International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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minimis, whether quantitatively or qualitatively, would imply that it is not.
The de minimis threshold concerns the magnitude of the possible effects of the
contractual cash flow characteristic. To be considered de minimis, the impact of the
feature on the cash flows of the financial asset must be expected to be de minimis in
each reporting period and cumulatively over the life of the financial asset.
6.4.1.B Non-genuine
features
Non-genuine features, as used in this context, are contingent features. A cash flow
characteristic is not genuine if it affects the instrument’s contractual cash flows only on the
occurrence of an event that is extremely rare, highly abnormal and very unlikely to occur.
This means, although the feature can potentially lead to cash flows which are not solely
payments of principal and interest, and those cash flows may even be significant, the
instrument would still qualify for amortised cost or fair value through other comprehensive
income measurement, depending on the business model. (See also Chapter 43 at 4.3.1).
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In our view, terms are included in a contract for an economic purpose and therefore
are, in general, genuine. The threshold ‘not genuine’ is presumably intended to deal with
clauses inserted into the terms of financial instruments for some legal or tax reason but
having no real economic purpose or consequence.
An example of a clause that has caused some debate in the context of IAS 32.AG28
which uses the term non-genuine is a ‘regulatory change’ clause, generally found in the
terms of capital instruments issued by financial institutions such as banks and insurance
companies. Such entities are generally required by local regulators to maintain certain
minimum levels of equity or highly subordinated debt (generally referred to as
regulatory capital) in order to be allowed to do business.
A ‘regulatory change’ clause will typically require an instrument which, at the date of
issue, is classified as regulatory capital to be repaid in the event that it ceases to be so
classified. The practice so far of the regulators in many markets has been to make
changes to a regulatory classification with prospective effect only, such that any
instruments already in issue continue to be regarded as regulatory capital even though
they would not be under the new rules.
This has led some to question whether a ‘regulatory change’ clause can be regarded
as a contingent settlement provision which is ‘not genuine’. This is ultimately a matter
for the judgement of entities in the context of the relevant regulatory environment(s).
This judgement has not been made easier by the greater unpredictability of the
markets (and therefore of regulators’ responses to it) since the financial crisis.
However, as the clause was inserted to provide regulators with flexibility in their
actions, even if they do not normally exercise that flexibility, it would be difficult to
argue that it is ‘non-genuine’.
Disregarding non-genuine features also means that the classification requirements of
IFRS 9 cannot be overridden by introducing a contractual non-genuine cash flow
characteristic in order to achieve a specific accounting outcome.
6.4.2
Contractual features that modify the consideration for the time
value of money
In some cases, the time value of money element may be what the standard describes as
‘modified’ and so ‘imperfect’. It cites, as an example, instances where the tenor of the
interest rate does not correspond with the frequency with which it resets. In such cases,
an entity must assess the modification to determine whether the contractual cash flows
represent solely payments of principal and interest on the principal outstanding. In
some circumstances, the entity may be able to make that determination by performing
a qualitative assessment whereas, in other circumstances, it may be necessary to
perform a quantitative analysis. [IFRS 9.B4.1.9B].
The objective of a quantitative assessment is to determine whether or not the
contractual (undiscounted) cash flows could be significantly different from the
(undiscounted) cash flows that would arise if the time value of money element was not
modified (referred to as ‘the benchmark’ cash flows).
For example, if the financial asset under assessment contains a variable interest rate that
is reset every month to a one-year interest rate, the entity compares that financial asset
3622 Chapter 44
to a financial instrument with identical contractual terms and credit risk, except the
variable interest rate is reset monthly to a one-month interest rate. If the modified time
value of money element could result in contractual (undiscounted) cash flows that are
significantly different from the (undiscounted) benchmark cash flows, the financial asset
fails the contractual cash flow characteristics test. To make this determination, the
entity must consider the effect of the modified time value of money element in each
reporting period and cumulatively over the life of the financial instrument. The reason
for the interest rate being set this way is not relevant to the analysis. If it is clear, with
little or no analysis, whether the contractual (undiscounted) cash flows on the financial
asset under the assessment could (or could not) be significantly different from the
(undiscounted) benchmark cash flows, an entity need not perform a detailed
assessment. [IFRS 9.B4.1.9C]. ‘Significantly different’ is not defined in IFRS 9 and is a matter
for management judgement.
