Co-investments and retained interests in managed portfolios: classification and measurement

Servicers and managers often invest alongside their clients through units in a portfolio vehicle, junior or mezzanine notes, or a retained slice of a portfolio they sold; these interests are usually illiquid, highly exposed to collection outcomes and sometimes subordinated, so defaulting to cost or amortised cost without testing the business model and cash flow characteristics, or without checking for significant influence or control, can leave losses unrecognised until the portfolio winds down.

What exactly does the entity hold: equity units, puttable fund units, senior notes, subordinated or first-loss notes, or a direct share of loans? Does the interest give control, joint control or significant influence over the vehicle, so that IFRS 10, IFRS 11 or IAS 28 applies before IFRS 9? For notes issued by a securitisation-type vehicle, are they contractually linked instruments that require looking through to the underlying pool? Is there an observable price, or will fair value rely on the entity's own collection forecasts, and who independently reviews those forecasts?

1. Confirm the scope: exclude interests that give control (consolidate), joint control or significant influence (equity method, unless an available exemption to measure at fair value through profit or loss is used); the remainder fall under IFRS 9. Where the entity also manages the vehicle, the co-investment also feeds into its principal or agent assessment under IFRS 10. 2. Recognise the investment when the entity becomes party to the contract, at fair value plus transaction costs unless classified at fair value through profit or loss. 3. Classify debt-type interests by business model and contractual cash flow characteristics: for tranches of contractually linked instruments, look through to the underlying pool and compare the tranche's credit risk exposure with that of the pool; junior and first-loss tranches commonly fail and are measured at fair value through profit or loss. 4. Classify equity units that are equity instruments of the issuer at fair value through profit or loss, unless the irrevocable election to present changes in other comprehensive income is made for a non-trading holding; puttable fund units are not equity instruments from the holder's perspective, because the exception that allows the issuer to classify them as equity applies only to the issuer; the holder therefore cannot make the election and assesses them as debt instruments, which generally fail the cash flow test because returns track the fund's net asset value. 5. For interests at amortised cost, apply the expected credit loss model. 6. Reassess scope (influence or control) when holdings or rights change; classification of financial assets changes only if the business model changes.

Measure interests at fair value through profit or loss at fair value at each reporting date using IFRS 13, typically a discounted cash flow of expected collections and disposals with market-participant assumptions about recovery rates, timing, servicing costs and the return a buyer would require; under one common presentation, cash distributions received reduce the carrying amount and the remaining change is the fair value gain or loss; an entity may instead present interest or distribution income separately, applied consistently and disclosed. Interests at amortised cost are measured using the effective interest method less expected credit losses; interests that are credit-impaired at purchase use a credit-adjusted effective interest rate.

Disclose: (1) the classification and carrying amount of co-investments and retained interests by category; (2) fair value hierarchy level, valuation techniques and significant unobservable inputs, with sensitivity for Level 3 measurements; (3) gains and losses recognised in profit or loss or other comprehensive income; (4) for interests in unconsolidated structured entities, the maximum exposure to loss; (5) related party disclosures where the vehicle or co-investors are related parties.

• Carrying junior or first-loss notes at amortised cost without performing the look-through test
• applying the equity other comprehensive income election to puttable fund units
• using the entity'
• s own optimistic business-plan collections as fair value inputs without adjusting to market-participant assumptions
• capitalising transaction costs into an investment measured at fair value through profit or loss
• overlooking significant influence created by board seats or management roles in the vehicle.