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IFRS 10 Consolidated Financial Statements Consolidation for Fund Managers.

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Presentation on theme: "IFRS 10 Consolidated Financial Statements Consolidation for Fund Managers."— Presentation transcript:

1 IFRS 10 Consolidated Financial Statements Consolidation for Fund Managers

2 IFRS 10 Consolidated Financial Statements Page 2Consolidation for Fund Managers Today’s agenda ► Background and objectives ► New definition of control ► Consolidation for fund managers ► Application under the local laws ► Investment entities ► Continuous assessment ► Transition ► Current issues / challenges

3 IFRS 10 Consolidated Financial Statements Page 3Consolidation for Fund Managers Background and objectives

4 IFRS 10 Consolidated Financial Statements Page 4Consolidation for Fund Managers Background and objectives ► Background ► Changes – WHO consolidates; no change in – HOW to consolidate ► Tension between the control model in IAS 27 and the risks and rewards approach in SIC-12 ► Divergent application of IAS 27 and SIC-12 in practice ► Global financial crisis – off-balance sheet entities ► Convergence with US GAAP (in part) ► Objectives ► Develop single control model applicable to all entities ► Improve disclosures – basis of judgments

5 IFRS 10 Consolidated Financial Statements Page 5Consolidation for Fund Managers New definition of control

6 IFRS 10 Consolidated Financial Statements Page 6Consolidation for Fund Managers New definition of control ► Control of an investee requires an investor to possess all three essential elements: ► Power over the investee; ► Exposure, or rights, to variable returns from its involvement with the investee; and ► Ability to use its power over the investee to affect the amount of the investor’s returns An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee

7 IFRS 10 Consolidated Financial Statements Page 7Consolidation for Fund Managers New definition of control Activities Identify which activities of the investee are considered to be the relevant activities, i.e., those that significantly affect the investee‘s returns Identifying activities Power Determine which party, if any, has power, that is, having existing rights that give it the current ability to direct the relevant activities Evaluating power Returns Assess whether the investor is exposed, or has rights, to variable returns from its involvement with the investee Assessing returns Understand purpose and design

8 IFRS 10 Consolidated Financial Statements Page 8Consolidation for Fund Managers Relevant activities are those that significantly affect the investee‘s returns New definition of control Identifying relevant activities ► Examples: ► Establishing operating, capital and financing policies ► Appointing, remunerating, and terminating employment of service providers or key management personnel ► Understand purpose and design of the investee ► If two investors direct different relevant activities ► Identify which investor can direct the activities that most significantly affect returns

9 IFRS 10 Consolidated Financial Statements Page 9Consolidation for Fund Managers New definition of control Evaluating power ► Main aspects of power: ► Arises from rights ► Need not be exercised (includes potential voting rights) ► Does not arise from protective rights ► Can exist even if others participate in directing the relevant activities (e.g., they have significant influence) ► Evidence that an investor directed activities in the past is an indicator of power, but is not conclusive Power is having existing rights that give an investor the current ability to direct the relevant activities

10 IFRS 10 Consolidated Financial Statements Page 10Consolidation for Fund Managers New definition of control Assessing returns ► Examples: ► Dividends, distributions of economic benefits, changes in the value of an investment ► Remuneration, fees, residual interests, tax benefits, exposure from providing support ► Synergies, cost savings, economies of scale, scarce resources, proprietary knowledge Returns can be only positive, only negative or positive and negative, but must have the potential to vary as a result of the investee’s performance

11 IFRS 10 Consolidated Financial Statements Page 11Consolidation for Fund Managers New definition of control Protective rights ► Protective rights do not give power ► When are rights merely protective rights? ► Fundamental changes in the activities of an investee ► Only apply in exceptional circumstances ► Examples of protective rights include the right to: ► Restrict an investee from undertaking activities that could significantly change the credit risk of the investee ► Approve an investee’s capital expenditures (greater than the amount spent in the ordinary business) ► Protective rights do not prevent another investor from having control

12 IFRS 10 Consolidated Financial Statements Page 12Consolidation for Fund Managers New definition of control Substantive rights ► Does the investor have the current ability to exercise power? ► Rights need to be substantive (i.e. the holder must have the practical ability to exercise those rights) ► Factors to consider – whether? ► Economic or other barriers exist (penalties, timing, etc.) ► Multiple parties have to agree to exercise right ► Holders would benefit from exercising the right ► Right is currently exercisable

13 IFRS 10 Consolidated Financial Statements Page 13Consolidation for Fund Managers Consolidation for fund managers

14 IFRS 10 Consolidated Financial Statements Page 14Consolidation for Fund Managers Consolidation for fund managers What do they need to know? ► Whether the fund manager (FM) is acting as principal or as agent. ► If the FM is deemed to be acting as principal for a fund it manages the FM would consolidate the fund. ► Conversely, if the FM is acting as an agent, it would not consolidate the fund it manages.

