IFRS 16: Are you ready?

by White & Case LLP

White & Case LLP

European Leveraged Finance Alert Series: Issue 8, 2018

On 13 January 2016, the International Accounting Standards Board (IASB) announced IFRS 16, a new accounting standard relating to the accounting treatment of leases. In short, the new standard requires lessees to recognise certain operating leases on their balance sheet, contrary to the previous off-balance sheet model. Given its significant impact, parties were urged to consider the impact of the new standards on their loan documentation. After a lengthy transition period, IFRS 16 will take effect on 1 January 2019. This article seeks to remind readers of the impact of IFRS 16, particularly in the context of loan agreements. However, more fundamentally, we will also explore how parties have (or have not, as the case may be) used the last three years to prepare for the change.


From 1 January 2019, IFRS 16 will replace the current arrangement under IAS 17, which treats finance leases and operating leases differently. Under IAS 17, finance leases are treated as debt, such that the 'purchase price' for the lease is noted as a liability on the balance sheet of the purchasing company and the leased asset is noted as an asset (and depreciates over time). Conversely, operating leases remain off-balance sheet, with lease payments charged to the lessee’s income statement as an operating expense. Accordingly, it is common for operating leases not to be taken into account when calculating the financial indebtedness of a company, as such amount is derived from its balance sheet position.

IFRS 16 seeks to remove this distinction and treat all leases the same for the purposes of lessee accounting; a shift in line with the general trend being adopted globally. Consequentially, all references to "operating lease" and "finance lease" for this purpose will become obsolete. Companies operating in the retail, transport and telecommunications sectors are expected to suffer the most following the change, as these typically rely heavily on property and equipment hires through leases. However, every company that draws this distinction will be impacted by the change, to a lesser or greater extent.

The above is a high-level summary only and readers should be aware that certain exceptions exist, for example, leases with a term of less than 12 months or in respect of 'low value' assets, which may receive treatment akin to an "operating lease" under the IAS 17 regime.

Impact on Loan Documentation

Whilst the above highlights the main accounting implications of the convergence of accounting treatment, below we consider the consequential impact on certain key facilities agreement provisions. For the purposes of the below and each other instance in this article, we are assuming that the relevant facilities agreement definition will now take account of operating leases as debt in all cases:

Financial covenants:

In most cases, facilities agreements take into account finance leases as part of the "Financial Indebtedness" and "Borrowings" definition, disregarding operating leases. Broadly speaking, with operating leases moving onto the balance sheet, any amounts payable under the leasing arrangements (whether these are considered operating or finance leases under IAS 17) will constitute debt, which in turn will increase the "Financial Indebtedness," as well as "Borrowings" and/or "Total Debt" figures for the purposes of financial covenant testing. Equally, "Finance Charge" figures are expected to be higher in recognition of the interest component of the leases. On the other side of the leverage, fixed charge cover and interest cover ratios, "EBITDA" numbers are also expected to be higher (although not by a corresponding amount to the increase in debt quantum), as EBIT (or operating profits), being the starting point of the "EBITDA" definition in facilities agreements, will no longer be reduced by the lease payment due under operating leases. The popularity of 'covenant-lite' and 'covenant-loose' structures will generally lessen this impact; however, if financial covenants are included in loan documentation, it is still advisable for borrowers and lenders to check if the borrower group is in compliance with their financial covenants and obtaining the benefit of any agreed headroom;

Undertakings and events of default:

Facilities agreements will contain a restriction on the incurrence of "Financial Indebtedness," which may be (i) in the form of an agreed cap (which could be significantly depleted by the inclusion of operating leases); (ii) a grower basket based on "EBITDA" (the size of which will increase on the basis of the discussions above) or assets (again expected to increase as operating leases will now also constitute a company's assets); or (iii) based on an agreed financial ratio (which again, will be impacted per the discussions above). Likewise, the ability to make restricted payments and/or make acquisitions is often also tied to such thresholds or agreed ratios. Similarly, as a result of the increase in "Financial Indebtedness," borrowers should consider whether any de minimis agreed as part of the cross-default and certain other events of default need to be increased to prevent inadvertent breach. Lenders and borrowers should consider whether the impact of IFRS 16 will affect the commercial agreement on these points and whether such thresholds need to be revisited; and

