If the final release is anything like the Exposure Draft, the amendment to FAS 140 could make the struggles of FIN 46 a fond memory
The Financial Accounting Standards Board has issued its Exposure Draft, Qualifying Special-Purpose Entities and Isolation of Transferred Assets, an amendment to FASB Statement No. 140. The project originally belonged to the Emerging Issues Task Force (EITF 02-12), but was assumed by the Board in January. One of the main drivers behind the amendment is to address the QSPE exemption in FIN 46. Comments on the draft are due by July 31.
Highlights (and lowlights) of the proposed amendment follow:
1) A QSPE may not hold equity instruments.
Query: What happens if debt instruments are required to be exchanged for equity instruments in a recapitalization? Note collateralized fund obligation (CFO) transactions will not qualify as Qs.
2) A QSPE may not enter into a derivative transaction with the transferor, its affiliates or agents
Query: How would back-to-back swaps be viewed?
3) A QSPE may not enter into an agreement with a transferor, its affiliates or agents that commits any of those parties to deliver additional cash or other assets to the SPE or its beneficial interest holders through liquidity commitments, financial guarantees, written options, or commitments to purchase or otherwise settle outstanding beneficial interests.
Note: Servicing advances are OK if the servicer can choose not to make the advance if it believes it is not recoverable; limited credit guarantees are not OK, put options back to the transferor are not OK, including those in the municipal bond tender option market. what about indemnifications for breaches of normal reps & warranties?
4) If the SPE has the ability to "reissue beneficial interests" (no working definition was provided), the following additional limitations apply:
a) The transferor (including affiliates and agents) "can not make decisions about reissuing beneficial interests" (no description was provided about unilateral versus. shared decision-making) if they also hold beneficial interests other than the most senior class.
Note: If the party taking the action does not have to exercise any discretion in taking the actions, then this provision is not violated. Consider single-seller ABCP programs and credit card revolving master trusts with the ability to issue both ABCP and term securities.
b) No single party (including affiliates and agents) can be committed to provide more than half the commitments to deliver additional cash or other assets to fulfill the SPE's obligations to beneficial interest holders (based on fair value).
Note: Consider the effects on the monoline guarantors with respect to SPEs that have the ability to reissue beneficial interests.
c) No party (including affiliates and agents) can make decisions about reissuing beneficial interests if that party also (1) is committed to deliver additional cash or other assets to fulfill the SPE's obligations to beneficial interest holders; or (2) holds beneficial interests other than the most senior class.
d) No party (including affiliates and agents) that holds beneficial interests other than the most senior class can be committed to deliver additional cash or other assets to fulfill the SPE's obligations to beneficial interest holders.
Items 4(c) and 4(d) can be summarized in a two out of three test as follows: A combination of any two of the following three factors concentrated in a single party is sufficient to prohibit an SPE from being a Q: (1) Owning beneficial interests other than the most senior, (2) Providing liquidity facilities or credit guarantees, and (3) exercising discretion in reissuing beneficial interests.
And in what is the most confusing portion of the document, unless the second transfer in a two-step transfer is to a QSPE, the transfer shall be deemed not to meet the requirements in paragraph 9(b) that the transferee has the right to pledge or exchange the transferred assets. This provision needs a lot more analysis before we can conclude on its significance, particularly by customers in multi-seller abcp programs.
Public companies will have to apply the Statement prospectively to transfers occurring after the beginning of the first quarterly period after the issuance of the final Statement. (For now, you might assume that it will apply in the first quarter of 2004).
A formerly qualifying Q that fails to meet one or more of the new conditions for being a Q shall continue to be considered a Q if it maintains its Q status under previous accounting standards, does not issue new beneficial interests after the effective date, and does not receive assets other than those it was committed to receive under arrangements made before the effective date of the Amendment. Otherwise, the formerly qualifying Q shall be considered disqualified and shall not be eligible for the exceptions in FAS 140 or FIN 46. Consider any Q that has funded longer-term assets with shorter term beneficial interests, this grandfathering provision will not protect them if they have to reissue beneficial interests after the effective date.
Marty Rosenblatt is a partner with Deloitte & Touche. The views expressed in this brief are his own and not necessarily of Deloitte & Touche.