As we addressed previously, the IASB has issued the Exposure Draft Financial Instruments with Characteristics of Equity—Proposed amendments to IAS 32, IFRS 7 and IAS 1, with a comment deadline of March 29, 2024.

We previously looked at the aspects of the exposure draft relating to the “fixed-for-fixed” criterion, settlement in an entity’s own equity instruments, and reclassifications. As background to another of the proposals, the basis for conclusions observes:

• In applying paragraph 19 of IAS 32 to classify a financial instrument (or a component of it) as a financial liability or an equity instrument, an entity considers whether it has an unconditional right to avoid delivering cash or another financial asset to settle a contractual obligation. In some cases, settlement occurs at the discretion of the entity’s shareholders. For example, the entity issues preference shares that require it to pay coupons subject to ordinary shareholders’ approval. Stakeholders have asked, whether, in such situations, the shareholders’ decision is treated as the entity’s decision and how shareholder decision-making rights affect whether the entity has an unconditional right to avoid settling an instrument in cash (or otherwise in such a way that the instrument would be a financial liability).
• In considering these questions, the Board observed that stakeholders held contrasting views:
  • (a) some are of the view that shareholders are always seen as part of the entity and, therefore, shareholder decisions are always treated as the entity’s decisions.
  • (b) others are of the view that shareholders are never seen as part of the entity and, therefore, shareholder decisions are never treated as the entity’s decisions.

The exposure draft accordingly proposes adding the following new material:

• …Judgement is required to assess whether (such) shareholder decisions are treated as entity decisions that result in it having an unconditional right to avoid delivering cash or another financial asset (or otherwise to settle it in such a way that it would be a financial liability). Factors an entity is required to consider in making that assessment include whether:
  • (a) a shareholder decision is routine in nature—made in the ordinary course of the entity’s business activities. Routine decisions that are part of the entity’s ordinary course of business are more likely to be treated as entity decisions.
  • (b) a shareholder decision relates to an action proposed or a transaction initiated by the entity’s management for shareholder approval. If the entity’s management can avoid an outflow of cash from the entity by not proposing an action requiring shareholder approval, shareholder discretion would have no bearing on the classification of the instrument because the shareholders would not have to make a decision. In contrast, if a shareholder decision relates to an action proposed or a transaction initiated by a third party, the shareholder decision is unlikely to be treated as an entity decision.
  • (c) different classes of shareholders benefit differently from a shareholder decision. If so, each class of shareholder is likely to make an independent decision as investors in a particular class of shares, and the shareholder decision is unlikely to be treated as an entity decision.
  • (d) exercise of a shareholder decision-making right enables a shareholder to require the entity to redeem—or pay a return on—its shares in cash or another financial asset (or otherwise to settle it in such a way that it would be a financial liability). Such decision-making rights indicate that the shareholders would make their individual decisions as investors in the shares, and the shareholder decision is unlikely to be treated as an entity decision.

The Board considered simply proposing that shareholder decisions that are routine in nature—those made in the ordinary course of business—are treated as entity decisions. However, it rejected this on the basis that it “might be too restrictive, in particular if a new type of transaction arises. The assessment of shareholder decision-making rights as either routine or non-routine could also change over time. For example, after shareholder decisions on the same type of transaction have occurred with enough regularity, what was previously regarded as non-routine might become routine.” The basis for conclusions suggests that the IASB doesn’t have complete confidence about where it ended up though, acknowledging that requiring an entity to exercise judgement based on a non-exhaustive set of factors is subjective, and that the proposed approach might be considered inconsistent with the approaches taken in other IFRS Accounting Standards. For the latter reason, “to avoid any unintended consequences, the Board decided that the proposed approach cannot be applied by analogy when applying the requirements in other IFRS Accounting Standards to transactions involving shareholders or management.” Indeed, this isn’t the most persuasive part of the exposure draft, but we’ll have to see whether commenters generally think an alternative approach (or even a continued silence) would be any better…

The opinions expressed are solely those of the author.