pwcinform..com Practical guide to Investment entities: Exception to December 2012

Transcription

1 pwcinform..com Practical guide to IFRS 10 Investment entities: Exception to consolidation December 2012

2 Contents At a glance 1 Key features of the guidance 1 Investment entities: Exception to consolidation 3 Background 3 Definition 4 Determining whether an entity is an investment entity 4 Business purpose 5 Fair value measurement 14 Typical characteristics of an investment entity 14 More than one investment 14 More than one investor 17 Unrelated investors 19 Ownership interests 20 Separate financial statements 21 Reassessment of investment entity status 21 Accounting for a change in status Becoming or ceasing to be an investment entity 22 Disclosure 23 Date of application and transition requirements 24 Appendix A 26 Investment entities: Exception to consolidation PwC Contents

3 At a glance Many funds and similar entities will be exempted from consolidating controlled investees under amendments to IFRS 10, Consolidated financial statements. This is a result of the IASB issuing amendments to IFRS 10, IFRS 12, Disclosure of interests in other entities and IAS 27, Separate financial statements, on 31 October These amendments will particularly benefit funds, as those that qualify will be able to fair value controlled investments, rather than having to consolidate them. The guidance applies to an investment entity. The amendment to IFRS 10 defines an investment entity and introduces an exception to consolidation. The amendments to IFRS 12 introduce disclosures that an investment entity needs to make. The amendments apply for annual periods beginning on or after 1 January 2014; earlier application is permitted. Key features of the guidance Definition of an investment entity First you will need to assess whether your entity meets the investment entity definition. An investment entity is an entity that: obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services; commits to its investor(s) 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. You will also need to consider a set of typical characteristics. These, combined with the definition, are intended to allow for an appropriate balance between creating a clear scope and allowing judgement in assessing whether your entity is an investment entity. The characteristics are: holding more than one investment; having more than one investor; having investors that are not your entity s related parties; and having ownership interests in the form of equity or similar interests. The absence of one or more of these characteristics does not prevent your entity from qualifying as an investment entity but you will need to determine why it is an investment entity even though it does not meet at least one of the typical characteristics; and you will need to give disclosures. Your entity will not be disqualified from being an investment entity where it also carries out any of the following activities: Providing investment-related services to third parties and to its investors, even when substantial. Providing management services and financial support to its investees, but only when these do not represent a separate substantial business activity and are carried out with the objective of maximising the investment return from the entity s investees. Accounting by an investment entity Instead of consolidating the entity s subsidiaries, you will account for them at fair value through profit or loss. The only exception is for subsidiaries providing services that are related to the entity s investment activity, which should be consolidated. Accounting by a non-investment entity parent for investments of an investment entity subsidiary Your business might be an investment entity but its parent might not be. A non-investment entity parent is required to consolidate line by line all entities it controls including those controlled through an investment entity. For example, an investment entity fund is controlled by an insurance group. The insurance group will have to consolidate line by line the subsidiaries of the fund in the insurance group s financial statements, even though the subsidiaries will be fair valued in the fund s own financial statements. What is known as the fair value roll-up is not allowed to be applied in a non-investment parent entity. Disclosures Where your entity qualifies as an investment entity, required disclosures include the following: significant judgements and assumptions made in determining that the entity meets the definition of an investment entity; Investment entities: Exception to consolidation PwC 1

4 reasons for concluding that the entity is an investment entity, even though it doesn t have one or more of the typical characteristics; information on each unconsolidated subsidiary (name, country of incorporation, proportion of ownership interest held); restrictions on unconsolidated subsidiaries transferring funds to the investment entity; financial or other support provided to unconsolidated subsidiaries during the year, where there wasn no contractual obligation to do so; and information about any structured entities that the entity controls (for example, any contractual arrangements to provide financial or other support). Transition guidance The amendments are generally applied retrospectively when your entity meets the definition of an investment entity at the date of initial application; this applies irrespective of whether the entity would have met the definition of an investment entity in prior reporting periods. Any difference at the beginning of the comparative period between: the previous carrying amount of the assets, liabilities and non-controlling interest of a controlled investee; and the recognised amount of the investor s interest in the investee (that is, it fair value), is adjusted to equity at the beginning of the immediately preceding period. Investment entities: Exception to consolidation PwC 2

