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IFRS FOR INVESTMENT FUNDSMay 2012,Issue 4

In this issue: Classication o nancialassets and liabilities under IFRS 9IFRS 9 Financial Instrumentsis to supersede IAS 39 Financial instruments:

Recognition and Measurement. Its classication requirements represent a

signicant change rom IAS 39 or nancial assets and a limited one or nancialliabilities. This publication covers the ollowing key questions related to classication

under IFRS 9 which may be o particular interest to investment unds.

1. What are the new classication requirements or nancial assets?

2. How are debt investments classied?

3. How is the objective o the business model in which the asset is held assessed?

4. Are the cash fows solely payments o principal and interest?

5. How are contractually linked instruments classied?

6. How are debt investments classied on initial application o IFRS 9?

7. How are investments in equity instruments classied?

8. How are investments in equity instruments classied on initial application o

IFRS 9?

9. How are nancial liabilities classied?

10. What are the new presentation requirements or nancial liabilities designated

at air value through prot or loss?

11. What about reclassication o nancial assets and transitional provisions?

The standard is eective or annual periods beginning on or ater 1 January 2015,

with early application permitted.

In November 2011 the IASB initiated a project o limited amendments to IFRS 9.

In January 2012 the IASB and the FASB decided to jointly redeliberate selected

aspects o their classication and measurement models to seek to reduce key

dierences. The redeliberations are to include the ollowing topics relevant to the

classication o nancial assets:

business model and cash fow characteristics o nancial assets eligible or

classication and measurement at amortised cost;

a possible air value through other comprehensive income category or debtinvestments; and

whether to re-introduce biurcation o embedded derivatives or nancial assets.

The target date or issuing an exposure drat with the proposed changes is the

second hal o 2012. This publication includes the IASBs tentative decisions on this

project up to and including the April 2012 meeting. We have highlighted in each

question a potential impact rom the IASB discussions assuming that the tentative

decisions made up to and including the April 2012 meeting remain unchanged.

This publication does not consider nancial instruments designated in hedging

relationships.

Welcome to theseries

Our series o IFRS

for Investment Funds

publications addresses

practical application issues

that investment unds may

encounter when applying

IFRS. It discusses the key

requirements and includes

guidance and illustrative

examples. The issues cover

such topics as presentation

and measurement o nancial

assets carried at air value,

liability vs equity classication

or nancial instruments

issued by investment unds

andsegment reporting.

This series considers

accounting issues rom

currently eective IFRS

as well as orthcoming

requirements. Further

discussion and analysis

about IFRS is included in our

publication Insights into IFRS.


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2 | IFRS or Investment Funds

2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

1. What are the new classicationrequirements or nancial assets?

IFRS 9 Financial Instrumentshas introduced new classication categories or nancial assets. The classication depends on the

type o business model within which those nancial assets are held and on the contractual characteristics o a nancial asset.

There are two classications: at air value and at amortised cost.

Classication o nancial assets upon initial recognition

Financial assets under IFRS 9: Financial assets under IAS 39:

amortised cost; and

air value.

air value through prot or loss;

held to maturity;

loans and receivables; and

available-or-sale.

This publication considers separately classication o debt investments, investments in equity instruments and derivatives.

Only debt instruments can be classied as measured at amortised cost. Investments in equity instruments and derivatives are

always classied as measured at air value.

Equity instruments are dened in the same way as in IAS 32 Financial Instruments: Presentation. This means that a holder o an

investment assesses whether the instrument meets the denition o equity rom the perspective o the issuer.

The table below summarises the classication and measurement requirements o IFRS 9.

Classication and measurement requirements or nancial assets under IFRS 9

Debt investments Investments in equity instruments Derivatives

Eligible or classication as measured

at amortised cost, i both o the

ollowing conditions are met.

The investment is held in a businessmodel whose objective is to collect

contractual cash fows (held-to-

collect (HTC) business model).

The contractual terms o the nancial

asset give rise on specied dates to

cash fows that are solely payments

o principal and interest on theprincipal amount outstanding (SPPI).

I a nancial asset does not meet both

o the above criteria, then it is classied

as measured at air value through prot

or loss.

Classied as measured at air value.

Changes in air value are recognised:

in prot or loss; or

in other comprehensive income

(OCI) i optional election is made.

The OCI option does not apply to:

instruments held-or-trading;

puttable instruments and obligations

arising on liquidation classied as

equity by the issuer by exception;

and

derivative instruments that meet the

denition o equity o the issuer.

Classied as measured at air value.

Gains and losses on re-measurement

are recognised in prot or loss.


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IFRS or Investment Funds | 3


Classication and measurement requirements or nancial assets under IFRS 9

Debt investments Investments in equity instruments Derivatives

On initial recognition, an investment

und may choose to designate a

nancial asset that otherwise would

qualiy or amortised cost accounting

as measured as at air value throughprot or loss. This optional designation

is permitted only i it eliminates or

signicantly reduces an accounting

mismatch.

