Board Meeting Handout Consolidation of Certain Special-Purpose Entities September 25, 2002

Transcription

1 Board Meeting Handout Consolidation of Certain Special-Purpose Entities September 25, 2002 The Board will discuss the following matters related to consolidation of special-purpose entities (SPEs). Multiparty SPEs (Attachment 1) Several respondents to the proposed Interpretation, Consolidation of Certain Special- Purpose Entities, recommended that the Board permit administrators of multiparty SPEs to assess their variable interests in relation to each silo individually rather than for the SPE as a whole. The proposed requirement in paragraph 17 states: If contractual or other legal provisions or agreements substantially restrict an enterprise s rights and obligations to specifically identified assets of an SPE and the interests of the creditors of the SPE apply equally to all of the SPE s assets, that enterprise shall treat those assets and the portions of the SPE s liabilities attributable to those assets as a separate SPE. (Footnote reference omitted.) An illustrative example that the Board will discuss is attached. The example is not intended to be realistic, only to illustrate the points to be discussed. Comments on the Proposed Interpretation (Attachment 2) The Board will discuss the comments on the proposed Interpretation. A summary of the most frequent comments is attached. Public Roundtable (Attachment 3) The Board will discuss certain matters that are likely to be discussed at the public roundtable on Monday, September 30, A staff-prepared proposed list of matters to be discussed is attached. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

2 ATTACHMENT 2 Consolidation of Certain Special-Purpose Entities Example of Silo Analysis ABCP Conduit is a hypothetical SPE that receives financial assets from 10 transferors and issues commercial paper. The transferors receive cash for 90 percent of the face value of the receivables and a residual interest with a face amount of 10 percent of the assets transferred. AdminCo decides which potential transferors are permitted to participate in the ABCP Conduit, places and services the commercial paper, and handles all other administrative matters. AdminCo also provides a guarantee of the commercial paper for up to 10 percent of the total amount outstanding. AdminCo receives a fee that is equal to the difference between the interest received on the assets of the conduit and the interest paid on the commercial paper. The expected future losses on the assets of ABCP Conduit are 20 percent. The commercial paper investors have little or no expected loss because they are protected by the 10 percent residual interest of the transferors, which is subordinate to the interests of commercial paper holders, and by the 10 percent guarantee provided by AdminCo. If AdminCo looks at each silo individually and allocates its guarantee proportionately, its variable interest in each silo is equal to 50 percent of the expected losses. Total expected losses are 20 percent (assuming an equal portion of the total losses apply to each silo), and AdminCo's guarantee is for 10 percent. The transferor has the other 50 percent of the expected losses. The tiebreaker in paragraph 20 would result in the transferor being the primary beneficiary because it incurs losses first. If AdminCo looks at ABCP Conduit as a whole, AdminCo is the primary beneficiary. AdminCo has a variable interest equal to 50 percent of the expected losses of the total conduit, while each transferor has 5 percent of the total expected losses. AdminCo has a significant variable interest that is significantly more than the variable interest of any other party. The following chart illustrates the difference. Silo1 Silo2 Silo3 Silo4 Silo5 Silo6 Silo7 Silo8 Silo9 Silo10 Silo perspective Transferor VI Administrator VI Conduit perspective Transferor VI 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Administrator VI 2