5 Investment entities: Exception to consolidation Background The IASB has amended IFRS 10 so that an investment entity fair values its subsidiaries instead of consolidating them. The Board believes that a class of entity (an investment entity) uses a different business model to most other entities. It manages all of its investments on a fair value basis, whether they are simple investments, associates or controlled. It provides fair value information to its users, and that fair value information is more useful for decisionmaking than consolidated information. The Board further noted that preparing consolidated financial statements for such entities could hinder users ability to assess their financial position and results; this is because consolidated financial statements emphasise the financial position, operations and cash flow position of their investees, rather than those of the entities themselves. Consolidation also hinders comparability within the financial statements; some of the items consolidated might be measured at historical cost, whilst other non-controlling interests might be carried at fair value. This makes assessment of the performance of an investment entity difficult; and it does not reflect the way in which the entity s business is managed. Such entities are investment entities and are usually investment funds. The IASB decided that these entities should fair value their investments (including investments in subsidiaries). Accounting by an investment entity IFRS 10 requires an entity that is a parent to present consolidated financial statements. The amendment provides a limited scope exception to parents that are investment entities. If your entity is an investment entity under the standard, it is exempt from consolidating underlying investees that it controls; instead, it is required to account for these subsidiaries at fair value through profit or loss under IFRS 9, Financial instruments. [IFRS 10 para 31]. PwC observation Many funds and similar entities do not have any subsidiaries. For example, a mutual fund might have many equity investments in other entities that are each a small, non-controlling holding in those entities. The exception in IFRS 10 only applies to a parent that is an investment entity. Similarly, the new disclosure requirements in IFRS 12 apply only to a parent that is an investment entity and has unconsolidated subsidiaries. So, you do not need to make an assessment of whether your entity is an investment entity where it does not control any subsidiaries. Similarly, even if it is an investment entity but does not have subsidiaries, the amendments to IAS 27 and IFRS 12 have no consequences. Notwithstanding the exception from consolidation in the amendment, you are required to consolidate any subsidiaries that provide services relating to your entity s investment activities. [IFRS 10 para 32]. This includes investment management services, investment advisory services and administrative support. Such services might form a substantial part of your business and might be provided to third parties as well; this will not disqualify your entity from being an investment entity. [IFRS 10 para B85C]. Accounting by the parent of an investment entity The exception from consolidation extends to the consolidated financial statements prepared by your investment entity s parent only where the parent qualifies as an investment entity itself. If your parent entity does not qualify as an investment entity, it will be required to consolidate all entities that it controls (including all underlying investees controlled through your investment entity and any other investment entities) under IFRS 10. Investment entities: Exception to consolidation PwC 3

6 Facts Parent is an insurance company, writing insurance business. Parent does not qualify as an investment entity under IFRS 10 because, amongst other things, its purpose is not to invest funds solely for capital appreciation and/or investment income. It sets up a subsidiary, IE, which manages funds that back some of Parent s insurance liabilities. Some of IE s investees are controlled private equity investments. IE qualifies as an investment entity under the criteria set out in the amendment to the standard and explained below. Example Parent (non-ie) Investment entity (IE) IE s investees Consolidates IE and its underlying investees Carries its investees at fair value through profit or loss Accounting treatment In IE s own separate and/or consolidated financial statements, IE measures its controlled investees at fair value through profit or loss. But Parent s consolidated financial statements will consolidate all of its controlled investees, including IE and IE s investees. Definition The standard defines an investment entity as, an entity that: obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services; commits to its investor(s) 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. [IFRS 10 para 27]. For your entity to qualify as an investment entity you must meet the above definition.you must also consider the following typical characteristics of an investment entity: holding more than one investment; having more than one investor; having investors that are not your entity s related parties; and having ownership interests in the form of equity or similar interests. [IFRS 10 para 28]. The above typical characteristics are indicative and supplement the definition to allow the use of judgement in assessing whether your entity qualifies as an investment entity. You will be required to make appropriate disclosures in your financial statements to explain why your entity meets the definition of an investment entity if (in the absence of one or more of the above typical characteristics) you conclude that your entity is nevertheless an investment entity. It is highly unlikely that your entity will meet the definition of an investment entity where it has none of the typical characteristics; but it might be possible. [IFRS 10 para BC234]. Determining whether an entity is an investment entity The above definition and typical characteristics require you to consider all the facts and circumstances when assessing whether your entity is an investment entity including its purpose and design. [IFRS 10 B85A]. The definition has three key elements: investment management services; business purpose; and fair value measurement. The amendment does not provide detailed guidance on the first element of the definition; but it does note that provision of investment management services differentiates investment entities from other entities. [IFRS 10 para BC237]. The amendment provides guidance around the second and third elements of the definition: business purpose and fair value measurement. Investment entities: Exception to consolidation PwC 4

