IFRS 9 - Investment in Tracker Certificate

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LindsayM
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IFRS 9 - Investment in Tracker Certificate

Post by LindsayM »

Hi Guys
I need an advise on how to account an investment in a Tracker Certificate which is linked to an index. Can it be treated as a derivative?
Thanks
Lindsay
DJP
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

Hello,

It is not a derivative because the initial value is not nil (nor close to nil), and most likely it does not have a maturity either.

Nevertheless, it should be accounted for at FVPL.

Cheers
JRSB
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Re: IFRS 9 - Investment in Tracker Certificate

Post by JRSB »

I had to look at what that is - it seems like buying into a Fund/ETF which in turn invests in the index/commodities/companies etc you want to track, and so the value moves in line with those. Sounds like a useful/easy way of getting into niche metals or something, interesting.
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Marek Muc
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Marek Muc »

DJP wrote: 27 Apr 2022, 12:42 Nevertheless, it should be accounted for at FVPL.
Are you saying that FVOCI cannot be used for this investment?
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

Correct. The only way (to my knowledge) of realising cash flows on these products is by selling them.
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

and by selling I mean "redeeming". Not sure if there's a market for these products, to be honest.
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Marek Muc
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Marek Muc »

This applies to all equity instruments really. But if it's not held for trading, I don't see why you couldn't classify it as FVOCI
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

For the same reason you cannot use the FVOCI option for mutual funds. They are puttable instruments and they do not meet the definition of an equity instrument (IFRS 9 BC5.21).
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Marek Muc »

Didn't know that, thanks!
Leo
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Leo »

Hi DJP, thank you very much for your insight ! Please let me quote the definition of equity instrument :

"The application of the basic definitions in IAS 32 means that an instrument is an equity instrument only if both the following conditions are met:
The instrument includes no contractual obligation either:
1. To deliver cash or another financial asset to another entity. Or To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the issuer.
2. If the instrument will, or may, be settled in the issuer’s own equity instruments, it is either: A non–derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments. Or A derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments. For this purpose the issuer’s own equity instruments do not include instruments that have all the features and meet the conditions described in IAS 32.16A and 16B (see section 4.6.2 below) or IAS 32.16C and 16D (see section 4.6.3 below) or instruments that are contracts for the future receipt or delivery of the issuer’s own equity instruments. [IAS 32.16].

As a pragmatic exception to these basic criteria, an instrument that would otherwise meet the definition of a financial liability is nevertheless classified as an equity instrument if it is either:
A puttable instrument with all the features, and meeting the conditions described, in IAS 32.16A and 16B (see section 4.6.2 below). Or An instrument entitling the holder to a pro rata share of assets on a liquidation with all the features, and meeting all the conditions, described in IAS 32.16C and 16D. [IAS 32.16]. This is discussed further in section 4.6.3 below.

Broadly speaking, apart from this exemption, an instrument can only be classified as equity under IAS 32:

If the issuer has an unconditional right to avoid delivering cash or another financial instrument (see section 4.2 below). Or If it is settled through the entity’s own equity instruments, it is for an exchange of a fixed amount of cash for a fixed number of the entity’s own equity instruments.
In all other cases it would be classified as a financial liability."
Leo
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Leo »

It does say that :

"As a pragmatic exception to these basic criteria, an instrument that would otherwise meet the definition of a financial liability is nevertheless classified as an equity instrument if it is either:
A puttable instrument with all the features, and meeting the conditions described, in IAS 32.16A and 16B (see section 4.6.2 below). Or An instrument entitling the holder to a pro rata share of assets on a liquidation with all the features, and meeting all the conditions, described in IAS 32.16C and 16D. [IAS 32.16]. This is discussed further in section 4.6.3 below."

If I understand English correctly, it means puttable instrument is classified as equity instrument ? Please help me to understand, why it is saying this here and in IFRS 9 BC5.21, its saying the contrary ?
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

I understand that this can be a bit confusing, but in substance all puttable instruments are financial liabilities because you cannot avoid settlement in cash (or in another financial asset). However, as an exception, the issuer classifies a puttable instrument as equity if certain conditions are met. But this is just a matter of presentation on the issuer's side.