Guarantor coverage:

Facilities agreements usually contain a guarantor coverage test, based on assets and "EBITDA" (although increasingly based solely on "EBITDA"). With asset and "EBITDA" numbers inflated by the impact of IFRS 16, it may be easier for borrowers to meet the agreed thresholds. Lenders may wish to consider whether it would be preferable to increase such threshold or use a different compliance metric, potentially a reason to reprise the turnover-based guarantor coverage test.

Current Market Approach

Given the adverse consequences that IFRS 16 could have for both borrowers and lenders under facilities agreements, on 14 June 2016, the LMA updated its recommended form of facilities agreement to provide an optional change to the definition of Finance Leases. The effect of this change is to preserve the pre-IFRS 16 position (namely, commercially retaining the distinction between operating and finance leases). Whilst the language is optional and aimed primarily at deals signed prior to the IFRS 16 effective date, the language is being universally adopted. In fact, in most top-tier sponsor deals, it is usual for additional language to be included in the construction clause of facilities agreements preserving the IAS 17 position.

Additionally, it is usual for borrowers and lenders to agree that Frozen GAAP shall apply, which again preserves the pre-IFRS 16 position. Frozen GAAP allows a borrower to deliver its financial statements and report on compliance with any financial covenants and guarantor coverage test using the same accounting principles, practices and policies it used for the preparation of its original financial statements. Implementation of Frozen GAAP can be by means of production of two sets of accounts (one for the purposes of compliance with accounting standards and one for the purposes of compliance with the facilities agreement); however, the more common approach is for the borrower’s auditors to provide a reconciliation statement alongside the company’s latest accounts, such that the accounts are based on IFRS 16, but the reconciliation statement shows the position under IAS 17.

What Does The Future Hold?

Interestingly, the current market approach shows a general reluctance by both borrowers and lenders to accept the new accounting standards; parties instead appearing to have utilised the options available to preserve the status quo. However, whilst relying on Frozen GAAP is viable in the short-term, it does not provide a long-term solution. Firstly, not only is the production of two sets of accounts (or providing a reconciliation statement) expensive for companies, it can also be time-consuming; companies will be required to maintain both accounting systems and then analyse both sets of data to produce the relevant deliverables. Separately, once IFRS 16 is effective, borrowers and lenders signing new loan documentation would need to agree to use original financial statements and produce a base case model based on a previous accounting standard, which seems illogical. Ultimately, Frozen GAAP is intended to be a temporary solution, drafting usually anticipating that borrowers and lenders will enter into good faith negotiations to amend facilities agreements as required.

Accordingly, rather than treating IFRS 16 as the elephant in the room, it would be advisable for borrowers and lenders, particularly for new transactions, to embrace IFRS 16 in original financial statements and the related base case models, with financial covenants, thresholds, baskets and ratios being adjusted accordingly. Likewise for existing deals, borrowers and lenders should use the opportunity to consider whether covenants and relevant thresholds should be reset so that borrowers can submit financial statements based on the new accounting standards, rather than relying on Frozen GAAP.

With the supply-demand imbalance currently favouring sponsors, some have questioned why sponsors are not aggressively canvassing for loan documentation to be updated to reflect IFRS 16. Some have suggested that the limited adverse consequences for sponsors and borrowers in maintaining the status quo is the reason for this: a number of facilities agreements contain senior leverage financial ratios only and therefore other forms of financial indebtedness are not taken into account, reducing the likelihood of a financial covenant breach. On the other hand, lenders may also be concerned with making the switchover, with suggestions from some debt analysts that the new standards create opportunity for manipulation by borrowers. Borrowers could, for example, use their commercial bargaining power to obtain leases of terms of less than 12 months (and therefore take advantage of the short-term lease exemption) or, alternatively, ensure substitutability of the asset or restrictions on its ability to exercise control (such that the arrangement does not constitute a lease for the purposes of the new standard).