Further discussed in Questions 2-6. Further discussed in Questions 7-8.

Another signicant change rom IAS 39 is the removal o the requirement to separate embedded derivatives rom a nancial

asset host (i the host is within the scope o IFRS 9). Instead, under IFRS 9 the whole combined instrument is assessed or

classication either as at air value or amortised cost.

Under IAS 39 an embedded derivative is separated i:

the embedded eature meets the denition o a derivative;

the embedded derivative is not closely related to the host; and

the entire contract is not measured at air value through prot or loss.

IFRS 9 retains the IAS 39 requirement to separate embedded derivatives rom host contracts that are:

nancial liabilities;

nancial assets not within the scope o IFRS 9; and

other contracts not within the scope o IFRS 9.

The IASB discussion on limited amendments to IFRS 9

Business model and cash fows characteristics assessment or amortised cost classication or nancial assets

Under the current version o IFRS 9, a nancial asset is required to meet two tests to be eligible or classication at other

than air value. The rst test relates to the entitys business model (see Question 3) and the second test relates to the assets

cash fow characteristics (see Question 4).

The IASB tentatively decided that a nancial asset would qualiy or amortised cost classication i:

it is held within a business model whose objective is to hold the asset in order to collect contractual cash fows; and

its contractual terms give rise to cash fows that are solely payments o principal and interest on the principal amount

outstanding.

These tentative decisions are largely in line with the current requirements o IFRS 9.

The IASB also tentatively decided to clariy the primary objective o hold to collect by providing additional implementation

guidance on the types o business activities and the requency and nature o sales that would prohibit nancial assets rom

qualiying or amortised cost measurement. This may help preparers in navigating the current guidance and examples in

IFRS 9 about assessing whether a more than inrequent level o sales is consistent with a hold to collect business model

(see Question 3).


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Biurcation o nancial assets and nancial liabilities

IFRS 9 currently does not permit biurcation o nancial assets but requires biurcation o embedded derivatives rom

nancial liabilities i they are not closely related.

At their April 2012 meeting the IASB tentatively decided to retain the current IFRS 9 guidance on biurcation. This means that

nancial assets that do not qualiy or amortised cost classication (see Question 2) would not be biurcated; instead, they

would be classied and measured in their entirety at air value through prot or loss. Financial liabilities, on the other hand,

would be biurcated using the existing closely-related biurcation requirements currently in IFRS 9 (see Question 9).

In relation to their decision to biurcate nancial liabilities, the IASB also conrmed that the own credit guidance in IFRS 9

would be retained (see Question 10).

A possible air value through OCI classication category or debt investments

At uture meetings on the classication and measurement o nancial instruments, the IASB will consider a possible third

classication category or nancial assets debt instruments measured at air value through OCI.


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2. How are debt investments classied?

The assessment o whether a debt investment is eligible or classication at amortised cost may involve judgement.

Investment unds can use the steps in the fowchart below to help determine the appropriate classication.

1. (see Question 3).

Is financial asset held within a HTC business model?

HTC business model test

2. SPPI test (see Question 4).

Are the cash flows from the financial asset solely payments of principal

and interest?

3. Fair value option applied?

Fair value through profit or loss Amortised cost

No

No

No

Yes

Yes

Yes

IFRS 9 retains the option in IAS 39 to voluntarily designate a nancial asset as at air value through prot or loss. This optional

designation is permitted only i it eliminates or signicantly reduces a measurement or recognition inconsistency (accounting

mismatch) that otherwise would arise rom measuring nancial assets or nancial liabilities, or recognising gains or losses on

them, on dierent bases.

The ollowing other two air value designation conditions currently available or nancial assets in IAS 39 are not retained in

IFRS 9 because the requirements o IFRS 9 rendered them redundant.

Instruments managed on a air value basis: under IFRS 9, nancial assets managed on a air value basis cannot qualiy oramortised cost measurement and thereore are mandatorily measured at air value.

Certain hybrid instruments: under IFRS 9, embedded derivatives with a host that is a nancial asset within the scope o the

standard are not subject to separation.

As with IAS 39, the election is available only on initial recognition and is irrevocable.


See Question 1 or a discussion o a potential impact on:

the business model and cash fows characteristics assessment or amortised cost classication or nancial assets; and

a possible air value through OCI classication category or debt investments.


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3. How is the objective o the business modelin which the asset is held assessed?

In order to determine whether a nancial asset may be measured at amortised cost, the investment und needs to identiy and

assess the objective o the business model in which this asset is held.

The objective o an investment unds business model is not based on managements intentions with respect to an individual

instrument, but is determined at a higher level o aggregation. The assessment o the business model should refect the way an

investment und manages its business. A single entity may have more than one business model or managing its investments

and the standard provides examples o dierent portolios being managed on dierent bases. Some investment unds may

have more than one business model or managing investments e.g. one portolio to collect the contractual cash fows andone to realise air value changes. In such cases, each business models objective is assessed separately rather than at the

investment und level.

