The exposure draft of the International Accounting Standard 39 looks like it is shaping up to better address securitization - though unless the accounting regulations take into consideration indicative consolidation scenarios under SIC-12, the European securitization market could fail to see substantive benefits.
A special panel concerning the latest developments on the IAS 39 exposure draft was incorporated into Moody's Investors Service second annual ABCP conference in London last week. Alex Bertolotti, director of the Financial Services Group at Deloitte & Touche, led the discussion.
Among other things, IAS 39 will aid in determining whether or not there has been a sale of the securitized assets from the originator to the SPE. The new exposure draft investigates whether the SPE should derecognize the assets once they are transferred to it. SIC-12 and IAS 27 deal with whether or not the originator should consolidate the SPE, which ultimately would lead to the assets being put back on to balance sheet.
SIC-12 addresses the characteristics that indicate control - a determinant of whether a special purpose vehicle is consolidated. Under SIC-12, there is a list of scenarios that determine a consolidation based on the activities of the SPE that are conducted on behalf of the originator. For example, the guidelines will take into consideration whether or not the SPE is providing long-term funding to the originator, or if the originator has decision-making powers, versus an auto-pilot mechanism based on transaction documentation. An example of a test is whether or not the transferor has the power to dissolve an SPE or change its charter. Also, the guidelines will test for whether or not the originator retains the majority of the benefits, the residuals, and/or ownership risks associated with the SPE.
It's likely that most SPEs would be subjected to at least one of the tests under SIC-12, explained Bertolotti.
Under the current IAS 39, there is no linked presentation and the SPE must recognize the asset if there is no profit or loss recorded and securitization financing appears as a liability, as in the case of secured borrowing.
The SPE should derecognize the assets if there is a sale or partial sale of the assets from the originator to the SPE. Also there is derecognition if the SPE loses control of the contractual rights that compromise a financial asset, unless the asset that is transferred is not readily obtainable in the market and the transferor retains substantially all of the risk and returns of ownership, explained Bertolotti.
The IAS exposure draft introduces the concept of continuing involvement as a test for derecognition of financial assets and liabilities. Under this approach, if the contractual right to a cash flow has been relinquished but the transferor can reacquire control of those contractual rights, it would result in continued recognition of the assets. If the contractual rights to cash flows are not relinquished and the entity has not entered into a pass through arrangement there is no derecognition of the assets.
However, if the entity had entered into a pass through arrangement in which there is no derecognition that results in the transferor reacquiring control of previous contractual rights and the transferor is not exposed to subsequent decreases or increases in the value of its prior contractual rights, this would result in derecognition of the assets. If the transferor were exposed to a fluctuation in the value of its previous contractual rights it would result in continued recognition of the asset.
"It's harder to derecognize an asset than it is to avoid recognition," explained Bertolotti. "If an SPE buys assets in the market the derecognition criteria are not applied to the sponsor entity, but the asset still could end up on the balance sheet via consolidation of the SPE under SIC-12. Unless SIC-12 also gets revisited the industry in no further forward."
The exposure draft has been out on the market since June this year and closed for commentary in mid October. The new standards should be released by the end of this year and, says Bertolotti, the standards will be applied for the financial year beginning after March 2003.
At this point the standards look to be implemented retroactively, which means that all transactions will have to be restated as if they were originally accounted for under the exposure draft regulations. It's likely to prove time-consuming and complex for market players. "Unless the IASB gives an exemption to allow grandfathering, the consequence will be time-consuming and costly restatement with potential re-recognition," he said.