IFRS 10- Principal and agent
Link between power and variable returns – Principal and agent [ Appendix A]
IFRS 10 contains explicit guidance on how to assess whether a decision maker is an agent (acting on behalf of others) or a principal (acting on its own behalf).
The guidance on delegated power mostly provides indicators of power and returns; in the main, it does not provide bright lines on how much power or exposure to variable returns is required to indicate whether a decision maker is acting as a principal or agent. Significant judgement might be required.
An agent is a party engaged to act on behalf of another party (the principal or principals). A principal can delegate some of its decision making authority over an investee to an agent; the agent does not control the investee when it exercises such powers on behalf of the principal.
An agent does not consolidate the investee, because the necessary link between power and exposure to variable returns is not present.
Conversely, a principal might control the relevant activities of an investee, which are carried out by an agent, and might be exposed to variable returns. Where this is the case, the principal is required to consolidate the investee as its subsidiary.
A decision maker will not necessarily be an agent because it has to act in the interests of other parties due to contractual or other legal reasons.
In some circumstances, the decision maker might receive a large proportion of the investee’s variable returns as a result of the decisions that it has made, so it might be assessed as a principal rather than an agent. The decision maker might be primarily acting for its own benefit.
Common situations where the principal/agent guidance might be relevant are noted below:
- A fund manager establishes, markets, manages and invests in a fund that also has third-party investors.
- A corporate delegates powers to another entity to manage a specific business activity (for example, where an entity enters into an outsourcing arrangement).
- A servicer collects and distributes cash flows, performs other administrative tasks and works out defaulted assets in a securitization structure.
Example: Assessing whether a fund manager is a principal or an agent
The fund manager of an investment fund typically has decision-making authority (power) over relevant activities of the fund because the fund manager can decide which investments the fund should acquire or dispose of.
The fund manager is also often exposed to variable returns from the fund through the management fees it receives and, potentially, because it is an investor in the fund. Accordingly, when a fund manager has power, and exposure or rights to variable returns, the fund manager should determine if it controls the fund based on an assessment as to whether it uses its power over the fund for its own benefit (i.e. as a principal) or for the benefit of others (i.e. as an agent).
As required by standard, the following factors should be considered in assessing whether a decision maker (i.e. the fund manager in the circumstances under consideration) is acting as a principal or an agent (the list is not exhaustive):
- the scope of its decision-making authority;
- the rights held by other parties;
- the remuneration of the decision maker; and
- the decision maker’s exposure to variability of returns from other interests that it holds in the entity.
Different weightings should be applied to each of these factors on the basis of the particular facts and circumstances.
The factors in standard should be considered together rather than in isolation and might be thought of as a means of answering two key questions.
- How much discretion does the fund manager have to make decisions without intervention by other parties?
- What is the extent and variability of the fund manager’s economic interest in the outcome of those decisions?
The more discretion a fund manager has to make decisions and the larger its economic interest in the outcome of those decisions, the more likely it is that the fund manager is making decisions to affect its own returns from the entity (and is, therefore, acting as a principal rather than as an agent of other investors).
The scope of a fund manager’s decision-making authority may indicate an agency relationship when there are relevant activities permitted by the fund’s founding documents or by law that are not directed by the fund manager.
In evaluating the scope of a fund manager’s decision-making authority, it is necessary to consider whether another party (e.g. an investment committee) has substantive rights to veto or overturn decisions made by the fund manager. When there is an investment committee, the composition of that committee (including who appointed the members) and the nature of its rights should be assessed.