15 IFRS 10 Consolidated Financial Statements Page 15Consolidation for Fund Managers Consolidation for fund managers A new concept of control Power Determine which party, if any, has power, that is, the current ability to direct the relevant activities. Power arises from rights, which may include: -Voting rights -Potential voting rights -Rights to appoint key personnel -Decision making rights within a management contract -Removal or kick-out rights Power does not arise from protective rights Identifying power Returns Assess whether the investor is exposed, or has rights, to variable returns from its involvement with the investee. Returns can be positive, negative or both. Example of returns include: -Dividends (from direct interest in the fund either directly or potentially through certain related parties) -Remuneration (as result of earning management fees and performance fees) Assessing returns Linkage Evaluate whether the investor has the ability to use its power to affect the investor’s returns from its involvement with the investee. If applicable, determine whether the investor is a principal or an agent, considering: -Scope of its authority -Rights held by other parties -Remuneration -Exposure to variability from other interests. Evaluate linkage Understand the purpose and design of investee

16 IFRS 10 Consolidated Financial Statements Page 16Consolidation for Fund Managers Consolidation for fund managers Linkage between power and variable returns ► Typically, a fund manager is likely to satisfy the first two criteria of the control model, as follows: ► Power — likely to have power, as the fund manager would normally have decision-making rights over the relevant activities. ► Variable returns — exposed to variable returns, as a result of earning management fees and performance fees and direct interest, if any. ► The key determinant in deciding whether a fund manager has control over a fund is the link between power and variable returns.

17 IFRS 10 Consolidated Financial Statements Page 17Consolidation for Fund Managers Principal? Consolidation for fund managers Linkage between power and variable returns ► Delegated power – principal or agent? ► An agent is a party engaged to act on behalf of another party or parties (the principal(s)) ► An agent does not control an investee ► Question – whether the FM is acting as a principal or as an agent that is acting primarily on behalf of other investors? Agent?

18 IFRS 10 Consolidated Financial Statements Page 18Consolidation for Fund Managers Consolidation for fund managers Linkage between power and variable returns ► De facto Agents ► - nature of relationships with other parties (such as related parties) needs to be considered ► - fund manager’s decision-making rights and exposure to variable returns via the de facto agent, together with its own, will need to be considered in totality when assessing control.

19 IFRS 10 Consolidated Financial Statements Page 19Consolidation for Fund Managers Consolidation for fund managers Factors to consider IFRS 10 paragraph B60 requires that the following factors are evaluated to determine whether the fund manager is acting as principal or agent: 1. Scope of the fund manager’s decision-making authority over the fund. 2. Rights held by third parties (including removal rights) 3. Remuneration to which the fund manager is entitled in accordance with the remuneration agreement(s) 4. Fund manager’s exposure to variability of returns from other interests that it holds in the fund.

20 IFRS 10 Consolidated Financial Statements Page 20Consolidation for Fund Managers Consolidation for fund managers 1. Scope of decision-making ► Range of activities that are permitted by the decision- making agreement or by law ► Whether relevant activities have been delegated ► Discretion that the decision-maker has when making decisions about those activities ► Level of involvement that the decision-maker had in determining the scope of its authority ► Opportunity and incentive to gain power ► Purpose and design ► Risks to which the investee was designed to be exposed ► Risks investee was designed to pass on to investors

21 IFRS 10 Consolidated Financial Statements Page 21Consolidation for Fund Managers Consolidation for fund managers 2. Rights held by other parties ► Held by a single investor  decision-maker is an agent ► More parties that have to agree on removal  more likely that decision-maker is a principal ► Removal rights held by an independent board who can remove decision-maker for any reasons  more likely decision- maker is an agent Fund manager Fund Kick-out rights Voting rights Investors

