6. An investment manager is required to determine whether it is a principal or an agent.
This step in the control assessment considers the interaction between the first two elements of the control definition and requires an investment manager to determine whether it acts as a principal or as an agent. A significant element of judgement will sometimes be required in making this assessment.
An agent is a party primarily engaged to act on behalf and for the benefit of another party or parties (the principal(s)). An agent does not control an investee when it exercises decision-making rights delegated to it.
The investment manager is an agent if there is a single party that holds substantive rights to remove it without cause. In the absence of this, the investment manager has to consider the following factors in determining whether it is an agent or a principal:
- The scope of its decision-making authority over the investee;
- The rights held by other parties (including the investee’s board of directors (or other governing body));
- The remuneration to which it is entitled; and
- Its exposure to variability of returns from other interests that it holds in the investee.
The weighting that is placed on these factors is based on the particular facts and circumstances. An investment manager may need to consider the following in making this assessment:
- the activities that are permitted according to the decision-making agreements and specified by law and the discretion that it has when making decisions about those activities,
- the risks to which the investee was designed to be exposed, the risks it was designed to pass on to the parties involved and the level of involvement it had in the design (including in determining the scope of decision-making authority) of the investee,
- the existence of substantive removal rights (kick-out rights) held by other parties,
- the existence of rights held by other parties that restrict its discretion (for example, whether it is required to obtain approval from other parties for its actions),
- the number of parties that are required to act together to exercise their rights in (c) and (d) above,
- which parties appoint the board of directors (or other governing body), if any, whether the rights of any such governing body are substantive or whether they are merely protective in nature, whether the members of any such governing body are independent of the investment manager, what mechanism exists for the investors to exercise their voting rights (such as established annual general meetings or the ability to call an extraordinary meeting or the length of any required notice period) and whether there are any barriers for investors to exercise their voting rights,
- whether its remuneration is commensurate with the services provided,
- whether the remuneration agreement includes only terms, conditions or amounts that are customarily present in arrangements for similar services and level of skills negotiated on an arm’s length basis,
- whether it holds other interests in the investee,
- the magnitude of, and variability associated with, its remuneration and other interests,
- whether its exposure to variability of returns is different from that of other investors and, if so, whether this might influence its actions.
Example – (extracted from Appendix B of IFRS 10):
A fund manager establishes, markets and manages a fund that provides investment opportunities to a number of investors. The fund manager must make decisions in the best interests of all investors and in accordance with the fund’s governing agreements. Nonetheless, the fund manager has wide decision-making discretion. The fund manager receives a market-based fee for its services equal to 1% of assets under management and 20% of all the fund’s profits if a specified profit level is achieved. The fees are commensurate with the services provided. The fund manager also has a 20% pro rata investment in the fund, but does not have any obligation to fund losses beyond its 20% investment. The fund has a board of directors, all of whose members are independent of the fund manager and are appointed by the other investors. The board appoints the fund manager annually. If the board decided not to renew the fund manager’s contract, the services performed by the fund manager could be performed by other managers in the industry.
Although the fund manager must make decisions in the best interests of all investors, the fund manager has extensive decision-making rights that give it the current ability to direct the relevant activities of the fund. Therefore, it has power over the investee.
The fund manager’s fees and its 20% investment expose the fund manager to variable returns from its involvement with the investee.
In the absence of a single party that holds substantive rights to remove the fund manager without cause, all the factors in IFRS 10 need to be considered in determining whether the fund manager is acting as a principal or whether he is acting as an agent. The combination of the fund manager’s 20% investment together with the fees (despite these being commensurate with the services provided) creates exposure to variability of returns from the activities of the fund that is of such significance that it indicates that the fund manager is a principal. However, the investors have substantive rights to remove the fund manager through the board of directors, which rights indicate that the fund manager is an agent. In this example, the fund manager places greater emphasis on the substantive removal rights and concludes that it does not control the fund.
Example – (extracted from Appendix B of IFRS 10):
An investee is created to purchase a portfolio of fixed rate asset-backed securities, funded by fixed rate debt instruments and equity instruments. The equity instruments are designed to provide first loss protection to the debt investors and receive any residual returns of the investee. On formation, the equity instruments represent 10% of the value of the assets purchased. The asset manager manages the active asset portfolio by making investment decisions within the parameters set out in the investee’s prospectus. For those services, the asset manager receives a market-based fixed fee of 1% of assets under management and performance-related fees of 10% of profits if the investee’s profits exceed a specified level. The fees are commensurate with the services provided. The asset manager holds 35% of the equity in the investee. The remaining 65% of the equity, and all the debt instruments, are held by a large number of widely dispersed unrelated third party investors. The asset manager can be removed, without cause, by a simple majority decision of the other investors.
Although operating within the parameters set out in the investee’s prospectus, the asset manager has decision-making rights that give it the current ability to direct the relevant activities of the investee. Therefore, it has power over the investee.
The asset manager’s fees and its equity interest expose the asset manager to variable returns from its involvement with the investee.
In the absence of a single party that holds substantive rights to remove the asset manager without cause, all the factors in IFRS 10 need to be considered in determining whether the asset manager is acting as a principal or whether he is acting as an agent. The combination of the asset manager’s equity interest together with the fees (despite these being commensurate with the services provided) creates exposure to variability of returns from the activities of the investee that is of such significance that it indicates that the asset manager is a principal. The removal rights held by the other investors receive little weighting in the analysis because those rights are held by a large number of widely dispersed investors. In this example, the asset manager places greater emphasis on its exposure to variability of returns of the investee from its equity interest, which exposure indicates that the asset manager is a principal, and concludes that it controls the investee
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