Convertible bond at the option of the issuer

[Leo]

In case of a fixed rate convertible bond that provide the issuer the option, at its own discretion, to convert the principal and any accrued interest at the same rate, then the instrument is classified as equity in its entirety.

This is because the issuer can avoid paying cash; (IAS 32.11.a.i)
and avoid exchanging into a variable number of its own equity instruments (IAS 32.11.b.ii).

However, IFRS requires that the terms of a convertible instrument are analysed and each component accounted for separately. So if you follow that logic, the liability host contract is a liability, because the issuer has to pay cash a maturity, and the conversion feature an equity because it converts into a fixed number of ordinary shares.

So why, a convertible bond that provide the issuer the option to convert into a fixed number of equity shares are not treated as a compound instrument, with a liability element and an equity element, but as an equity instrument in its entirety?

Any thoughts?

[kevin.aycardo]

Hi Leo,
I believe your question is answered in PwC's FAQ 43.74 (see attached). Please double check the fact pattern. In short, instruments convertible only at the option of the issuer can be accounted for as either equity in its entirety of a hybrid instrument (liability), depending on analysis of the host contract.

As always, this is a very complicated area.

Thanks.
Kevin

[Leo]

Hi Kevin, thanks for sharing! It seems that when the issuer has solely the option to convert, in this case, depending on management's own judgement, it can vary from liability to equity.

I guess 99/100, people would choose the equity classification.

In the case you shared, if there is no cash redemption option, which is based on the fair value of the shares at the redemption date, it would be a compound Financial instrument instead of a hybrid, because the option to convert into a fixed number of shares.

[Leo]

On the PWC's case, just a question,

A financial liability is:

a contract that will or may be settled in the entity’s own equity instruments and is:
(i)a non‑derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or
(ii)a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments

My point is on (ii) where it says a derivative that will or may be settled other than by exchange of a fixed amount of cash or another financial asset for a fixed number of its own equity shares.

In a case where a company issued a convertible bond which gives the issuer two options as follows:
option 1: convert into a fixed number of its shares.
option 2: settled with cash of equivalent value than option 1

If the option 1 is the only option, then, the instrument is either an equity or a compound (liability + Equity). However, it seems that the existence of option 2 make it a hybrid, because the conversion feature, is treated as a derivative instrument.

However, couldn't the holder get the shares, sell them in the market and get the cash for equivalent value?

any thoughts?