HTC model considerations

Sales o assets Not all investments in a HTC portolio have to be held to maturity. Some sales are permitted becausethe standard acknowledges that there are very ew business models that entail holding all instruments

in the portolio to maturity. An example o sales that may be regarded as being consistent with the HTC

business model are sales o investments that no longer comply with the investment mandate as a result

o a signicant decrease in the credit rating o the issuer.

However, i the number o sales is more than inrequent, then the investment und should assesswhether such sales are consistent with a HTC objective. There is no quantitative bright-line measure o

an acceptable requency o anticipated sales to meet the HTC criterion and in many cases judgement

may be required to determine the appropriate classication.

Factors to be

considered

Among the actors considered in the analysis o the business model are:

managements stated policies and objectives or the portolio and operation o these policies in

practice;

how management evaluates portolio perormance;

whether the investment strategy ocuses on earning contractual interest;

requency o expected sales out o the portolio and reasons or sales; and

whether debt investments sold are held or an extended period o time relative to their contractualmaturity.

Features not

consistent with

HTC business

model

The ollowing eatures are not consistent with a HTC objective:

active management o a portolio to realise air value changes;

management and evaluation o perormance o a portolio on a air value basis; and

trading intention (IFRS 9 retains the IAS 39 concept o held-or-trading).

In our experience, many investment unds have a strategy o generating prots through requent buying and selling.

Accordingly, they would be regarded as managing their debt portolio on a air value basis and thereore would ail the HTC

business model test. However, investment unds that hold debt investments to collect the contractual cash fows would be

able to meet the HTC criterion e.g. some money market unds.

It is unclear what the consequences are o a und concluding that the management o a portolio that was previously HTC is

no longer consistent with the HTC business model ollowing a change to an ongoing requent level o sales o nancial assets

rom that portolio, but where the reclassication criteria (see Question 11) have not been met. This may be the case where an


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investment und concludes that it no longer holds a particular portolio o investments or collection o contractual cash fows

but the change is not suciently signicant to the unds operations to trigger reassessment o the classication o the existing

portolio. However, when new investments are acquired subsequent to the change in business model, the HTC criterion would

not be met in respect o those assets and accordingly, these assets would not be eligible or measurement at amortised cost.

This may lead to some nancial assets in the portolio being measured at amortised cost and others, acquired ater the change,

being measured at air value. Eectively, ollowing the assessment, the und would have two portolios rather than one.


See Question 1 or discussion o a potential impact on the business model assessment or amortised cost classication or

nancial assets.


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4. Are the cash fows solely payments oprincipal and interest?

Once it is established that a particular debt investment is held in a HTC business model, the next step is an assessment o

the instruments contractual cash fows to determine i they meet the SPPI (solely payments o principal and interest on the

principal amount outstanding) criterion.

The assessment is made or the debt instruments as a whole without separating any embedded derivative eatures.

One o the challenges o this assessment is that the contractual cash fows may be called principal and interest in a contractual

agreement, but may not meet the IFRS 9 denition o principal and interest. The ollowing table provides guidance on theassessment.

SPPI criterion considerations

Denition o

interest

Interest (variable or xed) or the purposes o the SPPI test is dened as consideration or the time valueo money and the credit risk associated with the principal amount outstanding during a particular period

o time.

Currency The assessment is made in the currency o the instruments denomination.

Leverage Leverage increases variability o the contractual cash fows so that they do not have the economic

characteristics o interest. As a result, an instrument with leverage would ail the SPPI test.Changes in

timing or

amount o

contractual

payments

Any contractual changes to the timing or amount o cash fows are not SPPI, unless they are:

a variable interest rate that represents consideration or the time value o money and credit risk; or

a qualiying prepayment, put or term extension option (see below).

Prepayment,

put or extension

options

Instruments with extension, put or prepayment options meet the SPPI criterion only i the eature:

is not contingent on uture events, except or protecting the holder against credit deterioration/

change in control o the issuer, or protecting the holder or the issuer against changes in relevant

taxation/law; and

or prepayment or put options: the prepayment amount substantially represents unpaid principal

and interest but may also include reasonable compensation or early termination; or

or term extension options: results in contractual cash fows during the extension period that are

solely payments o principal and interest on the principal amount outstanding.


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Examples o debt investment eatures that are:

Consistent with the SPPI criterion Not consistent with the SPPI criterion

Variable interest reset at the rate o one-month LIBOR or

a one-month term.

Variable interest with an interest rate cap (this is a

combination o xed and foating rate, as the cap reduces

variability o cash fows).

Interest linked to the unleveraged infation index in the

currency o the instrument (in this case the linkage to

infation resets the time value o money to the currentlevel).

Variation in contractual interest that representscompensation or credit risk in response to perceived

changes in the creditworthiness o the borrower.

Interest rate o two times LIBOR (leveraged).

Bond that is convertible to an equity instrument o the

issuer (return on the bond is linked to the value o the

issuers equity).

