity most significantly affects the investee’s returns because the power
assessment would be the same in each case.
4.1.2
No relevant activities
We believe that structured entities for which there is no substantive decision making
are rare. That is, we believe virtually all structured entities have some level of decision-
making and few, if any, are on ‘autopilot’. Even if a structured entity operates on
‘autopilot’ there may be decisions outside the predetermined parameters that may need
to be taken if an expected return fails to materialise which could significantly affect the
returns of the entity and therefore be relevant activities.
In practice, many entities that may initially have few if any relevant activities can be
terminated by at least one of the parties involved in the structure. In this case the choice
of whether to terminate may often be viewed as the relevant activity. IFRS 10 would
most likely result in such entities being consolidated by an investor that has the power
to dissolve the entity, if this power would affect its variable returns. See 4.6 below for
additional guidance on evaluating relevant activities for structured entities and 6.3.2
below for additional guidance on liquidation and redemption rights.
However, if a structured entity truly has no decision-making then no investor controls
that structured entity. This is because no investor has power over the structured entity,
384 Chapter
6
that is, no investor has the current ability to direct the activities that significantly affect
the structured entity’s returns if there are no relevant activities after inception
significantly affecting those returns. As discussed above, we believe that such situations
where there is no substantive decision-making are rare. An example of a structured
entity over which no investor had power was included in the IASB’s publication, Effect
analysis: IFRS 10 – Consolidated Financial Statements and IFRS 12 Disclosure of
Interests in Other Entities. However, this example caused controversy and the Effect
Analysis was re-issued in 2013 with the example deleted.4
4.1.3
Single asset, single lessee vehicles
Some structured entities are single asset, single lease vehicles created to lease a single
asset to a single lessee. Between November 2014 and May 2015, the Interpretations
Committee discussed requests for clarification about the interaction of IFRS 10 and
IAS 17 – Leases – in two situations which involved the establishment of a structured
entity to lease a single asset to a single lessee.
In the first situation, the lease between the structured entity and the lessee was an
operating lease and the question was whether the lessee should consolidate the
structured entity. In the second situation, the lease between the structured entity and
the lessee was a finance lease and the question was whether the junior lender of the
structured entity should consolidate the structured entity. In both situations, the
consolidation decision would be based on an assessment of whether the entity controls
the structured entity. The Interpretations Committee was asked whether the lessee’s
use of the leased asset was a relevant activity of the structured entity when assessing
power over the structured entity.
The Interpretations Committee was of the view that the lessee’s right to use the asset
for a period of time would not, in isolation, typically give the lessee decision-making
rights over the relevant activities of the structured entity and hence would not typically
be a relevant activity of the structured entity. This is because on entering into a lease,
regardless of whether it is a finance lease or an operating lease, the structured entity
(lessor) would have two rights – a right to receive lease payments and a right to the
residual value of the leased asset at the end of the lease. Consequently, the activities
that would affect the structured entity’s returns would relate to managing the returns
derived from those rights; for example, managing the credit risk associated with the
lease pa
yments or managing the leased asset at the end of the lease term (for example,
managing its sale or re-leasing). How the decision-making relating to those activities
would significantly affect the structured entity’s returns would depend on the particular
facts and circumstances.
The Interpretations Committee noted that its conclusion does not mean that a lessee
can never control the lessor. For example, a parent that controls another entity for other
reasons can lease an asset from that entity. Further, in assessing control, an entity would
consider all of the rights that it has in relation to the investee to determine whether it
has power over that investee. This would include rights in contractual arrangements
other than the lease contract, such as contractual arrangements for loans made to the
lessor, as well as rights included within the lease contract, including those that go
beyond simply providing the lessee with the right to use the asset.
Consolidated financial statements 385
As a result, the Interpretations Committee concluded that the principles and guidance
within IFRS 10 would enable a determination of control to be made based on the
relevant facts and circumstances of the scenario and it is not its practice to give case-
by-case advice on individual fact patterns. Consequently, the Interpretations
Committee concluded that neither an Interpretation nor an amendment to a Standard
was required and decided not to add these issues to its agenda.5
4.1.4
Management of assets in the event of default
The management of defaults on assets held by a structured entity will frequently be a
relevant activity for that entity (see Example 6.5 at 4.1.1 above). However, in practice, if the
assets held by the structured entity are bonds, the activities of a decision-maker that is
contracted to manage any defaults may be limited to voting at creditors’ meetings, as an
independent administrator would be appointed to manage the bond default on behalf of all
bond holders. Whether the decision-maker has power (i.e. the current ability to direct the
management of defaults) or not will probably depend on the size of the structured entity’s
holding in the individual bonds that have defaulted. The greater the holding, the more
likely the decision-maker may be able to control decision-making in a creditors’ meeting.
4.2 Existing
rights
Once the relevant activities are identified, the next step is to determine which investor,
if any, has the current ability to direct those activities (i.e. who has the power).
