Key changes for financial instruments under IFRS

What’s the issue?

In preparation for the effective date from 1 January 2026, both the UK Endorsement Board (UKEB) and European Commission (EC) have adopted the May 2024 Amendments to the Classification and Measurement of Financial Instruments, which amend IFRS 9 Financial Instruments (IFRS 9) and IFRS 7 Financial Instruments: Disclosures (IFRS 7). The amendments, which were published by the IASB in May 2024, cover three key areas of change:

• Settlement date accounting - Specifying that financial liabilities shall be derecognised on the settlement date, unless the entity applies an accounting policy option for derecognising the financial liabilities that have been settled using an electronic payment system, at an earlier date when specific conditions have been met. This amendment may have practical implications.
• ESG-linked financial assets – Clarifying the classification of financial assets with Environmental, Social and Governance (ESG) and similar features, instruments with non-recourse features, and contractually linked instruments, and specify how the SPPI test should be carried out in these cases.
• Enhanced disclosure - Introducing additional disclosures to be presented under IFRS 7 on equity instruments measured at fair value through other comprehensive income and on financial instruments with contingent features.

Whilst the amendments are effective for the first-time from 1 January 2026 and restatement of comparative data is not mandatory, because the amendments must still be applied retrospectively, companies should consider if any of the changes require implementation preparation to be ready for the accounting impact to be recognised as at 1 January 2026.

What does this mean?

Settlement date accounting and derecognition of financial liabilities settled using an electronic payment system (IFRS 9 B3.1.2A and B3.3.8 to B3.3.10)

Derecognition requirements for financial assets and financial liabilities

The amendments add paragraph B3.1.2A to IFRS9, reiterating the general rules for recognition and derecognition of financial assets and liabilities.

For financial assets, it states that they shall be derecognised on the date on which the contractual rights to the cash flows expire or the asset is transferred. For financial liabilities, it states that they shall be derecognised on the settlement date. This is the date on which the liability is extinguished, i.e. it is discharged, or cancelled, or it expires. Settlement date is explained in the context of financial assets in paragraph B3.1.6 as the date that an asset is delivered to or by an entity.

The requirements mean that both financial assets and financial liabilities must be derecognised on the settlement date, rather than on an earlier date.

• For a financial asset (trade receivable), an entity receiving cash from a third party would derecognise the receivable when the cash is delivered to the entity.
• For a financial liability (trade payable), an entity delivering cash to a third party would derecognise the payable when the cash is received by the third party. 

Currently, there is diversity in practice as to when financial assets and financial liabilities should be derecognised and as such for some companies the amendment may result in derecognition at a later point in time that previously accounted for.

Election when settling financial liabilities using an electronic payment system

For financial liabilities settled using an electronic payment system, the amendments introduce in paragraphs B3.3.8 – B3.3.10 of IFRS 9 a choice of accounting policy, allowing financial liabilities to be derecognised before the settlement date, for example,e once the payment has been electronically initiated.

This election must be applied consistently to all payments settled using the same electronic payment system. This therefore means that companies will need to understand the various different electronic payments systems that it has in place, including the rights and obligations under those payment systems, to ensure there is consistent application of the requirements. For large groups, and companies with more than one electronic payment system, this may be more time-consuming. It may also mean that companies might wish to look to simplify their existing electronic payments systems.

The election is available only if the following three conditions are all met (once a payment has been initiated using an electronic payment system):

·        the entity does not have the practical ability to withdraw, stop or cancel the payment instruction;

·        the entity does not have the practical ability to access the cash to be used for settlement as a result of the payment instruction; and

·        the risk that the payment will not be settled is insignificant, which means that: (a) completion of the payment instruction follows a standard administrative process; and (b) there is only a short time period between the moment when the first two conditions are met and the moment when the counterparty actually receives the cash.

Conversely, the amendments specify that settlement risk (i.e. risk of non-payment) would not be insignificant if completion of the payment instruction were subject to the entity’s ability to deliver cash on the settlement date i.e. in the event of default by the entity.

Financial assets with contingent payment features (IFRS 9 B4.1.8A, B4.1.10-B4.1.10A & B4.1.13-B4.1.14)

The amendments introduce two clarifications to the SPPI test for financial assets with contingent payment features that are not directly correlated to credit risk, such as achieving an ESG performance target.

Clarification on the concept of a ‘basic lending arrangement’ - The first clarification relates to the principles underlying the concept of a ‘basic lending arrangement’, which apply to all the different elements of interest received by the lender (B4.1.8A). The assessment of each element focuses on the qualitative nature of the risks or costs that the lender is being compensated for.

In order to pass the SPPI test, the contractual cash flows of the instrument must be directly correlated with a variable that represents the risks or costs of a basic lending arrangement. An instrument would not pass the test if it were indexed to the price of a share, commodity, carbon index or the entity’s own economic performance, even if such contractual terms are common in the market in which the entity operates. Secondly, the amount of any adjustments to the remuneration component of the loan must also be considered: if the adjustments make a significant difference to contractual cash flows, the instrument may not pass the SPPI test.