7 Business purpose The purpose of your entity s business should be to obtain funds from its investor or investors, and to invest them solely to obtain returns from capital appreciation and/or investment income. Its business purpose might be evidenced in: documents (such as its offering memorandum, publications and other corporate or partnership documents); and the way it presents itself to other parties (for example, to potential investors or potential investees). So, if the entity states to its investors that it is making medium-term investment for capital appreciation, this will be consistent with the business purpose of an investment entity. But, if the entity presents its investment objective as jointly developing, producing or marketing products with its investees, its business purpose would appear to be inconsistent with that of an investment entity; this is because it suggests that its purpose includes earning returns from development, production or marketing activity. [IFRS 10 para B85B]. Part of your entity s business purpose might be to provide investment-related services (including investment advisory services, investment management, and investment support and administrative services) either directly or through a subsidiary. These services could be provided to investors and/or third parties. Participating in such investment-related services does not disqualify your entity from being an investment entity, even if these services form a substantial part of its business; this is because such services are an extension of its operations. [IFRS 10 paras B85C, BC240]. But, if such services are provided by one of your investment entity s subsidiaries, you will be required to consolidate the subsidiary. [IFRS 10 para 32]. PwC observation In many cases, entities will provide little or no investment management, consultancy or other services but they will have significant investing activities (for example mutual funds). In other cases, entities might provide significant investment management, consultancy or other services with little or no investing activities of their own (for example asset management companies). In either of these cases, it might be clear that the entity is an investment entity (the mutual fund), or is not an investment entity (the asset manager). But, for business models that include both investing activities and providing investment related services, judgement is likely to be required to determine whether or not the entity is an investment entity. The judgement applied could be so significant that an entity should describe it in its critical estimates and judgements. For example, a private equity firm that obtains funds from its investors, committing to provide them with investment management services in order to invest for capital appreciation and/ or investment income, might be an investment entity. This would be the case even though a significant portion of its activities includes providing sub-advisory and portfolio management services to third parties. But, the entity should consider all relevant factors, not only the mix of services and investing activity. Factors that are likely to indicate that the entity is not an investment entity are: earning revenue from providing substantial management services or strategic advice to investees; not measuring and evaluating all investments at fair value; or holding investments with no defined exit strategies. Careful consideration of all relevant facts and circumstances will be necessary to determine the appropriate accounting for the entity to apply. Investment entities: Exception to consolidation PwC 5

8 Participating in the following investment related activities (either directly or through one of your subsidiaries) does not disqualify your entity from being an investment entity; this is because these activities can be seen as being consistent with the entity s overall purpose of investing for capital and/or income. But, these activities need to be undertaken to maximise investment returns (capital appreciation and/ or investment income) from the entity s investees; and they must not represent a separate substantial business activity or a separate substantial source of income. These permitted activities are: providing management services and strategic advice to an investee; and providing financial support(such as a loan, capital commitment or guarantee) to an investee. [IFRS 10 para B85D]. A subsidiary of an investment entity that provides these services should be consolidated by the investment entity. [IFRS 10 para B85E]. PwC observation It might not always be apparent whether a subsidiary of an investment entity is providing investment related services (and should be consolidated) or is not providing such services (and should be measured at fair value through profit or loss). This assessment could be complicated by some apparent overlap between paragraph 27(a) (definition of an investment entity) and paragraph 32 (definition of entities that should be consolidated by an investment entity) of IFRS 10. The first element of the investment entity definition is that an entity obtains funds from investor(s) in order to provide them with investment management services. So, it might be argued that for a subsidiary of an investment entity to qualify as an investment entity itself, it must be providing investment management services. This could imply that all investment entity subsidiaries of investment entity parents should be consolidated by those parents. We do not believe that the IASB intended all investment entity subsidiaries of an investment entity parent to be consolidated. Otherwise, the amendment would have been clear that subsidiaries falling into paragraph 32 of IFRS 10 (providing investment related services) included all investment entity subsidiaries. Paragraph BC272 seems to confirm that investment entity subsidiaries generally should be measured at fair value by investment entity parents. Our view is that the only investment entity subsidiaries that should be consolidated by an investment entity parent are those which have a separate substantial business activity of providing investment-related services (such as those described in paras 32 and B85C-E). It might be unusual for an investment entity subsidiary to provide such services as a separate substantial activity. For example, a master fund that is controlled by a feeder fund, where the master fund's substantive activities are investing and managing the feeder s funds, is not providing investment related services. So it should be fair valued in the feeder funds financial statements. Investment entities: Exception to consolidation PwC 6

