1. Consolidation of Subsidiary -Private Brokerage Company

Enquiry:

A listed modaraba has 100% wholly owned subsidiary which is a private brokerage company.

The subsidiary (incorporated in Dec 2015) has not yet commenced its operations as Trading Right Entitlement Certificate (which is in the name of Modaraba) is pending transfer by PSX to brokerage subsidiary.

The question is that whether:

1. The subsidiary needs to be consolidated on each reporting period? i.e. quarterly, half yearly and annually.
2. Either whole set of financial statements will be made? i.e. BS, P&L, CF SOCE, Notes for each reporting period or any of these can be omitted?

Please note that the subsidiary is a private brokerage company duly incorporated in Dec 2015 and has not yet commenced its operations due to pending transfer of TREC by PSX.

Opinion:

The Committee understands that the Modaraba is registered under Modaraba Companies and Modaraba (Floatation and Control) Ordinance 1980 (Modaraba Ordinance).

The financial statements of the Modaraba are prepared in accordance with the approved accounting standards as applicable in Pakistan and the requirements of the Modaraba Ordinance, Modaraba Rules 1981 and Prudential Regulations for Modaraba. Further, the Modaraba Ordinance does not contain a provision for the preparation of consolidated financial statements.

However, section 503 of the Companies Ordinance 1984 (the Companies Ordinance) explains that the provisions and requirements of the Companies Ordinance are applicable to companies governed by special enactments including modarabas. The relevant clause of section 503 of the Companies Ordinance is reproduced as under:

“503. Application of Ordinance to companies governed by special enactments

(1) The provisions of this Ordinance shall apply-
(c) to modaraba companies and modarabas, except in so far as the said provisions are inconsistent with the provisions of the Modaraba Companies and Modaraba (Floatation and Control ) Ordinance, 1980 (XXXI of 1980);……”

The Committee would also like to refer following requirements of section 237 of the Companies Ordinance and paragraph 4 of IFRS 10 ‘Consolidated Financial Statements’, which are self-explanatory: (underline is ours)

237. Consolidated financial statements

(1) There shall be attached to the financial statements of a holding company having a subsidiary or subsidiaries, at the end of the financial year at which the holding company’s financial statements are made out, consolidated financial statements of the group presented as those of a single enterprise and such consolidated financial statements shall comply with the disclosure requirements of the Fourth schedule and International Accounting Standards notified under sub-section (3) of section 234.

(3) Every auditor of a holding company appointed under section 252 shall also report on consolidated financial statements and exercise all such powers and duties as are vested in him under section 255.

(4) All interim financial statements of a subsidiary as required under sub-section (3) shall be reviewed by the auditors of that subsidiary appointed under section 252 who shall report on such financial statements in the prescribed form.

IFRS 10

4. An entity that is a parent shall present consolidated financial statements. This IFRS applies to all entities, except as follows (we understand that these exceptions are not applicable in your case):

(a) a parent need not present consolidated financial statements if it meets all the following conditions:
(i) it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements;
(ii) its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets);
(iii) it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and
(iv) its ultimate or any intermediate parent produces financial statements that are available for public use and comply with IFRSs, in which subsidiaries are consolidated or are measured at fair value through profit or loss in accordance with this IFRS.

Based on the information provided to the Committee, it understands that your Modaraba is not an investment entity, and the exemption given for the requirements of section 237 of the Companies Ordinance through SECP’s SRO 56(1)/2016 and IFRS 10 are not applicable.

Your attention is also drawn to the requirements of IAS 34 ‘Interim Financial Reporting’: (underline is ours)

IAS 34

Interim period is a financial reporting period shorter than a full financial year.

Interim financial report means a financial report containing either a complete set of financial statements (as described in IAS 1 Presentation of Financial Statements (as revised in 2007)) or a set of condensed financial statements (as described in this Standard) for an interim period.

Conclusion:
Based on above, the Committee’s view to your queries is as follows:

1. A subsidiary of listed Modaraba should be consolidated at each reporting period despite the fact that it has not yet commenced the operations. Accordingly, the consolidated financial statements shall be prepared at the interim period/s in accordance with the requirements of the Companies Ordinance.
2. Complete set of financial statements as defined under paragraph 10 of IAS 1, should be made annually, whereas, for interim financial reporting, either a complete set of financial statements (as described in IAS 1) or a condensed set of financial statements can be made (as described in IAS 34).

IAS 34 defines the minimum content of an interim financial report which includes condensed financial statements and selected explanatory notes. IAS 34 does not prohibit or discourage an entity from publishing a complete set of financial statements in its interim financial report, nor does it prohibit or discourage an entity from including in condensed interim financial statements more than the minimum line items or selected explanatory notes as set out in this Standard.

