IFRS 9 and Pooled Funds David Green dgreen@arlingclose.com

A treasury manager and a financial accountant were overheard chatting by the coffee machine recently…

Treasury manager: That IFRS 9 is causing me a headache. I think I need to sell my investments in bond funds and property funds soon. If I hold onto them next year, I hear that any falls in their value will be charged to revenue, and the Finance Director will be very unhappy with me. It’s a shame because they are paying nearly 10 times base rate in income.

Financial accountant: Aha - that is indeed the standard accounting treatment under IFRS 9. But we can make a one-off “election” to take those losses, or any gains, to an unusable reserve instead. That basically means we can continue with “available for sale” accounting under another name.

TM: I heard that election only applied to strategic investments such as shares in bus and airport companies?

FA: No, that was something that both the IASB and CIPFA have considered in the past. But the IASB decided that it was too difficult to define a strategic investment, and I guess that CIPFA felt the same way. In any case they are adopting IFRS 9 in full without any adaptations.

TM: The IASB? Who are they? Something to do with Internal Audit?

FA: No, the International Accounting Standards Board. They’re the people who write the IFRS accounting rules.

TM: OK. But doesn’t the election only apply to equities, which means ordinary company shares, not pooled funds?

FA: Yes and no. The election only applies to “equity instruments”, but these are defined quite widely as “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities”. Entities includes partnerships and trusts, not just companies. And since we have a residual interest in the net assets of our bond and property funds, we can use the election for them.

TM: Now I heard at a conference recently that because we can ask for our money back from the funds they are called “puttable instruments” and therefore can’t be equity instruments.

FA: No, I’ve checked the funds’ prospectuses and they have the unconditional right to refuse any redemption requests we make. Our right to request our money back is not a contractual right to receive it back, and we can’t sue the fund for breach of contract if they refuse.

TM: What about that “substance over form” thing you keep talking to me about. They might have the right to refuse requests in theory, but they always pay out in practice.  So, doesn’t that mean we still have to account for them as puttable instruments?

FA: No, a contractual right has to be a legal right, you can’t have a contractual right in substance. The IASB has clear rules on similar things like preference shares and credit union shares. They say that a past history of payments and an intention to continue doing so do not constitute a liability to make payments. And in any case, pooled funds often do refuse to pay out. After the EU referendum in 2016, around half of all property funds closed their doors to withdrawals. What more evidence do you need?

TM: That sounds OK for our property funds, but what about the bond funds? I’m still worried the auditor might still say that they are puttable in substance.

FA: In that case we’ll refer to the application guidance on the definition of an equity investment. That says that “examples of equity instruments include … some puttable instruments” and lists some conditions. Our bond funds’ prospectuses meet all of those conditions and so our units in the bond funds are examples of equity instruments.

TM: But that’s only application guidance, isn’t it, so we can’t rely on it, can we? The same as CIPFA’s guidance notes.

FA: Well, CIPFA’s accounting guidance notes are just that – guidance and not mandatory. But the IASB application guidance is an integral part of the accounting standard, so it has the same status and we are obliged to follow it.

TM: Now I’ve heard that the guidance you’re talking about only applies to the presentation of the fund’s own financial statements, not to ours as an investor. Is that true?

FA: No, it’s in paragraph 13 which is part the application guidance on definitions. The guidance on presentation by issuers that you are talking about starts with paragraph 25.

TM: OK. But I thought I’d read somewhere that the election can only be used for investments that “meet the definition of an equity instrument” and not those like puttable instruments that “are classified as equity”.

FA: I think you’re starting to stretch the English language a bit far now. If the accounting standard says something is “classified as” or an “example of” then surely it should be accounted for the same as if it “meets the definition of” an equity instrument. I think you’re referring to a paragraph in the IASB’s basis for conclusions which notes the distinction between “classified as” and “defined as” but it doesn’t say they should be accounted for differently. And in any case, the basis for conclusions is not an integral part of the accounting standard, it’s just background commentary and certainly doesn’t override the application guidance.

TM: Well that’s great to hear. But if there’s no problem with IFRS 9, then why are people asking for a statutory override?

FA: Well, I guess not everyone has had the time to read both IFRS 9 and their fund prospectuses from cover to cover, so they might not appreciate the finer points. A clear piece of legislation will avoid the need for us to debate this with the auditors. And of course, pooled funds aren’t the only instruments affected by IFRS 9. Don’t forget the new impairment charges for our commercial loans portfolio and the valuation losses on those loans linked to people’s house prices.

TM: Thanks, I think I understand now. But we should have another chat sometime about impairment losses. I’m worried that might be the bigger issue now.

FA: No problem. I need another coffee.


This article was first published on Room 151.