Inverse foating interest rate loan (e.g. the interestrate on the loan increases i the market rate o interest

decreases).

IFRS 9 provides specic guidance or non-recourse nancial assets and or contractually linked instruments (see Question 5).

The act that a nancial asset is non-recourse does not in itsel mean that the SPPI criterion is not met. The investment undholding such an instrument has to assess the underlying cash fows to determine i the non-recourse eature limits the cash

fows in a manner inconsistent with the SPPI criterion. For example, in our view the SPPI criterion is not met or a loan to a

property developer where the contractual terms o the loan state that interest is payable only i specied rental income is

received.


See Question 1 or discussion o a potential impact on:

the cash fows characteristics assessment or amortised cost classication or nancial assets; and

biurcation o nancial assets and nancial liabilities.


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5. How are contractually linked instrumentsclassied?

IFRS 9 provides specic guidance or circumstances in which an issuer prioritises payments to the holders o multiple

contractually linked instruments so that it creates concentration o credit risk i.e. tranches. The right to payments on more

junior tranches (exposed to higher credit risk) depends on the issuers generation o sucient cash fows to pay more senior

tranches (exposed to lower credit risk). This could be the case in a securitisation arrangement, where a homogeneous pool oassets such as consumer loans, credit card receivables or trade receivables is transerred to a special purpose entity that then

issues securities to investors collateralised on this pool o assets. The securities issued to investors commonly have dierent

seniority and so bear dierent levels o credit risk.

A tranche meets the SPPI test i:

the contractual terms o the tranche itsel (without looking through to the underlying pool o nancial instruments) give rise to

cash fows that are SPPI;

the underlying pool o nancial instruments contains one or more instruments that gives rise to cash fows that are SPPI; and

the exposure to credit risk inherent in the tranche is equal to or less than theexposure to credit risk o the underlying pool o

nancial instruments.

The underlying pool o nancial instruments also may include derivatives that:

reduce the variability o cash fows (e.g. interest rate caps, foors or creditprotection); or

align the cash fows o the tranches with the cash fows o the underlying pool (e.g. interest rates swaps changing interest

streams rom xed to foating or a oreign exchange swap changing the currency o receipts).

To make the assessment about the instruments in the pool, an investor looks through to the underlying pool that creates rather

than passes through the cash fows. For example, i Fund B invests in contractually linked notes issued by C whose only asset

is a contractually linked note issued by D, then B looks through to the underlying pool o assets held by D to assess i that pool

meets the relevant requirements.

The investment und measures its investments in a tranche at air value i:

the und is unable to make the assessment as to whether the tranche or the underlying pool o instruments meet the SPPI

criterion; or

the instruments in the underlying pool can change later in a way that would not meet the SPPI test.


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Example 1 Investment in credit-linked notes

Fund Y invests in senior and subordinated junior tranches o credit linked notes issued by Z. The subordinated junior tranche

receives distribution only ater payments have been made to the holders o the senior tranche. The total senior tranche

issued by Z is 20 and the subordinated junior tranche is 10 (total o 30).

The tranches cash fows meet the SPPI criterion and the underlying pool consists only o loans that are SPPI.

Y holds investments in Zs notes in its HTC business model.

Are the investments o Y in junior and senior notes eligible or measurement at amortised cost?

As both the tranches in which Y has invested and the underlying pool o investments meet the SPPI criterion, the only

remaining test to consider is whether the credit risk inherent in each tranche is equal to or less than the exposure to creditrisk o the underlying pool o instruments. This condition would be met in respect o a tranche i, or example, in the event o

the underlying pool o instruments losing 50% as a result o credit losses, under all circumstances the tranche would lose

50% or less.

In this example i the underlying pool o loans lost 50% (i.e. 15), 10 o those losses would be absorbed by the juniortranche and the remaining 5 by the holders o the senior tranche. The resultant percentage o loss or the holders o the

senior tranche would be 25% (5 divided by 20). Because 25% is less than 50%, the senior tranche would be eligible or

classication at amortised cost.

However, in such a scenario the holders o the junior tranche would lose their entire investment. The junior tranche does not

meet the credit risk test because whenever the underlying pool suers a loss, investors in the junior tranche always suer aproportionately greater loss.

IFRS 9 does not mandate a single method to determine whether the credit risk condition is satised and in our view it isnot necessary to demonstrate that the 50% test in the example is passed in all circumstances in order to conclude that

the credit risk condition is satised. We believe that a und also may adopt an approach that models probability-weighted

expectations o credit losses to derive a weighted average range o expected losses within the pool and their allocation toeach tranche to determine whether the exposure o a tranche is proportionately more or less than the average exposure in

the pool. I the range o expected losses on the tranche is greater than the weighted average range o expected losses on

the underlying pool o nancial instruments, then the investment in the tranche should be measured at air value.


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6. How are debt investments classied oninitial application o IFRS 9?

The ollowing table illustrates how the IAS 39 categories or debt investments may align with IFRS 9 classications.

