Directing relevant activities

Having identified an investee’s relevant activities, the next step is to determine how directing relevant activities has been organised. IFRS 10 breaks this down into the following two steps (although in practice these steps are normally combined with the identification of relevant activities): Directing relevant activities

  • understanding the decisions about relevant activities (see below first box) [IFRS 10 B12] Directing relevant activities
  • identifying rights that confer ability to direct those decisions (see below second box) [IFRS 10 B14-B17]. Directing relevant activities

IFRS 10 envisages two types of rights that may confer ability to direct these decisions (ie power): Directing relevant activities

  • voting rights granted by equity instruments for example, ordinary shares Directing relevant activities
  • contractual rights [IFRS 10 B16-B17]. Directing relevant activities

The control assessment will typically be more straightforward when power is conferred through voting rights. In most cases involving conventional operating entities and governance structures, power is conferred by voting rights. For investees that would have been considered special purpose entities or structured entities however, power arises from more specific contractual rights.

The diagram below highlights how the direction of relevant activities differs for normal (Non-structured entities) and structured or special purpose entities:

Directing relevant activities

First box – Decisions about relevant activities

Decisions about relevant activities include but are not limited to:

  • establishing operating and capital decisions of the investee, including budgets
  • appointing and remunerating an investee’s key management personnel or service providers and terminating their services or employment [IFRS 10 B12].

These decisions are broad-based and relate to high level direction of the investee. For conventional investees where the relevant activities comprise a wide range of financial and operating activities, direction is generally through these broad-based decisions. In other words there is usually no need to identify relevant activities at a specific or detailed level.

In more complex situations where the relevant activities are identified at a more specific level, such as the preceding example above, direction might be through a more specific contractual right or process.

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In some cases voting rights might exist but, in practice, confer an ability to direct only administrative-type tasks with little or no effect on returns. The example below illustrates one such situation:

Second box – Voting versus contractual rights Directing relevant activities

Bank A establishes a special purpose vehicle, Entity B, and owns 100% of its shares. Entity B simultaneously enters into a trade receivables factoring agreement with Company C. The agreement sets out the terms on which Entity B will purchase Company C’s receivables, and the terms of financing provided by Bank A for that purpose. The agreement provides that Company C will continue to be responsible for collecting and managing the receivables, including in the event of default. Company C is also required to provide a guarantee that losses on the transferred receivables will not exceed a specified percentage.

Entity B’s articles of association restrict its activities to this specific factoring programme. Directing relevant activities

The shares held by Bank A confer the general range of voting rights associated with shares but cannot override the restriction on Entity B’s activities, or invalidate the contract with Company C.

What is it?

Although Bank A owns 100% of the shares of Entity B, it is unlikely that the associated voting rights confer the ability to direct the relevant activities. This is due to the combined effect of:

  • the restrictions placed on Entity B’s activities; and Directing relevant activities
  • the factoring agreement, which provides that Company C will manage the receivables (which is likely to be the activity with the greatest impact on Entity B’s returns).

Substantive and protective rights

In assessing whether it has power, an investor does not consider rights that it holds, or rights held by others, if those rights are:

  • not ‘substantive’; or
  • purely ‘protective’.
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Definition of substantive rights

[IFRS 10 B22]

For a right to be substantive, the holder must have the practical ability to exercise that right.

Definition of protective rights

[IFRS 10 Definitions and B26-B27]

Protective rights are rights designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate.Protective rights relate to fundamental changes to the activities of an investee or apply in exceptional circumstances. However, not all rights that apply in exceptional circumstances or are contingent on events are protective. Because protective rights are designed to protect the interests of their holder without giving that party power over the investee to which those rights relate, an investor that holds only protective rights cannot have power or prevent another party from having power over an investee.

Directing relevant activities

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