performance-related fees that are commensurate with the services provided, the combination of the fund
manager’s investment together with its remuneration could create exposure to variability of returns from the
activities of the fund that is of such significance that it indicates that the fund manager is a principal. The
greater the magnitude of, and variability associated with, the fund manager’s economic interests (considering
its remuneration and other interests in aggregate), the more emphasis the fund manager would place on those
economic interests in the analysis, and the more likely the fund manager is a principal.
For example, having considered its remuneration and the other factors, the fund manager might consider a
20% investment to be sufficient to conclude that it controls the fund. However, in different circumstances
(i.e. if the remuneration or other factors are different), control may arise when the level of investment is
different. [IFRS 10.B72 Example 14B].
Example 6.31: Determining whether a decision-maker is a principal or agent (5)
Assume the fact pattern and initial analysis in Example 6.28 above.
However, in this example, the fund manager has a 20% pro rata investment in the fund, but does not have any
obligation to fund losses beyond its 20% investment. The fund has a board of directors, all of whose members
are independent of the fund manager and are appointed by the other investors. The board appoints the fund
manager annually. If the board decided not to renew the fund manager’s contract, the services performed by
the fund manager could be performed by other managers in the industry.
Analysis
Although the fund manager is paid fixed and performance-related fees that are commensurate with the
services provided, the combination of the fund manager’s 20% investment together with its remuneration
creates exposure to variability of returns from the activities of the fund that is of such significance that it
indicates that the fund manager is a principal. However, the investors have substantive rights to remove the
fund manager – the board of directors provides a mechanism to ensure that the investors can remove the fund
manager if they decide to do so.
In this scenario, the fund manager places greater emphasis on the substantive removal rights in the analysis. Thus,
although the fund manager has extensive decision-making authority and is exposed to variability of returns of the
430 Chapter
6
fund from its remuneration and investment, the substantive rights held by the other investors indicate that the fund
manager is an agent. Thus, the fund manager concludes that it does not control the fund. [IFRS 10.B72 Example 14C].
Example 6.32: Determining whether a decision-maker is a principal or agent (6)
An investee is created to purchase a portfolio of fixed rate asset-backed securities, funded by fixed rate debt
instruments and equity instruments. The equity instruments are designed to provide first loss protection to the
debt investors and receive any residual returns of the investee. The transaction was marketed to potential debt
investors as an investment in a portfolio of asset-backed securities with exposure to the credit risk associated
with the possible default of the issuers of the asset-backed securities in the portfolio and to the interest rate
risk associated with the management of the portfolio. On formation, the equity instruments represent 10% of
the value of the assets purchased. A decision-maker (the asset manager) manages the active asset portfolio
by making investment decisions within the parameters set out in the investee’s prospectus. For those services,
the asset manager receives a market-based fixed fee (i.e. 1% of assets under management) and performance-
related fees (i.e. 10% of profits) if the investee’s profits exceed a specified level. The fees are commensurate
with the services provided. The asset manager holds 35% of the equity in the investee.
The remaining 65% of the equity, and all the debt instruments, are held by a large number of widely dispersed
unrelated third party investors. The asset manager can be removed, without cause, by a simple majority
decision of the other investors.
Analysis
The asset manager is paid fixed and performance-related fees that are commensurate with the services
provided. The remuneration aligns the interests of the fund manager with those of the other investors to
increase the value of the fund. The asset manager has exposure to variability of returns from the activities of
the fund because it holds 35% of the equity and from its remuneration.
Although operating within the parameters set out in the investee’s prospectus, the asset manager has the
current ability to make investment decisions that significantly affect the investee’s returns – the removal
rights held by the other investors receive little weighting in the analysis because those rights are held by a
large number of widely dispersed investors. In this example, the asset manager places greater emphasis on its
exposure to variability of returns of the fund from its equity interest, which is subordinate to the debt
instruments. Holding 35% of the equity creates subordinated exposure to losses and rights to returns of the
investee, which are of such significance that it indicates that the asset manager is a principal. Thus, the asset
manager concludes that it controls the investee. [IFRS 10.B72 Example 15].
