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For a reporting entity to determine whether it has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance, it must first identify which activities are significant, and then determine who has the power to direct those activities.

5.2.1 Identifying the VIE's most significant activities

Determining which activities most significantly impact a VIE’s economic performance can require significant judgment. First, a VIE’s purpose should be considered, including the risks that it was designed to create and pass along to all its variable interest holders. Next, the reporting entity should identify the activities of the VIE that significantly impact these risks. The activities of a VIE that give rise to, or stem from these risks generally impact the economic performance of the entity in a significant manner. Lastly, the reporting entity should determine which party has the ability to direct the activities identified that most significantly impact the VIE’s economic performance.

5.2.2 Decisions that most significantly impact performance

Once the most significant activities of the VIE have been identified, an analysis should be performed to understand the decisions related to those activities that most significantly impact the VIE’s economic performance. The party who can make decisions over the significant activities that most significantly impact the VIE’s economic performance would meet the power criterion. A variable interest holder is not required to have the power to direct all of an entity’s significant activities in order to have power.
The VIE model does not specify how to determine whether one or more activities represent the most significant of the VIE’s economically significant activities. A careful consideration of the following factors may prove helpful in considering which decisions most significantly impact the VIE’s economic performance:
  • How each decision impacts the risks that the VIE was designed to create and pass along to its variable interest holders
  • How the decisions impact the cash flows of the VIE
  • How the decisions impact operating margins of the VIE
  • Whether such decisions could increase the VIE’s revenues
  • How the decisions could affect the overall fair value of the VIE
  • The nature of the VIE’s assets, and how the decisions could impact the fair value of those assets

In some cases, it may be obvious which activities and decisions most significantly impact a VIE’s economic performance. In other cases, this analysis may be less clear. In those circumstances, judgment should be applied based on the facts and circumstances specific to the VIE, including its purpose and design and the risks it was intended to create and pass along to its variable interest holders.
As discussed in CG 4.4, an entity’s significant activities must be identified for purposes of determining whether the entity is a VIE under Characteristic 2. As a general matter, we expect the significant activities of an entity to be the same for both analyses (i.e., the VIE and primary beneficiary determinations). Refer to ASC 810-10-55-93 through ASC 810-10-55-205 for examples illustrating the application of the power criterion. Examples of common significant activities of entities by industry can also be found in CG 4.4.1.

5.2.3 Impact of financial responsibility in assessing power

The VIE model requires that implicit and explicit financial responsibilities be considered in the primary beneficiary analysis.

ASC 810-10-25-38F

Although a reporting entity may be significantly involved with the design of a VIE, that involvement does not, in isolation, establish that reporting entity as the entity with the power to direct the activities that most significantly impact the economic performance of the VIE. However, that involvement may indicate that the reporting entity had the opportunity and the incentive to establish arrangements that result in the reporting entity being the variable interest holder with that power. For example, if a sponsor has an explicit or implicit financial responsibility to ensure that the VIE operates as designed, the sponsor may have established arrangements that result in the sponsor being the entity with the power to direct the activities that most significantly impact the economic performance of the VIE.

Determining whether a reporting entity has an implicit financial responsibility to ensure that a VIE operates as designed requires judgment, including consideration of the entity’s purpose and design. We believe the determination of what constitutes an implicit financial responsibility should consider the likelihood of all potential events.
Although a variable interest holder’s involvement in the design of a VIE is not determinative that it has power over the entity, its involvement may demonstrate that it had the opportunity and incentive to establish arrangements to provide it with power. Such situations require a careful review of the entity’s governing documents to determine whether that variable interest holder truly has power.
If the ongoing decisions of a VIE do not significantly impact its economic performance (i.e., they are purely administrative in nature), then the predetermined decisions made at formation are likely more relevant to the power analysis. Examples of such activities may include the selection of assets to be purchased by the entity, what will occur when the entity is dissolved, and the rights of the various parties. Refer to CG 5.2.7 for further discussion around entities with limited or no ongoing significant activities.

5.2.4 Shared power among unrelated parties

In certain situations, the power to direct a VIE’s most significant activities may be shared among unrelated parties. In those situations, no party would be deemed the primary beneficiary of the VIE.

Excerpt from ASC 810-10-25-38D

If a reporting entity determines that power is, in fact, shared among multiple unrelated parties such that no party has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, then no party is the primary beneficiary. Power is shared if two or more unrelated parties together have the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and if decisions about those activities require the consent of each of the parties sharing power.