Sometimes, assessing power is straightforward, such as when power over an investee is
obtained directly and solely from the voting rights that stem from holding voting
interests (e.g. shares), and can be assessed by considering the voting rights from those
shareholdings. In other cases, the assessment is more complex and requires many
factors to be considered (e.g. instances when power is embedded in one or more
contractual arrangements). [IFRS 10.11].
Power arises from rights. To have power over an investee, an investor must have
existing rights that give the investor the current ability to direct the relevant activities.
The rights that may give an investor power can differ between investees. [IFRS 10.B14].
Examples of rights that, either individually or in combination, can give an investor
power include but are not limited to:
(a) rights in the form of voting rights (or potential voting rights) of an investee;
(b) rights to appoint, reassign or remove members of an investee’s key management
personnel who have the ability to direct the relevant activities;
(c) rights to appoint or remove another entity that directs the relevant activities;
(d) rights to direct the investee to enter into, or veto any changes to, transactions for
the benefit of the investor; and
(e) other rights (such as decision-making rights specified in a management contract)
that give the holder the ability to direct the relevant activities. [IFRS 10.B15].
Generally, when an investee has a range of operating and financing activities that significantly
affect the investee’s returns and when substantive decision-making with respect to these
activities is required continuously, it will be voting or similar rights that give an investor
power, either individually or in combination with other arrangements. [IFRS 10.B16].
386 Chapter
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4.2.1
Evaluating whether rights are substantive
For a right to convey power, it must provide the current ability to direct the relevant
activities. An investor, in assessing whether it has power, considers only substantive
rights relating to the investee (held by the investor and others). For a right to be
substantive, the holder must have the practical ability to exercise the right. [IFRS 10.B22].
An investor that holds only protective rights (see 4.2.2 below) does not have power over
an investee, and consequently does not control the investee. [IFRS 10.14]. Whether rights
are substantive depends on facts and circumstances. The table below (although not
exhaustive) describes the factors that should be considered. [IFRS 10.B23].
Figure 6.4:
Factors to consider in assessing whether a right is substantive
Factors Examples
●
Are there barriers (economic, operational or
●
Financial penalties
otherwise) that would prevent (or deter) the
●
High exercise or conversion price
holder(s) from exercising their right(s)?
●
Narrow exercise periods
●
Absence of a mechanism to exercise
●
Lack of information to exercise
●
Lack of other parties willing or able to take over or
provide specialist services
●
Legal or regulatory barriers (e.g. where a foreign
investor is prohibited from exercise)
●
Do the holders have the practical ability to exercise
●
The more parties necessary to come together to
their rights, when exercise requires agreement by
exercise this right, the less likely that the right is
more than one investor?
substantive
●
A mechanism is in place that provides those parties
with the practical ability to exercise their rights
collectively if they choose to do so
●
An independent board of directors may serve as a
mechanism for numerous investors to act
collectively in exercising their rights
●
Would the investor that holds the rights benefit
●
A potential voting right is in-the-money
from their exercise or conversion?
●
An investor would obtain benefits from synergies
between the investor and the investee
To be substantive, rights also need to be exercisable when decisions about the direction
of the relevant activities need to be made. Usually, to be substantive, the rights need to
be currently exercisable. However, sometimes rights can be substantive, even though
the rights are not currently
exercisable. [IFRS 10.B24]. This is illustrated by IFRS 10,
[IFRS 10.B24 Example 3-3D], as reflected in Example 6.7 below.
Example 6.7:
Rights exercisable when decisions need to be made
An investee has annual shareholder meetings at which decisions to direct the relevant activities are made. The
next scheduled shareholders’ meeting is in eight months. However, shareholders that individually or
collectively hold at least 5% of the voting rights can call a special meeting to change the existing policies
over the relevant activities, but a requirement to give notice to the other shareholders means that such a
meeting cannot be held for at least 30 days. Policies over the relevant activities can be changed only at special
or scheduled shareholders’ meetings. This includes the approval of material sales of assets as well as the
making or disposing of significant investments.
Consolidated financial statements 387
The above fact pattern applies to each scenario described below. Each scenario is considered in isolation.
Scenario A
An investor holds a majority of the voting rights in the investee. The investor’s voting rights are substantive because
the investor is able to make decisions about the direction of the relevant activities when they need to be made. The
fact that it takes 30 days before the investor can exercise its voting rights does not stop the investor from having the
current ability to direct the relevant activities from the moment the investor acquires the shareholding.
Scenario B
An investor is party to a forward contract to acquire the majority of shares in the investee. The forward contract’s
settlement date is in 25 days. The existing shareholders are unable to change the existing policies over the relevant
activities because a special meeting cannot be held for at least 30 days, at which point the forward contract will
have been settled. Thus, the investor has rights that are essentially equivalent to the majority shareholder in
scenario A above (i.e. the investor holding the forward contract can make decisions about the direction of the
relevant activities when they need to be made). The investor’s forward contract is a substantive right that gives
the investor the current ability to direct the relevant activities even before the forward contract is settled.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 77