IAS 39 IFRS 9

Category Rationale Category Rationale

At air value

through prot

or loss, held-or-

trading

Acquired or sale in the near term.

or

On initial recognition was part o a portolio with a

recent actual pattern o short-term prot taking.

At air value

through prot or

loss mandatory

Not held in a HTCbusiness model.

Designated as at

air value through

prot or loss

Investments are managed and their perormance

is evaluated and reported to key management

personnel on a air value basis.

Designated as at

air value through

prot or loss

Eliminates or signicantly reduces an accounting

mismatch.

Hybrid contracts with embedded derivatives icertain conditions are met.1

Based on the

assessment o the

whole instrument

and measuredeither at:

amortised cost;

or

air value

through prot or

loss.

At amortised cost

i held in a HTC

business model,

ulls the SPPIcriterion andnot

designated as at air

value through prot

or loss.

In other cases

measured at air

value through prot

or loss.

Held-to-maturity

investments

Non-derivative nancial assets (other than loans and

receivables) with xed or determinable payments

and a xed maturity that an entity has the positive

intention and ability to hold to maturity.

Loans and

receivables

Non-derivative nancial assets with xed or

determinable payments, not quoted in an active

market, other than held-or-trading, designated as at

air value through prot or loss or available-or-sale.

Available-or-sale Designated as available-or-sale or not classied into

other categories.

An investment und is permitted, but not required, at the date o initial application o IFRS 9 to:

revoke a previous designation o a debt investment as measured at air value through prot or loss even i the designation

would continue to mitigate an accounting mismatch; or

designate a debt investment as measured at air value through prot or loss i doing so mitigates an accounting mismatch.

An investment und revokes its previous designation o a nancial asset as at air value through prot or loss made on the basis

that it mitigated an accounting mismatch i it no longer mitigates an accounting mismatch at the date o initial application o

IFRS 9.

The designation or revocation is made on the basis o the acts and circumstances that exist at the date o initial application andthe revised classication is applied retrospectively.

1 Some derivative eatures in a hybrid contract may pass the SPPI test and the entire contract may be classied at amortised cost e.g. aprepayment or term extension option that is SPPI. However, many embedded derivative eatures may cause the entire hybrid contract to ail theSPPI test and as a result be classied as at air value through prot or loss.


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See Question 1 or discussion o a potential impact on:

the business model and cash fows characteristics assessment or amortised cost classication or nancial assets;

biurcation o nancial assets and nancial liabilities; and

a possible air value through OCI classication category or debt investments.


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7. How are investments in equity instrumentsclassied?

An investment in equity instruments is measured at air value through prot or loss, unless the und elects to present air value

changes in OCI.

Because the term equity is dened consistently with IAS 32, the investor that wishes to make the air value through OCI

election has to assess rst whether the instrument meets the denition o equity in the nancial statements o the issuer.

Investments in instruments that do not meet the denition o equity in the nancial statements o the issuer are not eligible

or the air value through OCI election. As the majority o units issued by investment unds do not meet the denition o equity

under IAS 32, the OCI classication or investments in such units is not available.

The election to present air value changes in OCI can be made at initial recognition only on an instrument-by-instrument basis

(e.g. individual share) and is irrevocable.

Fair value with changes in OCI considerations

1 Not applicable or

held-or-trading

investments

Held-or-trading investments in equity instruments cannot be measured at air value through OCI.

The concept o held-or-trading is carried orward unchanged rom IAS 39 to IFRS 9: nancial

instruments are held-or-trading i they are acquired or sale in the near term, or on initial

recognition are part o a portolio or which there is evidence o a recent actual pattern o short

term prot taking, or i the instrument is a derivative.An investment und may invest in a derivative instrument that meets the denition o an equity

instrument o the issuer because it satises the xed-or-xed criterion in IAS 32. However,

the und could not classiy such an investment as at air value through OCI because derivative

instruments are within the concept o held-or-trading in IFRS 9.

2 Not applicable

or puttable

instruments and

certain obligations

arising only on

liquidation

The Basis or Conclusions (BC5.21) or IFRS 9 notes that the air value through OCI option reers

only to equity instruments dened as such by IAS 32 and not to instruments dened as nancial

liabilities but classied as equity by the issuer e.g. puttable instruments or instruments (or

components o instruments) that impose on the entity an obligation to deliver a pro rata share o

its net assets to another party only on liquidation such as interests in limited-lie unds.

3 Not applicableor certain

investments in

associates

This option is not available or investments in associates and joint ventures accounted orunder the exception rom equity method accounting in IAS 28 Investments in Associatesor

venture capital organisations, mutual unds, unit trusts and similar entities because the optional

exception requires measurement at air value through prot or loss.

4 Gains and losses

and impairment

Fair value changes are accumulated in OCI and are not transerred to prot or loss on disposal or

in any other circumstances, although they may be reclassied within equity. Accordingly, there is

no need or impairment testing o these assets.

