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Derecognition

Date recorded:

Accounting for repurchase agreements (repos) and similar transactions

The staff started the discussion by pointing out that they were still analysing the effects of the 'Repo 105' issue on the proposed guidance and would present the result of this analysis to the Board at one of the following meetings. At the February meeting the Board agreed to treat repurchase agreements as secured borrowings (financing), rather than sales of the asset (as proposed in the ED/2009/3 Derecognition). This decision would present an exception from the overall derecognition model being developed. At the February meeting the Board agreed that all three following conditions must be fulfilled for repurchase transactions to be treated as financing:

  1. The financial assets to be repurchased or redeemed are the same or substantially the same as those transferred
  2. The agreement is to repurchase or redeem them before maturity, at a fixed or determinable price
  3. The agreement is entered into contemporaneously with, or in contemplation of, the transfer

The Board started the discussion with assessment whether the proposed guidance (similar to that which exist under U.S. GAAP) should be provided specifying what constitutes 'substantially the same'.

After a brief discussion the Board agreed to incorporate the basic characteristics of the assets specified in the U.S. guidance related to 'substantially the same', namely:

  1. The same primary obligor
  2. Identical form and type so as to provide the same risks and rights
  3. The same maturity
  4. Identical contractual interest rates
  5. Similar assets as collateral
  6. The same aggregate unpaid principal amount or principal amounts within accepted 'good delivery' standards for the type of security involved

The Board also agreed to provide application guidance for some of these characteristics (inspired by the guidance in the US GAAP).

One Board member suggested that the wording of some of the guidance should be clarified and definition tightened, for example, to reflect credit risk and position in the waterfall structure in determination of substantially the same. In his view, the US guidance was useful but since its publication substantial development in the securitisation market made some amendments and clarifications necessary. The staff agreed to incorporate these suggestions and discuss them with the FASB (the FASB will held an educational session on derecognition the following week).

The Board continued its discussion by assessing the need for an additional 'collateral maintenance' criterion to be required for classification of a repo as secured borrowing (as required by the U.S. GAAP). One Board member suggested introducing such a provision into the proposed guidance. In their opinion the argument that collateral maintenance criterion is closely related to the legal isolation test was not a strong one, as default could happen not only as a result of bankruptcy but, for instance, illiquidity of the market. In the view of this Board member there should be an additional criterion that would distinguish between repos classified as financing and those derecognised as sales. Other Board members did not believe that such additional criterion was operational.

Some Board members suggested that the issue of collateral in repo transactions is dependent on jurisdiction and is not accounting but predominantly a regulatory issue.

Finally, the Board agreed not to add the collateral maintenance criterion to the proposed guidance on repos.

Pass-through arrangements, nonrecourse loans and accounting for assets and liabilities of SPEs

The Board continued its discussion whether the pass through criteria in IAS 39.19 were still relevant for the determining whether an asset should be derecognised.

The Board discussed the first condition (no obligation to pay amounts to the eventual recipients unless equivalent amounts were collected from the original assets). The staff noted that the real issue was not whether payments would have to be made but rather whether the transferor has passed or agreed to pass the cash flows to the other party. The staff thus proposed that if the transferor agreed to pass some or all of the economic benefits of the asset to the transferee, irrespective of any explicit or implicit guarantee, the asset should be derecognised.

One Board member noted that even though application of the model was theoretically sound, he felt uncomfortable with the outcome as such guidance might perpetuate perverse incentives for earnings management. This Board member was particularly concerned with the recognition of the gain on derecognition of financial assets measured at amortised cost. As such, he suggested that this pursued approach is suitable only to financial asset measured at fair value and not for those measured at amortised cost. In response, another Board member stated that this is the natural consequence of the mixed measurement model that results from the guidance in IFRS 9 Financial Instruments. Another Board member suggested that comprehensive set of disclosures might alleviate some of these concerns.

