The Financial Accounting Standards Board has added a new item to its agenda to revise the accounting standards for repurchase agreements in response to the problems that led to the collapse of MF Global.
Last year, FASB revised its standards for repurchase agreements in response to the use of so-called “Repo 105” transactions that were identified by the bankruptcy examiner for Lehman Brothers (see
FASB decided at a meeting Wednesday to add a new agenda item on repurchase agreements because of problems at another financial firm that collapsed in a spectacular way late last year, MF Global, which relied on a different form of repurchase agreement known as “repo to maturity” (see
“Investors have raised concerns that the existing standard on repurchase agreements should be reconsidered to reflect changes in market practices,” said FASB chair Leslie F. Seidman in a statement. "The board will reconsider both the accounting and disclosure requirements to ensure that investors are getting useful information about repurchase arrangements.”
The existing accounting guidance for repurchase agreements and similar arrangements was originally established in 1996 by FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Because repurchase agreements involve shared rights to the transferred financial assets, they were, and continue to be, difficult to characterize because they possess attributes of both sales and secured borrowings, FASB noted. During the original deliberations over the standards, various alternatives were considered to best represent the rights and obligations associated with the transferred financial assets to neither overstate nor understate the assets and liabilities of either party to the transaction.
In determining whether such transactions are sales or secured borrowings, the existing accounting framework focuses on which party has control over the transferred financial assets based on the rights and obligations held by each party. During the term of a typical repurchase agreement, the transferee can obtain certain benefits of the transferred financial assets by selling or pledging them.
However, the determination of whether these transactions are sales or secured borrowings rests on an evaluation of whether the transferor maintains “effective control” over the transferred financial assets. Effective control is maintained if there is an agreement conveying both the right and obligation to repurchase the same or “substantially-the-same” financial assets at a fixed price before their maturity.
Under this model, typical repurchase agreements are secured borrowings, while "repo-to-maturity" transactions are generally considered sales. This model largely preserved prevailing practices used to distinguish between agreements viewed by market participants as financings from those viewed as sales of financial assets with a concurrent forward agreement (a derivative). However, over time, market practices have changed, including collateral posting practices and the types of securities transferred in these arrangements.
Last April, the FASB issued Accounting Standards Update No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements, which removed from the assessment of effective control (a) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (b) the collateral maintenance implementation guidance related to that criterion.
The new requirements are effective for interim or annual periods beginning on or after Dec. 15, 2011. The project that led to that accounting standards update was intentionally narrow in order to resolve a specific practice issue in an expeditious manner. During the course of that project, various issues were raised by constituents that, while beyond the scope of that immediate project, appeared to warrant further study.
Those issues relate to other elements of the guidance for determining whether repurchase agreements are sales or secured borrowings, implications of the Update on existing transactions such as mortgage dollar-roll repurchase agreements, and disclosure requirements.
As in other cases where FASB reassessed its existing accounting standards when stakeholders raised concerns or practice issues arose, FASB has conducted a review to evaluate the incremental accounting issues, considering both the technical aspects of the guidance and the utility of financial reporting results of these arrangements. Outreach efforts by the board indicated that users view repurchase agreements as financing transactions, citing the transferor’s retention of both the credit risk of the transferred financial assets and other important benefits of those assets.
Users of financial statements also said they believed there was a need for improved disclosures for repurchase agreements, especially the impact of such transactions on the liquidity risk profile of the transferor.
As a result of the outreach that FASB conducted and the continued focus on the accounting for repurchase agreements and similar transactions, FASB said it believes a more comprehensive review of the existing accounting and disclosure requirements is warranted.
As part of the new agenda project, FASB plans to explore the potential opportunity to more fully converge the accounting for repurchase agreements and similar transactions in U.S. GAAP and International Financial Reporting Standards, along with opportunities for the simplification of accounting guidance in this area.
