Despite widespread objections from securities professionals, the Financial Accounting Standards Board (FASB) is expected to approve a set of policies that would, in most cases, require financial institutions to link the initial transfer of a security and the subsequent repo financing for accounting purposes.
For the ABS industry, the policies would affect the way that dealers and their investor clients book the transactions. In the ABS market, dealers commonly sell an ABS or MBS and loan funds to investors to pay for the security. That dealer can account for the loan as an asset, which can be repaid after the repo settles and the investor claims the security, an accounting expert said.
Dealers commonly account for the security transfer and the repo financing as separate transactions, even when the same counterparties are involved. Referred to as FSP FAS 140-d, the staff position would end that long-standing practice. The policies primarily spell out four specific criteria that must all be met so that the initial transfer of a security and a subsequent repo financing could be considered separate accounting transactions.
That is not the way business is typically done at large financial institutions, accounting sources said. Generally, asset transfers, including securitizations, and repurchase agreements are done in separate departments, as are many of the auditing functions, said Pat Donoghue, project manager for the FSP 140-d at the FASB.
A group of auditors brought the old practice to the FASB's attention and said that the transfers of certain securities and subsequent repo financings should be considered linked for accounting purposes. The FASB agreed with this assessment.
"Anytime you transfer a financial asset, you have to evaluate all the involvements that the transferor has with the financial asset, no matter when that involvement occurs," Donoghue said.
The four criteria are that: the initial transfer and the repo financing are not contractually contingent on one another; the transaction is not non-recourse to the counterparty and the repo is for an affixed price and not fair value; the financial asset be readily obtainable in the marketplace and that the sale and repo are executed at fixed prices determined by market rates; and that the repo matures before the security.
For the second criterion, the FASB reasoned that repo financings based on fair value wind up being dependent on or influenced by the value of the transferred security or a similar one and should be considered linked, Donoghue said. As for the third, the FASB requires that the financial asset be readily obtainable in the marketplace and that the sale and repo are executed at fixed prices determined by market rates.
"If the asset is not readily attainable and is unique, it is unlikely that anyone other than the transferor would have the knowledge and willingness to provide the financing," Donoghue said.
Those who have raised objections said that routinely linking the transfer of securities and the subsequent repo financing would require firms to undertake extensive and costly system conversions.
Last year, the American Securitization Forum (ASF) issued a comment letter, signed by members of its accounting committee, which questioned the necessity of the FSP, saying that it was based on an entirely new linkage model not contemplated by FAS 140 and designed with a specific transaction in mind.
"We believe that the introduction of a new model to analyze these transactions creates significant operational burdens that far outweigh any incremental benefits to be derived from this new guidance," the letter said.
If the measures are eventually implemented, thereby considering asset transfers and subsequent repo financings as linked, then purchasers and sellers might stop seeing them as assets and sales, one opponent said. Instead, those contracts could potentially be considered as forwarded assets and derivatives, say accounting sources.
Accounting professionals also said the time lapse between the initial transfer and subsequent financing should be evaluated before determining whether the events are linked.
"The longer the timeframe between the two transactions would be evidence that the transactions should not be linked," Robert Axel, vice president and chief accountant at Prudential Financial, wrote in a comment letter. "Conversely, the shorter the timeframe between the two transactions would be evidence that the transactions could be linked."
The participants' intentions as well as the size of an institution, especially those that might have separate trading and repo desks, should be considered in determining whether the events are linked or not, Axel said.
The FASB did make a couple of concessions. The scope of FAS 140-D is limited only to transactions done concurrently or in consideration of the initial transfer, Donoghue said. The FASB also dropped a criterion that would have required the borrower to maintain rights to the collateral and barred the lender from selling or pledging the collateral at any point before the repo settlement, unless the asset is readily obtainable. That requirement, Donoghue said, would have been too costly.
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