The following table lists examples of modifications of the consideration for the time
value of money which possibly meet the contractual cash flow characteristics test,
depending on the outcome of the assessment described above.
Example 44.16: Examples of a modified time value of money component
Modification
Fact pattern
1
Average interest rate
The stated coupon on a debt instrument is referenced to an average of
long and short term benchmark interest rates for a specified period. For
example, 3-month Euribor rate determined as an average of six-month
and one month rates during the previous quarter.
2
Lagging interest rate
The stated interest rate is referenced to lagging interest rates. For
example, 6-month Euribor rate set for a 6 month period, but where the
rate is fixed 2 months before the start of the interest period.
3
Tenor mismatch
The stated interest rate is reset to a reference interest rate but the
frequency of reset does not match the tenor of the reference rate. For
example, the interest rate on a retail mortgage is reset semi-annually
based on three-month Libor.
4
Combination of the above
The stated interest rate is reset monthly to an average 12-month
reference rate. The interest rate is fixed based on the average rate one
month before the start of the interest period.
Time value of money does not include credit risk, so it is important to exclude it from
the ass
essment. The standard suggests this is done by comparing the instrument with a
benchmark instrument with the same credit risk, but presumably the comparison could
be against an instrument with a different credit risk, as long as the effect of the
difference can be excluded. [IFRS 9.B4.1.9C].
When assessing a modified time value of money element, an entity must consider factors
that could affect future contractual cash flows. In making the assessment, it must consider
every interest rate scenario that is reasonably possible instead of every scenario that could
possibly arise. This requirement is illustrated in Example 44.18 below.
If an entity concludes that the contractual (undiscounted) cash flows could be significantly
different from the (undiscounted) benchmark cash flows, the financial asset does not pass
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the contractual cash flow characteristics test and therefore cannot be measured at
amortised cost or fair value through other comprehensive income. [IFRS 9.B4.1.9D].
The following examples illustrate instruments with a modified time value of money
element and how the benchmark test is applied to them.
Example 44.17: Interest rate period selected at the discretion of the borrower
An entity holds an instrument that is a variable interest rate instrument with a stated maturity date that permits
the borrower to choose the market interest rate on an ongoing basis. For example, at each interest rate reset
date, the borrower can choose to pay three-month LIBOR for a three-month term or one-month LIBOR for
a one-month term.
The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding as long as the interest paid over the life of the instrument reflects consideration for basic
lending risks and costs as well as a profit margin. Basic lending risks and costs include consideration for
the time value of money, for the credit risk associated with the instrument and for other basic lending risks
and costs. The fact that the LIBOR interest rate is reset during the life of the instrument does not in itself
disqualify the instrument.
However, if the borrower is able to choose to pay a one-month interest rate that is reset every three months,
the interest rate is reset with a frequency that does not match the tenor of the interest rate. Therefore the time
value of money element is modified. That is because the interest payable in each period is disconnected from
the interest period.
In such cases, the entity must qualitatively or quantitatively assess the contractual cash flows against the cash
flows of a benchmark instrument to determine whether the mismatch between the two sets of cash flows
could be significantly different. The benchmark instrument is identical in all respects except that the tenor of
the interest rate matches the interest period. If the analysis results in the conclusion that the two sets of cash
flows could be significantly different, payments would not represent principal and interest on the principal
amount outstanding.
The same analysis would apply if the borrower is able to choose between the lender’s various published
interest rates (e.g. the borrower can choose between the lender’s published one-month variable interest rate
and the lender’s published three-month variable interest rate). [IFRS 9.B4.1.13 Instrument B].
Example 44.18: Five-year constant maturity bond
Some bonds pay what is called a constant maturity interest rate. For example, an instrument with an original
five-year maturity may pay a variable rate that is reset semi-annually but always reflects a five year rate. In
such cases, the time value of money element is modified. The entity must determine whether the instrument’s
cash flows could be significantly different from those on a bond with a similar maturity, credit risk and
interest rate reset frequency, but that that pays a semi-annual rate of interest.
