Summary of proposed amendments to IFRS 9/IFRS 7

The IASB has issued an exposure draft (‘ED’) with proposed amendments to IFRS 9 Financial Instruments (‘IFRS 9’) and IFRS 7 Financial Instruments: Disclosures (‘IFRS 7’) following feedback received during the Post-implementation Review (‘PIR’) of IFRS 9 Classification and Measurement

Feedback on the ED is due on 19 July 2023.

The ED in a nutshell…

Issues addressed

IFRS 9 Financial Instruments

Settlement of financial liabilities using an electronic payment system (‘EPS’)
Criteria for classifying certain debt instruments as solely payments of principal and interest (‘SPPI’):

Environmental, social and governance (‘ESG’)-linked features;
- Non-recourse features;
- Contractually linked instruments (‘CLIs’)

IFRS 7 Financial Instruments: Disclosures

Equity instruments at fair value through other comprehensive income (‘FVOCI’)
Contractual terms that may impact contractual cash flows depending on contingent events

Proposed amendments/additions

Settlement of financial liabilities using an EPS

For more detail on the origination of this issue refer to our April 2023 edition of Beyond the GAAP.

The proposed amendment clarifies that entities need to apply settlement date accounting when derecognising a financial instrument, and to permit early discharge using an EPS if certain criteria are met:

The entity must have initiated the payment instrument and…

have no ability to withdraw, stop or cancel;
no practical ability to access the cash as a result; and
settlement risk = insignificant

Insignificant risk = completion of payment through EPS follows a standard administrative process + time to complete is short.

If completion of instruction is subject to the entity’s ability to pay then risk cannot be considered insignificant.

To be applied consistently to all settlements using the same EPS.

Criteria for classifying a financial asset as SPPI:

ESG-linked features;
Non-recourse features;
CLIs

ESG-linked features

The proposed amendment includes clarifications to assess remuneration received by a lender in determining what is, and isn’t, consistent with a basic lending arrangement.

High-level:

- What is being compensated for, rather than how much

- Common market/industry practice is not sufficient conclude that SPPI criteria is met

- The direction and magnitude of a change in contractual cash flows must align with the change in basic lending risks/costs

The ED further clarifies how the above should apply to financial assets with contractual terms that impact contractual cash flows depending on the occurrence/non-occurrence of contingent events.

The contingent cash flows should be:

- included in SPPI analysis regardless of probability

- consistent with basic lending arrangement:

Contingent event = specific to borrower; and
Resulting cash flows cannot represent an investment on the debtor/exposure to the performance of specific assets

To illustrate this, the ED proposes the inclusion of additional examples specific to financial assets with ESG-linked features.

The examples clarify that these financial assets meet the SPPI criteria where the contractual cash flows may change as a result of the debtor meeting/not meeting ESG targets (contingent event), provided that the targets are specific to the debtor. E.g. the interest rate is adjusted periodically where the debtor achieves a specified reduction in carbon emissions.

Where the cash flows change due to a market index, these financial assets would not meet the SPPI criteria.

The urgency behind this proposed amendment is in response to feedback received from PIR participants. ESG-linked financial assets are growing exponentially in global markets, and there is currently diversity in practice when assessing the contractual cash flow characteristics for classification.

The proposed amendments are, however, not specific to ESG-linked financial assets.

Non-recourse features

The proposal clarifies that a financial asset has non-recourse features if:

the contractual right to cash flows is limited to those generated by specific assets; I.e. throughout the life of the financial asset and on default; and
the risk exposure is to the performance of the specific asset, not the credit risk of the debtor

The proposed amendment further clarifies that consideration must be given to legal and capital structure of the debtor when performing the SPPI assessment. The ED proposes examples of factors to consider when making this assessment.

CLIs

CLIs are instruments that are usually issued by a special purpose vehicle and are backed by financial assets held by the vehicle. For more detail refer to our April 2023 edition of Beyond the GAAP.

The proposed amendments clarify the definition of CLIs for scoping purposes. The distinction between CLI transactions and financial assets with non-recourse features is also made clearer.

The ED further clarifies that the underlying pool of instruments may include financial instruments that are not within the scope of IFRS 9, provided that the contractual cash flows meet the SPPI criteria.

Disclosures

Equity instruments at FVOCI
Contractual terms that may impact contractual cash flows depending on contingent events

Equity instruments at FVOCI

The ED proposes that the amount of change in the fair value during the period should be disclosed, showing separately:

the amount relating to investments derecognised during the period; and
the amount relating to the remaining investments held

Contractual terms that may impact contractual cash flows depending on contingent events

The ED proposes disclosure of:

the nature of the contingent event (qualitative);
the possible range of changes to contractual cash flows (quantitative); and
gross carrying amount of the related financial assets (and amortised cost liabilities)

These disclosures must be made separately for each class of financial assets at amortised cost/FVOCI, and financial liabilities at amortised cost.

Effective date and transition

The effective date is not yet determined.

The ED proposes that the amendments be applied retrospectively, however restatement of prior periods would not be required.

Want more detail? The full ED can be accessed on IFRS.org.

Interested in financial instruments with ESG-linked features? Follow our IFRS series on sustainability-linked financing:

Introduction

Why ESG-linked features impact financial assets classification under IFRS?

How do ESG-linked features impact the borrower/issuer under IFRS 9?

Authors:
Justine Lewis, Manager

26 May 2023