Another Board member was concerned with application of such guidance to structured entities and expressed his doubts, whether this guidance would not lead to structuring opportunities. The staff responded that the guidance takes a symmetrical view on recognition and derecognition of financial assets (that is, no stickiness).

The Board briefly discussed the remaining two criteria of the IAS 39 pass-through test (prohibition of selling or pledging the original asset, obligation to remit any cash flows without material delay). One Board member noted that the last condition is closely related to the overall agent principal issue that the Board is addressing in several projects. As such he suggested that the Board revisits this issue once the guidance on agent/principal relationship is finalised in other projects.

Finally, the Board agreed that the pass through test in IAS 39 does not need to be included in the proposed derecognition requirements as the proposed guidance addresses the issues that were intended to be captured by the pass through test. Nonetheless, the Board agreed to provide illustration of these conditions in the application guidance.

The Board continued with the discussion of 'empty SPEs'. Some Board members expressed their concerns that the proposed derecognition approach would lead to almost all SPEs to be empty.

Most of the Board members did not share these concerns. In their opinion, even though the proposed guidance would increase the prevalence of 'empty SPEs', the application of the derecognition principle would depend on the nature of the beneficial interest issued. Moreover, some of the 'empty SPEs' would be treated in the same way under IAS 39 requirements. For these Board members this was not an issue and conceptual derecognition principle would bring more clarity and transparency in the conditions.

Finally, the Board agreed not to introduce any additional criteria that would address the issue of 'empty SPEs'.

The Board discussed the nonrecourse loans issue. In the discussion the Board tried to clarify the difference between overcollateralization and nonrecourse provisions.

After a considerable discussion, the Board agreed that the proposed treatment of recourse and nonrecourse transactions should not differ.

Some Board members were concerned with potential valuation of the continuing involvement. Nonetheless, it they agreed that it was more a recognition rather than a derecognition issue.

Disclosures

The Board continued its discussion by considering the feedback from constituents on disclosure requirements related to derecognition.

Based on the analysis of comment letters constituents generally supported the proposed disclosures objectives, but expressed some concerns related to specific disclosures proposed.

The Board reaffirmed the derecognition objectives as proposed in the ED/2009/3. With regards to the specific disclosures, the Board agreed with the disclosures related to transactions that do not result in derecognition of financial assets.

Nonetheless, as one Board member pointed out, the wording of the guidance have to be tightened to avoid disclosure of non-relevant information.

The Board agreed with the proposed disclosures on transactions that result in derecognition of financial assets. The Board asked the staff to consider whether the disclosure of fair value of derecognised financial assets in which an entity has continuing involvement is always necessary and can be ascertained (for example, fair value of guaranteed receivables, when the entity guarantees nominal amount, that is, guarantees credit risk but not market risk). The Board also agreed to aggregate disclosure when an entity has more than one category of continuing involvement with the same derecognised financial asset.

The Board decided not to provide further guidance around the aggregation of gains and losses resulting from derecognition and from continuing involvement.

In the light of the 'Repo 105' controversy the Board decided to retain the requirement to disclose the level of transfer activity not evenly distributed throughout the reporting period.

With regards to the disclosures regarding modification to liabilities that does not result in extinguishment and modification the terms of a financial asset for a borrower in financial difficulties, the Board asked the staff to determine a suitable threshold for disclosures. Many Board members expressed their concerns that without such threshold trivial disclosures would be provided. Moreover, some Board members expressed their concerns that collection of data in the circumstances would be difficult what would make these disclosures non-operational.

Support for the package of decisions

The Chairman noted that the majority of the derecognition approach has been deliberated and therefore asked Board members to indicate their dissent. Mr. Smith indicated he would dissent to the publication of the guidance as he does not consider it to be improvement over the current guidance in IAS 39. He expressed his concerns that the proposed guidance would lead to free choice on derecognition of financial assets with no discipline with regards to cash flow remittance. Therefore, in his view this guidance would be more appropriate for a fair value model of financial instruments rather than mixed-measurement model. Mr. Finnegan indicated he might dissent on the same basis.

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