(May 25, 2017)

2. Query on Consolidation

Enquiry:

SL needs your technical advice regarding existence of control over an associated company PL and consolidation of financial Statement.

Both the companies have common Chief Executive Officer (CEO). The information regarding the associated company is as below.

1. SL holds 49.24% shares of PL.
2. Number of directors on behalf of SL on the board of PL are three out of seven directors.

PL does not meet the definition of a subsidiary company for SL as per section 3 of the Company Ordinance 1984. Majority of the Directors are not representing SL, and the decisions are made by majority of the Board.

Your technical advice is sought, whether the accounts of SL will be consolidated with the accounts of PL (an unquoted Limited Company) for publication or SL will show its investment in PL on equity basis.

Opinion:

The Committee would like to draw your attention to the following paragraphs of IFRS 10 ‘Consolidated Financial Statements’:

6.  An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.

7.  Thus, an investor controls an investee if and only if the investor has all the following:

1. power over the investee (see paragraphs 10–14);
2. exposure, or rights, to variable returns from its involvement with the investee (see paragraphs 15 and 16); and
3. the ability to use its power over the investee to affect the amount of the investor’s returns (see paragraphs 17 and 18).

B18  In some circumstances it may be difficult to determine whether an investor’s rights are sufficient to give it power over an investee. In such cases, to enable the assessment of power to be made, the investor shall consider evidence of whether it has the practical ability to direct the relevant activities unilaterally. Consideration is given, but is not limited, to the following, which, when considered together with its rights and the indicators in paragraphs B19 and B20, may provide evidence that the investor’s rights are sufficient to give it power over the investee:

1. The investor can, without having the contractual right to do so, appoint or approve the investee’s key management personnel who have the ability to direct the relevant activities.
2. The investor can, without having the contractual right to do so, direct the investee to enter into, or can veto any changes to, significant transactions for the benefit of the investor.
3. The investor can dominate either the nominations process for electing members of the investee’s governing body or the obtaining of proxies from other holders of voting rights.
4. The investee’s key management personnel are related parties of the investor (for example, the chief executive officer of the investee and the chief executive officer of the investor are the same person).
5. The majority of the members of the investee’s governing body are related parties of the investor.

B38  An investor can have power even if it holds less than a majority of the voting rights of an investee. An investor can have power with less than a majority of the voting rights of an investee, for example, through:

1. a contractual arrangement between the investor and other vote holders (see paragraph B39);
2. rights arising from other contractual arrangements (see paragraph B40);
3. the investor’s voting rights (see paragraphs B41–B45);
4. potential voting rights (see paragraphs B47–B50); or
5. a combination of (a)–(d).

IFRS 10 explicitly includes the concept of ‘de facto’ control, where an investor with less than a majority of voting rights has power over an investee. The primary focus of the analysis under IFRS 10 remains on whether an investor has sufficient voting rights to give that investor the practical ability to direct the relevant activities. This involves an assessment of the size of its holding of voting rights relative to the size and dispersion of holdings of the other vote holders. An investor therefore needs to consider the indicators given in B42:

B42 When assessing whether an investor’s voting rights are sufficient to give it power, an investor considers all facts and circumstances including:

1. the size of the investor’s holding of voting rights relative to the size and dispersion of holdings of the other vote holders noting that:
2. the more voting rights an investor holds, the more likely the investor is to have existing rights that give it the current ability to direct relevant activities;
3. the more voting rights an investor holds relative to other vote holders, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;
4. the more parties that would need to act together to outvote the investor, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;
5. potential voting rights held by the investor, other vote holders or other parties (see paragraph B47-B50)
6. rights arising from contractual arrangements (see paragraph B40)
7. any additional facts and circumstances that indicate the investor has, or does not have, the current ability to direct the relevant activities at the time that decisions need to be made, including voting patterns at previous shareholders’ meetings.

The Committee would like to draw your attention to following additional facts and circumstances to consider which includes:

1. Voting patterns at previous shareholders’ meetings
2. Whether the investor has the practical ability to direct the relevant activities unilaterally (e.g., the investee and the investor have the same key management)
3. Whether the investor has a special relationship with the investee (e.g., the investee depends on the investor to fund a significant part of its operations)
4. Whether the investor has a large exposure to variable returns (which may be an indicator that the investor had an incentive to obtain rights sufficient to give it power)

There is an important distinction to be drawn about voting patterns. IFRS 10 makes it clear that the focus is on the number of vote holders that have participated in the past and the absolute proportion of voting rights that have historically been exercised. It is not on whether other vote holders have voted in the same way as the investor.

