FASB repurchase agreement proposal aims to adequately reflect risks

FASB issued proposed revisions Tuesday to financial reporting standards for repurchase agreements, in part to address investors’ concerns that some current practices do not adequately reflect the transferor’s obligations and risks.

The Proposed Accounting Standards Update, Transfers and Servicing (Topic 860)—Effective Control for Transfers With Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings, is available for comment through March 29 on FASB’s website.

According to an issue of FASB in Focus devoted to the topic, the market for repurchase agreements has experienced significant change since FASB issued its first guidance on this subject in 1996 in FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

Repurchase agreements increasingly involve asset types that are not U.S. Treasury or government agency securities and may be less liquid. That can affect how the transactions operate and how investors consider the risks associated with them.

If approved, the proposal would make changes to financial reporting for repurchase agreements and other transfers with forward agreements to repurchase transferred assets. The proposal is intended to clarify the guidance for distinguishing whether these transactions are sales or secured borrowings, and improve disclosures about them.

For some arrangements, the proposal also would result in financial reporting that is more comparable with IFRS.

To determine whether a repurchase agreement or similar transaction is a sale or an off-balance-sheet secured borrowing, an evaluation of whether the transferor maintains “effective control” over the transferred asset often is required.

Current FASB standards say the transferor maintains effective control if a contemporaneous forward agreement exists to repurchase the same or “substantially-the-same” asset at a fixed price from the transferee before its maturity. In these cases, secured borrowing accounting is required.

But in current standards, effective control is not maintained if a transferor will not recover the transferred asset at the conclusion of the agreement because the asset has matured. In those cases, sale accounting rather than off-balance-sheet secured borrowing accounting is required.

This distinction has been disputed by stakeholders who say secured borrowing accounting is appropriate in both cases because, during the terms of both transactions, the transferor remains exposed to the credit risk related to the transferred asset and obtains benefits from the asset.

The proposed guidance would eliminate that distinction and require secured borrowing accounting regardless of whether the transferred asset will mature and prevent the transferor from recovering the asset at the end of the agreement. In both cases, the transferor will be deemed to maintain effective control. This proposed guidance would result in financial reporting more closely aligned with IFRS.

In other circumstances, where the transferor does not maintain effective control, the transaction would be required to be assessed under remaining derecognition conditions to determine whether it should be accounted for as a secured borrowing or sale with a forward purchase agreement.

Describing “substantially the same”

The proposal also intends to address stakeholder requests by providing:

– More guidance on assessing whether financial assets to be repurchased are “substantially the same” as those initially transferred.

– Improved disclosures regarding the effect of repurchase agreements and similar transfers on the transferor’s risk profile.

A change also was proposed for accounting in circumstances when a financial asset is transferred and a contemporaneous “repurchase financing” agreement financing that asset also exists between the same two counterparties. The proposal would eliminate the current requirement, which calls for combined accounting for the initial transfer and the repurchase agreement in some cases.

Instead, the proposal would require separate accounting for the initial transfer and the repurchase financing.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.