Proposed changes to IAS 39 relating to securitisation

by Vinod Kothari

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The international accounting standards setter International Accounting Standards Board (IASB) has published an Exposure Draft of proposed amendments to the IAS 39 that deals generally with accounting for financial instruments, and forms the basis of securitization accounting in most non-US countries except UK.

From surrender of control to no continuing involvement
The proposed amendment marks a change in approach by the IASB where the existing approach to recognition, that is, off-balance sheet accounting, called "surrender of control" approach, is going to be replaced by "no continuing involvement" approach. The surrender of control approach is based on the US FAS 140.

The preconditions for off-balance sheet accounting under the new approach will be as under:

  • Off balance sheet treatment will be denied in the following cases where the transfer of assets by the originator:

    • may result in the transferor (including a consolidated entity) reacquiring control of its previous contractual rights (for example, through a repurchase agreement, a call option held by the transferor, or a put option written by the transferor); or
    • gives the transferor (including a consolidated entity) an obligation to pay subsequent decreases, or a right to receive subsequent increases, in the value of its previous contractual rights (for example, through a credit guarantee, a total return swap, or a cash- settled put or call option).
  • The transfer of assets is either a contractual transfer, or is a pass-through arrangement is allowed an off balance sheet treatment. (see below)

Thus, the two conditions for "no continuing involvement", substantially similar to the surrender of control conditions earlier, are either a legal transfer or a pass-through mechanism, coupled with no buy-back option or general credit support by the transferor. Apparently, legal transfer of receivables, a precondition under the US FASB norms, will not be required for off-balance sheet under IAS 39, since a pass-through arrangement need not be a legal true sale. This goes handy for the European deals many of which are structured around the secured loan or equitable transfer structure.

Pass through approach

  • The pass through approach is defined as under:

    • (a) The transferor does not have an obligation to pay amounts to the transferee unless it collects equivalent amounts from the transferred asset or portion thereof that qualifies for derecognition (ie the transferee is entitled only to the cash flows of the underlying financial asset or the portion thereof that qualifies for derecognition).
    • (b) The transferor is prohibited by the terms of the transfer contract or documents from selling or pledging the transferred asset or otherwise using that asset for its benefit.
    • (c) The transferor has an obligation to remit any cash flows it collects on behalf of the transferee without material delay. The transferor is not entitled to reinvest such cash flows for its own benefit.

The pass-through approach is clearly a ring-fencing, not being a true sale. In other words, if contractually, the transferor has committed to not selling the identified receivables, nor entitled to reinvest the same, nor required to pay except out of the collections of the receivables, the pass-through approach will be applied. Coupled with the other condition discussed above, a pass-through will also qualify for off-balance sheet treatment.

Apparently, the pass-through approach will apply to both the originator and the SPV. An SPV may also de-recognise the assets acquired if the arrangement is a typical pass-through.