Investment funds

[Hanspeter]

Hi all,
I would like to ask, following this post viewtopic.php?t=917:

1) Is an investment in an exchange-traded fund (ETF) an equity instrument under IAS 32? If yes, which points in IAS 32 are the basis for this particular example?

2) Is an investment in a money market fund an equity instrument under IAS 32 (where the money market fund does in general "again" invest in exchange-traded instruments)? If yes, which points in IAS 32 are the basis for this particular example?

Thank you very much for the clarification on those points.

[Leo]

viewtopic.php?p=6026&hilit=etf#p6026

[Hanspeter]

I must cite different aspects of the previous discussion to get an understanding and after that I may be able to ask the question accordingly with the missing understanding from my side.

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).

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.

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).

From the quotes I would construct the following:

The products (Stock-ETFs, Bond-ETFs, MMFs [money market funds]) are not puttable instruments. Since a puttable instrument is a financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset. But in the case of these products the “sale” takes place on a secondary market and not against the issuer.
The products (Stock-ETFs, Bond-ETFs, MMFs [money market funds]) also do not represent an obligation (for the issuer) to pay cash (to the holder). Therefore, I would conclude that these products are equity financial instruments.
Is this correct?

[Ketan Marwah]

Hi,

Don’t rush to conclude something so early for all types of investment funds;). IFRS 9 defines equity instruments from the issuer’s point of view, based on the criteria set in IAS 32 financial instruments – presentation.
Money market funds/debt investment funds are mutual funds that invest in debt securities characterized by short maturities and minimal credit risk. Since such units do not meet certain criteria of IAS 32 (does not represent residual interest), therefore such investments would not be an equity investments in my view.
The fund would have to meet the definition of a “puttable” instrument as defined in paragraphs 16A to 16D of IAS 32 and it would have to hold only equities, ETT funds, cash (according to requirements) and certain hedging instruments (such as currency hedges) to qualify as an equity investment.

Also a side note: In the current form of IFRS 9, investments in equity funds are not eligible for the same accounting treatment as direct equity investments. Investments in fund units are not eligible for measurement at FVOCI (not recyclable to income), which is authorised for equities.

[hubertd]

Also a side note: In the current form of IFRS 9, investments in equity funds are not eligible for the same accounting treatment as direct equity investments. Investments in fund units are not eligible for measurement at FVOCI (not recyclable to income), which is authorised for equities.

Hi Ketan,

Would you mind to direct me to the ifrs 9 article(s) which confirm that equity funds cannot be held at FVOCI?

Thank you

[Ketan Marwah]

Hi Hubertd,

IFRS 9.BC5.21 states that the term ‘equity instrument’ used in paragraph 4.1.4 is as defined in IAS 32 and that puttable instruments that are classified as equity in certain circumstances do not meet the definition of an equity instrument.
In light of the above, the Staff believe that it is clear that the financial instruments described in IAS 32.16A-16D are financial liabilities and are not equity instruments as defined. Accordingly, such financial instruments are not eligible for the OCI presentation election in terms of IFRS 9.4.1.4.

[hubertd]

Thanks a lot Ketan

[CBD]

Hi everyone,

I would like to jump on this thread and clarify my understanding.

I thought the debt/equity classification of an investment in a fund is based on whether it is puttable. And if it is puttable, it can be classified as equity under IAS 32 if it meets the criteria in IAS 32 para 16A-D. Do we still need to further consider the nature of the underlying investments? If a Company were to hold ordinary shares of another Company that only has debt securities, wouldn't these shares still be equity?

I thought that ETFs (regardless of their underlying investments) cannot be booked at FVOCI because they are essentially still puttable instruments from the issuer's perspective. While individual retail investors can only sell their shares on the market, authorised financial institutions can typically redeem their shares with the fund (albeit at a large volume). As the classification is dependent on the issuer's perspective, the holder will have to account for these as puttable instruments. Hence, they will not be able to book them at FVOCI as these are not considered to be equity under IFRS 9.

Appreciate if anyone could share your thoughts on the above. There isn't much information on the C&M for ETFs.

Thanks!

[Marek Muc]

Lots of insightful thoughts have already been shared in this topic and the one linked to here I think your questions have been answered, haven't they?