Equity Financing in Business:- Large groups of companies have been issuing perpetual bond issues in recent times. As regards debts, the traditional reflex suggests that these issued securities are part of the liabilities on the liabilities side of the balance sheet and that the interest paid is recorded as a charge in the income statement.
Equity Financing in Business
We will see that IFRS analysis can lead to qualifying these debt instruments as equity with all the consequences.
The Issue of Perpetual Bond Debts
Take the example of the EDF group which issued in January 2013 several tranches of perpetual subordinated notes in Euros and pounds sterling (“hybrid” issue):
- 1,250 million Euros with a coupon of 4.25% and a 7-year repayment option
- 1,250 million Euros with a coupon of 5.375% and a repayment option at 12 years
- £ 1,250 million with a coupon of 6% and a repayment option at age 13
- US $ 3 billion with a coupon of 5.25% and a 10-year repayment option.
Indefinite Subordinated Notes (TSDI)
Note that indefinite subordinated notes (TSDI) are subordinated issues whose duration is infinite, repayment is at the option of the issuer. Subordinated securities are bonds whose repayment, in the event of bankruptcy or liquidation of the issuer, is not a priority and is “subordinated” to that of other senior creditors.
In the notes to the financial statements, the EDF group explains: “Due to their characteristics and in accordance with IAS 32, these issues have been recognized in equity as of the receipt of the funds for an amount of € 6,125 million (net of transaction costs). Remuneration, recognized as a reduction of equity, was paid in 2013 for an amount of 103 million Euros. ”
This type of issue therefore presents the issuer’s point of obvious interest; they contribute to the strengthening of their credit ratios since they increase shareholders’ equity. In addition, the remuneration paid is recorded directly as a deduction from equity, so there is no impact on income.
In the notes to the financial statements, the EDF group justifies this accounting treatment as follows: “Subordinated notes with an indefinite term in Euros and in foreign currencies are recognized in accordance with IAS 32 and taking into account their specific characteristics. They are recognized in equity at their historical cost when there is an unconditional right to avoid paying cash or another financial asset in the form of a repayment or a return on capital. ”
What Distinguishes IFRS
IFRS distinguishes between debt and equity instruments based on a very general definition of IAS 32: “a financial instrument is an equity instrument if and only if the issuer has no contractual obligation to return cash or another financial asset to conditions that would be potentially unfavorable to it “. As a result, non-redeemable perpetual bond issues, except at the initiative of the issuer and for which coupon payments may be deferred at the initiative of the issuer, are classified as equity.
In conclusion, is this accounting treatment really consistent with the economic reality? It is clearly a question of quasi-equity which the rating agencies hold for half in equity. This approach is undoubtedly in fine, the most pragmatic.