Notwithstanding these concerns and the reluctance from most market participants to adopt the new standards, some market participants may see a smooth transition over to IFRS 16. Those with significant operating leases may have been using EBITDAR (the "R" representing "before rental expenses") rather than EBITDA. Such parties will see a position similar to that to be enjoyed under IFRS 16, as contrary to the IAS 17 position (whereby the operating lease payment reduces the EBITDA figure, as this amounted to operating expenses), this already negates the rental impact of assets and therefore assists in reducing the impact of operating leases coming onto balance sheets. For most borrowers, however, this will not be the adopted metric and parties will still be expected to grapple with (and ultimately accept) the accounting standard change. Interestingly, however, some advocates for change have suggested that merely accepting the position is not enough, and instead, IFRS 16 should be viewed as the much-needed catalyst to instigate even further change in the market. One such change may be to move away from using EBITDA as a key performance indicator altogether, on the basis that the test is purely subjective (being a number derived from financial statements by a borrower rather than a clear line item); an argument compounded by increasing discussions and concern with respect to add-backs to EBITDA as part of facilities agreement negotiations. Instead, some have suggested that cashflow or operating cashflow be used as the preferred testing measure as these can potentially be less easily manipulated. Only time will tell if these are viable options.


Parties are advised to familiarise themselves with IFRS 16 and look to implement the standards into their facilities agreement ahead of the upcoming effective date. It is surprising to see such reluctance amongst market participants to accept the new accounting standards, with parties instead focussed on preserving their current arrangements. At the other end of the spectrum, some market participants are pushing for significant changes in market dynamics through suggesting new performance measures. It is unclear how the market will react to this. What is clear, however, is that despite the extensive implementation period, the market is still not ready for IFRS 16, and time is nearly up.

Click here to download PDF.

Rizwan Latif (White & Case, Associate, London) contributed to the development of this publication.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© White & Case LLP | Attorney Advertising

Written by:

White & Case LLP

White & Case LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide

JD Supra Privacy Policy

Updated: May 25, 2018:

JD Supra is a legal publishing service that connects experts and their content with broader audiences of professionals, journalists and associations.

This Privacy Policy describes how JD Supra, LLC ("JD Supra" or "we," "us," or "our") collects, uses and shares personal data collected from visitors to our website (located at www.jdsupra.com) (our "Website") who view only publicly-available content as well as subscribers to our services (such as our email digests or author tools)(our "Services"). By using our Website and registering for one of our Services, you are agreeing to the terms of this Privacy Policy.

Please note that if you subscribe to one of our Services, you can make choices about how we collect, use and share your information through our Privacy Center under the "My Account" dashboard (available if you are logged into your JD Supra account).

Collection of Information

Registration Information. When you register with JD Supra for our Website and Services, either as an author or as a subscriber, you will be asked to provide identifying information to create your JD Supra account ("Registration Data"), such as your:

  • Email
  • First Name
  • Last Name
  • Company Name
  • Company Industry
  • Title
  • Country

Other Information: We also collect other information you may voluntarily provide. This may include content you provide for publication. We may also receive your communications with others through our Website and Services (such as contacting an author through our Website) or communications directly with us (such as through email, feedback or other forms or social media). If you are a subscribed user, we will also collect your user preferences, such as the types of articles you would like to read.

Information from third parties (such as, from your employer or LinkedIn): We may also receive information about you from third party sources. For example, your employer may provide your information to us, such as in connection with an article submitted by your employer for publication. If you choose to use LinkedIn to subscribe to our Website and Services, we also collect information related to your LinkedIn account and profile.