3 ATTACHMENT 2 Proposed Interpretation, Consolidation of Certain Special-Purpose Entities Summary of Frequent Comments As of September 6, 2002, the Board had received 124 responses to the request for comments. (Comments received since that date are not reflected in this summary.) A large majority of those letters came from banks and other financial services enterprises that are involved in securitizations or leasing. General Reactions There were several types of general reactions to the proposed Interpretation. Most respondents praised the Board for addressing the accounting for SPEs, and many supported basing consolidation on holdings of variable interests (risks and rewards). However, a few stated that the proposed Interpretation is unnecessary because except for a few violations of the existing accounting principles, SPEs are not a reporting problem. Most respondents believed the proposed Interpretation would require consolidation of too many SPEs, but a few stated that it would result in less consolidation than today. The paragraph 8(c) exception was frequently cited as a reason. One respondent stated that the Board should provide deconsolidation guidance. The following are summarized versions of other most common general comments. 1. The proposal is too complex and subjective to be applied consistently. 2. The Board did not follow an appropriate due process because this should not be an Interpretation. It should be a Statement because it amends other literature. (FASB Statement No. 13, Accounting for Leases, and FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, were the ones most frequently cited, but certain EITF Issues also were mentioned.) 3. The basic approach is wrong. Variable interests do not convey a controlling financial interest and the liabilities or assets of an SPE are not liabilities or assets of its primary beneficiary. A few general alternatives were suggested: 3

4 ATTACHMENT 2 a. Financial components approach b. Proportionate consolidation c. Additional disclosure and codification of existing rules d. Add a presumption that every SPE will be consolidated by some entity. 4. The proposed Interpretation will inappropriately require consolidation of many SPEs and, thereby, restrict the use of SPEs, distort the market, impair capital flows, and reduce financing options for deserving borrowers. In contrast, Fitch Ratings (letter # 12) stated that consolidation of conduits by the 6 largest conduit administrator banks would not cause their capital to fall below the "well capitalized" level and that it should not affect the credit ratings of SPEs. A number of respondents requested that the Board resolve implementation issues before issuing the final Interpretation, and a few specifically requested that those issues not be resolved by a group like the Derivatives Implementation Group. There were also numerous questions and suggestions about accounting after initial consolidation and many requests for examples of application of the proposed Interpretation. Comments about Specific Paragraphs There were comments about every paragraph except those in the introduction. The staff has not done a statistical analysis, but based on our judgment, the 10 most common comments (abbreviated versions not necessarily in order of frequency) were: 1. Consolidation should only be required with a majority variable interest. For financial SPEs that meet the conditions in paragraph 22, the requirement should be majority variable interest and an ability to purchase and sell assets. 2. The effective date should be six to nine months later than the effective date in the proposed Interpretation, or it should be the same as the effective date of the amendment of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, and the Interpretation on guarantees. 3. Silo analysis should apply to all participants in multiparty SPEs. Residual interests in intermediate qualifying SPEs should be considered variable interests in conduits. 4. Fees negotiated at arm's length should be presumed to be market based. 5. Comparison to substantive operating enterprises should not be required to overcome the presumption in paragraph 12. 4

5 ATTACHMENT 2 6. Variable interests should not be reassessed or should only be reassessed if a triggering event occurs. The information to assess variable interests of other parties will not be available or will be burdensome to acquire. Even if the information is available, the actions of other parties should never require one to consolidate. 7. Provide exceptions for [fill in the blank]. Almost every type of SPE was mentioned. 8. The distinction between SPEs and substantive operating enterprises is not clear. 9. The required amount of equity in paragraph 9 and the assessment of variable interests should not be based on expected future losses. (Point estimates, probable losses, reasonably possible losses, and maximum losses were suggested alternatives.) 10. Initial measurement at fair value of consolidated SPEs should not be required. The following comments also were made by a large number of respondents. 1. The 10 percent presumption should be eliminated. (A few said it should be an absolute requirement instead of a presumption.) 2. A numerical value should be assigned to significant. 3. The substantive operating enterprise exception in paragraph 8(c) should be eliminated or at least narrowed. 4. A de facto agency relationship should be defined in more detail, or the provision should be eliminated. 5. Related parties should specifically include employees and board members. 6. The criteria to qualify as a financial SPE in paragraph 22 are too restrictive. a. SPEs should qualify even if they hold derivatives. b. The criteria should be independent of Statement 140 and not change automatically if Statement 140 changes. 7. The conditions for consolidating financial SPEs are too restrictive. a. Sufficient discretion should be defined in paragraph 23(a). b. Paragraph 23(b) should have a significance test. c. Paragraph 23(c) should be eliminated, or fees should be presumed to be market. 8. Administrators should not be required to make the disclosures in paragraph Grandfather all existing SPEs. (Other respondents requested grandfathering certain types of SPEs but not all.) 10. Paragraph 27 (pro forma disclosures) may be impossible to apply. 5

