Transfers and Servicing: Accounting for Repurchase Agreements Comment Letter Summary

Transcription

1 Transfers and Servicing: Accounting for Repurchase Agreements Comment Letter Summary Overview 1. On January 15, 2013, the Board issued proposed Accounting Standards Update, Transfers and Servicing (Topic 860): Effective Control for Transfers with Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings. The main objectives of the proposed Update include the following: Clearly identify repurchase agreements, securities lending transactions, and other transactions that should be accounted for as secured borrowing transactions. Improve the accounting and disclosure for those transactions. 2. Specifically, the proposed Update would entail the following: (c) (d) Require repurchase-to-maturity agreements that meet certain requirements to be accounted for as secured borrowings. Eliminate the current requirement to link certain transactions related to an initial transfer and a related repurchase financing. Address diversity in practice in interpreting substantially the same characteristics by clarifying the characteristics of financial assets that may be considered substantially the same. Require two new disclosures for certain transfers of financial assets with agreements that both entitle and obligate a transferor to repurchase the transferred financial asset from the transferee. 3. The comment period for the proposed Update ended on March 29, Twentythree comment letters were received. The table below provides information on the types of comment letter respondents.

2 Type of Respondent No. of Responses Preparers 10 Professional Organizations 6 Public Accounting Firms 3 Government Agency 1 Individuals 3 Total This document provides a summary of the significant feedback received on the proposed amendments and is organized as follows: (c) (d) (e) (f) (g) (h) Amendments to effective control Scope of the proposed amendments Separate accounting for initial transfer and repurchase financing Substantially the same Disclosures Transition and effective date Alternative solutions Legal isolation. Amendments to effective control 6. While most respondents agreed with the outcome of secured borrowing accounting for repurchase-to-maturity transactions, the majority of the respondents that addressed this issue did not support the approach taken. Those respondents disagreed with the proposed amendments to the condition for derecognition related to effective control. 2

3 7. Most respondents noted that the proposed amendments represent a significant divergence from the effective control model. They cited that the proposed Update has acknowledged this divergence in the basis for conclusions. Many respondents argued that the transferor has lost effective control in repurchase-to-maturity transactions because the transferor will not receive the previously held financial assets at a future date. For example, one respondent noted that the transferor does not benefit from the ownership of the financial asset during the term of the repurchase agreement, does not have access to the transferred asset, and does not have the ability to direct the transferee s use of the asset. This respondent also stated that even though cash may be the equivalent amount of the financial asset at the repurchase date, it is not substantially the same asset as the financial asset initially transferred. 8. Respondents noted that the proposed amendments would change the focus of the derecognition analysis from control to risks and rewards for a subset of transactions. Those respondents noted that the proposed amendments would lead to a combination of an effective control model and a risks-and-rewards model, which would result in inconsistent accounting application for similar transactions. Additionally, these respondents stated that the proposed amendments lack a clear principle. Respondents believe that repurchase-to-maturity transactions are precluded from sale accounting even though effective control is lost because certain risks and rewards have not transferred to the transferee because the transferor is subject to the market value adjustments of the collateral during the term of the repurchase agreement. However, transactions that are net cash settled any time before maturity are still eligible for sale accounting despite the transferor s retention of all the risks and rewards for what can be substantially all of the financial asset s term. Furthermore, most respondents disagreed that the application of secured borrowing accounting for repurchase agreements should be determined on the basis of the timing of the settlement (before maturity versus at maturity) or the form of the settlement (cash settlement versus physical settlement). Respondents expressed concern that the proposed amendments would allow for structuring opportunities whereby nonsubstantive changes may be made to 3