Power is shared if two or more unrelated parties together have the ability to direct the activities of a VIE that most significantly impact the VIE’s economic performance. This is often the case when each party is required to consent to decisions relating to those significant activities, assuming the consent requirement is substantive.
This principle is illustrated in the example included in ASC 810-10-55-182 through ASC 810-10-55-192. In that example, two unrelated companies are each responsible for manufacturing, distributing, and selling a product and are required to obtain each other’s consent with respect to the decisions relating to those activities. If two or more unrelated parties are required to vote on (i.e., consent to) all decisions that significantly impact the VIE’s economic performance, power is shared.
Question CG 5-2 addresses whether it is possible for a joint venture that is a VIE to not have a primary beneficiary.
Question CG 5-2
If all parties involved with a joint venture that is a VIE must consent to all decisions that most significantly impact the VIE’s economic performance, would it be appropriate to conclude the VIE does not have a primary beneficiary?
PwC response
It depends. When a joint venture is a VIE and the venture partners are not related parties, no primary beneficiary will exist if all activities that significantly impact the VIE’s economic performance require the consent of each of the venture partners. If the venture partners are related parties or de facto agents (refer to CG 5.4), then one of the venture partners will be required to consolidate the VIE if power over all of the VIE’s significant activities is shared. The evaluation of circumstances where power is shared among related parties is discussed in further detail in CG 5.7.1.
Circumstances may arise where some but not all of a VIE’s significant activities require the consent of two or more unrelated parties. Some have interpreted the use of “most” in ASC 810-10-25-38D to mean majority, thereby suggesting that power is shared when a VIE’s economically significant activities that are responsible for driving a majority of its economic performance require the consent of two or more unrelated parties.
We believe shared power does not exist unless the consent of each party believed to share power is required for all of the VIE’s most significant activities. Although the consent of two or more unrelated parties may be required for a majority, but not all of a VIE’s most significant activities (e.g., two out of three of the VIE’s significant activities identified), the ability of one party to unilaterally direct a single significant activity may call into question whether power over the VIE is in fact shared.
In those situations, the party with the ability to unilaterally direct the VIE’s other significant activity may wield incremental power relative to the other party or parties believed to share power. This “relative power” model may suggest that the party with the ability to unilaterally direct a single significant activity of the VIE has power over the entity and may be the VIE’s primary beneficiary.

5.2.4.1 Shared power–unrelated parties: majority vs. unanimous consent

In some situations, the decisions that most significantly impact the economic performance of an entity that is a VIE may require the approval of a majority of the parties involved with the VIE. We believe the unanimous consent of all parties involved is required to demonstrate that power is shared when two or more unrelated parties direct the significant economic activities of the VIE. If all of the unrelated parties are required to consent to decisions related to the VIE’s most significant activities, we believe power would be shared.

5.2.5 Unrelated parties direct same activities–power not shared

If a conclusion is reached that power is not shared, but the same activities that most significantly impact the VIE’s economic performance are performed by multiple unrelated parties, then the party with the power over the majority of those significant activities will meet the power criterion. However, if no party has power to unilaterally direct a majority of the VIE’s significant activities, then no party will meet the power criterion.

Excerpt from ASC 810-10-25-38D

If a reporting entity concludes that power is not shared but the activities that most significantly impact the VIE’s economic performance are directed by multiple unrelated parties and the nature of the activities that each party is directing is the same, then the party, if any, with the power over the majority of those activities shall be considered to have the characteristics in paragraph 810-10-25-38A(a).

This principle is illustrated in the example included in ASC 810-10-55-194 through ASC 810-10-55-196. In that example, two unrelated parties are individually responsible for manufacturing, distributing, and selling a product (i.e., the VIE’s significant activities) in different locations, and neither is required to obtain the other’s consent over decisions relating to the significant activities for which it is responsible. If one party directs a majority of the entity’s significant activities, then that party would be the VIE’s primary beneficiary. We believe it would be rare that neither party direct a majority of the entity’s significant activities if there are only two parties involved that direct the same activities.
This principle may also apply when analyzing securitization vehicles for consolidation. For example, three separate parties may be responsible for servicing separate and distinct pools of assets held as collateral by the securitization vehicle.
Consider a situation in which three companies (Company A, B, and C) each perform servicing of the mortgage loans in a mortgage loan securitization. Each company can make servicing decisions independently (i.e., without the consent of any other party). Servicing of the mortgage loans is determined to be the activity that most significantly impacts the economic performance of the VIE. If neither Company A, B, nor C are responsible for servicing a majority of the mortgage loans held by the VIE, then no party may have power over the entity.
Example CG 5-1 illustrates the evaluation of the impact of a change in power due to the passage of time.
EXAMPLE CG 5-1
Evaluating the impact of a change in power due to the passage of time
Company X owns a power plant. Company A and Company B purchase outputs from Company X under power purchase agreements (PPAs). Company X is determined to be a VIE and both Company A and Company B’s PPAs are determined to be variable interests. The estimated life of the power plant is 30 years.
Company A’s PPA provides it with the contractual right to operate the power plant for the first 15 years of the power plant’s life, while Company B’s PPA provides it with the contractual right to operate the power plant for the remaining 15 years. The power granted to Company A and Company B through their PPAs is determined to provide them with the power to direct the activities of Company X that will most significantly impact the economic performance of Company X during the effective periods of their contracts.
Which company would be deemed to meet the power criterion?
Analysis
While both Company A and Company B’s variable interest provide them with the power to direct the significant activities of Company X, Company B’s power does not become effective until Company A’s power ceases. In these situations it may likely be determined that Company A meets the power criterion during the term of its PPA, while Company B will meet the power criterion once Company A’s PPA has expired and Company A no longer has a variable interest in Company X.

