January 16, 2013
Volume 20, Issue 3

by Adrian Mills, Ana Zelic, and Kristen Mascis, Deloitte & Touche LLP

Summary

On January 15, 2013, the FASB issued a proposed ASU¹ that would amend U.S. GAAP by requiring repurchase agreements (“repos”²) that meet the criteria for secured-borrowing accounting to be accounted for as secured borrowings rather than as sales with forward repurchase agreements, including those repos that settle at the maturity of the transferred assets.³ The proposed ASU would:

• Eliminate an entity’s ability to conclude that effective control is not maintained solely because the repo settles at maturity of the transferred assets. (As a result, more repurchase transactions may be accounted for as secured borrowings.)
• Clarify the existing “substantially the same assets” criteria that entities should consider in determining whether repos should be accounted for as secured borrowings.
• Replace the existing guidance on repurchase financing transactions, requiring instead that such transactions be assessed in the same manner as other repurchase transactions.
• Add new disclosure requirements to give users of financial statements more information about the nature of repos and their impact on the entity’s liquidity.
• Require entities to generally apply the guidance in the proposed ASU by recording a cumulative-effect adjustment to the statement of financial position as of the beginning of the period of adoption.

The effective date is yet to be determined. Comments on the proposal are due by March 29, 2013.

Background

ASC 860⁴ describes how an entity should account for transfers of financial assets, including repos. Under that guidance, transfers of financial assets are accounted for as a sale of financial assets only if all of the following conditions are met:

1. The transferred assets have been isolated from the transferor — even in bankruptcy.
2. The transferee has the right to pledge or exchange the transferred assets.
3. The transferor does not maintain effective control (e.g., through an agreement that entitles and obligates the transferor to repurchase or redeem them before their maturity).⁵

If any of the above conditions are not met, the transaction is accounted for as a secured borrowing with a pledge of collateral.

For repos, the sale or borrowing analysis often is focused on the effective control criteria, as outlined in (3) above. ASC 860 currently states that a transferor is considered to maintain effective control over the assets only if all of the following conditions are met:

• “The financial assets to be repurchased or redeemed are the same or substantially the same as those transferred.”
• “The agreement is to repurchase or redeem [the financial assets] before maturity, at a fixed or determinable price” (emphasis added).
• “The agreement is entered into contemporaneously with, or in contemplation of, the transfer.”⁶

Because certain repos settle at the maturity of the transferred assets, they fail to satisfy the condition that repurchase must occur before maturity, and the transferor therefore does not maintain effective control. As a consequence, if the remaining conditions for derecognition in ASC 860 are met (i.e., isolation and the transferee’s right to pledge or exchange the asset), repos that settle at maturity would be accounted for as a sale with a forward repurchase agreement (i.e., a derivative measured at fair value through net income). However, the FASB now believes that such accounting “does not clearly convey sufficient information about an entity’s risks [and could] potentially obscure the entity’s need for liquidity to fulfill the obligations arising from those transactions.”

Overview of the Proposed Amendments

Criteria for Secured-Borrowing Accounting

The proposed ASU would not change the existing general derecognition conditions under ASC 860 related to isolation and the transferee’s right to pledge or exchange an asset in determining whether transfers of financial assets are accounted for as a sale of financial assets or a secured borrowing. However, the proposal would amend the conditions for determining whether the transferor maintains effective control over the transferred assets. In particular, under the proposal, “an agreement that at its inception involves a transfer of existing financial assets and both entitles and obligates the transferor to repurchase or redeem the transferred financial assets from the transferee maintains the transferor’s effective control over those assets as described in paragraph 860-10-40-5(c)(1) if all of the following conditions are met:”

aa. The financial assets to be transferred upon settlement of the agreement are any of the following:

1. Financial assets that are the same as those initially transferred

2. Financial assets that satisfy the characteristics in [ASC 860-10-40-24A] to be considered substantially the same as the assets initially transferred

3. For an agreement with a settlement date that is at the maturity of the transferred financial asset, an exchange of cash equal to the redemption or settlement value of the initially transferred financial asset from the transferee to the transferor and the transfer of the fixed repurchase price from the transferor to the transferee (or the difference between those amounts). . . .

c. The agreement is to repurchase or redeem the financial assets at a fixed or determinable price.

d. The agreement is entered into contemporaneously with, or in contemplation of, the initial transfer.