6 ATTACHMENT 3 Proposed Interpretation, Consolidation of Certain Special-Purpose Entities Proposed List of Matters for Discussion at the Public Roundtable September 30, 2002 The following is a list of the matters the Board would like to discuss at the public roundtable on the proposed Interpretation (although not necessarily in the order listed). Participants may raise other matters if time is available. 1. Distinguishing between entities subject to consolidation based on voting interests (substantive operating enterprises) and entities subject to consolidation based on variable interests (SPEs)) a. The criteria for identifying a business in EITF Issue 98-3, "Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business" b. The provisions in the April 10 draft (which was based primarily on support of another enterprise's operations) c. The equity interest provisions in paragraph 9 identify enterprises subject to consolidation based on voting interests. All other business entities would be subject to consolidation based on variable interests. 2. The proposed exception in paragraph 8(c) for SPE-like subsidiaries of substantive operating enterprises and SPE-like groups of assets and liabilities of substantive operating enterprises a. Retain the proposed exception b. Delete the proposed exception c. Modify the proposed exception so that an SPE-like subsidiary qualifies for an exception only if it meets certain conditions (for example, if the parent can unilaterally liquidate the SPE and recover the assets). 3. Identifying variable interests in SPEs a. Symmetry between risk of loss and potential for gain b. Derivative instruments c. Investment grade debt d. Guarantees e. Contracts involving fees that are not market based. 4. Identification of a primary beneficiary a. Significant and significantly more variable interests b. Majority variable interests 6

7 ATTACHMENT 3 c. Quantitative and qualitative factors. 5. Reassessment of consolidation of SPEs at each reporting date a. Assess at inception only (do not reassess) b. Reassess annually c. Reassess only if a triggering event occurs. 6. Disclosures about unconsolidated SPEs a. Criteria for requiring the disclosures b. Information to be disclosed. 7. Special provisions related to SPEs that hold certain financial assets a. Usefulness of the special provisions and consistency with the general provisions b. Restrictions on the activities and holdings of the SPEs derivatives and equity securities c. Conditions for consolidation (the two-out-of-three approach) d. Silos and residual interests in intermediate qualifying SPEs (between a transferor and a multiparty SPE). 8. Transition and effective date a. Initial measurement at fair value b. Effective date for existing SPEs c. Effective date for new SPEs. 9. Consolidation procedures a. Fair value measurement b. Accounting for noncontrolling interests and earnings or losses not attributable to the primary beneficiary. 10. Other matters a. Exceptions for certain leasing arrangements b. Effects on privately held businesses under common control c. Effects on charitable trusts and not-for-profit organizations. 7

8 Board Meeting Handout September 25, 2002 Norwalk, CT Business Combinations II Purchase Method Procedures The Board will discuss issues raised at the joint meeting with the IASB on September 18, At today s meeting, the staff will (1) report to the Board tentative decisions made by the IASB Board at its September 19, 2002 decision-making meeting concerning issues discussed at the joint meeting, and (2) ask the Board to consider whether certain issues raised at the joint meeting should be included or excluded from the scope of this project. The matters for discussion include: 1. Report on Decisions by the IASB (a) Measurement Date for Equity Instruments Issued as Consideration (b) Initial Measurement of Acquired Assets and Assumed Liabilities Selection of a Disposition Market Price if Multiple Disposition Markets Exist 2. Project Scope and Next Steps (a) Amendments to Postemployment Benefit Plans That Are a Condition of the Business Combination (b) Intended Changes by the Acquirer to Employee Benefits and Other Postretirement Benefit Plans (c) Employee Benefit Payments Triggered by a Business Combination (d) Constructive Obligations (e) Noncontrolling Interests The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