5 Dividend income Dividend income is recognised in prot or loss in accordance with IAS 18 Revenueunless the

dividend clearly represents a recovery o part o the cost o the investment. In the latter case, theright to the dividend is recognised as a separate asset with the corresponding decrease in the air

value o the investment and has no net eect on OCI.

In our view, a dividend has to meet the denition o dividend income under IAS 18 to be

recognised in prot or loss.


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Fair value with changes in OCI considerations

6 Transaction costs In our view, transaction costs incurred on initial recognition o investments in equity instruments

in respect o which the OCI election has been made are treated dierently to those incurred on

disposal.

Transaction costs incurred on initial recognition are eectively recognised in OCI, because the

investment in equity instruments is initially measured at air value plus those transaction costs,

but subsequently at air value with gains and losses recognised in OCI.

However, in our view transaction costs incurred on disposal o an investment in equity

instruments classied at air value through OCI are recognised in prot or loss as presentation inOCI is not specically permitted or required by the standard.

7 Classication by

the issuer is key

In our view, the option cannot be applied i the holder cannot determine i the instrument meets

the denition o equity rom the perspective o the issuer.

Example 2 Investment in redeemable shares

Feeder und F invests in the redeemable units o Master und M. F does not consolidate M.

The units meet the denition o a nancial liability under the general classication in IAS 32, but are presented as equity in

Ms nancial statements, because they meet the criteria in paragraphs 16A and 16B o IAS 32.

Can F measure the investment in Ms units at air value through OCI?

The election to present air value changes in OCI is not available or puttable instruments, irrespective o the issuers

presentation. F measures its investment in Ms units at air value through prot or loss.

Example 3 Investment in convertible bonds

Fund C invests in a convertible bond and classies it as measured at air value through prot or loss because the bond does

not meet the SPPI criterion (see Question 4).

C exercises the conversion option and converts the bonds to shares that are classied as equity by the issuer.

Can C measure the investment in shares ater conversion at air value through OCI?

In our view, i C exercises the conversion option in a convertible bond and converts the bond to the equity instruments othe issuer, then C should account or the equity instrument as a new asset. Accordingly, at initial recognition, C may elect to

classiy the shares as at air value through OCI i they are not held or trading.

IFRS 9 removes the IAS 39 exception or investments in equity instruments that do not have a quoted market price in an active

market to be measured at cost i their air value cannot be measured reliably. Similarly, it has no exception or derivative assets

that are linked to and settled by delivery o such unquoted equity instruments.


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8. How are investments in equity instrumentsclassied on initial application o IFRS 9?

The ollowing table illustrates how the IAS 39 categories or investments in equity instruments may align with IFRS 9

classications.

IAS 39 IFRS 9

Category Rationale Category RationaleAt air valuethrough protor loss, held-or-trading

Acquired or sale in the near term.

or

On initial recognition was part o a portolio with a

recent actual pattern o short-term prot taking.

At air valuethrough prot orloss mandatory

Fail the SPPI

criteria.

Fail the OCI

designation

criteria as held or

trading.

Designated as atair value throughprot or loss

Eliminates or signicantly reduces an accounting

mismatch.

Investments are managed and their perormance

is evaluated and reported to key managementpersonnel on a air value basis.

Hybrid contracts with embedded derivatives i

certain conditions are met.

At air value

through prot or

loss

or

Designated as

at air value

through OCI

Fail the SPPI

criteria.

Optional

designation atair value through

OCI at initial

recognition.

Available-or-sale Designated as available-or-sale or not classied intoother categories.

At the date o initial application o IFRS 9 an investment und may designate an investment in an equity instrument as at air

value through OCI. The designation is made on the basis o acts and circumstances (see Question 7) that exist at the date o

initial application o the standard and is applied retrospectively.

IFRS 9 retains the concept o held-or-trading used in IAS 39. However, or the purpose o determining eligibility or the

air value through OCI election on transition, an investment und determines whether an asset is held or trading as i it had

acquired the asset on the date o initial application. Thereore, in our view it is possible to designate as at air value through OCI

an investment in an equity instrument that was classied as held-or-trading at the investments original acquisition date i it

does not meet the held-or-trading denition at the date o initial application.


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9. How are nancial liabilities classied?

Classication o nancial liabilities under IFRS 9 remains unchanged rom IAS 39. This includes classication o nancial

liabilities such as puttable instruments and obligations arising on liquidation that do not meet the requirements o IAS 32 or

equity classication by exception. For completeness, the fowchart below outlines the decision tree or classication o nancial

liabilities under both IAS 39 and IFRS 9.

Financial liability in the scope of IFRS 9 (and IAS 39)

Held for trading (including

derivatives)?

Hybrid contract with separable

embedded derivative(s)?

Fair value through profit or loss Amortised cost

No

Designated as at fair value through

profit or loss if conditions are met?

YesNo

YesYes

No

Derivative(s) Host

In contrast to nancial assets, an investment und may allocate nancial liabilities classied under IAS 39 directly into IFRS 9

categories as there are generally no changes in measurement basis.

