De facto agent

The de facto agent assessment is part of IFRS 10 Consolidated financial statements (i.e. assessment of control over an investee for consolidation purposes), the de facto agent is a party engaged to act on behalf of another party (the principal). A principal may delegate some of its decision authority over the investee to the agent, but the agent does not control the investee when it exercises such powers on behalf of the principal (IFRS 10 B58).

The decision-making rights of the agent should be treated as being held by the principal directly in assessing control. Power resides with the principal rather than the agent (IFRS 10 B59).

As a result the principal may have to consolidate the investee’s financial statement because the decision making rights of the agent are of a de facto agent who should not consolidate the investee’s financial statements into its consolidated financial statements.

The overall relationship between the decision-maker and other parties involved with the investee must be assessed to determine whether the decision-maker acts as an agent. The standard sets out a number of specific factors to consider; several are determinative, but the majority are judgemental and need to be considered together in assessing the overall relationship.

A party is a de facto agent when the investor has, or those that direct the activities of the investor have, the ability to direct that party to act on the investor’s behalf. The decisions and judgements to be made are summarised as follows:

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IFRS 10 B65

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IFRS 10 B69 – B70

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IFRS 10 B62

IFRS 10 B63

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IFRS 10 B64 – B67

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IFRS 10 B68

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IFRS 10 B71 – B72

 

See below – Variable returns

De facto agent

IFRS 10 also requires management to consider whether there are other parties who are acting on behalf of an investor by virtue of their relationship with the investor, that is, whether the other parties are acting as de facto agents of the investor. The rights held by de facto agents, and the returns received by such parties, are considered when evaluating whether an investor has control.

IFRS 10 provides examples of parties that might be considered de facto agents of an investor, such as those who are related parties, as defined in IAS 24 Related Party Disclosures, those who maintain a close business relationship with the investor, or those who cannot finance their operations without subordinated support from the investor.

The standard identifies a number of possible de facto agent/principal relationships including:

  1. IAS 24 related parties of the principal;
  2. parties that received interests in the investee as a contribution or loan from the principal;
  3. parties that agreed not to sell, transfer or encumber their interests in the investee without the principal’s approval;
  4. parties that cannot finance operations without subordinated financial support from the principal;
  5. parties that have largely similar governing body members or key management personnel as the principal; and
  6. parties that have close business relationships with the principal.

An agent need not be bound to the principal by a contract. IFRS 10 uses the term ‘de facto agents’ to describe agents who may be acting on behalf of principals even when there is no contractual arrangement in place.  Identification of such relationships is expected to be highly judgemental. Consideration should be given to the nature of relationships between the investor and various parties and how they interact with each other (IFRS 10 B73).

An investor with a de facto agent should consider the de facto agent’s decision-making rights, as well as its indirect exposure to variable returns through the de facto agent when assessing control of the investee (IFRS 10 B74).

Example 1

A fund manager establishes, markets and manages a publicly-traded, regulated fund. The fund was marketed to investors as an investment in a diversified portfolio of equity securities of publicly-traded entities. (IFRS 10 B72)

IFRS 10 Criteria Additional facts relevant to assessment of IFRS 10 criteria
Scope of decision-maker’s authority
Fund manager is subject to narrowly defined parameters set out in the investment mandate.

Within the defined parameters, the fund manager has discretion about the assets in which to invest.

Rights held by other parties Investors do not hold any substantive rights that would affect the decision-making authority of the fund manager, but can redeem their interests within particular limits set by the fund.

The fund is not required to establish, and has not established, an independent board of directors.

Remuneration of decision-maker A market-based fee equal to 1 per cent of the fund’s net asset value.

The fees are commensurate with the services provided.

Decision-maker’s exposure to  variability from other interests Fund manager has a 10 per cent pro rata investment in the fund.

Fund manager does not have any obligation to fund losses beyond its 10 per cent investment.

It has been assessed that the fund manager’s remuneration and investment does not • create exposure that is of such significance that it indicates that the fund manager is a principal.

Is the fund manager a principal?

Solution
Consideration of the fund manager’s exposure to variability of returns together wit


Example 2A fund manager establishes, markets and manages a fund that provides investment opportunities to a number of investors. Is the fund manager principal or agent in examples A-C? These examples are considered in isolation.

IFRS 10 Criteria Additional facts relevant to assessment of IFRS 10 criteria
Scope of decision-maker’s authority
Examples A-C

The fund manager must make decisions in the best interests of all investors and in accordance with the fund’s governing agreements.

Despite this, the fund manager has extensive decision-making authority to direct the relevant activities of the fund.

Rights held by other parties Example A

The investors can remove the fund manager by a simple majority vote, but only for breach of contract.

Example B

Same as example A.

Example C

The fund has a board of directors comprised entirely of directors that are independent of the fund manager.

The board appoints the fund manager annually.

The services performed by the fund manager could be performed by other fund managers.

Remuneration of decision-maker Examples A-C

A market-based fee of
– 1% of assets under management; and
– 20% of profits if a specified profit level is achieved.

Fees are commensurate with services provided.

