Power through contractual arrangements
An investee”s only business activity, as specified in its founding documents, is to purchase receivables and service them on a day-to-day basis for its investor. The servicing includes collecting the principal and interest payments as they fall due and passing them on to the investor. For any receivable in default, the investee is required to automatically put the receivable in default to the investor, as contractually agreed in the put agreement between the investor and the investee.
The relevant activity is managing the receivables in default, because it is the only activity that can significantly affect the investee”s returns. Managing the receivables before default is not a relevant activity because it does not require substantive decisions to be made that could significantly affect the investee”s returns the activities before default are predetermined and amount only to collecting cash flows as they fall due and passing them on to investors.
The purpose and design of the investee gives the investor decision-making authority over the relevant activity. The terms of the put agreement are integral to the overall transaction and the establishment of the investee. Therefore, the put agreement, together with the founding documents of the investee, gives the investor power over the investee. This is the case, even though:
- the investor takes ownership of the receivables only in the event of default; and
- the investor”s exposures to variable returns are not technically derived from the investee (because the receivables in default are no longer owned by the investee and are managed outside the legal boundaries of the investee).
To conclude whether the investor has control, it would also need to assess whether the other two criteria are met, i.e. it has exposure to variable returns from its involvement with the investee and the ability to use its power over the investee to affect the amount of its returns.