If the criteria set out below are met, it may be clear that that the investor has power over the investee, and no further analysis is needed (refer example 4 of the standard):

1. Direction of relevant activities is determined by majority vote
2. The investor holds significantly more voting rights than any other vote holder or organised group of vote holders
3. Other shareholdings are widely dispersed (IFRS 10.B43/B44).

In other situations the guidance above is not conclusive and further analysis of additional facts and circumstances is required. The fewer voting rights the investor holds, and the fewer parties that would need to act together to outvote the investor, the more reliance is placed on additional facts and circumstances to assess whether the investor’s rights are sufficient to give it power (IFRS 10.B45). An Investor has no power if additional facts and circumstances still do not provide a clear answer (IFRS 10.B46).

Additional facts and circumstances also need to be analysed which include indicators of a special relationship with the investee, which suggest more than a passive interest and voting patterns. As noted above, when voting patterns of previous shareholders meetings are analysed, the standard requires only the number of other shareholders that attended (to calculate the majority of votes required to unilaterally make decision) to be considered, but not their voting patterns. Examples 5 to 8 from the standard illustrate how additional rights, and voting patterns, are taken into consideration.

Conclusion:

In the light of above, an investor can control an investee with less than the majority of voting rights. The Committee considers that common directorship is not a conclusive factor for determining control. Other factors like contractual arrangements and circumstances discussed above may also require judgment and need to be considered carefully.

Based on all the information provided to us, including the shareholder’s agreement, the Committee concludes that:

1. SL does not directly or indirectly controls, beneficially owns or holds more than fifty per cent of PL voting.
2. Group A comprising SL, APL and their subsidiaries has power under shareholders’ agreement to appoint four directors out of seven (including chief executive). Under the same shareholders’ agreement, the rights of board of directors have significantly been reduced from the usual statutory rights and even most of the ordinary matters to be decided by the general meeting with a majority of at least 2/3rd, with other annual matters requiring approval of the general meeting with 85% voting. This shows that most significant decisions that affect the business cannot be taken without a greater majority.
3. While SL is entitled to variable returns, prima facie it does not have the power over the investee in a host of key matters. Accordingly, based on the information and facts available the Committee is of the view that PL is not the subsidiary of SL.

(May 16, 2016)

3. IFRS 10 exemption from Consolidation

Enquiry:

Paragraph 4(a) of IFRS 10 – “Consolidated Financial Statements” – allows that an entity with subsidiaries need not present consolidated financial statements, if a number of detailed conditions are met. The aforesaid paragraph of IFRS 10 is as follows:

“a parent need not present consolidated financial statements if it meets all the following conditions:

1. it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements;
2. its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets);
3. it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and
4. its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and complv with IFRSs.”

How should the requirement that the entity’s parent produces financial statements that “comply with IFRSs” be interpreted? Does it mean that the criteria in IFRS 10.4(a) are only met, if the entity’s parent produces financial statements that comply “as-is” with IFRSs as issued by the lASs? Is the condition (iv) above considered to be met in the local environment when an explicit and unreserved statement of compliance with IFRSs is not made in the financial statements locally?

Opinion:

With reference to your query relating to interpretation of para 4(a)(iv) that qualifying for the exemption, the reporting entity should be compliant of full IFRS; the Committee is of the view that since while adopting IFRS 10 in Pakistan, no modification to the requirement of compliance with IFRS for the consolidated financial statements of the parent was made, therefore the exemption is only available when the parent prepares IFRS compliant financial statements having an explicit and unreserved statement of compliance with IFRSs.

Further the Committee would like to draw your attention to the requirements of Section 237 of the Companies Ordinance 1984 reproduced below: (underline is ours)

237. Consolidated financial statements. – (1) There shall be attached to the financial statements of a holding company having a subsidiary or subsidiaries, at the end of the financial year at which the holding company’s financial statements are made out, consolidated financial statements of the group presented as those of a sing le enterprise and such consolidated financial statements shall comply with the disclosure requirement of the Fourth Schedule and an International Accounting Standards notified under sub-section (3) of section 234.

(January 04, 2016)

4. Implementation of IFRS 10 ‘Consolidated Financial Statements’ on Mutual Funds in Pakistan

Enquiry:

We refer to ICAP circular 2008/01 wherein it was stated that “the matter is under consideration of the Professional Standards and Technical Advisory Committee of ICAP and joint committee of the ICAP & MUFAP, therefore, till the outcome of the decision of both the committees, members are advised not to consolidate their funds” and the recent introduction of consolidation under IFRS 10 which is creating confusion in the Industry.