The conclusions in Examples 6.27 to 6.32 above in respect of whether the fund manager
is a principal (and therefore has control) or an agent (and therefore does not have
control) can be summarised as follows:
Remuneration Equity
holding
Removal
rights
Control?
1% of NAV
10% None No
1% of NAV plus 20% profits above a
None None No
certain level
1% of NAV plus 20% profits above a
2%
Only for breach of contract
No
certain level
1% of NAV plus 20% profits above a
20% (illustrative)
Only for breach of contract
Yes
certain level
1% of NAV plus 20% profits above a
20%
Yes – annually by board
No
certain level
appointed by other investors
1% of NAV plus 10% profits above a
35% of equity (0% of debt)
Yes – by simple majority of
Yes
certain level
other widely diverse investors
Consolidated financial statements 431
Example 6.33 below illustrates a slightly different type of structure where there is an
entitlement to a residual return rather than a pro rata return.
Example 6.33: Determining whether a decision-maker is a principal or agent (7)
A decision-maker (the sponsor) sponsors a multi-seller conduit, which issues short-term debt
instruments to unrelated third party investors. The transaction was marketed to potential investors as an
investment in a portfolio of highly rated medium-term assets with minimal exposure to the credit risk
associated with the possible default by the issuers of the assets in the portfolio. Various transferors sell
high quality medium-term asset portfolios to the conduit. Each transferor services the portfolio of assets
that it sells to the conduit and
manages receivables on default for a market-based servicing fee. Each
transferor also provides first loss protection against credit losses from its asset portfolio through over-
collateralisation of the assets transferred to the conduit. The sponsor establishes the terms of the conduit
and manages the operations of the conduit for a market-based fee. The fee is commensurate with the
services provided. The sponsor approves the sellers permitted to sell to the conduit, approves the assets
to be purchased by the conduit and makes decisions about the funding of the conduit. The sponsor must
act in the best interests of all investors.
The sponsor is entitled to any residual return of the conduit and also provides credit enhancement and liquidity
facilities to the conduit. The credit enhancement provided by the sponsor absorbs losses of up to 5% of all of
the conduit’s assets, after losses are absorbed by the transferors. The liquidity facilities are not advanced
against defaulted assets. The investors do not hold substantive rights that could affect the decision-making
authority of the sponsor.
Analysis
Even though the sponsor is paid a market-based fee for its services that is commensurate with the
services provided, the sponsor has exposure to variability of returns from the activities of the conduit
because of its rights to any residual returns of the conduit and the provision of credit enhancement and
liquidity facilities (i.e. the conduit is exposed to liquidity risk by using short-term debt instruments to
fund medium-term assets). Even though each of the transferors has decision-making rights that affect
the value of the assets of the conduit, the sponsor has extensive decision-making authority that gives it
the current ability to direct the activities that most significantly affect the conduit’s returns (i.e. the
sponsor established the terms of the conduit, has the right to make decisions about the assets (approving
the assets purchased and the transferors of those assets) and the funding of the conduit (for which new
investment must be found on a regular basis)). The right to residual returns of the conduit and the
provision of credit enhancement and liquidity facilities expose the sponsor to variability of returns from
the activities of the conduit that is different from that of the other investors. Accordingly, that exposure
indicates that the sponsor is a principal and thus the sponsor concludes that it controls the conduit. The
sponsor’s obligation to act in the best interest of all investors does not prevent the sponsor from being
a principal. [IFRS 10.B72 Example 16].
6.7
Other illustrative examples
Example 6.34 below illustrates the application of the guidance relating to the
determination of a principal or an agent for a bank that establishes a structured entity
to facilitate a securitisation.
432 Chapter
6
Example 6.34: Determining whether a bank is a principal or agent in relation to
a securitisation
3rd party swap
provider
AAA 55%
Fixed rate
notes issued
Fees
to 3rd party
Bank
Structured entity
AA 20%
investors
Receivables
AA 20%
BB 4%
Equity 1%
Receivables
A bank establishes a structured entity to facilitate a securitisation. It transfers floating rate receivables to the
structured entity. The structured entity issues tranched fixed rate notes to investors (rated AAA, AA, A and
BB) and an equity tranche to the bank. The AAA tranche is the most senior and the equity tranche is the most
junior in the event that there is insufficient cash to meet the payments under the terms of the notes.
