1.4 Key Differences Between the Voting Interest Entity Model and the VIE Model

Definition of a controlling financial interest

For legal entities other than limited partnerships (and similar entities), the usual condition for consolidation is ownership of a majority voting interest.

For limited partnerships (and similar entities), the usual condition for consolidation is ownership of a majority of the limited partnership’s kick-out rights.

However, for all legal entities, control may not rest with the majority owner if certain conditions exist.

A reporting entity has a controlling financial interest if it has both of the following characteristics: (1) the power to direct the activities of the entity that most significantly affect the entity’s economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the entity or the right to receive benefits from the entity that could potentially be significant to the entity.

Under the VIE model (unlike the voting interest entity model), a broader list of activities is typically considered in the determination of which party, if any, should consolidate.

Impact of related parties

Related parties and de facto agents are not considered.

Related parties, including de facto agents, must be considered. The identification of related parties can have a significant impact on the consolidation analysis, including potentially requiring one of the related parties to consolidate even though the reporting entity, on its own, does not have a controlling financial interest. See Section 8.3 for a discussion of how related parties affect the analysis under the VIE model.

Participating rights — definition

Participating rights allow the limited partners or noncontrolling shareholders to block or participate in certain significant financial and operating decisions of the limited partnership or the corporation that are made in the ordinary course of business.

An owner of a majority voting interest will be precluded from consolidating if a noncontrolling shareholder or limited partner has a substantive participating right in certain (but not all) significant financial and operating decisions that occur as part of the ordinary course of the investee’s business.

In addition, the voting interest definition is used for limited partnerships (and similar entities) in the determination of whether the partnership is a VIE.

Participating rights provide the ability to block or participate in the actions through which an entity exercises the power to direct the activities of a VIE that most significantly affect the VIE’s economic performance. To have a substantive participating right in determining whether a limited partnership or similar entity is a VIE, the limited partners must participate in certain significant financial and operating decisions that occur as part of the ordinary course of the limited partnership’s business in a manner similar to their participation under the voting interest entity model.

However, to be a substantive participating right and preclude another party from controlling, the right must be held by a single reporting entity and unilaterally exercisable relative to the activities that most significantly affect the economic performance of the VIE.

Forward starting rights and potential voting rights

Only existing voting rights are considered in the analysis of which party has a controlling financial interest.

Potential voting rights are not considered until they are currently held unless they are deemed to be held because of a nonsubstantive exercise or purchase price and there are no significant decisions in the ordinary course of business that will be made before the potential voting right is exercisable. See Section D.1.4.

Since the evaluation of economic performance, and therefore determining which reporting entity has power over the activities that most significantly affect the VIE’s economic performance, takes into account the life of the legal entity, forward starting rights are considered in the primary-beneficiary determination.

In addition, forward starting rights as a result of a contingent event should be evaluated in the determination of whether the contingency initiates or results in a change in power and, for the latter, whether the contingency is substantive. See Section 7.2.10.

Disclosures

The required disclosures for consolidated subsidiaries are limited, including disclosures related to consolidated subsidiaries that are not wholly owned.

In addition to the general disclosures required for consolidated voting interest entities, there are specific VIE disclosures for consolidated and unconsolidated VIEs. See Section 11.2.