9 PwC observation Some funds provide management services and financial support to their investees. Such activities do not form a substantial business activity carried out by the fund and income from such activities does not form a substantial source of their income. The purpose is to maximise investment return from the underlying investees. Where this is the case, such funds will not be disqualified as investment entities. Example Private equity fund providing guarantee or funding support Asset manager Employees 40 limited partners (unrelated) LPs commit 2,500 in capital GP and manager of the fund (directs relevant activities of the fund and is responsible for selection, management and sale of portfolio) Co-investment LP Fund (limited life of 12 years) LPs entitled to proportionate share of net asset of the fund Holds controlling or significant interest in entities. Facts Two years ago, an asset manager (AM) set up a fund as a limited partnership with 40 limited partners (LPs) and a limited life of 12 years. The LPs are not related; they commit to provide 2,500m. The AM (as a co-investment limited partner) commits an additional 25m, which are its own funds or funds of its employees. The investment objective of the partnership (as set out in the limited partnership agreement) is as follows: to invest directly in entities in order to acquire a controlling or significant share; and to exit these at a later stage through a trade sale or an IPO process (a buy-out fund ) between the eighth and twelfth years of the fund s operation, with the aim of generating at least a preferred return rate (the hurdle rate) of 10%. The AM (who is the general partner of the fund) directs the relevant activities of the partnership; these include: The appointment of an AM representative to the board of directors of the underlying investee entities. Providing strategic and economic advice to the investees through separate service agreements. Providing and arranging financing and (where necessary) financial guarantees in order to assist investees in executing their strategic plans. Evaluating and influencing the underlying policies, procedures and key management of the investments. Investment entities: Exception to consolidation PwC 7

10 The AM considers these activities to be necessary to maximise the overall value of the underlying investees. The AM is also responsible for the selection, management and sale of the fund s investment portfolio. The AM is responsible for providing a quarterly individual capital statement for each LP, detailing the fair value of each investment; and the partnership accounts for all its investees on a fair value basis. Each LP interest is entitled to a share of disposal proceeds or net asset values on a winding up of the fund. The general partner (that is, the AM) is entitled to management fees and a profit share of capital gains above the 10% hurdle rate. The partnership has no equity. Is the fund an investment entity, in view of the activities that it performs? Conclusion Judgement is required to conclude whether the fund is an investment entity. The fund meets the first and third parts of the definition of an investment entity: It obtains funds from more than one LP to make investments and to provide them with investment management services. It measures and evaluates the performance of its investments on a fair value basis. The second part of the definition is less clearly satisfied. The fund makes each investment with the objective of generating capital return and investment income. It does not intend to hold any of its investments indefinitely; this is because it has a limited life and a defined exit strategy for its investees. But it carries out other activities and its business purpose requires further consideration. The fund also displays all four typical characteristics: it holds more than one investment; it has more than one investor; investors in the fund are unrelated to the reporting entity; and ownership interests in the fund are in the form of partnership interests that entitle partners to a share of net assets. Regarding business purpose, the fund is involved in providing other investment related activities, these include: Providing financial support to the underlying investee, including providing guarantees. Providing strategic and economic direction to the underlying investments. These activities are consistent with the business purpose of an investment entity; and they are permitted so long as they are undertaken to maximise investment returns (capital appreciation and/ or investment income) from the investees. But they should not represent a separate substantial business activity or source of income. Judgement is required to make this assessment. Exit Strategy One of the ways your entity s business purpose will be evident is through having an exit strategy for its investments, specifically documenting how it plans to realise capital appreciation on substantially all of its equity and non-financial investments. The exit strategy should clearly document a substantive timeframe for exiting the investments. This does not need to be detailed for each investment: strategies could be identified by types or portfolios of investments held. [IFRS 10 para B85F]. The absence of such a strategy indicates an intention to hold investments indefinitely. Similarly, if your entity holds any debt investments that are perpetual, it should have identified an exit strategy for such debt investments. [IFRS 10 para B85F]. Without an exit plan, the entity s intention could be to hold such debt securities indefinitely. Holding dated debt instruments to maturity is seen as a valid exit strategy; this is because there is no possibility of holding dated debt investments indefinitely. [IFRS 10 para BC245]. Investment entities: Exception to consolidation PwC 8