If repos meet the revised effective-control conditions, the transaction would be accounted for as a secured borrowing (there would be no need to assess the other ASC 860 general derecognition conditions related to legal isolation and the transferee’s rights to pledge or exchange). However, if repos do not meet one or more of the effective-control conditions above for determining whether to account for such transactions as secured borrowings or sales with forward repurchase agreements, entities would continue to apply the other ASC 860 general derecognition conditions.⁷

Substantially the Same Assets

One of the conditions that can affect whether an entity accounts for a repo as a secured borrowing or as a sale with a forward repurchase agreement is whether the asset being repurchased at settlement is the same or substantially the same as the asset given up. ASC 860 currently provides application guidance to help entities make this determination. However, the FASB learned through its outreach activities that entities interpret “substantially the same” and the related application guidance differently. Thus, the proposed ASU (1) clarifies that “to be substantially the same, the financial asset that is initially transferred and the financial asset that is to be repurchased or redeemed should provide the same risks and rights to the transferor so as to place the transferor in the equivalent economic position with the return of a substantially-the-same asset compared with the return of the identical asset” and (2) adds to the implementation guidance on determining when financial assets exchanged (in particular, asset-backed securities) are considered substantially the same.⁸

Repurchase Financing Transactions

The proposed guidance would eliminate the current guidance in ASC 860 on repurchase financing transactions. Under the current guidance, there is a rebuttable presumption that an initial transfer and a repurchase financing that are entered into contemporaneously with, or in contemplation of, each other would be considered linked and thus potentially a derivative if the transferor regains effective control over the initially transferred assets through repurchase financing.

The proposed ASU would require the repurchase financing transaction to be evaluated under the criteria for secured-borrowing accounting without the presumption of linkage and consequential potential for derivative accounting. Thus, these transactions may be accounted for as secured borrowings more often than they are currently.

Disclosure

In addition to the information required by ASC 860, the proposed ASU would require entities to disclose as of each balance sheet date (1) the “gross amount of the total borrowing, disaggregated by class of financial asset pledged as collateral” for repos accounted for as secured borrowings and (2) the carrying amount of assets derecognized during the reporting period only “because the assets to be repurchased [did] not meet the substantially-the-same requirements.”

Transition

Under the proposal, entities would be required to apply the guidance in the final ASU in the following manner:

• For repos that settle at the maturity of the transferred assets, and for repurchase financings involving such repos, that are outstanding as of the beginning of the first reporting period in which the guidance is effective, entities should record a cumulative-effect adjustment to the statement of financial position as of the beginning of that period.
• For all other repos, the ASU should be applied prospectively when those transactions are entered into or modified after the effective date.
• Entities would be required to disclose, as of the beginning of the first reporting period in which the guidance becomes effective, a description of the accounting change, method of the change, and the effect on the balance sheet.

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1 FASB Proposed Accounting Standards Update, Effective Control for Transfers With Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings.

2 The proposed ASU defines a repo as an “agreement under which the transferor (repo party) transfers a financial asset to a transferee (repo counterparty or reverse party) in exchange for cash and concurrently agrees to reacquire that financial asset at a future date for an amount equal to the cash exchanged plus a stipulated interest factor.”

3 The ASU’s proposal requiring secured borrowing accounting for repos that settle at maturity of the transferred assets would generally result in convergence with IFRSs for this type of transaction because under the derecognition model in IAS 39, Financial Instruments: Recognition and Measurement, the risks and rewards would typically be viewed as retained by the transferor.

4 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s ”Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”

5 See ASC 860-10-40-5.

6 In April 2011, the FASB issued Accounting Standards Update No. 2011-03, Reconsideration of Effective Control for Repurchase Agreements, which eliminated from U.S. GAAP the requirement for entities to consider whether a transferor (i.e., seller) has the ability to repurchase or redeem the financial assets on substantially agreed terms, even in the event of default by the transferee, in a repo when determining whether the transferor maintained effective control and thus accounted for the repo as a secured borrowing rather than as a sale (with a forward repurchase agreement).

7 The proposed ASU further indicates that “the agreement shall be evaluated under paragraph 860-10-40-5(c) to the extent that it involves other features that warrant consideration under the effective control condition.”

8 In accordance with ASC 860-10-40-24A (as added by the proposal) and with ASC 860-10-40-24 (under existing guidance), in making such assessment, entities must consider whether the exchanged financial assets (1) have the same primary obligor, maturity, contractual interest rates, aggregate unpaid principal amount, or principal amounts within accepted good delivery standards for the type of security involved; (2) are similar assets as collateral, and (3) are of the same form and type.

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