Clarification on how these principles are applied - The second clarification relates to how these principles are applied. Thus, paragraph B4.1.10A states that if the nature of a contingent event does not relate directly to changes in the risks and costs of a basic lending arrangement (e.g. the debtor achieves a reduction in carbon emissions), the instrument may still pass the SPPI test provided that:

• The contractual cash flows, considered in isolation before and after the occurrence of the contingent event, and irrespective of the probability of it occurring (B4.1.10), are solely payments of principal and interest.
• The contractual cash flows resulting from a contingent event are not significantly different from the contractual cash flows on a similar financial instrument without such a contingent feature (this may be assessed qualitatively or, failing that, quantitatively).

Two illustrative examples are provided to show how this approach would work for loans indexed to ESG performance criteria that would (B4.1.13) or would not (B4.1.14) pass the SPPI test.

Financial assets with non-recourse features (IFRS 9 B4.1.16A-B4.1.17)

A financial asset has non-recourse features if the lender’s or investor’s rights are limited to the cash flows generated by specified underlying assets – regardless of whether these are explicitly designated or held in an ad hoc vehicle or SPV or not – rather than having the right to the totality of the debtor’s assets. In other words, the lender is exposed to the assets’ performance risk rather than the lender’s credit risk (B4.1.16A).

The amendments specify that to carry out the SPPI test for a financial asset with non-recourse features, an entity must:

• Assess (‘look through to’) the link between the underlying assets or cash flows and the contractual cash flows of the financial asset.
• Consider other contractual arrangements, such as any credit enhancements arising from equity instruments (e.g. subordinated debt) issued by the debtor (B4.1.17).

Contractually linked financial assets (IFRS 9 B4.1.20-B4.1.23)

Contractually linked instruments (CLIs) are issued by an SPV and backed by underlying financial assets held by that vehicle.

For the purposes of assessing whether they pass the SPPI test, the amendments state that these instruments meet the definition of financial assets with non-recourse features and have additional specific characteristics. It specifies that the requirements on CLIs set out in paragraphs B4.1.21 to B4.1.26 apply when the following conditions are met:

• Payments to investors are prioritised through a waterfall payment structure.
• The prioritisation of payments results in a disproportionate reduction of the contractual rights of some investors if insufficient cash flows are generated by the underlying financial assets.

However, some transactions in which an SPV issues several tranches of debt instruments, which at first glance appear to meet these conditions, must be subject to a more in-depth analysis. If the SPV issues junior debt instruments, and these instruments, which cannot in practice be sold to a third party, are held by the entity that sold the receivables to the SPV (the sponsor), the rules on CLIs shall not be applied to these instruments. Indeed, in this case, the SPV has issued only one tranche of instruments that can be sold to third parties, namely the senior debt instruments. The junior debt instruments are there to provide enhanced credit protection. The holders of the senior debt instruments must apply the rules on debt assets without recourse features to determine whether or not their assets pass the SPPI test (B4.1.20A).

Lastly, when applying the ‘look through’ assessment to CLIs, the amendments expand the scope of eligibility to certain financial assets that are partially outside the scope of IFRS 9, such as lease receivables, provided that their cash flows are “equivalent” to solely payments of principal and interest (B4.1.23). The equivalence condition is not met if the lease receivables are subject to residual value risk or are indexed to a rental yield index.

Enhanced disclosures in the notes to the financial statements (IFRS 7 11A-11B & 20B-20D)

The amendments to IFRS 7 introduce additional required disclosures.

For investments in equity instruments measured at fair value through other comprehensive income (with no recycling to profit or loss) – There are two disclosure changes:

• Changes in fair value over the reporting period, distinguishing between those relating to instruments derecognised over the period and those relating to instruments still held at the closing date (IFRS7.11A(f)).
• Any transfers of the cumulative gain or loss within equity related to the investments derecognised during that reporting period (IFRS 7.11B(d)).

Application guidance has been added to paragraph IG 11A of IFRS 7 to illustrate the new requirements.

For financial instruments with contingent payment features that are not directly correlated to credit risk - Detailed disclosures must be presented for each class of financial assets, including (IFRS7.20C):

• A qualitative description of the contractual terms that could change future cash flows (i.e. the nature of the contingent event);
• Quantitative information on the range of possible changes to future cash flows; and
• The gross carrying amount of financial assets and the amortised cost of financial liabilities that include such features.

This information shall be presented separately for each class of financial assets measured at amortised cost or fair value through other comprehensive income, and for each class of financial liabilities measured at amortised cost.

When is this effective?

The amendments are mandatory for accounting periods beginning on or after 1 January 2026.

The transition provisions, as set out in paragraphs IFRS 9 7.1.12 to 7.1.13 and 7.2.47 to 7.2.49, require the amendments be applied retrospectively, although restatement of comparative data is not mandatory. Entities are permitted to restate prior periods only if it is possible to do so without the use of hindsight.

If the prior period is not restated, however, the accounting impact must be determined from the date of initial application. The effect of initially applying these amendments shall be recognised as an adjustment to the opening balance of financial assets and financial liabilities and the cumulative effect, if any, as an adjustment to the opening balance of retained earnings (or other components of equity as appropriate) as at the date of initial application – this will be 1 January 2026 assuming the amendments are not applied early.