The remuneration is intended to align the interests of the fund manager with those of the other investors.

It is assessed that the remuneration, on its own, does not create sufficient exposure to variability of returns for the fund manager to be a principal.

Decision-maker’s exposure to  variability from other interests Example A

The fund manager also has a 2% investment in the fund that aligns its interests with those of the other investors.

The fund manager does not have any obligation to fund losses beyond its 2% investment.

Example B

The fund manager has a more substantial pro rata investment in the fund.

The fund manager does not have any obligation to fund losses beyond that investment.

Example C

The fund manager has a 20 per cent pro rata investment in the fund.

The fund manager does not have any obligation to fund losses beyond its 20% investment.

Solution
Example A The fund manager is an agent.The market-based fee of 1% of assets and 20% of profits, as well as the 2% investment does not create sufficient exposure for the fund manager to be a principal.

The other investors’ rights to remove the fund manager are protective as they are exercisable only for breach of contract.

Example B It depends on the amount of the fund manager’s investment in the fund.

For example, a 20% investment may be sufficient to conclude that the fund manager is principal.

The amount of exposure that will result in principal classification will change in different circumstances (for example, if the remuneration is different).

The other investors’ rights to remove the fund manager are protective, as in example A.

Example C The fund manager is an agent. The investors have substantive rights to remove the fund manager, and the board of directors provides a mechanism to exercise these rights.

Example 3

A fund manager establishes, markets and manages a fund that provides investment opportunities to a number of investors, as follows:

 

IFRS 10 Criteria Additional facts relevant to assessment of IFRS 10 criteria
Scope of decision-maker’s authority
The asset manager manages the active asset portfolio by making investment decisions within the parameters set out in the investee’s prospectus.
Rights held by other parties The asset manager can be removed, without cause, by a simple majority decision of the other investors.

The other equity and debt investors comprise of a large number of widely dispersed, unrelated third party investors.

Remuneration of decision-maker The asset manager receives fees of:
– 1% of assets under management; and
– 10% of profits if profits exceed a specified level.The fees are market-based and are commensurate with services provided.

The remuneration aligns the interests of the fund manager with those of other investors.

Decision-maker’s exposure to  variability from other interests The asset manager holds 35% of equity in the investee.

Is the asset manager a principal?

Solution
The asset manager is a principal and thus has control.

  • Holding 35% of the equity, in addition to the exposure provided by the fees, provides sufficient variability for the asset manager to be classified as a principal.
  • The right to remove the asset manager without cause receives lower emphasis in this example, as this right is not easily-exercisable, requiring the concerted effort of a large number of widely-dispersed investors.

Control in IFRS 10

At the heart of IFRS 10 is the requirement that in order for an investor to have control over an investee, the investor must have all three of the following: De facto agent

  1. Power over the investee; De facto agent
  2. Exposure or rights to variable returns from its involvement with the investee; and De facto agent
  3. The ability to use its power over the investee to affect the amount of the investor’s returns. De facto agent

IFRS 10 provides guidance on applying this new control model with a view to addressing some of the more complex areas that led to diversity in the past. This includes: when holding a significant but less than a majority of voting rights can give power (i.e. “de facto power”), when potential voting rights should be considered in the assessment of control, what factors should be considered in assessing control for entities not controlled by voting rights (i.e. special purpose entities or structured entities), when an entity is acting as an agent on behalf of others and how this impacts the assessment of control. De facto agent

Although not an exhaustive list, these are some of the areas that could lead preparers to reach a different conclusion under IFRS 10 than they had previously under IAS 27/SIC-12 as to whether an entity should be consolidated. De facto agent

Variable returns

Variable returns Variable returns Variable returns Key items to address De facto agent

  • Concept of variable returns is broad De facto agent
  • Determine if returns are variable and how variable they are based on substance of the return and not its legal form (e.g., fixed interest payments on a bond are variable as they won’t be paid in the event of a credit default) De facto agent
  • If the reporting entity issues an instrument to another entity and in doing so transfers risk to another entity vs. absorbing risk from the other entity, it generally is not exposed to variability of returns from the other entity. De facto agent

Principal-Agent relationships are not confined to investment funds

IAS 27 and SIC-12 did not contain requirements or guidance to assess whether an investor is a principal or an agent. In contrast, IFRS 10 specifically requires that in order for an investor with decision-making rights to have control, it must act as a principal and not an agent. De facto agent

  • The examples in IFRS 10 are geared toward the asset management industry – in particular, determining whether a fund manager is a principal or agent in respect of an investment fund of which it is both a manager and investor. However, a principal-agent relationship may also arise where an investor has a management contract or similar arrangement with an investee and may be making decisions on behalf of other investors, as is often the case in the real estate, construction and mining industries and in outsourcing arrangements. De facto agent
  • An investor also needs to pay close attention to whether other parties are acting on the investor’s behalf (i.e. as a de facto agent). If the investor has a de facto agent, it considers the de facto agent’s decision-making rights and its exposure to variable returns as its own when assessing control. De facto agent

De facto agent

De facto agent

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