Agency relationships in consolidation

Agency relationships in consolidation – An investor with decision making rights has to determine whether it is a principal or an agent. An ‘agent’ is defined as ‘a party primarily engaged to act on behalf and for the benefit of another party or parties (the principal(s)) and therefore does not control the investee when it exercises its decision making authority’.

Thus, sometimes a principal’s power may be held and exercisable by an agent, but on behalf of the principal. An investor that is an agent does not control an investee when it exercises decision making rights delegated to it. Agency relationships in consolidation

Principal versus Agent Agency relationships in consolidation

To determine whether a decision maker is an agent, it shall consider the overall relationship between itself, the investee being managed and other parties involved with the investee. ALL the following factors also need to be considered unless a single party holds substantive rights to remove the decision maker without cause. Agency relationships in consolidation

Scope of decision making authority

  • The activities permitted by the decision making agreement and specified by law
  • The discretion available to the decision maker when making decisions
  • Purpose and the design of the investee
  • The risks the investee will be exposed to
  • The risk it will pass on to the parties involved with it and
  • The level of involvement the decision maker had in the design of the investee

Rights held by other parties

Substantive rights may affect the decision maker’s ability to direct relevant activities

  • When a single party holds removal rights, this is sufficient to conclude that the decision maker is an agent
  • Substantive right to restrict activities of the decision maker – apply same treatment as removal rights


The greater the magnitude of and variability associated with the decision maker’s remuneration in relation to the returns expected, the more likely that the decision maker is a principal.

A decision maker cannot be an agent unless the following conditions are present

  • The remuneration is commensurate with the services provided
  • The remuneration includes only terms, conditions or amounts that are customarily present for similar services and level of skills negotiated on an arm’s length basis

Decision maker’s returns from other interests in the investee

A decision maker shall consider its exposure to variability of returns from its other interests in the investee in assessing whether it is an agent, in doing this the following are considered

  • The greater the magnitude of, and variability associated with, its economic interests, considering its remuneration and other interests in aggregate, the more likely that the decision maker is a principal
  • Whether its exposure to variability of returns is different from that of the other investors and, if so, whether this might influence its actions

As a further clarification of the Principal versus Agent assessment the following example is provided: Agency relationships in consolidation

Pluto owns 68% of Jupiter and the remaining 32% is owned by Mars.

Pluto appoints Mars which is a management company to run its investment entity Jupiter. Mars is paid fixed and performance fees in relation to the services provided. This, in combination with the return on investment creates exposure to variability in return.

Pluto has the right to remove Mars as the management company of Jupiter if it so wishes.


Pluto has power as Pluto has substantive rights to remove Mars if it so wishes therefore Mars is an agent and not a principal therefore Mars would not need to consolidate Jupiter.

Agency relationships in consolidation:

Agency relationships in consolidation

Scope of decision-making authority

In many cases, it will be clear that control of an investee is held through voting rights. However, when this is not clear, a crucial step in assessing control is identifying the relevant activities of the investee. Relevant activities and how they influence whether an investor has power are discussed on this page. Agency relationships in consolidation

The scope of a fund manager’s decision-making authority is considered by evaluating the activities that it is able to direct and the discretion it has when making these decisions. In particular, it is necessary to understand how the decision-making authority relates to the relevant activities of the fund. Agency relationships in consolidation

In some cases, a fund manager will need to work within the defined fund mandate, such as in an index tracking fund. However, this alone does not mean that the fund manager has decision-making authority. Further assessment is needed to determine what type of decisions can or need to be made, and what the fund manager’s role will be in making those decisions. Where a fund manager’s mandate excludes discretion over certain key activities of a fund, the degree to which this affects its ability to direct the relevant activities will need to be carefully considered.

Something else -   Control without a majority of voting rights

Rights held by third parties — removal (or kick-out) rights

This factor considers the circumstances in which a third party (or parties) has the ability to remove the fund manager. For a right to convey power, the right must give current ability to direct the relevant activities. Rights are only considered if they are substantive (i.e., the holder must have the practical ability to exercise the right). Whether or not the rights are substantive depends on the facts and circumstances of each case. Agency relationships in consolidation Agency relationships in consolidation

Rights held by a single party
Removal rights are determinative when a single third party is able to remove the fund manager without cause. Agency relationships in consolidation

Rights held by many parties
While removal rights may be stipulated in the investment management agreement, on some occasions they may only be exercised if a number of different investors act together. The greater the number of parties that need to act together, the less indicative this will be of an agency relationship. Agency relationships in consolidation

Removal rights that are protective in nature
Protective rights typically relate to fundamental changes in the activities of an investee. These rights protect the investor in circumstances that are beyond the purpose and design of the entity. For example, rights that provide for the removal of the fund manager for committing fraud would not typically be considered part of the purpose and design, and therefore are protective rights. Consequently, power does not arise from protective rights and they are not relevant when assessing whether a fund manager is acting as principal or agent.

