Solely Payments of Principal and Interest

Definition

Solely Payments of Principal and Interest (SPPI) is in the context of IFRS 9 one of the two required conditions for classifying an instrument at Amortised Cost. It specifies that the contractual terms of the lending agreement gives rise on specified dates of Contractual Cashflows that are either

• repayments of the borrowed principal or
• interest on the principal amount outstanding.

Assets that satisfy the SSPI condition but which are held under a business model that involves selling assets are to be measured at fair value through other comprehensive income FVOCI.

In the above, principal is the fair value of the financial asset at initial recognition. However that principal amount may change over the life of the financial asset (for example, if there are repayments of principal)

Assets that fail the SPPI test, are evaluated at Fair Value (FVPL)

Determination

• Contractual cash flows that are solely payments of principal and interest on the principal amount outstanding are consistent with a basic lending arrangement.
• An originated or a purchased financial asset can be a basic lending arrangement irrespective of whether it is a loan in its legal form.
• Contractual cash flows are to be assessed for the currency in which the financial asset is denominated
• Contractual terms that introduce exposure to risks or volatility in the contractual cash flows that is unrelated to a basic lending arrangement, such as exposure to changes in equity prices or commodity prices, do not give rise to contractual cash flows that are solely payments of principal and interest on the principal amount outstanding
• Contracts involving leverage increases the variability of the contractual cash flows with the result that they do not have the economic characteristics of interest. Stand-alone option, forward and swap contracts are examples of financial assets that include such leverage. Such contracts do no meet the SPPI condition

Leverage

Leverage is a contractual cash flow characteristic of some financial assets. Leverage increases the variability of the contractual cash flows with the result that they do not have the economic characteristics of interest. Examples of financial assets that include leverage:

• Stand-alone options
• Forward contracts
• Swap contracts

Assets including leverage in the above sense cannot be measured at amortised cost or fair value through other comprehensive income.

Other considerations

• Consideration for the time value of money
• Contractual terms that change the timing or amount of contractual cash flows (pre-payments, extensions)

Time Value of Money

When assessing a modified time value of money element, an entity must consider factors that could affect future contractual cash flows.

For example (Paragraph B4.1.9D), if an entity is assessing a bond with a five-year term and the variable interest rate is reset every six months to a five-year rate, the entity cannot conclude that the contractual cash flows are solely payments of principal and interest on the principal amount outstanding simply because the interest rate curve at the time of the assessment is such that the difference between a five-year interest rate and a six-month interest rate is not significant. Instead, the entity must also consider whether the relationship between the five-year interest rate and the six-month interest rate could change over the life of the instrument such that the contractual (undiscounted) cash flows over the life of the instrument could be significantly different from the (undiscounted) benchmark cash flows. However, an entity must consider only reasonably possible scenarios instead of every possible scenario. If an entity concludes that the contractual (undiscounted) cash flows could be significantly different from the (undiscounted) benchmark cash flows, the financial asset does not meet the condition in paragraphs 4.1.2(b) and 4.1.2A(b) and therefore cannot be measured at amortised cost or fair value through other comprehensive income.

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