The principal change rom IAS 39 in respect o nancial liabilities is the new presentation requirements or nancial liabilities

designated as at air value through prot or loss (see Question 10). In addition, IFRS 9 has removed the cost exception or derivativenancial liabilities linked to and settled by delivery o unquoted equity instruments whose air value cannot be determined reliably.

Also, at the date o initial application o IFRS 9 an investment und:

may designate a nancial liability as measured at air value through prot or loss i doing so mitigates an accounting mismatch;

may revoke a previous designation o a nancial liability as measured at air value through prot or loss i the designation waspreviously made on the basis that it mitigated an accounting mismatch, even i it still mitigates such a mismatch; and

revokes its previous designation made on the basis that it mitigated an accounting mismatch i it no longer mitigates such a

mismatch.

The designation and revocation is made on the basis o the acts and circumstances that exist at the date o initial application

and the revised classication is applied retrospectively.


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10. What are the new presentationrequirements or nancial liabilitiesdesignated at air value through prot or loss?

IFRS 9 introduced new presentation requirements or nancial liabilities that are designated at air value through prot or loss.

For such liabilities, the eect o changes in credit risk is generally presented in OCI and the remainder o the air value changes

is presented in prot or loss (split presentation).

Total change in fair value of

financial liability designated at

fair value through profit or loss

Amount attributable to changes

in credit risk

Other changes in

fair value

Other comprehensive

incomeProfit or loss

However, the gains and losses on a nancial liability designated as at air value through prot or loss in their entirety are

presented in prot or loss in the ollowing cases:

i split presentation would create or enlarge an accounting mismatch in prot or loss; or

i the nancial liability is a loan commitment or a nancial guarantee.

The determination o whether split presentation would create or enlarge an accounting mismatch in prot or loss is made at

initial recognition and is not re-assessed.

To determine when split presentation would create or enlarge an accounting mismatch in prot or loss, an investment undassesses whether it expects that the eects o changes in the nancial liabilitys credit risk will be oset in prot or loss by a

change in the air value o another nancial instrument. Such an expectation is based on an economic relationship between

the characteristics o the nancial liability and the characteristics o another nancial instrument. For example, an economic

relationship may result rom a contractual linkage between the nancial liability and another nancial instrument, but it may also

occur in the absence o such linkage. However, an economic relationship does not arise by coincidence.

The key application challenge o presenting separately the eect o changes in a liabilitys credit risk is to select an appropriate

method or splitting credit risk changes rom the total changes in the air value o the instrument.

For the purposes o this presentation requirement, credit risk is dened as the risk that the issuer will ail to perorm on that

particular liability and not as the overall creditworthiness o the issuer. The amount o the air value change attributable to

changes in credit risk is calculated as either:

total changes in air value o the nancial liability less changes attributable to market conditions that give rise to market risk

(so called deault method); or

an alternative method that more aithully represents the amount o change in air value attributable to credit risk.


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Any method used to separate the changes attributable to credit risk makes maximum use o observable inputs and minimum

use o unobservable inputs.

The deault method is appropriate only where changes in air value arising rom actors other than changes in the liabilitys

credit risk and changes in observed benchmark market risk are not signicant. The table below outlines how this method can beimplemented in our experience.

Calculation o changes in credit risk or a debt liability deault method

Step 1 At the start o the period

Calculate the nancial liabilitys internal rate o return using the nancial liabilitys air value and

contractual cash fows at that date.Deduct rom this internal rate o return the observed (benchmark) interest rate at that date so as to

arrive at an instrument-specic component o the internal rate o return.

Step 2 At the end o the period

Compute a present value o the cash fows o the nancial liability using the nancial liabilitys

contractual cash fows at that date and a discount rate equal to the sum o:

the observed (benchmark) interest rate at that date; and

the instrument-specic component o the internal rate o return determined in Step 1.

Step 3 At the end o the period

Deduct the present value calculated in Step 2 rom the air value o the nancial liability at that date.

The resulting dierence is the change in air value that is not attributable to changes in the observed

(benchmark) interest rate and that is presented in OCI.

The IASB states that i an entity repays the contractual amount o a nancial liability, then the cumulative eect o changes inthe nancial liabilitys credit risk will net to zero because its air value will equal the contractual amount. However, i the wording

o the guidance on the deault method (as set out in the above table) were applied literally to all periods in a scenario covering

more than one period, it usually would lead to a result in which the air value changes accumulated in OCI do not accumulate to

a net amount o zero on repayment o the nancial liability at its contractual maturity. Under the deault method as described

above, the calculation o the credit risk component o the change in air value is calculated separately or each period and

without reerence to the cumulative position since inception.

Amounts presented in OCI under the split presentation are never reclassied to prot or loss. This prohibition applies even i a

gain or loss related to a change in the nancial liabilitys credit risk is realised by settling or repurchasing the nancial liability at

air value. However, the cumulative gain or loss may be transerred to a dierent component o equity.