4 contracts and result in economically similar transactions having significantly different accounting treatments. Consequently, these respondents do not find the proposed amendments to be a practical long-term solution. Below are examples of structuring opportunities that were provided by respondents. (c) Under the effective control model, changing the maturity or the redemption date of the assets that are subject to repurchase by an insubstantial amount can change the accounting outcome. A repurchase-to-maturity transaction and a transfer of financial assets coupled with a total return swap that was contemporaneously entered into may be economically equivalent. However, under the proposed Update, the repurchase-to-maturity transaction would be accounted for as a secured borrowing, while the transfer and swap would be accounted for as a sale and a derivative. A repurchase-to-maturity transaction and a transfer of a financial asset coupled with a credit guarantee may be economically equivalent. Under the proposed Update, the transferor in a repurchase-to-maturity transaction would require secured borrowing accounting. However, a transfer of the very same financial asset coupled with a credit guarantee would be accounted for as a sale and a guarantee that would be accounted for either as a derivative or as a guarantee, depending on the terms of the guarantee. Scope of the proposed amendments 9. Many of the respondents who commented on the scope of the proposed Update indicated that the scope of the proposed amendments is not clearly articulated. These respondents stated that the scope of the amendment to the effective control guidance can be interpreted to include a wide range of legal agreements, including a sale and a total return swap, while the discussion in the basis for conclusions suggests that the guidance does not extend beyond repurchase agreements. If the Board decides to move forward with the proposed amendments as currently 4

5 drafted, those respondents recommended that the scope be clarified and offer a variety of approaches. Some of the following suggestions to clarify the scope were identified in the comment letters: (c) (d) Explicitly state whether a sale and a total return transaction are within the scope of the proposed amendments. Make an explicit exception to the effective control model and require the secured borrowing treatment only for repurchase-to-maturity transactions. Provide additional examples for the effective control criterion to illustrate transactions that are and are not within the scope of the proposed amendments. Reference common examples of industry standard agreements, such as Master Repurchase Agreement, Global Master Repurchase Agreement, Securities Lending Agreement, and Master Securities Lending Agreement, and require that transactions under these agreements be accounted for as secured borrowings. Separate accounting for initial transfer and repurchase financing 10. Many of the respondents who commented on the proposed amendments to the repurchase financing guidance agreed with the proposed amendments that would require an initial transfer and a repurchase agreement that relates to a previously transferred financial asset between the same counterparties that is entered into contemporaneously with, or in contemplation of, the initial transfer (a repurchase financing) to be accounted for separately. Those respondents noted that separate accounting would reflect the economics of those agreements and would be consistent with the way an entity manages the various risks arising from investment activities. 11. However, some of the respondents who commented on this issue disagreed with the proposed amendments. They argued that separate accounting would not reflect the economic substance of a repurchase financing transaction because separate 5

6 accounting would require a transferee to recognize a financial asset that it does not control with a corresponding liability that does not represent an amount that the transferee would be required to pay. In addition, secured borrowing accounting would inflate the volume of activity and result in an overstatement of both assets and liabilities on the transferee s balance sheet. Substantially the same 12. Many of the respondents who commented on the proposed amendments to the substantially the same criterion agreed that the return of a financial asset that is substantially the same maintains the transferor s effective control over the transferred financial asset. However, those respondents generally asserted that the proposed amendments to the substantially the same characteristics do not clarify how those characteristics should be applied and are inoperable for transfers of existing assets and forward repurchases of to-be-announced (TBA) securities. Some of these respondents noted that the current guidance is sufficient and should not be amended. They indicated that the amendments are already captured within the existing concept of substantially the same through the characteristics associated with the market yield, as described in paragraph (3). One respondent stated that the proposed amendments would not address the diversity in practice because the analysis of substantially the same is highly judgmental. 13. In addition, some respondents expressed concern that the use of historical data (as described in proposed paragraph (c)) to assess the substantially the same characteristics would not be practical because of the uncertainty surrounding the securities that will be returned. Those respondents believe that this paragraph could be interpreted to suggest that the assessment is performed after the completion of the transaction or solely on historical experience rather than at inception of the transaction based on the contractual terms. They recommended that the Board clarify that the substantially the same analysis should be performed at the inception of the transaction, and the absence of such clarification could ultimately require a look-back review. 6