22 IFRS 10 Consolidated Financial Statements Page 22Consolidation for Fund Managers Consolidation for fund managers 2. Rights held by other parties (cont’d.) Many parties required to act together Single party/few parties required to act together Exercisable only for causeExercisable without cause Significant financial penalty to exerciseInsignificant financial penalty to exercise Skills held by decision-maker are unique Several other parties could fulfil role of decision-maker Not currently exercisableCurrently exercisable PrincipalAgent Decision-maker Evaluating whether removal rights are substantive

23 IFRS 10 Consolidated Financial Statements Page 23Consolidation for Fund Managers Consolidation for fund managers 3. Remuneration ► To be an agent, remuneration must : ► Be commensurate with services provided AND ► Includes only terms, conditions, or amounts that are customarily present in arrangements for similar services negotiated on an arm’s length basis Commensurate“Market” termsConclusion  Greater magnitude and variability of remuneration compared to expected returns – more likely principal  ×Not an agent ×  ××

24 IFRS 10 Consolidated Financial Statements Page 24Consolidation for Fund Managers Consolidation for fund managers 4. Exposure to variability through other interests ► Are any interests held by related parties? ► Greater the magnitude of, and variability associated with, its economic interests, more likely it is a principal ► Does exposure differ from other investors? Delegated 80% Fund manager Fund Delegated 80% Parent Investors Direct 20%

25 IFRS 10 Consolidated Financial Statements Page 25Consolidation for Fund Managers Consolidation for fund managers Analysis of the examples in IFRS 10 The overall evaluation of whether a decision maker is acting in the capacity of principal or an agent is primarily a qualitative evaluation requiring the use of judgement. Example Scope of decision making rights Removal rightsRemunerationOther interestsConclusion 13 Narrowly defined parameters None1% of net asset value 10% direct interest Agent 14A Wide ranging discretion Removal for cause 1% of net asset value and 20% of profits after a hurdle is reached 2% direct interest Agent 14B Wide ranging discretion Removal for cause 1% of net asset value and 20% of profits after a hurdle is reached 20% direct interest Principal 14C Wide ranging discretion Removal without cause by independent board 1% of net asset value and 20% of profits after a hurdle is reached 20% direct interest Agent 15Narrow discretion Removal without cause by widely dispersed investors 1% of net asset value and 10% of profits after a hurdle is reached 35% direct interest Principal

26 IFRS 10 Consolidated Financial Statements Page 26Consolidation for Fund Managers Application under the local laws

27 IFRS 10 Consolidated Financial Statements Page 27Consolidation for Fund Managers Application under the local laws A typical fund structure Foreign promoters Fund Manager Mutual Fund / Investment Entity SECP / Registrar Regulator Other Investors Trustee Custodian Shariah Advisor AuditorDistributor Unit Holders No Cross Holding or Common Directorship

28 IFRS 10 Consolidated Financial Statements Page 28Consolidation for Fund Managers Application under the local laws (cont’d.) Roles and responsibilities A FM shall: ► manage the assets of the fund ► maintain proper accounts and records ► obtain a rating of the fund ► process payments immediately ► manage the fund according to its constitutive documents, etc. ► establish & maintain sufficient risk management systems and controls A trustee shall: ► control/hold the property of the fund ► approve the sale, purchase, issue & transfer of units by the fund ► ensure that the investment and borrowing limits are complied with ► ensure that the FM has been diligent in appointing brokers ► call a meeting of the unit holders ► not invest in the fund for which it acts as trustee A unit holder shall: ► be bound by the terms of the trust deed ► not be liable to make any further contributions to the fund ► have a beneficial interest in the trust proportionate to the units held by him ► receive reports from the trustee in accordance with the regulations

29 IFRS 10 Consolidated Financial Statements Page 29Consolidation for Fund Managers Application under the local laws (cont’d.) Criteria under IFRS 10 ExplanationAs per local laws and practices Conclusion 1.Scope of decision-making authority. (Wide / narrow ranging discretion)  Range of activities that the FM is permitted to direct (by agreement or law)  Discretion that FM has when making decisions  Level of involvement the FM had in determining the scope of authority  Regulation 55 of the NBFC Regulations, 2008 and SECP circular no.7 of 2009 specifies the limits on how much to invest (quantitative thresholds) and where to invest (rated debt securities, etc.)  The nature of investments is also defined in the offering document / trust deed.  Normally a FM sets up a fund and his powers are defined in the offering document / trust deed.  Investment parameters are defined by law and are also set out in the offering document and the trust deed.  Depending on the facts and circumstances of the case the FM may have wide or narrow ranging discretion, hence it could be either an agent or a principal.