11 PwC observation A business purpose of investing for capital appreciation and/or income is not consistent with an objective of holding investments indefinitely. Most non-investment entities do not plan to sell, list or otherwise dispose of most of their subsidiaries within a particular timeframe. A fund, on the other hand, will usually have an exit strategy. An entity should have exit strategies in order to demonstrate a business purpose consistent with being an investment entity. The amendment gives the following examples of potential exit strategies for different types of investment: Exit strategies for private equity securities can include an initial public offering, a private placement, a trade sale of a business, distributions (to investors) of ownership interests in investees and sales of assets (including the sale of an investee s assets followed by a liquidation of the investee, such as when the fund is a limited life fund). If your entity has investments in traded equity investments, exit strategies might include selling the investment in a private placement or in a public market. An exit strategy for real estate investments might be sale through specialised property dealers or through the open market. [IFRS 10 para B85G]. Example A fund holds investments in both equity securities and fixed-maturity debt securities. The stated objective of the fund is to provide investment management services to its investors, and invest funds received from investors solely for returns from capital appreciation and/or investment income. Assume that the fund meets all of the typical characteristics listed in IFRS 10. The fund s strategy for holding debt instruments is to manage its liquidity risk and to mitigate the risk of holding more volatile investments. The fund has a documented exit strategy for substantially all of its equity investments; but it has no documented exit strategy for its debt investments. The absence of a documented exit strategy for debt investments does not disqualify the fund from being an investment entity, and it does not contradict its business purpose. The debt instruments have a fixed maturity, so they cannot be held indefinitely. Exit mechanisms that have been put in place only for default events (such as breach of contract or nonperformance) are not considered exit strategies for the purpose of the investment entity assessment. [IFRS 10 para B85F]. PwC observation Exit strategies will often be evident from a fund prospectus or an entity s investment management agreement. For example, a limited life fund by definition has exit strategies for its investments. A fund that instructs its manager to turn over its equity investments at least every five years has an exit strategy. But an entity that is set up for long-term capital growth through manufacturing and selling products in a particular market - and which has no explicit plans to dispose of any of its equity investments - might have more difficulty determining that it has exit strategies for its investments. Such an entity might in fact, be more like a conglomerate and might not have a business purpose of investing for capital appreciation and/or investment income. Your entity might meet its business objective through holding some investments in another entity for legal, regulatory, tax or similar business reasons. You might not have identified an exit strategy for such investments. But, if the entity that you have invested in has an exit strategy for its investments, your entity will likely qualify as an investment entity. This will often be the case in master-feeder structures. A feeder fund invests in a master fund and does not have a plan to exit the master fund. But, the master fund will make investments and provided there are exit strategies for those investments, the feeder fund will not be disqualified from being an investment entity. Investment entities: Exception to consolidation PwC 9

12 Example A master-feeder structure (based on IFRS 10 para IE12, example 4) An entity, master fund MF1, is formed in 20X1 with a 10-year life. The equity of MF1 is held by two related feeder funds. The feeder funds are established in connection with each other to meet legal, regulatory, tax or similar requirements. The feeder funds are capitalised with a 1% investment from the general partner and 99% from equity investors that are unrelated to the general partner (with no party holding a controlling financial interest). The general partner of both FFD (a domestic feeder) and FFO (an offshore feeder) is the manager of MF1, FFD and FFO. GP 1% Multiple investors 99% GP 1% Multiple investors 99% FFD (Domestic Feeder fund) FFO (Off shore Feeder fund) MF 1 (Master fund) Portfolio of investments Facts The purpose of MF1 is to hold a portfolio of investments in order to generate capital appreciation and investment income (such as dividends, interest or rental income). The investment objective communicated to investors is that the sole purpose of the master-feeder structure is to provide investment opportunities for investors to invest in a large pool of assets. MF1 has identified and documented exit strategies for the equity and nonfinancial investments that it holds. MF1 also holds a portfolio of dated debt investments: some of these will be held until maturity and others will be traded. MF1 has not identified which specific investments will be held and which will be traded. MF1 measures and evaluates substantially all of its investments (including its debt investments) on a fair value basis. Also, investors receive periodic financial information, on a fair value basis, from the respective feeder funds, FFD and FFO. Are MF1, FFD and FFO investment entities? Conclusion MF1 and the feeder funds FFD and FFO each meet the definition of an investment entity. The following conditions exist: MF1 and the feeder funds FFD and FFO have obtained funds for the purpose of providing investors with investment management services. The master-feeder structure s business purpose (which was communicated directly to investors of the feeder funds) is investing solely for capital appreciation and investment income and MF1 has identified and documented potential exit strategies for its equity and non-financial investments. Investment entities: Exception to consolidation PwC 10