Your interactions with our Website and Services: As is true of most websites, we gather certain information automatically. This information includes IP addresses, browser type, Internet service provider (ISP), referring/exit pages, operating system, date/time stamp and clickstream data. We use this information to analyze trends, to administer the Website and our Services, to improve the content and performance of our Website and Services, and to track users' movements around the site. We may also link this automatically-collected data to personal information, for example, to inform authors about who has read their articles. Some of this data is collected through information sent by your web browser. We also use cookies and other tracking technologies to collect this information. To learn more about cookies and other tracking technologies that JD Supra may use on our Website and Services please see our "Cookies Guide" page.

How do we use this information?

We use the information and data we collect principally in order to provide our Website and Services. More specifically, we may use your personal information to:

  • Operate our Website and Services and publish content;
  • Distribute content to you in accordance with your preferences as well as to provide other notifications to you (for example, updates about our policies and terms);
  • Measure readership and usage of the Website and Services;
  • Communicate with you regarding your questions and requests;
  • Authenticate users and to provide for the safety and security of our Website and Services;
  • Conduct research and similar activities to improve our Website and Services; and
  • Comply with our legal and regulatory responsibilities and to enforce our rights.

How is your information shared?

  • Content and other public information (such as an author profile) is shared on our Website and Services, including via email digests and social media feeds, and is accessible to the general public.
  • If you choose to use our Website and Services to communicate directly with a company or individual, such communication may be shared accordingly.
  • Readership information is provided to publishing law firms and authors of content to give them insight into their readership and to help them to improve their content.
  • Our Website may offer you the opportunity to share information through our Website, such as through Facebook's "Like" or Twitter's "Tweet" button. We offer this functionality to help generate interest in our Website and content and to permit you to recommend content to your contacts. You should be aware that sharing through such functionality may result in information being collected by the applicable social media network and possibly being made publicly available (for example, through a search engine). Any such information collection would be subject to such third party social media network's privacy policy.
  • Your information may also be shared to parties who support our business, such as professional advisors as well as web-hosting providers, analytics providers and other information technology providers.
  • Any court, governmental authority, law enforcement agency or other third party where we believe disclosure is necessary to comply with a legal or regulatory obligation, or otherwise to protect our rights, the rights of any third party or individuals' personal safety, or to detect, prevent, or otherwise address fraud, security or safety issues.
  • To our affiliated entities and in connection with the sale, assignment or other transfer of our company or our business.

How We Protect Your Information

JD Supra takes reasonable and appropriate precautions to insure that user information is protected from loss, misuse and unauthorized access, disclosure, alteration and destruction. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. You should keep in mind that no Internet transmission is ever 100% secure or error-free. Where you use log-in credentials (usernames, passwords) on our Website, please remember that it is your responsibility to safeguard them. If you believe that your log-in credentials have been compromised, please contact us at privacy@jdsupra.com.

Children's Information

Our Website and Services are not directed at children under the age of 16 and we do not knowingly collect personal information from children under the age of 16 through our Website and/or Services. If you have reason to believe that a child under the age of 16 has provided personal information to us, please contact us, and we will endeavor to delete that information from our databases.

Links to Other Websites

Our Website and Services may contain links to other websites. The operators of such other websites may collect information about you, including through cookies or other technologies. If you are using our Website or Services and click a link to another site, you will leave our Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We are not responsible for the data collection and use practices of such other sites. This Policy applies solely to the information collected in connection with your use of our Website and Services and does not apply to any practices conducted offline or in connection with any other websites.

Information for EU and Swiss Residents

JD Supra's principal place of business is in the United States. By subscribing to our website, you expressly consent to your information being processed in the United States.

