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What is meant by 'settled net in cash' in this context?

Suppose entity A confirms that Entity B (unconnected ) can borrow €10m 1 year from today. Market rate of interest, no special terms.
Entity has a reporting date in 6 months' time, so the legal obligation is there, but no loan made yet. But a loan commitment exists.

Is this outside the scope of IFRS 9 and so not recognised at all (apart from ECLs) - or is the commitment a FVTPL liability?

If it is a liability, what is the Dr entry? Not a financial asset yet (or is this considered to also constitute a contractual right to receive the repayment, even though not paid out yet?). In which case Debit and Credit equal financial asset/financial liability?

Comment/direction gratefully received!


IFRS 9 2.3:
The following loan commitments are within the scope of this Standard:
(a) loan commitments that the entity designates as financial liabilities
at fair value through profit or loss (see paragraph 4.2.2). An entity
that has a past practice of selling the assets resulting from its loan
commitments shortly after origination shall apply this Standard to
all its loan commitments in the same class.
(b) loan commitments that can be settled net in cash or by delivering or
issuing another financial instrument. These loan commitments
are derivatives. A loan commitment is not regarded as settled net
merely because the loan is paid out in instalments (for example, a
mortgage construction loan that is paid out in instalments in line
with the progress of construction).

I note on the revolving credit facility thread, exIFRS explained that 'vanilla' loan commitments (which this would fall into) are outside scope, so i suppose the meaning of settled net in cash is what would help distinguish between in scope and out.

A loan commitment is a commitment to make a loan in the future at a specified rate. This meets the definition of a derivative. Therefore, the IASB decided to simplify the accounting for loan commitments by excluding them from IFRS 9, unless you designate them at FVTPL, or if they can be net settled in cash, or if the commitment is to provide the loan at a below-market interest rate.

"Loan commitments that can be settled net in cash" means that you can be compensated (or compensate) the other party for changes in the interest rates or credit spreads between the commitment date and the drawdown date. (Basically you would be settling the value of the derivative.)

So answering your question, you don't have to book anything until the loan is drawn. You may have to disclose the commitments as part of other standards disclosures such as IFRS 7 liquidity risk disclosures (if you're the borrower) or IAS 37 (if you're the lender).

That's a great response, thanks very much.
A fascinating world that accounting can't quite seem to cope with.

If the loan commitment is determined to be outside the scope of IFRS 9, the ECL requirements would still apply to the loan commitments per IFRS 9.2.1(g) '..however, an issuer of loan commitments shall apply the impairment requirements of this Standard to loan commitments that are not otherwise within the scope of this Standard.' Does this mean the ECL would be recognised in the P&L even though the loan is not yet recognised (drawn down)?

Yes, if you give out a loan commitment, you have to book an ECL (which shows up in the P&L), since you have now a commitment that could lead to future losses. Compare it to for example giving out a credit card, there you have also agreed to a right of the customer in the future drawing down the loan, but already today, you have to book the ECL.

Is a "loan commitment" the same as "a loan already granted"?
When there is an example of a standard revolving credit facility (one borrows money from bank, then repays, then borrows again when they want etc., no rules, only an upper limit), I believe these two are not the same. For instance, bank allows me to borrow up to 50 million EUR and a week later I borrow 10 million EUR. Isn't it that only the remaining 40 million EUR is in fact a "loan commitment" (outside IFRS 9) and, at the same time, 10 million EUR I factually took, is a loan granted (a financial instrument under IFRS 9)?

Consequently, if "a loan already granted" is in fact a financial instrument, then it would probably require to be accounted for using effective interest method. Let's now say that each month, apart from regular interest, a bank charges additional fee (the amount depends of average debt during that month). Is it even doable to calculate an effective interest rate on a credit facility like this (given the fact I can make over a dozen transactions per day)?

A loan commitment is indeed the undrawn part of a credit facility. The drawn portion is a financial instrument accounted for under IFRS 9.

From experience, and apart from sophisticated banks, most entities amortise transaction costs on a straight line basis as a proxy to the effective interest rate. You will see that in most cases the difference of using one and the other method is immaterial.

Thanks. But I believe that in my example (each month an additional fee that depends of average debt during that month) it is allowed to put such fees straight into the P&L?

When it comes to revolving facilities, they are treated as one instrument together, as can be seen from IFRS 9.5.5.20:
However, some financial instruments include both a loan and an undrawn commitment component and the entity’s contractual ability to demand repayment and cancel the undrawn commitment does not limit the entity’s exposure to credit losses to the contractual notice period. For such financial instruments, and only those financial instruments, the entity shall measure expected credit losses over the period that the entity is exposed to credit risk and expected credit losses would not be mitigated by credit risk management actions, even if that period extends beyond the maximum contractual period.

The "average debt" you describe sounds to me like interest (since it is proportional to drawn balance), so it seems like it should qualify in as interest income.

Hi Kieran -- to answer your question, I would take a practical approach here and take those monthly fees straight to P&L.You may want to do a couple of simulations and calculations to prove that the difference is immaterial compared to using the effective interest method.