13 Although FFD and FFO do not have an exit strategy for their interests in MF1, they can be considered to have an exit strategy for their investments; this is because MF1 was formed in connection with the feeder funds and holds investments on their behalf. The investments held by MF1 are measured and evaluated on a fair value basis and information about the investments made by MF1 is given to investors on a fair value basis through the feeder funds. MF1 and the feeder funds were formed in connection with each other for legal, regulatory, tax or similar requirements. When considered together, MF1, FFD and FFO display the following typical characteristics of an investment entity: Although the feeder funds each hold a single investment in MF1, they could be considered indirectly to hold more than one investment; this is because MF1 holds a portfolio of investments. Although MF1 is 100% owned by the two feeder funds, the feeder funds FFD and FFO are funded by many investors who are unrelated to the feeder funds (and also unrelated to the general partner/manager of the funds). Ownership in the feeder funds is represented by units of equity interests. Earnings from investments If your entity or another member of your group can obtain or is seeking other benefits from your entity s investees that are unavailable to unrelated parties, that investee is not held with the sole objective of obtaining capital appreciation and/ or investment income. Instead, your entity might hold the investment in some operating or strategic capacity. Such an objective means that your entity does not qualify as an investment entity. Some examples of such benefits, which are inconsistent with an investment entity s business purpose, include: The acquisition, use, exchange or exploitation of the processes, assets or technology of an investee. This includes scenarios where you have (or another member of the group that you are a part of has) disproportionate or exclusive rights to acquire assets, technology, products or services of any investee (for example, by holding an option to purchase an asset from an investee if the asset s development is deemed successful). Your entity or any other member of your group entering into a joint arrangement (as defined in IFRS 11) or other agreement with an investee to develop, produce, market or provide products or services. Financial guarantees or assets provided by your entity s investee serve as collateral for your entity s borrowing arrangements or for those of another member of your group; but an investment entity can use an investment in an investee as collateral for any of its borrowings. An option held by your entity s related party to purchase from your entity or any other member of your group an ownership interest in an investee of the entity. Any transactions between you (or any other member of your group) and an investee that: are on terms that are unavailable to entities that are neither your related parties or related parties of another member of your group or the investee; are not at fair value; or represent a substantial portion of the investee s or your business activity, including business activities of other entities of your group. [IFRS 10 para B85I]. It is consistent with an investment entity s business purpose to have a strategy to invest in more than one investment in the same industry, market or geographical area in order to benefit from synergies that increase the capital appreciation of those investments. This is the case unless your entity is receiving any returns beyond solely capital appreciation and/ or investment income by holding such investments. [IFRS 10 paras B85J and BC243]. Investment entities: Exception to consolidation PwC 11

14 Example High technology fund (based on IFRS 10 para IE7, example 2) TechCorp Unrelated investors Option to buy Technology 70% ownership 30% ownership interest New Opportunities Tech Fund Manages Investment adviser Holds investments Technology start-up companies Facts A fund is formed by Technology Corp Inc ( TechCorp ) to invest in technology start-up companies for capital appreciation. TechCorp holds 70% of the shares in the fund, called New Opportunities Tech Fund and controls the fund. The other 30% of the shares in New Opportunities Tech Fund is owned by a number of unrelated investors. New Opportunities Tech Fund will invest in start-ups; and it will bring together a team of specialists to grow the start-ups. TechCorp holds options to acquire any of the investments held by New Opportunities Tech Fund, exercisable after 5 years following the purchase of the start-ups by the fund. The exercise price of the options is fair value. TechCorp is likely to exercise the options if the businesses or technology developed by the investees would benefit the operations of TechCorp. No plans for exiting the investments have been identified by the fund. New Opportunities Tech Fund is managed by an investment adviser that acts as agent for the investors in the fund. Is New Opportunities Tech Fund an investment entity? Conclusion New Opportunities Tech Fund s business purpose is to invest for capital appreciation, and it provides investment management services to its investors. But the fund is not an investment entity because of the following arrangements and circumstances: TechCorp, the fund s parent, holds options to acquire the investees owned by New Opportunities Tech Fund if the assets developed by the investees would benefit the operations of TechCorp. This provides a benefit to TechCorp in addition to capital appreciation and/or investment income. The investment plans of the fund do not include exit strategies for its equity investments. The options held by TechCorp are not controlled by the fund (since they are exercisable by TechCorp) and do not constitute an exit strategy. Investment entities: Exception to consolidation PwC 12