Something else -   Consolidation in summary

Almost all contracts will provide for the removal of the fund manager in some manner, so judgement will need to be exercised to determine whether the right is substantive or protective.

Currently exercisable Agency relationships in consolidation
An investor has power when it has existing rights that give it the ‘current ability’ to direct the relevant activities. However, current ability does not always mean ‘able to be exercised this instant’. In order to assess the current ability, an understanding is required to determine whether there are any restrictions regarding such rights and how the restrictions will affect the decision-making (if at all) during the period of this restriction. For example, if limited decisions will be made prior to the right becoming exercisable, the restriction may not be substantive.

If an investor has the ability to remove the fund manager subject to a notice period, the current ability will be affected by the length of the notice period and any restrictions surrounding the decision making of the fund manager during this notice period.

Penalty fees
The ability to remove the fund manager may be subject to barriers to exercise. Barriers may include a lack of suitable replacements or a penalty or severance fee payable to that fund manager if it is removed. The magnitude of such fees will have a bearing on how substantive the removal right is and, in certain circumstances, the penalty or fee may render the removal right non-substantive.

Other rights
In some cases, rights held by other parties (such as liquidation rights and redemption rights) may be considered in the same way as removal rights if, in substance, they have the same effect as a removal right when assessing whether a fund manager is an agent or a principal.

– Liquidation rights
These rights may allow investors to enforce the liquidation of a fund. For example, investors may be allowed to close the fund earlier than the fund’s contracted life, if specific performance targets are not met within the fund’s early years. Alternatively, liquidation rights could be structured without cause. When assessing the substance of these rights, a fund manager will need to consider the relevant facts and circumstances.

– Redemption rights
Funds will often contain redemption rights that allow investors to redeem their units. These rights may in substance represent liquidation rights; that is, if the level of redemption is significant, it may force the fund manager to liquidate the fund and its underlying assets. However, there may be restrictions on the ability to exercise redemption rights (e.g., gating provisions), and therefore, the fund manager may be able to reject a redemption request. In assessing whether these rights are substantive, a fund manager or investor will need to consider all of the relevant facts and circumstances.

Something else -   Control by using options

Some of the criteria that may be more relevant when evaluating removal rights are shown below:

Principal or agent considerations


The following conditions are necessary for a fund manager to be deemed an agent:

  • The remuneration the fund manager earns is commensurate with the services it renders.
  • The remuneration arrangement only includes terms and conditions that are customarily present in arrangements for similar services and level of skills negotiated on an arm’s length basis.

Most fund manager contracts will satisfy the remuneration conditions, because third parties investing in a fund are unlikely to agree to remuneration clauses that are not commensurate with the service rendered by the fund manager, or fee structures that are not market related. However, meeting these conditions in isolation is not sufficient to conclude that a fund manager is an agent.

Exposure to variability of returns through other interests

The greater the magnitude and variability of the returns that a fund manager is exposed to from its involvement with a fund, the less likely it is acting as an agent. IFRS 10 describes variable returns as those that have the potential to vary as a result of the investee’s performance. For a typical fund manager, variable returns are likely to be a combination of a direct interest, management fees and performance or other incentive fees that the fund manager earns.

In assessing a fund manager’s exposure to variability of returns, one challenge is how to consider a fund manager’s various interests on a collective basis. This may include management fees, performance fees, direct interests, loans and the provision of guarantees. The differing nature of these interests means that any method of aggregation will be highly subjective. For example, performance fees receive only upside and guarantees are only exposed to downside risk, whereas direct interests are exposed to both upside and downside variability, as the return varies with the value of the fund.

The presence of a downside risk would be weighted more heavily than economic interests that are exposed only to upside risk (e.g., management fees).


Agency relationships in consolidation

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Something else -   IFRS 10 Special control approach

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