30 IFRS 10 Consolidated Financial Statements Page 30Consolidation for Fund Managers Application under the local laws (cont’d.) Criteria under IFRS 10 ExplanationAs per local laws and practicesConclusion 2. Rights held by third parties. (Are they substantive or protective?) Factors to determine whether rights are substantive include:  Financial or other barriers  Removal rights held by a single party (without cause)  Removal rights held by many parties (with cause) A typical trust deed provides a right to remove the FM if any of the following happens:  Wilful contravention of the trust deed  Liquidation of FM  Receiver being appointed at FM  Becoming ineligible to act as a FM  The suspension of redemption of units of the fund for more than fifteen working days and the unit holders representing at least three-fourth in value of total outstanding units pass a resolution to remove the FM.  Rights that provide for the removal of the FM for committing fraud or wilful contravention are protective rights.  Typically, the rights are not substantive because they normally require numerous parties to exercise them.  Power does not arise from protective rights and they are not relevant when assessing whether a FM is acting as principal or agent.

31 IFRS 10 Consolidated Financial Statements Page 31Consolidation for Fund Managers Application under the local laws (cont’d.) Criteria under IFRS 10 ExplanationAs per local laws and practices Conclusion 2. Rights held by third parties (cont’d). (Are they substantive or protective?) In some cases, rights held by other parties (such as liquidation rights and redemption rights) may be considered in the same way as removal rights if, in substance, they have the same effect as a removal right when assessing whether a FM is an agent or a principal. 1. Liquidation rights 2. Redemption rights As per NBFC Regulations 2008, regulation 54, sub- regulation 3(a) the net assets of an Open End Scheme shall be one hundred million rupees at all times during the life of the scheme and all existing Open End Schemes shall ensure compliance with this minimum scheme size by the first day of July  If a small number of unit holders hold substantial percentage of units in a fund, this might indicate that they hold substantive rights to remove the FM.

32 IFRS 10 Consolidated Financial Statements Page 32Consolidation for Fund Managers Application under the local laws (cont’d.) Criteria under IFRS 10ExplanationAs per local laws and practices Conclusion 3. Remuneration. (Commensurate and market based). The greater the magnitude and variability of remuneration - more likely the FM is deemed to be a principal. A FM may charge performance based or fixed fee or a combination of both which shall not exceed the limit prescribed in Regulation 61 of the NBFC Regulations, 2008 and such fee structure shall be disclosed in the Offering Document. Both the criteria are generally met and, hence, it indicates that the FM is an agent.

33 IFRS 10 Consolidated Financial Statements Page 33Consolidation for Fund Managers Application under the local laws (cont’d.) Criteria under IFRS 10ExplanationAs per local laws and practices Conclusion 4. Exposure to variability of returns from other interests held. (Percentage of holding)  Interest does not mean just an equity or debt investment.  Examples of other interests: guarantees / indemnity, liquidity facilities, subordinated loans, etc.  Also need to consider not only the interests held by the decision- maker directly, but also the interests held by related parties.  As per the Companies Ordinance, 1984:  20% interest –associate  50% interest – subsidiary  Section 237 of Companies Ordinance, 1984 requires every holding company to present consolidated accounts including the financial statements of the holding company and its subsidiaries.  Indemnity provided by FM to the fund to cover exposure such as WWF. Management will have to determine at what point the investment becomes large enough such that it is influencing the behaviour of the FM, or the group as a whole, and that actually, the fund is controlled by the group. The examples in the standard suggest that this might be at about 20%.

34 IFRS 10 Consolidated Financial Statements Page 34Consolidation for Fund Managers Application under the local laws (cont’d.) The Decision Tree 1. Scope of decision-making authority Wide ranging discretionPrincipal Narrow ranging discretionAgent 2. Rights held by third parties SubstantiveAgent ProtectiveNot relevant 3. Remuneration Commensurate and market basedAgent Not commensurate and market basedPrincipal 4. Exposure to variability of returns from other interests held 20% or morePrincipal < 20%Agent

35 IFRS 10 Consolidated Financial Statements Page 35Consolidation for Fund Managers Investment entities

36 IFRS 10 Consolidated Financial Statements Page 36Consolidation for Fund Managers Investment entities Overview ► ‘Investment entity’ is now defined in IFRS 10 ► An investment entity does not consolidate subsidiaries unless they provide investment-related services (see later) ► An investment entity measures its subsidiaries at fair value through profit or loss in accordance with IFRS 9 Financial Instruments (IAS 39 in Pakistan) ► An entity must consider all facts and circumstances, including purpose and design, to make the assessment ► The amendment is effective for annual periods beginning on or after 1 January 2014, but may be applied earlier