  • Our Legal Basis for Processing: Generally, we rely on our legitimate interests in order to process your personal information. For example, we rely on this legal ground if we use your personal information to manage your Registration Data and administer our relationship with you; to deliver our Website and Services; understand and improve our Website and Services; report reader analytics to our authors; to personalize your experience on our Website and Services; and where necessary to protect or defend our or another's rights or property, or to detect, prevent, or otherwise address fraud, security, safety or privacy issues. Please see Article 6(1)(f) of the E.U. General Data Protection Regulation ("GDPR") In addition, there may be other situations where other grounds for processing may exist, such as where processing is a result of legal requirements (GDPR Article 6(1)(c)) or for reasons of public interest (GDPR Article 6(1)(e)). Please see the "Your Rights" section of this Privacy Policy immediately below for more information about how you may request that we limit or refrain from processing your personal information.
  • Your Rights
    • Right of Access/Portability: You can ask to review details about the information we hold about you and how that information has been used and disclosed. Note that we may request to verify your identification before fulfilling your request. You can also request that your personal information is provided to you in a commonly used electronic format so that you can share it with other organizations.
    • Right to Correct Information: You may ask that we make corrections to any information we hold, if you believe such correction to be necessary.
    • Right to Restrict Our Processing or Erasure of Information: You also have the right in certain circumstances to ask us to restrict processing of your personal information or to erase your personal information. Where you have consented to our use of your personal information, you can withdraw your consent at any time.

You can make a request to exercise any of these rights by emailing us at privacy@jdsupra.com or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

You can also manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard.

We will make all practical efforts to respect your wishes. There may be times, however, where we are not able to fulfill your request, for example, if applicable law prohibits our compliance. Please note that JD Supra does not use "automatic decision making" or "profiling" as those terms are defined in the GDPR.

  • Timeframe for retaining your personal information: We will retain your personal information in a form that identifies you only for as long as it serves the purpose(s) for which it was initially collected as stated in this Privacy Policy, or subsequently authorized. We may continue processing your personal information for longer periods, but only for the time and to the extent such processing reasonably serves the purposes of archiving in the public interest, journalism, literature and art, scientific or historical research and statistical analysis, and subject to the protection of this Privacy Policy. For example, if you are an author, your personal information may continue to be published in connection with your article indefinitely. When we have no ongoing legitimate business need to process your personal information, we will either delete or anonymize it, or, if this is not possible (for example, because your personal information has been stored in backup archives), then we will securely store your personal information and isolate it from any further processing until deletion is possible.
  • Onward Transfer to Third Parties: As noted in the "How We Share Your Data" Section above, JD Supra may share your information with third parties. When JD Supra discloses your personal information to third parties, we have ensured that such third parties have either certified under the EU-U.S. or Swiss Privacy Shield Framework and will process all personal data received from EU member states/Switzerland in reliance on the applicable Privacy Shield Framework or that they have been subjected to strict contractual provisions in their contract with us to guarantee an adequate level of data protection for your data.

California Privacy Rights

Pursuant to Section 1798.83 of the California Civil Code, our customers who are California residents have the right to request certain information regarding our disclosure of personal information to third parties for their direct marketing purposes.

You can make a request for this information by emailing us at privacy@jdsupra.com or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

Some browsers have incorporated a Do Not Track (DNT) feature. These features, when turned on, send a signal that you prefer that the website you are visiting not collect and use data regarding your online searching and browsing activities. As there is not yet a common understanding on how to interpret the DNT signal, we currently do not respond to DNT signals on our site.

Access/Correct/Update/Delete Personal Information

For non-EU/Swiss residents, if you would like to know what personal information we have about you, you can send an e-mail to privacy@jdsupra.com. We will be in contact with you (by mail or otherwise) to verify your identity and provide you the information you request. We will respond within 30 days to your request for access to your personal information. In some cases, we may not be able to remove your personal information, in which case we will let you know if we are unable to do so and why. If you would like to correct or update your personal information, you can manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard. If you would like to delete your account or remove your information from our Website and Services, send an e-mail to privacy@jdsupra.com.

Changes in Our Privacy Policy

We reserve the right to change this Privacy Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our Privacy Policy will become effective upon posting of the revised policy on the Website. By continuing to use our Website and Services following such changes, you will be deemed to have agreed to such changes.

Contacting JD Supra

If you have any questions about this Privacy Policy, the practices of this site, your dealings with our Website or Services, or if you would like to change any of the information you have provided to us, please contact us at: privacy@jdsupra.com.

