GFMAGSCCA 7 December 2004

1

• GFMA/GSCCA 7 December 2004
• IFRS issues for the Private Equity Industry

2
Overview

• New GAAP/Old GAAP/developments
• Issues for manager and GPs
• Consolidation and equity accounting
• IAS 32/39 quick overview of new GAAP
• Importance and consequences of fair value
  option
• Difficult messages for secondaries and fund of
  funds
• Issues for managers
• PwC activities

3
New GAAP/Old GAAP

• Whats it all about?
• New GAAP mandatory for year-ends after 31/12/04
• 15 standards in the improvements project and
• IAS 32/39 and.
• New IFRSs 1 to 5
• Whats irrelevant in new GAAP?
• 2 (Inventory), 16 (tangible fixed assets), 17
  (leases) , 33(EPS), 40 (Investment property),
  IFRS 4 (Insurance).

4
IASB stable platform recent changes
IAS
39
1
41
40
2
7
38
37
8
36
10
35
IFRS
11
34
12
33
1
2
3
32
14
31
5
4
15
30
16
29
17
28
27
18
26
24
19
23
20
22
21
5
Issues for managers/GPs

• Start up costs
• Placement fees
• Interest in a fund and fair value change
  recognition especially on carry
• Employee and stock-based compensation
• and our old friend IAS 27 - consolidation

6
Consolidation and equity accounting

• Consolidation
• IAS 27 Consolidated and separate financial
  statements
• SIC 12 Consolidation special purpose entities
• IFRS 5 Non-current assets held for sale
• Significant influence
• IAS 28 Investments in associates (equity
  accounting)
• IAS 31 Jointly controlled entities
  (proportional consolidation)

7
IAS 27

• A parent must present consolidated financial
  statements.
• Unless all following conditions met (27p10)
• parent is a wholly-owned sub (or permission
  from minority)
• parents debt/equity instruments not traded in
  public market
• parent not in process of filing for public
  listing
• ultimate parent produces publicly available
  consolidated IFRS financial statements

8
Subsidiaries

• A subsidiary is an entity that is controlled by a
  parent
• Control is the power to govern the financial and
  operating policies of an entity so as to obtain
  benefits from its activities (27p4)
• THERE ARE NO EXEMPTIONS (except p10) FROM
  CONSOLIDATING A SUBSIDIARY
• unless it is held for sale gt apply IFRS 5
• Particularly no exemption ..simply because the
  investor is a venture capital organisation.. or
  similar entity (27p19)

9
Control power

• Presumed to exist when parent owns more than half
  of voting power. Also exists if less than 50
  when entity has power
• over 50 voting rights via agreement with other
  investors
• to govern policies by statute or agreement
• to appoint/remove majority of board (provided
  board controls the entity)
• to cast majority of votes at board meetings

10
SIC12

• Applies to Special Purpose Entities
• Treat as subsidiary when substance of
  relationship is of control
• Autopilot
• Majority of benefits
• Exposed to majority of risks

11
GP/mgr consol ready reckoner subject to (lots
of) change
12
Some effects

• Fund controlled by GP which produces IFRS
  publicly available FS
• Structuring through parallels/co-invests etc
• SIC 12 benefits test vs current voting rights
• Horrid issues for GPs and managers.
• .but better news for investors
• GUERNSEY vs JERSEY LPs

13
IAS 39 Quick overview New GAAP assets
classification
 

• Financial assets at fair value through profit or
  loss (FVTPL)
• Loans and receivables
• Held to maturity
• Available for sale

 
14
Classification Financial Assets (Four
categories)
 
At fair value through profit or loss
Held for trading
Designated at inception
Intention of short term profit All derivatives
except hedges and immeasurables.
No restrictions on designation Irrevocable
cannot be moved. EXPOSURE DRAFT!!
 
15
Classification Financial Assets (Four
categories)
 
Available for sale
All equity securities not classified in FVTPL
category. All financial assets not in another
category. Any financial assets other than those
held for trading may be designated to this
category at inception.
 
16
Why is classification important?

• Because it drives measurement

17
Subsequent measurement
Assets/Liabilities at fair value through profit
or loss
At FV through profit or loss
At amortised cost
Loans and receivables
Held to maturity
At FV through equity
Available for sale
Other liabilities
18
Pros and cons of FVTPL

• PRO
• All gains/losses in one place
• Associates/JVs out of scope
• Hedging is irrelevant
• No impairment testing
• No splitting of FX component on monetary
  instruments
• Embedded derivatives not separated

• CON
• More natural to defer unrealised gains in equity
• Potential tax consequences
• Inconsistency with investor tax reporting
• Transparency of transaction costs

19
Fair Value Hierarchy
Active market Published quotations
Best evidence
20
Fair Value Hierarchy
Active market Published quotations
Best evidence
No active market Valuation Techniques
Alternative
21
Fair Value Hierarchy
Active market Published quotations
Best evidence
No active market Valuation Techniques
Alternative
No active market - Equity investments only ? Cost
less impairment
Very rare
22
Features of debt

• Obligation to pay cash
• Mandatory redemption
• Puttable instruments _at_ NAV
• Only a conditional right to avoid
• Indirect obligation
• Settled in a variable number of shares
• Contingent settlement provisions

23
Features of equity

• Discretion over cash payments (i.e. no
  obligation)
• Fixed amount of cash for a fixed amount of
  shares
• Not dependent on
• Ability to make distributions
• Intention to make distributions
• Negative impact on ordinary shares
• Amount of issuers reserves
• Expectation of profits for the period

24
Debt vs equity

• start

• YES

• Is there a contractual obligation to deliver cash
  or another financial asset ?

• LIABILITY

• NO

• Do the terms and conditions establish an indirect
  obligation to deliver cash or another financial
  asset ?

• Does the settlement depend on the outcome of
  uncertain future events or circumstances beyond
  the control of both the issuer and the holders?

• Is there a contractual obligation to exchange
  financial assets or liabilities under conditions
  that are potentially unfavourable to the entity ?

• YES

• NO

• NO

• YES

• Will or may the obligation be settled by the
  issuer by delivering a variable number of
  issuers own equity instruments ?

• YES

• NO

• YES

• Is the contingent settlement provision not
  genuine or only in case of liquidation ?

• NO

• NO

• YES

• EQUITY

25
Classifying investor interests

• Mainly/probably debt
• Extent of GP discretion
• Significant reporting consequences (eg
  distributions in income)
• Tax consequences
• Control considerations

26
Secondaries/Fund of Funds

• Initial recognition/first time gains
• Derecognition on partial disposals
• What is fair value?
• Are underlyings IAS 39 fair valued
• Has carry been accounted for
• Tax
• DCF modelling and future costs
• Distributions in specie

27
Whats the future?

• WANNA KNOW ABOUT
• US GAAP?