SPPI on convertible note

[Leo]

Hi,

I agree that convertible note with a feature that allow the investors to convert into a fixed number of shares at maturity date fails the SPPI test. However, I've come across a case where it says that the instrument might satisfy the SPPI if the note is convertible into a variable number of shares with a fair value equal to unpaid amounts of principal and interest on the principal amount outstanding. The argument is based on the shares could be considered as a 'currency'.

From my point of view, the reason why a convertible note fails SPPI is because the contractual cash flows are not payments of principal and interest and don't reflect the characteristics of a basic lending arrangement. Hence, no whatever conversion feature is, it is not basic lending arrangement...

What's your opinion?

[Leo]

On top of what I've said, convertible note with conversion feature that allows a holder to convert into a variable number of shares based on the fair value of the note is more frequent than conversion into a fixed number of shares.

[Leo]

Comparing the view of EY vs PWC. Worth noting that EY's publication is dated 2015. So, views may have changed since?

[DJP]

Please note that that the instrument does not have to be a basic lending arrangement; it's the payments that must be the same as under a basic lending arrangement. So if the consideration you get upon conversion is exactly equal to the consideration you would get if you had a plain vanilla debt instrument, you do not fail the SPPI test (but at the point of conversion you will have to derecognise the instrument and recognise the shares, which are not SPPI). However, as EY indicates, this type of deals will often involve other features that need to be taken into consideration.

[Leo]

that's very clear thanks DJP