7 14. Respondents who disagreed with the proposed implementation guidance for substantially the same analysis also believe that the analysis would be inoperable. Some of the following reasons were provided: (c) Certain dollar roll transactions often involve sales of specified agency pools of mortgage-backed securities or TBA securities with the simultaneous purchase of TBAs that settle through a clearing house that seeks to assign trades in a manner that provides for optimal net settlement of each counterparty s open position. Member firms will typically submit large volumes of sales and purchases to the clearing house and receive securities as settlement only for their net position. As a result, it is not possible to match a specific sale transaction to a specific repurchase transaction. In addition, the clearing house determines which securities a member firm will receive in the net settlement process. While the returned securities must meet good delivery standards, a member firm cannot stipulate which securities it will receive or which counterparty will deliver those securities. Consequently, the securities returned may not be the same or substantially the same as those transferred. Because the entity does not know which securities it must repurchase, evaluating prepayment characteristics for TBA securities will be difficult, and minor differences in terms without significant differences in the economic risks can result in significantly different accounting outcomes. 15. Additionally, some respondents believe that the substantially the same characteristics would require changes to operating systems and control processes. Consequently, these respondents are concerned that the costs of implementing the proposed amendments to the substantially the same criterion may outweigh the benefits of the changes. 7

8 16. Some respondents also noted that the proposed amendments to the substantially the same characteristics may be interpreted as a required approach that is overly prescriptive. One of these respondents believes that it is more important for an entity to consider all the relevant factors and the economic intent of the transaction rather than follow a list of criteria to perform the substantially the same analysis. Another respondent suggested that the Board clarify that the implementation guidance presents examples of how the analysis may be performed rather than a required method. Furthermore, other respondents recommended that the Board provide additional implementation guidance to illustrate the application of the substantially the same characteristics. Disclosures 17. For those agreements that are accounted for as secured borrowings, the proposed amendments would require the transferor to disclose the gross amount of the total borrowing disaggregated on the basis of the class of financial asset pledged as collateral. Some preparer respondents who commented on this disclosure disagreed that the proposed disclosure would provide decision-useful information. 18. For transfers in which the assets to be repurchased are not considered to be substantially the same, the proposed amendments would require the transferor to disclose the carrying amounts of assets derecognized during the reporting period. All respondents, mainly preparers who commented on this disclosure requirement, disagreed that the proposed disclosure would provide decision-useful information. Two of these respondents do not see a conceptual basis for the required disclosures. These respondents stated that the substantially the same analysis is highly judgmental, and noted that there are other circumstances in which accounting judgments are made without a requirement to disclose the basis for the judgment. Those respondents also noted that the scope of the disclosures is ambiguous because the scope can be interpreted to require an entity to track a broad range of transactions that do not meet the substantially the same characteristics. As such, they requested that the scope be clarified. The respondents also recommended that 8

9 the disclosures should be required only for repurchase agreements outstanding at the end of the reporting period and not for all repurchase agreements. They noted that the accounting for the repurchased security once the repurchase obligation has settled is transparent. Instead of the proposed disclosures, one respondent suggested requiring a qualitative disclosure of whether the level of activity during the reporting period differs significantly from that at period-end. 19. Respondents who disagreed with the proposed disclosures for repurchases of assets that are not considered substantially the same also cited operational issues regarding tracking and data gathering to comply with these disclosures. In addition to the concerns mentioned in paragraph 13, these respondents are concerned that the disclosures are not operable because of current system limitations. Entities currently do not track transactions that fail each separate derecognition criterion. If a transaction fails one of the criteria for sale accounting, the remaining criterion is not reviewed. As such, it may be difficult for entities to isolate transactions that do not qualify for sale accounting. Respondents noted that cost incurred to make changes to the operating systems and to the control processes to comply with the proposed disclosures would outweigh the benefits of the disclosures. 20. Some respondents also noted that much of the information in the proposed disclosures for secured borrowing and for transfers in which the assets to be repurchased are not considered to be substantially the same is similar to information already provided under the Securities and Exchange Commission s (SEC) requirements, current U.S. generally accepted accounting principles (GAAP), or regulatory reports, as noted below: Two respondents cited the Dear CFO letter that the SEC sent to public entities in March One respondent noted that the Dear CFO letter requested that public entities provide information on the amount of repurchase agreements that qualified for sale accounting, a description of differences in transaction terms that resulted in a transaction qualifying for sale treatment versus collateralized financings, and detailed analysis supporting use of sale accounting for repurchase agreements. 9

