Control and consolidation of SPEs
Control and consolidation questions are not decided
solely by legal ownership under IFRS. The substance
of an SPE and its relationship to the various parties
that participate in it will determine which party
has control and thus should consolidate the SPE
[SIC-12.8]. SIC-12 is an interpretation
of IAS 27 and was written as an anti-abuse measure
to prevent entities from manipulating financial
statements through use of financial engineering.
Application of SIC-12 results in consolidation of
many vehicles that would have otherwise resulted
in 'off-balance sheet' treatment
.
Control may arise through the predetermination
of the auto-pilot mechanism even where an entity
owns less than half or even none of the SPE's 'voting'
power. Application of the control concept requires
a judgement of all relevant factors. Control is
also presumed to exist where [SIC-12.10]:
| a) |
the SPE's activities are being conducted
on behalf of the entity according to its specific
business needs, such that the entity obtains
benefits from the SPE's operations; |
|
| b) |
the entity has the decision-making power
to obtain the majority of the benefits from
the SPE's activities or initiated creation of
the SPE including setting up the 'autopilot'
mechanism; |
|
| c) |
the entity has the right to obtain the
majority of benefits from the SPE's activities
and is therefore exposed to the risks incident
to those activities; or |
|
| d) |
the entity retains a majority of the residual
interest or ownership risks of the SPE or its
assets.
|
The presence of any single factor above may mean
that the reporting entity should consolidate the
SPE .
An SPE can be imagined where the majority
of benefits might flow to one entity and a majority
of risks be retained by another. However, this situation
is unlikely to occur in practice, once the economic
and commercial aspects of the SPE are well understood.
Only one party should consolidate an SPE where more
than one party has access to the benefits and is
exposed to the risks of the SPE. Judgement must
be exercised to determine which party controls the
SPE (a greater share of the risks of the SPE may
be indicative).
Analysis of benefits
The entity that obtains most of benefits from the SPE,
or its activities are conducted such that the entity
obtains benefits from it, are two potential indicators
of control over an SPE [SIC-12.10(c)]. The requirement
to look at both financial benefits and operational
benefits is crucial and indicative of the breadth
of SIC-12.
Some possible financial benefits are fees, reduced
costs of borrowing or an ability to participate
in the potential upside of the assets in a structure.
Financial benefit encompasses both absolute income
and reduction of costs. Another example of a financial
benefit is where an entity is restricted by regulators
from, say, writing credit derivatives, but wants
to participate in the market and does so through
an SPE, which gives it the same exposure in a legally
acceptable form .
Operational benefits are where an SPE carries out
research and development activities as an 'independent'
foundation. The foundation may have been endowed
by the entity, which has first rights to purchase
any commercially viable products or processes . Alternatively, an SPE may be set up to re-purchase
used office equipment from customers and resell
it, or retire it, to ensure that cheap second-hand
products do not depress the price of new equipment
.
Analysis of risks
The entity that is exposed to the principal risks
of the SPE may also be deemed to have control and
thus be required to consolidate. Again, risks are
not limited to strictly financial risks but can
include operational risks as well. The types of
financial risk that need to be considered are currency,
interest rates, equity prices, credit risk and residual
value risk. Where risks can be easily hedged in
the market (such as currency and interest rate risk),
this is often an auto-pilot requirement of the SPE
and these risks are seldom its principal risks.
Financial risk is not measured in absolute terms
but rather by reference to the variability of the
outcome. A portfolio of factored receivables might
have a 3% expected default risk. The party that
takes on that risk has most of the variable return
and thus most of the risks .
Operational risks arise where assets that have
been derecognised to the SPE are still used in the
entity's business. It may be that the entity has
an obligation to maintain or renew the assets .
Residual or ownership risks
An entity will be required to consolidate an SPE
when it has retained most of the entity's residual
or ownership type risks [SIC-12.10(d)]. An entity
may have derecognised receivables through a non-recourse
sale to an SPE. However, if the entity has provided
a guarantee to the SPE's equity holders that credit
losses will be no more than a pre-set percentage
of assets, the credit guarantee effectively returns
the residual risks to the entity.
A total return swap on a portfolio that the SPE
owns, or a residual value guarantee of the value
of an asset leased by the SPE, are other examples
of where the residual risks are left with the entity
.
Recognition and measurement
All SPEs controlled by the entity are consolidated
from the point that control exists. The usual procedures
are followed for consolidation; elimination of inter-company
activity and presentation of minority interests
up to 100% .
Presentation and disclosure
IAS 27 requires specific disclosures for subsidiaries
that are consolidated for reasons other than majority
of voting power. This includes a description of
the relationship between the parent and subsidiary
that gives rise to control and consolidation [IAS27R.40].
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