FASB Floats Proposal to Close Repo Agreement Loophole

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By Frank Byrt

On January 15, 2013, the Financial Accounting Standards Board (FASB) issued a request for public comment on its proposal to improve financial reporting disclosures on repurchase agreements, known in the industry as "repo agreements", in order to more properly reflect a company's obligations and risks in some circumstances.

The proposed change is meant to clarify guidance for distinguishing between transactions that are sales that can be moved off the balance sheet and on-balance sheet secured borrowings. 

The proposed accounting standards update is titled: Transfers and Servicing (Topic 860)  Effective Control for Transfers with Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings

"Investors have raised concerns that current accounting and disclosures for repurchase agreements do not appropriately reflect the transferor's obligations and risks resulting from those transactions in certain circumstances", said FASB Chairman Leslie F. Seidman, in a statement. "The Board is seeking stakeholder input on changes intended to ensure that investors are getting useful information about these and similar arrangements."

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

FASB says the market for repurchase agreements has changed significantly since it issued its first rules in 1996, and the proposed changes are meant to bring reporting on them up-to-date.

According to FASB, its current 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 under those rules, 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.

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.

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. 

The proposed change in guidance would also result in US financial reporting for such assets to be more closely aligned with International Financial Reporting Standards. 

This is FASB's second change to repo agreement accounting in the last two years and likely stems from less than full disclosure of accounting practices for repo agreements that came to light in the collapse of Lehman Brothers.

Comments can be made on the FASB website. The request for comment period closes March 29.

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