The bank services the receivables on behalf of the structured entity including the management of defaults (if
any), and has substitution rights over the receivables within certain parameters (for example, asset quality).
The bank receives a fee for managing the receivables, that is 1% of the notional amount of the receivables
and is commensurate with the level of work performed and only includes market terms. The investors are not
able to remove the bank from performing this function, other than in exceptional circumstances, such as
negligence by the bank.
A third party provides an interest rate swap to convert the cash flows of the receivables into the cash flows
required to be paid to meet the terms of the notes.
As the bank retains only the equity tranche, it concludes that it is no longer exposed to substantially all the
risks and rewards of ownership and can derecognise the receivables on transfer to the structured entity and
recognises just the equity tranche as its continuing involvement in the receivables.
Analysis
The purpose and design of the structured entity was to:
(a) enable the bank to generate external funding through the securitisation structure; and
(b) provide investors with an attractive investment opportunity.
The activities of the structured entity that significantly affect its returns are:
• selection and transfer of assets at inception;
• determining which assets are held by the structured entity (i.e. asset substitution); and
• management of defaults on the receivables.
The bank has decision-making rights over all of these relevant activities in its capacity as sponsor and service
provider, so it has power over the structured entity.
The bank has exposure to variable returns through its holding of the equity tranche of the notes, in addition
to the 1% management fee.
However, the question arises as to whether the bank is using its power as principal or as agent. To make that
determination, the four factors (scope of decision-making authority, rights held by other investors,
remuneration and exposure to variability of returns through other interests) need to be evaluated. Although
the bank was involved in the design of the structured entity, the scope of the bank’s decision-making authority
is considered to be narrow as substitution rights have to be within certain parameters. However, the rights of
the investors to remove the bank is not considered to be substantive, as it can only be removed by the investors
in exceptional circumstances. In respect of remuneration, the bank earns a modest fee for services rendered
Consolidated financial statements 433
that is commensurate with the services provided. Taking account of all the factors, the variability of returns
of the equity tranche is likely to be significant relative to the total returns of the entity, such that the bank
would be considered to exercise its power as principal rather than as agent. As a result, it is likely that the
bank would be considered to use its power to affect its returns.
In conclusion, the bank has control and therefore consolidates the structured entity.
7
RELATED PARTIES AND DE FACTO AGENTS
IFRS 10 also requires an investor to consider whether there are other parties who are
acting on behalf of the investor by virtue of their relationship with it. That is, IFRS 10
requires consideration of whether the other parties are acting as de facto agents for the
investor. The determination of whether other parties are acting as de facto agents
requires judgement, considering not o
nly the nature of the relationship but also how
those parties interact with each other and the investor. [IFRS 10.B73].
Such relationships need not be contractual. A party is a de facto agent when the investor
has, or those that direct the activities of the investor have, the ability to direct that party
to act on the investor’s behalf. In these circumstances, the investor considers its de facto
agent’s decision-making rights and its indirect exposure, or rights, to variable returns
through the de facto agent together with its own when assessing control of an investee.
[IFRS 10.B74].
IFRS 10 lists several examples of parties that might be de facto agents for an investor:
(a) the investor’s related parties;
(b) a party that received its interest in the investee as a contribution or loan from
the investor;
(c) a party that has agreed not to sell, transfer or encumber its interests in the investee
without the investor’s prior approval (except for situations in which the investor
and the other party have the right of prior approval and the rights are based on
mutually agreed terms by willing independent parties);
(d) a party that cannot finance its operations without subordinated financial support
from the investor;
(e) an investee for which the majority of the members of its governing body or for
which its key management personnel are the same as those of the investor; and
(f) a party that has a close business relationship with the investor, such as the
relationship between a professional service provider and one of its significant
clients. [IFRS 10.B75].
However, just because a party falls within the examples above, that does not mean that
it is necessarily a de facto agent for the investor, as shown in the diagram below. It
simply means that management must carefully evaluate whether that party is a de facto
agent for the investor. Parties that are actually de facto agents are only a sub-set of the
list above. Therefore, management must determine whether the other party is acting on
behalf of the investor because of its relationship to the investor. IFRS 10 does not
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