37 IFRS 10 Consolidated Financial Statements Page 37Consolidation for Fund Managers Investment entities Definition ► An investment entity is an entity that: ► Obtains funds from one or more investors for the purpose of providing those investors with professional investment management services ► Commits to its investors that its business purpose is to invest funds solely for returns from capital appreciation, investment income or both And ► Measures and evaluates the performance of substantially all of its investments on a fair value basis

38 IFRS 10 Consolidated Financial Statements Page 38Consolidation for Fund Managers Investment entities Typical characteristics Factors to consider alongside the definition: ► The entity has more than one investment – to diversify the risk portfolio and maximise returns ► The entity has more than one investor – to pool funds to maximise investment opportunities ► Investors in the entity are not related parties of the entity ► Ownership interests in the entity are in the form of equity or similar interests

39 IFRS 10 Consolidated Financial Statements Page 39Consolidation for Fund Managers Investment entities Reassessment of status ► If there are changes to: ► One or more of the three elements of the definition of an investment entity Or ► The typical characteristics of an investment entity Then the entity must reassess whether it is an investment entity ► Any change in investment entity status must be accounted for prospectively from the date of change

40 IFRS 10 Consolidated Financial Statements Page 40Consolidation for Fund Managers Investment entities Parent of an investment entity Non-investment entity parent of an investment entity ► The exception to consolidation is not retained by the parent entity if it is not an investment entity itself ► Instead, the parent must consolidate all its subsidiaries ► This is a difference from US GAAP – all parent entities can retain (or ‘roll-up’) the exception to consolidation of its investment entity subsidiary

41 IFRS 10 Consolidated Financial Statements Page 41Consolidation for Fund Managers Investment entities Conclusion (Non-Investment Entity Parent) Ultimate Parent (Listed) (Non-Investment Entity Parent) Fund Manager Investment Entity (Mutual Fund) 50% Investee 40% Investee Consolidation (IFRS 10, Para. 4) > Consolidation, if listed > No consolidation, if unlisted (IFRS 10, Para. 4) No consolidation (IFRS 10, Para. 31) At fair value through profit or loss (IAS 39 / IFRS 9)

42 IFRS 10 Consolidated Financial Statements Page 42Consolidation for Fund Managers Continuous assessment

43 IFRS 10 Consolidated Financial Statements Page 43Consolidation for Fund Managers Continuous assessment ► Reassess if facts and circumstances suggest change to one of the criteria of control ► Examples: ► Changes to dispersion of other shareholdings ► Acquisition of new rights or existing rights becoming substantive

44 IFRS 10 Consolidated Financial Statements Page 44Consolidation for Fund Managers Transition

45 IFRS 10 Consolidated Financial Statements Page 45Consolidation for Fund Managers Transition ► Effective for annual periods beginning on or after 1 January 2013 (in Pakistan, 1 January 2015) ► Retrospective application ► As if it was always consolidated (since the date of gaining control) ► If under IFRS 10, there is a change in the consolidation conclusion at the date of initial application, the requirement to adjust comparative information is limited to the period immediately preceding the date of initial application. Adjustment to earlier periods is permitted but not required.

46 IFRS 10 Consolidated Financial Statements Page 46Consolidation for Fund Managers Current issues / challenges

47 IFRS 10 Consolidated Financial Statements Page 47Consolidation for Fund Managers Current issues / challenges 1. Clarification required with regard to ICAP Circular 2008/01 ‘Consolidation of Mutual Funds by Fund Managers’. 2. Section 3 of CO84 - a subsidiary if another company holds more than fifty percent of its voting power or directors. Section 237 – holding company to present consolidated financial statements of the group as those of a single enterprise. A clarification may prove useful to indicate that the requirement in the Companies Ordinance presents the bare minimum criteria for consolidation.

48 IFRS 10 Consolidated Financial Statements Page 48Consolidation for Fund Managers Current issues / challenges (cont’d.) 3. A survey conducted in EU markets revealed that application of IFRS 10 would lead to consolidation of more entities/funds because of the new definition of control. 4. A challenge will be to continue to reassess the status each year due to a change in percentage of holding as a result of open-end nature of the fund and adjust the accounting treatment accordingly.


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