The Industry’s viewpoint is that IFRS 10 should not be applicable on the mutual funds industry. Asset management companies should not consolidate the funds under their management along with their financial statements, as consolidation may lead to serious distortion and volatility in the financial statements of the Management Company which will be grossly misleading.

While IASB’s exception for Investment Entities clearly excludes mutual funds from consolidation, the asset management companies need to be examined on the definition of control. We have examined the same and have the view that asset management companies operating in Pakistan fall under the role of Agent and therefore should be classified as investment entities.

Consolidating mutual funds into asset management companies will create serious distortion and volatility in the financial statements of the Management Company which will be grossly misleading. That when consolidated into the management companies into their sponsor entities will lead to further distortion and as most of those sponsors are listed will mislead the investors. As explained by IASB, the fair value information is more useful for decision making than consolidated information. The consolidated information with regards to mutual funds industry will have no purpose whatsoever as mutual funds are pooled investments and the right of ownership is pari passu for all investors in the fund and not the asset management companies or their sponsors.

In this regards, a clarification/ circular similar to circular 2008/01 should be issued by ICAP that all mutual funds and asset management companies are “investment entities” and therefore consolidation under IFRS 10 will not be applicable on the industry. We are available for further discussion in this regards so that the same can be addressed before the end of the Financial Year.

Opinion:

Issue
After the introduction of IFRS 10 ‘Consolidated Financial Statements’ (“IFRS 10”), the Institute has been approached by number of practicing members for seeking opinion on whether:

1. The Asset Management Companies (“AMCs”) meets the definition of Investment Entity under the requirements of IFRS 10;
2. AMC controls the Mutual Funds (“MFs”); and
3. MF should be consolidated with the AMC under the requirements of IFRS-10.

1. Investment Entity

	Requirements of IFRS 10	Yes/ No		Basis of Opinion
	27. “…A parent shall determine whether it is an investment entity. An investment entity is an entity that:			When evaluating whether AMCs satisfy the definition of investment entities, first we need to understand that MFs and AMCs are two distinct and separate legal entities. The majority of investors of MFs are substantially different from the shareholders of AMCs, although the shareholders of AMCs may also invest in MFs to whom the AMCs provide asset management services. In assessing whether the entity meets the definition of an investment entity, an entity is required to consider the requirements of paragraphs 27 and 28 and the criteria given in B 85 of IFRS 10.
	a) obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services;	No		AMCs do not obtain funds directly on their own account but invite funds for investment schemes (MFs), which are separate legal entities. The AMCs in Pakistan do not satisfy the typical characteristics required in paragraph 28 of IFRS 10. While the investees (investment schemes) can be more than one, the shareholders of AMCs are generally very few/one who are its related parties (e.g. banks are parent companies of AMCs). Most of the AMCs operating in Pakistan are public unlisted companies which are closely held by a few investors.
				As per the guidance given in paragraphs B85Q to B85S of IFRS 10, typically an investment entity would have several investors who pool their funds to gain access to investment management services and investment opportunities that they might not have access to individually. This is generally what happens in a MF but not in the case of an AMC.
	b) commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income, or both; and	No		MFs commits to the unit holders that its business purpose is to invest funds in various investment portfolios solely for returns based on capital appreciation, investment income, or both. This is not true in case of AMCs. AMCs primary business and principal source of income, is asset management services to MFs managed by it. AMCs (investor) may also invest surplus funds in the MFs (investee) managed by it and benefit from payout and capital appreciations. However, such investment is not its core business.
	c) measures and evaluates the performance of substantially all of its investments on a fair value basis…”	Yes		As per B85K of IFRS 10, an essential element of the definition of an investment entity is that it measures and evaluates the performance of substantially all of its investments on a fair value basis. In order to demonstrate that it meets the definition, an investment entity: (a) provides investors with fair value information and measures substantially all of its investments at fair value in its financial statements; and (b) reports fair value information internally to the entity’s key management personnel (as defined in IAS 24), who use fair value as the primary measurement attribute to evaluate the performance of substantially all of its investments and to make investment decisions. As explained above primary business of AMCs is provision of asset management services and its performance is evaluated with reference to the size of assets under its management and the fee income therefrom. However, AMCs also measure their investment at fair value.
				CONCLUSION: AMCs in Pakistan do not meet all the criteria as laid down by IFRS 10.27. Therefore, in our opinion, AMCs are not Investment Entities. In our view, AMCs shall be required to consolidate those MFs under its management which meet the criteria discussed above. If AMC is acting as principal then only it needs to consolidate unless exemptions under para 31 and 33 of IFRS 10 are claimed. In Pakistan majority of AMCs are subsidiaries of banks and are presented in the consolidated financial statements of the parent.