15 Example Real estate fund Facts A real estate fund is set up to invest in real estate assets for the benefit of institutional and retail investors. It is set up and managed by an investment manager experienced in the real estate business. The fund invests in real estate companies and other real estate investment funds which own, manage and lease out real estate assets. The investment manager has a policy of acquiring and disposing of its real estate investments over a five to ten year timeframe, based on market conditions. The fund earns dividends and share of profits, and it realises capital gains from its real estate investments. The fund reports (internally and externally) all its investments at fair value and its performance is assessed based on those fair values. The fund issues redeemable participating units which are redeemable at a share of the fund s net asset value (NAV). The founding documents of the fund confirm its objectives and strategy as stated. Is the fund an investment entity? Conclusion The fund meets the definition of an investment entity because its objective is to generate returns from capital appreciation and investment income through investment management services. It manages its investments on a fair value basis, which is reported to its investors. It displays the typical characteristics of an investment entity which are: it has more than one unrelated investor; it holds multiple investments; and it has ownership interests in the form of fund units which represent a proportionate share of its underlying assets. Example Real estate entity (based on IFRS 10 para IE9, example 3) Facts Real Estate Investments ( REI ) was formed in order to develop, own and operate retail, office and other commercial properties. REI usually holds each of its properties in separate wholly-owned subsidiaries. Those subsidiaries have no other substantial assets or liabilities other than borrowings used to finance the related investment property. REI and each of its subsidiaries report their investment properties at fair value under IAS 40, Investment property. REI does not have a set time frame for disposing of its property investments, but it uses fair value to help identify the optimal time for disposal. REI and its investors also use measures other than fair value (including information about expected cash flows, rental revenues and expenses) to assess performance and to make investment decisions. The directors and managers of REI do not consider fair value information to be the primary measurement attribute to evaluate the performance of REI s investments; instead, they see that information as part of a group of equally relevant key performance indicators. REI undertakes extensive property and asset management activities (including property maintenance, capital expenditure, redevelopment, marketing and tenant selection) some of which it outsources to third parties. This includes the selection of properties for refurbishment, development and the negotiation with suppliers for the design and construction work to be done to develop such properties. This development activity forms a separate substantial part of REI s business activities. Is REI an investment entity? Conclusion REI is not an investment entity because: It has a separate substantial business activity that involves the active management of its property portfolio, including lease negotiations, refurbishments and development activities, and marketing of properties to provide benefits other than capital appreciation and/ or investment income. REI s investment plans do not include specified exit strategies for its investments. As a result, it plans to hold those property investments indefinitely. Although REI reports its investment properties at fair value under IAS 40, fair value is not the primary measurement attribute used by management to evaluate the performance of its investments. Other performance indicators are used to evaluate performance and make investment decisions. Investment entities: Exception to consolidation PwC 13

16 Fair value measurement As an investment entity, fair value should be the primary measurement attribute for substantially all investments. For an entity that provides investment management services and invests for capital appreciation and/or investment income, fair value is likely to be more relevant information to evaluate the performance of your entity s investments (both internally and externally) compared to consolidating the entity s subsidiaries or using the equity method for the entity s interests in associates or joint ventures. Consequently, the amendment requires your entity to measure and evaluate the performance of substantially all of its investments on a fair value basis in order to qualify as an investment entity. [IFRS 10 para 27(c)]. This requirement applies to investments. So, it does not apply to non-investment assets or to financial liabilities. For example head office property and related equipment held under IAS 16, Property, plant and equipment do not need to be measured and evaluated on a fair value basis. [IFRS 10 para B85M]. It is evident that fair value information is your primary measurement attribute if fair value information is: used internally by key management personnel to assess performance of substantially all the entity s investments; and provided to your entity s investors and the entity measures substantially all its investments at fair value in its financial statements where this is permitted or required by IFRS. [IFRS 10 para B85K]. Note that fair value information includes using information from financial assets that are fair valued on the statement of financial position with fair value changes recognised in other comprehensive income under IFRS 9 and IAS 39, Financial instruments: Recognition and measurement such as available for sale assets. An investment entity accounts for: investment property using the fair value model in IAS 40, Investment property ; associates and joint ventures on a fair value basis by electing the exception from the equity method in IAS 28, Investment in associates ; and financial assets on fair value basis under IFRS 9. [IFRS 10 para B85L]. Typical characteristics of an investment entity Your entity is expected to display the following characteristics in order to qualify as an investment entity, in addition to meeting the definition. These characteristics are considered typical of investment entities: holding more than one investment; having more than one investor; having investors that are not the entity s related parties; and having ownership interests in the form of equity or similar interests. [IFRS 10 para 28]. The characteristics require you to apply additional judgement. Your entity can be an investment entity in the absence of one or more of these characteristics, provided you have assessed why it is appropriate for it to qualify as an investment entity in the absence of the typical characteristic(s) and make appropriate disclosure in the financial statements (see section on Disclosures ). It is considered highly unlikely, but possible, that your entity will qualify as an investment entity where it seems to strictly meet the definition but possesses none of the typical characteristics. [IFRS 10 para BC234]. More than one investment An investment entity will typically hold (directly or through another entity) more than one investment, with the objective of diversifying its risks and maximising returns. [IFRS 10 para B85O]. You should look at all the facts and circumstances to determine whether your entity qualifies as an investment entity, considering its business purpose, where you hold only one investment. Some scenarios where it might be appropriate to hold a single investment - and nevertheless qualify as an investment entity - are included in the amendment: Your entity has made only one investment because it is in a start up period and has not yet identified suitable multiple investments. Your entity has not yet made new investments to replace those that have been disposed of. Your entity has been established to pool investors funds to purchase a single investment that would have been unobtainable by individual investors (for example, when the required minimum investment is too high for an individual investor). Your entity is in the process of liquidation. [IFRS 10 para B85P]. Investment entities: Exception to consolidation PwC 14