10 Consequently, public entities are considering areas in which their disclosures relating to repurchase agreements and similar transactions could be enhanced. Additionally, one respondent noted that the SEC issued a proposed rule, Release No , Short-Term Borrowings Disclosure (September 17, 2010), to codify the provisions for disclosure of short-term borrowings that are currently applicable to bank holding companies. (c) Those respondents noted that the required disclosures are similar to information already provided by bank holding companies and banks that are considered systematically important institutions to the Federal Reserve. One of the respondents expressed concern that the level of disaggregation that would be required by the proposed disclosures would divulge proprietary information, while another respondent noted that the information on the 4G Liquidity Report to the Federal Reserve is aggregated on the basis of their regulatory risk rating instead of class of the financial asset. Another respondent believes that the required disclosures by Accounting Standards Update No , Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities, are adequate. Update requires both gross information and net information about instruments and transactions that are eligible for offsetting in the statement of financial position and instruments and transactions that are subject to an agreement similar to a master netting arrangement. This respondent believes that the disclosure in the proposed Update to disaggregate the total borrowing would not provide decision-useful information. Another respondent also noted that repurchase agreements that meet derecognition requirements are generally accounted for as a sale with a forward repurchase commitment. Because the forward repurchase commitment is generally accounted for as a derivative instrument, an entity must provide the required disclosures in Topic 815, Derivatives and Hedging. As such, this respondent questioned 10

11 whether the additional costs incurred to comply with the proposed amendments would outweigh the incremental benefits. 21. Respondents generally believe that changes to the disclosures should be considered as part of a broader assessment of the derecognition model or as part of the liquidity and interest rate risk disclosures. Transition and effective date 22. Some of the respondents who commented on the transition provisions recommended that the proposed amendments be applied prospectively to all transactions. These respondents prefer prospective application for the following reasons: It would be consistent with other past amendments to the derecognition model within Topic 860, Transfers and Servicing. For transfers with forward repurchase agreements that settle at the maturity of the transferred financial asset and repurchase financings that involve such agreements, it would be burdensome for an entity to calculate the cumulative effective adjustment calculation. 23. Some respondents agreed with the transition provisions in the proposed amendments. If the Board retains the transition provisions in the proposed amendments, those respondents recommended that the Board explicitly clarify whether the resulting change to the current accounting treatment will give rise to an election date for the fair value option in accordance with paragraph One respondent, an association representing real estate investment trusts, recommended full retrospective application. Another respondent recommended retrospective application only for separate accounting (and not for repurchase-tomaturity transactions as secured borrowing). This respondent noted that retrospective application would enhance comparability. 11

12 25. Some respondents agreed with early adoption whereas some disagreed that early adoption should be permitted because it would impair comparability. 26. Respondents generally recommended that the effective date be at least one year from the date the proposed amendments are finalized to provide entities with adequate time to prepare for the change in requirements. 27. The majority of the respondents who commented on the effective date provisions stated that the effective date should be the same for both public entities and nonpublic entities. However, some of those respondents believe that the effective date should be delayed for nonpublic entities because standards are more difficult and costly for nonpublic entities to apply. Alternative solutions 28. Respondents suggested various approaches to resolve concerns about the proposed amendments. As a long-term solution, some respondents recommended that the Board consider the accounting for repurchase agreements as part of a broader project on derecognition of financial instruments to ensure a consistent and integrated model. As a short-term solution, some respondents suggested that the Board require only additional disclosures for repurchase agreements and similar transactions. Legal Isolation criteria 29. One respondent provided comments on the legal isolation criterion for sale accounting and the basis for conclusions relating to legal isolation. Under current U.S. GAAP, a true sale opinion from an attorney in the context of U.S. bankruptcy laws could signify that the transferred financial assets have been isolated from the transferor even in bankruptcy or other receivership (paragraph ). This respondent noted that a true sale has no specific meaning in statutory law. A true sale analysis often refers to a legal analysis to determine if a transferred asset should be treated as a sale or as a secured borrowing, and the conclusion to a legal 12

13 analysis depends on the jurisdictions involved. However, transferred assets can be considered legally isolated from the bankruptcy estate of the transferor if the repurchase agreement meets the requirements set forth in the safe harbor provisions of the U.S. Bankruptcy Code. The respondent is concerned that the basis for conclusions, which states that the Board observed that it would appear that obtaining a true sale opinion would be appropriate in circumstances in which the financial assets transferred fall outside the security types that are subject to the safe harbors provided in the U.S. Bankruptcy Code and when different jurisdictions are involved, would be interpreted to imply that a true sale opinion is not necessary when the financial assets fall within the safe harbor provisions (paragraph BC25). 13