2. Control of Asset Management Company

Requirements of IFRS 10	Yes / No	Basis of Opinion
7. “…An investor controls an investee if and only if the investor has all the following:
a) power over the investee;	Yes	In order to establish control, first criteria is to assess power of AMCs (investor) over schemes (investee) under its management. Power is the current ability to direct the relevant activities. Power arises from rights, which may include: voting rights potential voting rights rights to appoint key personnel decision making rights within a management contract removal or kick-out rights However, power does not arise from protective rights. The AMCs in Pakistan establish market and manage a publicly regulated MF in accordance with narrowly defined parameters set out in the investment mandate governed by local laws and regulations (Non- Banking Finance And Notified Entities Regulations, 2008). In Pakistan, MFs are not required to establish, and have not established, an independent board of directors. In Pakistan, the unit holders do not hold any substantive rights that would affect the decision-making authority of the AMCs, but can redeem their interest at the NAV of that day. Although AMCs are operating within the parameters set out in the investment mandate and in accordance with the regulatory requirements, it has decision-making rights that give it the current ability to direct the relevant activities of the MF. Thus, AMCs (investors) has power over the investment schemes (MFs/Investee).
b) exposure, or rights, to variable returns from its involvement with the investee; and	Case-to-Case basis	In order to establish control, second criteria is to assess whether the investor (AMC) is exposed, or has rights, to variable returns from its involvement with the scheme (investee). Returns can be positive, negative or both. Example of returns include: Dividends (from direct interest in the fund either directly or potentially through certain related parties) Remuneration (as result of earning management fees and performance fees) As per section 61 of Non- Banking Finance And Notified Entities Regulations, 2008: “An Asset Management Company shall be entitled to an accrued remuneration equal to an amount not exceeding three percent of the average annual net assets of the Collective Investment Scheme that has been verified by the trustee and is paid in arrears on monthly basis during the first five years of existence of the Collective Investment Scheme and thereafter of an amount equal to two per cent of such assets or such other amount as may be specified by the Commission: Provided that an Asset Management Company may charge performance based or fixed fee or the combination of both which shall not exceed the limit prescribed in this Regulation and such fee structure shall be disclosed in the Offering Document.” AMCs in Pakistan are entitled to remuneration (i.e. management fee) as per the above regulation. In addition AMCs may also invest surplus funds in units of the schemes and earn return similar to those of other unit holders of the scheme (i.e. investment return). If the AMC has no investment return than variability of returns from the activities of the fund will be nil. Thus, second criteria for control establishment will not be met, therefore, control will not be established. However, if the AMC is earning management fee as well as investment return, then AMC will be exposed to the variability of returns from the activities of the mutual fund. Thus, the assessment of exposure to variable returns will need to be assessed on case to case basis. However, considering the general practice in Pakistan, most of the AMCs are exposed to the variability of returns from the activities of the mutual fund as these AMCs have also invested in units of MFs to which it is providing management services.
c) the ability to use its power over the investee to affect the amount of the investor’s returns…”	Case-to-Case basis	In order to establish control, third criteria is to evaluate whether the investor (AMC) has the ability to use its power to affect the returns from its involvement with the investee (MFs). This criteria requires to determine whether the AMC is acting as a Principal or Agent to the unit holders of MF by considering following factors: scope of its decision-making authority over the fund, rights held by other parties (including removal rights), remuneration to which the fund manager are entitled in accordance with the remuneration agreement, exposure to variability from other interests that it holds in the mutual funds. Thus AMCs in Pakistan: have wide scope of decision- making power over the unit holders, will be removed only if there is willful contravention of trust deed, liquidation, appointment of receiver, etc. These rights are considered to be the protective rights. are entitled to remuneration. are exposed to variability of interest through their investments, if any, in the units of MFs managed by it. After analyzing relevant illustrative examples of IFRS 10, it should be assumed that if AMC exposure to variability of returns is 20% or more than relationship of Principal is established with unit holders of MF.
		CONCLUSION: In our opinion, majority of AMCs in Pakistan would meet the first two requirements of control definition that is power and exposure to variability of returns. However, keeping in mind the illustrative examples of IFRS 10 and to avoid subjectivity, if AMCs exposure to variability to returns is 20% or more then the AMCs’ exposure to variability of returns from the activities of the fund is of such significance that it indicates that the AMC is a Principal to the unit holders of MF as the AMC meet all criteria laid down by IFRS 10.7 for control establishment. Therefore, parent and subsidiary relationship will be established between AMC and MF, unless it is proved that AMC is acting as an Agent to the unit holders of MF.

(June 23, 2015)