17 PwC observation Most of the above single investor situations occur where a single investment is held temporarily or during a period of transition. It would be highly unusual to have only one investment for the life of an investment entity. The intention of investment entities is usually to hold more than one investment. If the intention is to hold multiple investments (but, for some practical or genuine reasons, your entity could not do so at the reporting date) it will likely continue to qualify as an investment entity. Example Limited Partnership (based on IFRS 10 para IE1, example 1) Facts An entity (LP) is formed in 20X1 as a limited partnership with a 10-year life. The offering memorandum states that LP s purpose is to invest in entities with rapid growth potential, with the objective of realising capital appreciation over their life. Entity GP (the general partner of LP) provides 1% of the capital to LP and has the responsibility of identifying suitable investments for the partnership. Approximately 75 limited partners (who are unrelated to GP) provide 99% of the capital to the partnership. LP begins its investment activities in 20X1.But no suitable investments are identified by the end of 20X1. In 20X2, LP acquires a controlling interest in one entity, ABC Corporation. LP is unable to close another investment transaction until 20X3, when it acquires equity interests in five additional operating companies. Other than acquiring these equity interests, LP conducts no other activities. LP measures and evaluates its investments on a fair value basis and this information is provided to GP and the external investors. LP has plans to dispose of its interests in each of its investees during the 10-year stated life of the partnership. Such disposals include the outright sale for cash, the distribution of marketable equity securities to investors (following the successful public offering of the investees securities) and the disposal of investments to the public or other unrelated entities. Is LP an investment entity? Conclusion From the information provided, LP meets the definition of an investment entity from formation in 20X1 to 31 December 20X3 because the following conditions exist: LP has obtained funds from the limited partners and is providing those limited partners with investment management services. LP s only activity is acquiring equity interests in operating companies with the purpose of realising capital appreciation over the life of the investments. LP has identified and documented exit strategies for its investments, all of which are equity investments. LP measures and evaluates its investments on a fair value basis and reports this financial information to its investors. In addition, LP displays the following typical characteristics of an investment entity: LP is funded by many investors. Its limited partners are unrelated to LP. Ownership in LP is represented by units of partnership interests acquired through a capital contribution. LP does not hold more than one investment throughout the period. But this is because it was still in its start-up period and had not identified suitable investment opportunities. Investment entities: Exception to consolidation PwC 15

18 Example Access fund Facts An access fund was set up in connection with a main fund. The access fund is the named shareholder on the register of the main fund. The access fund originally invested in the main fund at the initial offering stage of the main fund. Within the governing documents of the main fund, there was an initial subscription of $500 million. Once these capital amounts were raised, the main fund would be closed to new investors. This is referred to as a soft-closed fund. The main fund is closed to monies from new investors but not from existing investors. The main fund has been set up to make multiple investments, and it has an exit strategy set out in its founding documents. The objective of the access fund is to invest solely in the main fund. Shareholders who want access to the main fund can only do so through the access fund; this is because the main fund is closed to new shareholders. Shareholders of the access fund are entitled to a proportionate share of net assets of the access fund. The access fund provides investment management services to its unrelated investors; and it will receive returns from capital appreciation and investment income (that is, distributions from the main fund). The access fund manages its investment in the main fund on a fair value basis. Is the access fund an investment entity? Conclusion The access fund meets the definition of an investment entity: The fund obtains funds from investors with the objective of providing investment management services. The objective of making investments is generating capital returns and investment income; the fund will receive dividends from the main fund and capital appreciation through increases in the fair value of the main fund. Although the access fund does not have an exit strategy for its investment in the main fund, the main fund has exit strategies for its investments. It measures and evaluates the performance of its investment in the main fund on a fair value basis. The access fund displays three of the four typical characteristics of an investment entity: The fund has multiple investors. The multiple investors are unrelated. The fund has ownership interests in the form of units that entitle the investors to the net assets of the fund. The access fund does not display the fourth typical characteristic (that is, it has one single investment), but it concludes that it qualifies as an investment entity. It has been set up to provide investment management services to its investors with the objective of earning capital appreciation and investment income from its investment in the main fund. It manages its underlying investment on a fair value basis. The fact that it does not meet the characteristic in these circumstances is not inconsistent with the overall definition and business purpose of being an investment entity. The access fund is required to make appropriate disclosures as to why it has concluded that it is an investment entity despite not displaying all of the typical characteristics. Investment entities: Exception to consolidation PwC 16