Hybrid capital - equity or debt?

Following my blog posting on Hybrid Capital, a reader wrote in asking whether deeply subordinated perpetual hybrid bonds containing features such as the deferment of interest payments would be treated as equity or debt under the IFRS  under IAS 32.

As with many accounting questions, there is no easy answer, as everything will depend upon the actual terms of the instrument.  IAS 32 contains a certain amount of Application Guidance which signposts how one would go about deciding.  For example, paragraph AG6, reproduced below, makes it clear that a perpetual liability to pay interest still means that you are party to a debt liability.

AG6 'Perpetual' debt instruments (such as 'perpetual' bonds, debentures and capital notes) normally provide the holder with the contractual right to receive payments on account of interest at fixed dates extending into the indefinite future, either with no right to receive a return of principal or a right to a return of principal under terms that make it very unlikely or very far in the future.  For example, an entity may issue a financial instrument requiring it to make annual payments in perpetuity equal to a stated interest rate of 8 per cent applied to a stated par or principal amount of CU1,000.  1 Assuming 8 per cent to be the market rate of interest for the instrument when issued, the issuer assumes a contractual obligation to make a stream of future interest payments having a fair value (present value) of CU1,000 on initial recognition.  The holder and issuer of the instrument have a financial asset and a financial liability, respectively.

Paragraph AG6 is based on the premise that you are required to make the interest payments on the instrument.  Conversely, paragraph AG26 which discusses the classification of non-redeemable preference shares as debt or equity, tells us that when distributions to holders of the instrument are at the discretion of the issuer then the instrument is equity.

In the case of any actual instrument, one would need to look at the circumstances under which deferment of interest could occur, assess their likelihood and the other implications for the issuer, consider the detailed guidance in IAS 32, and then come to a decision on debt or equity classification.

Following on from the comment raised to my previous posting, I thought I would let you all know about an enhancement that has been made to the comment facility on my blog.

Blog comments allow you to add your thoughts or understanding to a featured topic for the benefit of the treasury community and, following user feedback, I have made it easier to leave comments. 

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I would like to thank you all for your continued support and look forward to hearing from you in the future.

Mohammed Amin