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11. What about reclassication o nancialassets and transitional provisions?

Reclassication o nancial assets

Classication o nancial assets is determined on their initial recognition. Subsequent reclassication between categories is

generally prohibited.

The only exception is when an entity changes its business model in a way that is signicant to its operations. Such changes to

the business model are:

determined by senior management as a result o internal or external changes;

demonstrable to external parties; and

are expected to be very inrequent.

When such changes take place an entity has to re-assess whether the initial classication o the relevant nancial assets

remains appropriate. I it is no longer appropriate, then the relevant nancial assets are reclassied.

Transitional provisions

The transition requirements o IFRS 9 are detailed and complex.

As the rst step in applying IFRS 9, an investment und has to determine the date o initial application (DIA) o the standard.

For initial application on or ater 1 January 2011, the DIA is the beginning o the rst reporting period in which an entity adopts

IFRS 9. Identication o the DIA is relevant to several assessments necessary to apply IFRS 9, some o which have beenoutlined in Questions 6, 8 and 9. Other such assessments include:

whether a nancial asset is held within HTC business model; and

whether presenting the eects o changes in a nancial liabilitys credit risk in OCI would create or enlarge an accounting

mismatch in prot or loss.

Transitional provisions contain certain relies rom ull retrospective application. For example, IFRS 9 is not applied to nancial

assets and liabilities that have been derecognised by the DIA. Accordingly, such instruments continue to be accounted or

under IAS 39 in the comparative period. However, this relie means that on adoption o IFRS 9 an entity cannot ully calculate

the inormation required on transition (or restate its comparative inormation, i such inormation is provided), until it reaches the

DIA when it becomes clear which nancial assets have to be restated.

IFRS 9 does not require a restatement o comparative inormation on transition. Instead the requirements are as ollows.

Initial application o IFRS 9 Required disclosures

Periods beginning ater 1 January 2012 and beore 1 January

2013

A und elects to:

provide the specic inormation set out in IFRS 9; or

restate prior periods.

Periods beginning on or ater 1 January 2013 A und provides the specic inormation set out in IFRS 9.

Our publication: Insights into IFRS, 8th Editionprovides more guidance on the application o transitional provisions o IFRS 9.


The IASB is still to reconsider transition and disclosure requirements.


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Other KPMG publicationsA more detailed discussion o the general accounting issues that arise rom the application o IFRS can be ound in our

publication Insights into IFRS. In addition, we have a range o publications that can help you urther, including:

Illustrative nancial statements: Investment unds

Illustrative nancial statements or interim and annual periods

IFRS compared to US GAAP

IFRS Handbooks, which include extensive interpretative guidance and illustrative examples to elaborate or clariy the

practical application o a standard, including IFRS Handbook: First-time adoption o IFRSs

New on the Horizon publications, which discuss consultation papers

First Impressions publications, which discuss new pronouncements

Newsletters, which highlight recent accounting developments

IFRS Practice Issues publications, which discuss specic requirements o pronouncements

Disclosure checklist.

IFRS-related technical inormation is also available at kpmg.com/irs.

For access to an extensive range o accounting, auditing and nancial reporting guidance and literature, visit KPMGs

Accounting Research Online. This web-based subscription service can be a valuable tool or anyone who wants to stay inormed

in todays dynamic environment. For a ree 15-day trial, go to aro.kpmg.com and register today.

KPMGs Global Investment Management practice

Our member rms combine their depth o local knowledge with our global networks cross-border experience to deliver

practical, eective and insightul advice to our global investment management clients. Our proessionals in Audit, Tax

and Advisory are specialists in their elds and have deep experience in the issues and needs o investment management

businesses.

We oer proessional services to a wide range o industry participants at a local, national and global level. Our clients include

investment managers, wealth managers, und administrators and service providers who ocus on retail/mutual unds, hedge

unds, private equity unds, real estate unds, inrastructure unds and other alternative investment unds (such as distressed

debt and environmental assets), as well as sovereign wealth unds and pension unds.

Acknowledgements

We would like to acknowledge the principal contributors to this publication. They are Ewa Bialkowska and Arina Tomiste o the

KPMG International Standards Group.
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ContactsGlobal investment management contacts

Wm David Seymour

Global Head

Americas region

KPMG in the US

T: +1 212 872 5988

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Bonn Liu

ASPAC region

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Tom Brown

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KPMG in the UK

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Neale Jehan

Fund Centres GroupKPMG in the Channel Islands

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Tony Rocker

Inrastructure Funds

KPMG in the UK

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Jonathan Thompson

Real Estate FundsKPMG in the UK

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Mikael Johnson

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Fund Centres IFRS Working Group

Andrew Stepaniuk

Leader Fund Centres IFRS Working Group

KPMG in the Cayman Islands

T: +1 345 914 4315

E:[email protected]

Paul Reid

KPMG in Australia

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Publication name: IFRS for Investment Funds

Publication number: Issue 4

Publication date: May 2012

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