9 Board Meeting Handout Financial Instruments: Liabilities and Equity September 25, 2002 The Board will discuss issues related to disclosure, transition, and effective date for the limited-scope Statement. DISCLOSURE The Board will discuss disclosure requirements such as whether to include certain disclosure requirements found in EITF Issue No , Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company s Own Stock. TRANSITION The Board will consider whether the Statement should be applied prospectively, retroactively, or as a cumulative effect of an accounting change. Additionally, if the Board decides to require retroactive application, it will discuss the appropriate restatement period to be applied. EFFECTIVE DATE The Board will discuss when the Statement would be effective. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

10 Board Meeting Handout PRINCIPLES-BASED APPROACH TO U.S. STANDARD SETTING SEPTEMBER 25, 2002 The Board will discuss a principles-based approach to U.S. standard setting that would reduce the level of detail and complexity in accounting standards. That discussion will focus on whether to issue for public comment a proposal discussing the approach, the comment period, and whether to hold a public roundtable meeting with respondents to the proposal on December 9, Accounting Standards Accounting standards developed under a principles-based approach would, among other things: Establish accounting and reporting objectives based on the economic substance of the transactions covered by the standards Set forth as general principles, fundamental recognition, measurement, and reporting requirements derived from the conceptual framework designed to meet those objectives Provide few, if any, exceptions, in particular, exceptions to mitigate the effects of applying the general principles Provide additional guidance for applying the general principles limited, however, to situations typically covered by the standards, encouraging professional judgment in other more specific situations. Implications for Change A principles-based approach would require changes (in some cases, significant) involving all participants in the U.S. financial reporting process including the FASB and other standard setting bodies (EITF and AcSEC), preparers, auditors, the SEC, and investors and other users. Not only do those changes relate to how those accounting standards are developed, they relate to how those accounting standards are applied and enforced. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

11 Board Meeting Handout Proposed AICPA Document September 25, 2002 The Board will meet with representatives of the Accounting Standards Executive Committee (AcSEC) to consider clearance of an Exposure Draft of a proposed AICPA Statement of Position, Clarification of the Scope of the Investment Companies Audit and Accounting Guide and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies. The Board previously objected to issuance of the Exposure draft at its March 27, 2002 meeting, and recommended that AcSEC consider certain changes. Further, the Board expressed its view that an investment company (other than a separate account of an insurance company as defined in the Investment Company Act of 1940) must be a separate legal entity to be within the scope of the Guide. Background The AICPA Audit and Accounting Guide, Audits of Investment Companies (the Guide), provides special accounting guidance for entities within its scope, particularly regarding the entity's reporting of investments at fair value and not consolidating the accounts of certain investees. Entities that are not within the scope of the Guide or other specialized industry practice generally account for their investments in conformity with FASB Statements No. 115, Accounting for Certain Investments in Debt and Equity Securities, and No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations; APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock; and ARB No. 51, Consolidated Financial Statements, as amended by FASB Statement No. 94, Consolidation of All Majority-Owned Subsidiaries. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

12 During the development of a revision to the Guide in the late 1990s, the FASB expressed concern that the Guide s scope was unclear, particularly as it pertains to certain venture capital investment companies. Accordingly, the purpose of the proposed SOP is to clarify the scope of the Guide to assist preparers and auditors in determining whether the Guide should be applied. It would clarify the scope of the Guide by providing specific guidance for determining whether an entity is within its scope. In addition, it would provide guidance for determining whether the specialized industry accounting principles of the Guide (referred to as investment company accounting) should be retained in the financial statements of a parent company of an investment company or an investor in an investment company that has the ability to exercise significant influence over the investment company and applies the equity method of accounting to its investment in the entity (referred to as an equity method investor). 2