Bottom line is: the FVOCI option in IFRS 9 is only for equity instruments, but puttable instruments are not equity instruments (although they are presented as such in the issuers' financial statements if certain conditions are verified).
Leo
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Leo »

Hi DJP, thank you so much.

Can I understand this :

IAS32 deals with classification of financial instruments by their issuer but not their holders, so, although puttable instruments could be classified as equity instrument by the issuer, it doesn't mean that the holder can do it as well.

Puttable instrument (per IFRS9 BC5.21) is not classified as equity instrument by the Holder.
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

Yes, your understanding is correct.

Please bear in mind that classification of "equity" or "financial liability" on the issuer's side is irrelevant for the holder. All those instruments are financial assets for the holder and it is the type of cash flows and business model that determine their classification on the holder's side. However, since the FVOCI option was specifically introduced in IFRS 9 for equity investments, we need to assess whether the instruments are -- in substance -- equity instruments.
Leo
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Leo »

That's very helpful !!! Thank you
LindsayM
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Re: IFRS 9 - Investment in Tracker Certificate

Post by LindsayM »

Thank you very much for your answers. Greatly appreciate.
Leo
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Leo »

Hi everyone,

Sorry to bother you again, just a quick question. I came across a publication from EY :

https://www.ey.com/en_gl/ifrs-technical ... ember-2018

On page 32/33, there are two category of funds, one is called "Listed/Unlisted managed funds" and the other one is called "Money market funds". The first one is classified within equity instruments, and the second one is in a separate category.

From our previous discussions, I'm quite certain that mutual funds are equivalent to Money market funds, an I correct ?

Then, what are listed/unlisted managed funds ? What is the main factor that triggers a different classification, as equity instruments (hence, eligible to FVTOCI ?) ?

Thank you in advance for your help !
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LindsayM
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Re: IFRS 9 - Investment in Tracker Certificate

Post by LindsayM »

Money market funds are not hedge funds. That's why they are not classified as equity.
DJP
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

A few observations:

MMFs are mutual funds, but not all mutual funds are MMFs.

Most mutual funds are NOT equity because they are puttable and, therefore, FVOCI is not an option. Equity financial instruments do not represent an obligation to pay cash. IAS 32 gives some exception for puttable instruments to be classified as equity, but this does not change the nature of the instruments; some mutual funds may be classified as equity in the accounts of the issuer, but they continue to be financial liabilities if they are puttable. That said, there are certain mutual funds out there where the fund manager has discretion on redemptions; that would make those instruments equities (certain hedge funds could be an example).

The reason why MMFs are presented separately in the illustrative financial statements you sent may be because certain MMFs meet the criteria of cash equivalents, or simply because the preparer of the financial statements wants to present MMFs separately from other mutual funds from a risk/liquidity standpoint.
Leo
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Re: IFRS 9 - Investment in Tracker Certificate

Post by Leo »

Thanks DJP, I think they are presented separately simply because MMF aren't Equity Instruments, so they have to be presented apart from the rest.

So, I understand that the factor that qualifies a fund as equity instrument or not, it's whether fund manager has discretion on redemption ? Is that the only characteristic that makes the hedge fund different from mutual funds from the IFRS point of view ?
Last edited by Leo on 06 Jun 2022, 10:15, edited 1 time in total.
DJP
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

Correct

(I have never seen any in practice, but I am assuming they may exist.)
JRSB
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Re: IFRS 9 - Investment in Tracker Certificate

Post by JRSB »

By puttable, do we mean 'redeemable at the option of the holder', in laymans' terms?
DJP
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Re: IFRS 9 - Investment in Tracker Certificate

Post by DJP »

Yes
JRSB
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Re: IFRS 9 - Investment in Tracker Certificate

Post by JRSB »

thanks
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