JD Supra Cookie Guide

As with many websites, JD Supra's website (located at www.jdsupra.com) (our "Website") and our services (such as our email article digests)(our "Services") use a standard technology called a "cookie" and other similar technologies (such as, pixels and web beacons), which are small data files that are transferred to your computer when you use our Website and Services. These technologies automatically identify your browser whenever you interact with our Website and Services.

How We Use Cookies and Other Tracking Technologies

We use cookies and other tracking technologies to:

  1. Improve the user experience on our Website and Services;
  2. Store the authorization token that users receive when they login to the private areas of our Website. This token is specific to a user's login session and requires a valid username and password to obtain. It is required to access the user's profile information, subscriptions, and analytics;
  3. Track anonymous site usage; and
  4. Permit connectivity with social media networks to permit content sharing.

There are different types of cookies and other technologies used our Website, notably:

  • "Session cookies" - These cookies only last as long as your online session, and disappear from your computer or device when you close your browser (like Internet Explorer, Google Chrome or Safari).
  • "Persistent cookies" - These cookies stay on your computer or device after your browser has been closed and last for a time specified in the cookie. We use persistent cookies when we need to know who you are for more than one browsing session. For example, we use them to remember your preferences for the next time you visit.
  • "Web Beacons/Pixels" - Some of our web pages and emails may also contain small electronic images known as web beacons, clear GIFs or single-pixel GIFs. These images are placed on a web page or email and typically work in conjunction with cookies to collect data. We use these images to identify our users and user behavior, such as counting the number of users who have visited a web page or acted upon one of our email digests.

JD Supra Cookies. We place our own cookies on your computer to track certain information about you while you are using our Website and Services. For example, we place a session cookie on your computer each time you visit our Website. We use these cookies to allow you to log-in to your subscriber account. In addition, through these cookies we are able to collect information about how you use the Website, including what browser you may be using, your IP address, and the URL address you came from upon visiting our Website and the URL you next visit (even if those URLs are not on our Website). We also utilize email web beacons to monitor whether our emails are being delivered and read. We also use these tools to help deliver reader analytics to our authors to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

Analytics/Performance Cookies. JD Supra also uses the following analytic tools to help us analyze the performance of our Website and Services as well as how visitors use our Website and Services:

  • HubSpot - For more information about HubSpot cookies, please visit legal.hubspot.com/privacy-policy.
  • New Relic - For more information on New Relic cookies, please visit www.newrelic.com/privacy.
  • Google Analytics - For more information on Google Analytics cookies, visit www.google.com/policies. To opt-out of being tracked by Google Analytics across all websites visit http://tools.google.com/dlpage/gaoptout. This will allow you to download and install a Google Analytics cookie-free web browser.

Facebook, Twitter and other Social Network Cookies. Our content pages allow you to share content appearing on our Website and Services to your social media accounts through the "Like," "Tweet," or similar buttons displayed on such pages. To accomplish this Service, we embed code that such third party social networks provide and that we do not control. These buttons know that you are logged in to your social network account and therefore such social networks could also know that you are viewing the JD Supra Website.

Controlling and Deleting Cookies

If you would like to change how a browser uses cookies, including blocking or deleting cookies from the JD Supra Website and Services you can do so by changing the settings in your web browser. To control cookies, most browsers allow you to either accept or reject all cookies, only accept certain types of cookies, or prompt you every time a site wishes to save a cookie. It's also easy to delete cookies that are already saved on your device by a browser.

The processes for controlling and deleting cookies vary depending on which browser you use. To find out how to do so with a particular browser, you can use your browser's "Help" function or alternatively, you can visit http://www.aboutcookies.org which explains, step-by-step, how to control and delete cookies in most browsers.

Updates to This Policy

We may update this cookie policy and our Privacy Policy from time-to-time, particularly as technology changes. You can always check this page for the latest version. We may also notify you of changes to our privacy policy by email.

Contacting JD Supra

If you have any questions about how we use cookies and other tracking technologies, please contact us at: privacy@jdsupra.com.

- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.