In making this assessment, the entity cannot conclude that the contractual cash flows are solely payments of
principal and interest on the principal amount outstanding, simply because the interest rate curve at the time
of the assessment is such that the difference between a five-year interest rate and a semi-annual interest rate
is not significant. Rather, the entity must also consider whether the relationship between the five-year interest
rate and the semi-annual interest rate could change over the life of the instrument such that the contractual
(undiscounted) cash flows over the life of the instrument could be significantly different from the
(undiscounted) benchmark cash flows. [IFRS 9.B4.1.9D].
In this example, if the entity considers future developments, it is unlikely that it can conclude that the
contractual cash flows could not be significantly different from the benchmark cash flows, considering the
magnitude of the mismatch between the interest rate tenor and reset frequency. The bond will always pay a
five year rate even though, except at the outset, this exceeds the instrument’s remaining life. Therefore, the
instrument is not likely to meet the contractual cash flow characteristics test.
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6.4.3
Regulated interest rates
In some jurisdictions, the government or a regulatory authority sets interest rates. For
example, such government regulation of interest rates may be part of a broad
macroeconomic policy or it may be introduced to encourage entities to invest in a
particular sector of the economy. In some of these cases, the objective of the time value
of money element is not to provide consideration for only the passage of time.
However, the Board notes that the rates are set for public policy reasons and thus are
not subject to structuring to achieve a particular accounting result. [IFRS 9.BC4.180].
Consequently, as a concession, a regulated interest rate is considered by the IASB to
serve as a proxy for the time value of money element for the purpose of applying the
contractual cash flow characteristics test if that regulated interest rate:
• provides consideration that is broadly consistent with the passage of time; and
• does not provide exposure to risks or volatility in the contractual cash flows that
are inconsistent with a basic lending arrangement. [IFRS 9.B4.1.9E].
As the standard does not establish criteria to determine whether a regulated rate
provides consideration that is ‘broadly consistent’ with the passage of time, consensus
needs to be established on how this concession is applied in practice. However, in the
Basis for Conclusions, the board implies that the particular instrument described in the
following example would satisfy the two criteria above.
Example 44.19: Regulated interest rates –‘Livret A’
In France the interest rate on ‘Livret A’ savings products issued by retail banks is determined by the central
bank and the government according to a formula that reflects protection against inflation and an adequate
remuneration to provide incentive for investment. The legislation requires a particular portion of the amounts
collected by the retail banks to be lent to a governmental agency that uses the proceeds for social programmes.
The IASB noted that the time value element of interest on these accounts may not provide consideration for
only the passage of time
; however the IASB believes that amortised cost would provide relevant and useful
information as long as the contractual cash flows do not introduce risks or volatility that are inconsistent with
a basic lending arrangement. [IFRS 9.BC4.180].
6.4.4
Other contractual features that change the timing or amount of
contractual cash flows
Some financial assets contain contractual provisions that change the timing or amount
of contractual cash flows. For example, the asset may be prepaid before maturity or its
term may be extended. In such cases, the entity must determine whether the
contractual cash flows that could arise over the life of the instrument due to those
contractual provisions are solely payments of principal and interest on the principal
amount outstanding.
To make this determination, the entity must assess the contractual cash flows that could
arise both before, and after, the change in contractual cash flows. The entity may also
need to assess the nature of any contingent event (i.e. the trigger) that would change the
timing or amount of contractual cash flows. While the nature of the contingent event in
itself is not a determinative factor in assessing whether the contractual cash flows are
solely payments of principal and interest, it may be an indicator.
For example, compare a financial instrument with an interest rate that is reset to a higher
rate if the debtor misses a particular number of payments to a financial instrument with
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an interest rate that is reset to a higher rate if a specified equity index reaches a particular
level. It is more likely in the former case that the contractual cash flows over the life of
the instrument will be solely payments of principal and interest on the principal amount
outstanding, because of the relationship between missed payments and an increase in
credit risk. In contrast, in the latter case, the contingent event introduces equity price risk
which is not a basic lending risk. [IFRS 9.B4.1.10].
The following are examples of contractual terms that result in contractual cash flows
that are solely payments of principal and interest on the principal amount outstanding: