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ASC 810 defines a decision maker as an entity or entities with the power to direct the activities of another legal entity that most significantly impact the legal entity’s economic performance. Determining whether the fees paid to an entity’s decision maker constitute a variable interest in the entity can be one of the most challenging exercises required under ASC 810’s consolidation model. The assessment is particularly complex if parties related to the decision maker also hold interests in the entity being analyzed. Moreover, the conclusion reached with respect to this matter has potentially significant “knock-on” ramifications for other key judgments, including:
  • Concluding whether the entity is a VIE, specifically, whether the entity’s equity holders at risk have the power to direct the activities of the entity that most significantly impact its economic performance (as discussed in CG 4.1)
  • If the entity is a VIE, concluding whether the decision maker is its primary beneficiary

As such, particular care must be exercised when performing this evaluation.
The consolidation model incorporates various tests and conditions to determine whether fees paid to a decision maker or a service provider should be considered a variable interest in an entity. ASC 810-10-55-37 prescribes the current framework for making this assessment.

Excerpt from ASC 810-10-55-37

Fees paid to an entity’s decision maker(s) or service provider(s) are not variable interests if all of the conditions below are met:

  1. The fees are compensation for services provided and are commensurate with the level of effort required to provide those services.
  2. Subparagraph superseded by Accounting Standards Update 2015-02.
  3. The decision maker or service provider does not hold other interests in the VIE that individually, or in the aggregate, would absorb more than an insignificant amount of the VIE’s expected losses or receive more than an insignificant amount of the VIE’s expected residual returns.
  4. The service arrangement includes only terms, conditions, or amounts that are customarily present in arrangements for similar services negotiated at arm’s length.
  5. Subparagraph superseded by Accounting Standards Update 2015-02.
  6. Subparagraph superseded by Accounting Standards Update 2015-02.

Application of these conditions is discussed below.
For ease of reference, unless the context indicates otherwise, the term “decision maker” is intended to encompass both a decision maker and any other service providers.

3.4.1 Variable interests—assessing “commensurate” and “at market”

To be considered indicative of a fiduciary relationship, the decision-making fee arrangement must be arms-length and contain customary terms and conditions (“at market”) and represent compensation that is considered fair value for the services provided (“commensurate”).
  • Assessing the “commensurate” condition–We believe that the purpose of this condition is to identify arrangements that provide a decision maker with a significant off-market fee element and/or that are structured in a manner that suggests the fee is inconsistent with the decision maker’s role.
  • Assessing the “at market” condition–Unique provisions or terms seemingly at odds with market convention may indicate that the decision maker is serving in a manner inconsistent with a fiduciary role or relationship.

To determine whether its fee arrangement is at market and commensurate, a reporting entity may consider the following factors, among other items:
  • Is the entity owned by substantive third party investors?

    If the entity is owned by substantive third party investors, that fact may provide persuasive evidence that the arrangement reflects arms-length, market-based terms and conditions.

    We believe it is reasonable to assume in many instances that independent investors would not invest in an entity that is counterparty to a services agreement that contains off-market or non-customary terms and conditions, or a fee structure that is above-market.
  • Does the decision maker hold other variable interests (beyond its fee arrangement) that are unique as compared to variable interests held by the entity’s other investors?

    Decision makers often voluntarily or involuntarily make co-investments in entities they manage so that their interests are aligned with the entity’s investors. If these other interest(s) are unique in comparison to the variable interests held by the entity’s third-party investors, we believe it would be inappropriate to qualitatively conclude that the arrangement is “at market” and “commensurate.” For example, a security with economic rights and privileges different from other third-party investors may be unique. We believe normal decision makers that are acting in an agency capacity generally do not hold variable interests that differ from those held by the entity’s other independent investors.

If the legal entity being evaluated is not owned by substantive third party investors and/or the decision maker holds another unique variable interest, we believe it would be inappropriate to qualitatively conclude that the decision-making fee is “at market” and “commensurate.” In those situations, additional analysis would be required to support this assertion. This analysis could include an evaluation of other fee arrangements involving other third-party decision makers for the same or similar services.
Question CG 3-1 addresses whether servicing arrangements in asset-backed securitizations that include “servicing advances” and “clean up calls” meet the “at market” condition to not be considered a variable interest.
Question CG 3-1
Do servicing arrangements that include “servicing advances” and “clean up calls” meet the “at market” condition to not be considered as a variable interest?
PwC response
Yes, we believe that servicing contracts that include the right to provide “servicing advances” and the right to exercise “clean up calls” are customary in many asset-backed securitization arrangements and would generally meet the “at market” condition to not be considered as a variable interest.

3.4.1.1 Contractual features that expose decision makers to risk of loss

When evaluating the decision-making fee arrangement, if there is any fee or related obligation embedded within the service contract that exposes the decision maker to a risk of loss as described in ASC 810-10-55-37C, the decision-making fee would be excluded from applying the exception in ASC 810-10-55-37 and would therefore be considered a variable interest in the entity it to which it provides services.

ASC 810-10-55-37C

Fees or payments in connection with agreements that expose a reporting entity (the decision maker or the service provider) to risk of loss in the VIE would not be eligible for the evaluation in paragraph 810-10-55-37. Those fees include, but are not limited to, the following:

  1. Those related to guarantees of the value of the assets or liabilities of a VIE
  2. Obligations to fund operating losses
  3. Payments associated with written put options on the assets of the VIE
  4. Similar obligations, such as some liquidity commitments or agreements (explicit or implicit) that protect holders of other interests from suffering losses in the VIE.

Therefore, those fees should be considered for evaluating the characteristic in paragraph 810-10-25-38A(b). Examples of those variable interests are discussed in paragraphs 810-10-55-25 and 810-10-55-29.

In other words, if there are other features or obligations embedded in the servicing contract, beyond those of providing services to direct the activities of the entity, which would expose the decision maker to a risk of loss of the entity, the decision-making fee would be considered a variable interest. This evaluation does not consider the level of significance and/or likelihood of the exposure to loss.
In contrast, as discussed in CG 3.4, if the decision maker has other separate interests or arrangements with the VIE, in addition to the contract to provide services (i.e., not embedded in the service contract), it will evaluate whether those separate interests individually, or in the aggregate, would absorb/receive more than an insignificant amount of the VIE’s expected losses/residual returns, as is required under ASC 810-10-55-37(c). If they do not, the decision maker fee would not be considered a variable interest in the entity. That evaluation will include any fees which may also have the characteristics as those mentioned in ASC 810-10-55-37C within those separate interests or arrangements.

3.4.2 Variable interests—assessing other interests in the entity

ASC 810-10-55-37(c) requires a decision maker to consider the nature and extent of other interests it holds in the entity (interests other than its fee). Holding these “other economic interests” in the entity that result in the decision maker absorbing more than an insignificant amount of variability will cause the decision-making fee arrangement to be a variable interest. In addition, certain related party interests must be considered in this assessment.
The assessment of whether the decision maker’s collective other interests expose it to more than insignificant variability is both qualitative and quantitative, and requires the exercise of judgment.
New guidance
In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, which changed the way that certain related party interests under common control are considered in the assessment.
The provisions in ASU 2018-17 are effective for public business entities for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2020. Early adoption is permitted, including adoption in an interim period. All entities are required to apply the amendments retrospectively with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented.

3.4.2.1 Indirect interests held through related parties—after ASU 2018-17

Prior to ASU 2018-17, indirect variable interests held by related parties were considered on a proportionate basis, unless those interests were held by related parties under common control.
In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, which required decision makers to treat indirect interests in a VIE held through related parties under common control on a proportionate basis as well.
The amendments in ASU 2018-17 align how interests held by a commonly controlled related parties are treated for the purposes of applying ASC 810-10-55-37 to how they are considered for the primary beneficiary assessment. Refer to CG 5.6 for further discussion and an example.
The change is intended to result in more decision makers being deemed to be acting in an agency capacity and ultimately reduce the risk that decision makers with little to no direct and indirect variable interests could nonetheless be deemed the primary beneficiary of a VIE.
ASC 810-10-55-37D articulates the framework that a decision maker must apply when evaluating indirect interests held through related parties.

Excerpt from ASC 810-10-55-37D

For purposes of evaluating the conditions in paragraph 810-10-55-37, any variable interest in an entity that is held by a related party of the decision maker or service provider should be considered in the analysis. Specifically, a decision maker or service provider should include its direct variable interests in the entity and its indirect variable interests in the entity held through related parties, considered on a proportionate basis. For example, if a decision maker or service provider owns a 20 percent interest in a related party and that related party owns a 40 percent interest in the entity being evaluated, the decision maker’s or service provider’s interest would be considered equivalent to an 8 percent direct interest in the entity for the purposes of evaluating whether the fees paid to the decision maker(s) or the service provider(s) are not variable interests (assuming that they have no other relationships with the entity). The term related parties in this paragraph refers to all parties as defined in paragraph 810-10-25-43, with the following exceptions:

  1. An employee of the decision maker or service provider (and its other related parties), except if the employee is used in an effort to circumvent the provisions of the Variable Interest Entities Subsections of this Subtopic.
  2. An employee benefit plan of the decision maker or service provider (and its other related parties), except if the employee benefit plan is used in an effort to circumvent the provisions of the Variable Interest Entities Subsections of this Subtopic.

For purposes of evaluating the conditions in paragraph 810-10-55-37, the quantitative approach described in the definitions of the terms expected losses, expected residual returns, and expected variability is not required and should not be the sole determinant as to whether a reporting entity meets such conditions.

To have an indirect variable interest, a decision maker must have a direct variable interest in a related party that, in turn, has a direct and/or indirect variable interest in the entity being evaluated for consolidation. Although this requirement may appear straightforward, the analysis will become more complex when the economic interests held deviate from “plain vanilla” equity interests held by the decision maker in the related party, and/or by the related party in the entity being evaluated for consolidation. For example, the decision maker may hold a convertible preferred equity investment in the related party that in turn holds a debt investment in the entity being evaluated for consolidation.
Example CG 3-10 illustrates the determination of whether a decision-making fee is considered a variable interest in a VIE.
EXAMPLE CG 3-10
Determining whether a decision-making fee is considered a variable interest in a VIE
Subsidiary A and Subsidiary B are under common control of Parent. Subsidiary A has a 15% equity interest in Subsidiary B. Subsidiary A entered into a management contract with a fund, determined to be a VIE, whereby it receives a management fee that is considered at market and commensurate. Subsidiary B has a 20% equity interest in the fund.
Is Subsidiary A’s management fee a variable interest in the VIE?
Analysis
No. Subsidiary A’s indirect interest in the VIE on a proportionate basis results in a 3% (15% ×20%) economic interest in the fund, which Subsidiary A would likely conclude is not more than insignificant. Therefore, its management fee would not be a variable interest, and Subsidiary A would be considered to be operating in an agency capacity. Prior to adopting ASU 2018-17, Subsidiary A would have treated its indirect interest in the VIE as if it held Subsidiary B’s 20% interest directly, which likely would have been more than insignificant. Even though the management fee would not be a variable interest for purposes of Subsidiary A’s financial statements, Parent would have a variable interest when assessing its indirect interest in the fund.

See ASC 810-10-65-9 for transition guidance related to the amendments in ASU 2018-17, including guidance for instances when a reporting entity is required to consolidate or deconsolidate a legal entity as a result of the initial application of the ASU.

3.4.2.1A Indirect interests held by related parties–before ASU 2018-17

ASC 810-10-55-37D articulates the framework that a decision maker must apply when evaluating indirect interests held through related parties.

Excerpt from ASC 810-10-55-37D

For purposes of evaluating the conditions in paragraph 810-10-55-37, any interest in an entity that is held by a related party of the decision maker or service provider should be considered in the analysis. Specifically, a decision maker or service provider should include its direct economic interests in the entity and its indirect economic interests in the entity held through related parties, considered on a proportionate basis. For example, if a decision maker or service provider owns a 20 percent interest in a related party and that related party owns a 40 percent interest in the entity being evaluated, the decision maker’s or service provider’s interest would be considered equivalent to an 8 percent direct interest in the entity for the purposes of evaluating whether the fees paid to the decision maker(s) or the service provider(s) are not variable interests (assuming that they have no other relationships with the entity). Indirect interests held through related parties that are under common control with the decision maker should be considered the equivalent of direct interests in their entirety.

We believe that the terms “indirect interest” and “indirect economic interest,” which are used interchangeably in the guidance, are intended to mean indirect variable interest in all cases. To have an indirect interest, a decision maker must have a direct variable interest in a related party that, in turn, has a direct and/or indirect variable interest in the entity being evaluated for consolidation.
Although this requirement may appear straightforward, the analysis will become more complex when the economic interests held deviate from “plain vanilla” equity interests held by the decision maker in the related party, and/or by the related party in the entity being evaluated for consolidation. For example, the decision maker may hold a convertible preferred equity investment in the related party that in turn holds a debt investment in the entity being evaluated for consolidation.
For purposes of applying the indirect interest concept, related party relationships should broadly be segregated between related parties that are under common control, and those that are not, as discussed more fully below.
The FASB has acknowledged that there is no definition t of “common control” in the codification.

Excerpt from BC69 in ASU 2015-02

Current GAAP uses the term common control in multiple contexts, and the term is not defined in the Master Glossary. Therefore, for purposes of evaluating the criteria in paragraphs 810-10-25-42, 810-10-25-44A, and 810-10-55-37D, the Board’s intent was for the term to include subsidiaries controlled (directly or indirectly) by a common parent, or a subsidiary and its parent.

Refer to BCG 7.2.1 for information about assessing whether common control exists.
If the decision maker and the related party are under common control, then the entirety of the interest held by the related party in the underlying entity should be attributed to the decision maker.
Note that the treatment of interests held by a commonly controlled related party for purposes of applying ASC 810-10-55-37 differs from the way such interests are considered in the primary beneficiary assessment. Refer to CG 5.6 for further discussion.

3.4.2.2 Consideration of employees and employee benefit plans

A decision maker’s employees or employee benefit plans may hold variable interests in the entity being evaluated for consolidation by its decision maker. Although employees and employee benefit plans may be related parties of a decision maker, the decision maker need not consider those interests when evaluating criterion (c) in ASC 810-10-55-37 unless those employees or plans are being used to circumvent the VIE guidance more generally. See excerpt from ASC 810-10-55-37D above which clarifies this matter.
ASC 810-10-55-37D does not specifically state whether the portion of any interest held by a decision maker’s employees or employee benefit plan that has been financed by the decision maker should be deemed an indirect interest attributable to the decision maker. In contrast, for purposes of the primary beneficiary analysis, ASC 810-10-25-42 explicitly states that a decision maker should treat the portion of any employee interests that it has financed as an indirect economic interest.
In our view, if a decision maker contributes to its employee benefit plans, and the employee benefit plans in turn make independent decisions to invest in an entity, we believe the interests held by the employee benefit plans should not be attributed to the decision maker in connection with its evaluation of potential “other economic interests” held by related parties under ASC 810-10-55-37D.
On the other hand, if a decision maker provides financing for a specific interest held by an employee or employee benefit plan as part of the design of the underlying entity, and that funding is atypical or inconsistent with past practice, those arrangements may be indicative of efforts to circumvent the consolidation rules. If the facts and circumstances suggest that the arrangements were structured principally to achieve a desired accounting outcome, we believe that those financed interests should be attributed to the decision maker for purposes of assessing the “other economic interests” criterion.

3.4.2.3 Evaluating “more than insignificant”

ASC 810-10-55-37(c)’s “other economic interests” criterion requires the decision maker to assess the significance of its other economic interests in an entity. In that assessment, the decision maker should consider those interests’ relative exposure to the entity’s expected losses and relative entitlement to the entity’s expected residual returns. Each of these concepts is a defined term in the ASC Master Glossary. ASC 810-10-55-37D provides useful guidance regarding the application of these concepts.

Excerpt from ASC 810-10-55-37D

For purposes of evaluating the conditions in paragraph 810-10-55-37, the quantitative approach described in the definitions of the terms expected losses, expected residual returns, and expected variability is not required and should not be the sole determinant as to whether a reporting entity meets such conditions.

Judgment is required when assessing whether other economic interests held by (or attributed to) a decision maker absorb more than an insignificant amount of an entity’s expected losses or receive more than an insignificant amount of an entity’s expected residual returns. Although this assessment must still benchmark those interests against the entity’s expected losses and expected residual returns, it is clear from the foregoing excerpt that the FASB does not intend for this requirement to be demonstrated by detailed computational analyses. Rather, preparers are to exercise judgment in performing a qualitative assessment of the economics provided by any other interests they hold.
Additionally, “more than an insignificant amount” is not defined in the context of the consolidation model. However, the concept is intended to mean the same as “significant”–said differently, a “more than insignificant amount” does not imply or contemplate a threshold (or range) that falls somewhere between “insignificant” and “significant.” Although a “more than insignificant amount” cannot be reduced to a “bright line,” we believe that the interpretation of “more than insignificant” is a fairly low threshold and it is reasonable to view 10% or more as presumptively indicative of other interests constituting a “more than insignificant amount.”
When evaluating the significance of other economic interests held by (or attributed to) a decision maker relative to the entity’s anticipated variable returns, the following factors or indicators may be useful:
  • The size of the interest relative to the overall capitalization of the entity
  • The commercial reasons behind the decision maker’s ownership of those interests

    For example, consider situations in which investments by the decision maker were made to support marketing of investments into the entity. In this case, it may indicate that the decision maker made such investment to signal to others that the decision maker is willing to put its own interests at risk. This may indicate that the decision maker is not acting as a fiduciary as it made the investment to demonstrate to the other investors that it has “skin in the game.”
  • The risks and rewards of the variable interests held by the reporting entity relative to the overall economics of the structure
  • The relative seniority of variable interests held by the decision maker

We believe that as a variable interest falls lower in the entity’s priority of payments, the threshold at which the interest should be considered “more than insignificant” also drops.
As noted above, when assessing whether a decision maker’s other economic interest is considered “more than insignificant,” it should be considered against the entity’s expected losses and expected residual returns, which by their definitions allow the consideration of probability. Consequently, if the reporting entity determines that it holds an interest in an entity that is more than insignificant, it will likely also meet the primary beneficiary “potentially significant economics” criterion in ASC 810-10-25-38A(b). As discussed in CG 5.5, the assessment of whether a reporting entity has a potentially significant economic exposure in the VIE does not allow consideration of probability, and thus, in practice, the “potentially significant” threshold in the primary beneficiary economics criterion is effectively lower than the “more than insignificant” threshold in the decision maker’s other economic interest test.

3.4.3 Reconsidering decision maker and service provider arrangements

CG 5.1 describes reconsideration events to re-evaluate whether or not an entity is, in fact, a VIE under the VIE model. The VIE model requires an ongoing reconsideration of whether a reporting entity is the primary beneficiary of a VIE due to changes in facts and circumstances. The VIE model does not specify whether the reassessment of a decision maker’s arrangement as a variable interest should be based on specific reconsideration events (similar to reconsidering the status of a VIE), or should be carried out on a continuous basis (as is required for the primary beneficiary analysis). We believe that the decision about when to reassess the conclusion is a policy choice by the reporting entity.
Regardless of which policy is elected, the assessment should focus on events that would incentivize the decision maker to begin acting as a principal, or conversely, would suggest the decision maker is acting in an agency capacity, such as:
  • Changes in the terms of the management or service provider arrangement
  • The decision maker or service provider’s acquisition or disposition of variable interests in the entity being evaluated for consolidation (either directly or through their related parties)
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