5.2.6 Unrelated parties direct different activities–power not shared

If the activities that significantly impact the VIE’s economic performance are directed by multiple unrelated parties, and the nature of the activities each party is directing are different, then the reporting entity should identify which party has the power to direct the activities that most significantly impact the VIE’s economic performance. One party will have the ability to direct the most significant activities, and that party will meet the power criterion.
Example CG 5-2 and Example CG 5-3 illustrate the impact of multiple unrelated parties concurrently directing different significant activities.
EXAMPLE CG 5-2
Multiple unrelated parties concurrently direct different significant activities
Fruit Co. and Bottle Co. (unrelated parties) form Juice Co. Both Fruit Co. and Bottle Co. contribute an equal amount of cash and receive a 50% equity interest in Juice Co. Fruit Co. is an agricultural company specializing in the production of organic fruit used in high-end fruit drinks. Bottle Co. bottles and distributes beverages.
Fruit Co. and Bottle Co. formed Juice Co. for the purpose of manufacturing organic fruit juices for distribution to retailers throughout the US. Juice Co. has been determined to be a VIE. Profits and losses of Juice Co. will be allocated equally to Fruit Co. and Bottle Co. based on their relative ownership percentages. Apart from their equity interest, neither Fruit Co. nor Bottle Co. holds any other variable interest in Juice Co.
How should Fruit Co. determine if it meets the power criterion?
Analysis
First, Fruit Co. must determine the purpose and design of Juice Co., including the risks it was designed to create and pass through to its variable interest holders. Juice Co. was created to provide Fruit Co. access to Bottle Co.’s low-cost bottling process and distribution network, while providing Bottle Co. access to Fruit Co.’s supply of organic fruit.
Next, Fruit Co. must determine which activities of Juice Co. most significantly impact its economic performance and determine whether it has the power to direct those activities. The party with the power to direct those activities would meet the power criterion.
Fruit Co. has determined the agricultural activities (i.e., the growth of the core ingredient in Juice Co.’s primary product) have a more significant impact on the economic performance of Juice Co. than the production/bottling and distribution activities combined.
In this example, agricultural decisions most significantly impact Juice Co.’s economic performance. Since Fruit Co. unilaterally directs agricultural activities, it would meet the power criterion. Even if Bottle Co. directs more significant activities in absolute terms, those activities do not represent Juice Co.’s most significant activities.
EXAMPLE CG 5-3
Multiple unrelated parties concurrently direct different significant activities
Fruit Co. and Bottle Co. (unrelated parties) form Juice Co. Both Fruit Co. and Bottle Co. contribute an equal amount of cash and receive a 50% equity interest in Juice Co. Fruit Co. is an agricultural company specializing in the production of organic fruit used in high-end fruit drinks. Bottle Co. bottles and distributes beverages.
Fruit Co. and Bottle Co. formed Juice Co. for the purpose of manufacturing organic fruit juices for distribution to retailers throughout the U.S. Juice Co. has been determined to be a VIE. Profits and losses of Juice Co. will be allocated equally to Fruit Co. and Bottle Co. based on their relative ownership percentages. Apart from their equity interest, neither Fruit Co. nor Bottle Co. holds any other variable interest in Juice Co.
How should Fruit Co. determine if it meets the power criterion?
Analysis
First, Fruit Co. must determine the purpose and design of Juice Co., including the risks it was designed to create and pass through to its variable interest holders. Juice Co. was created to provide Fruit Co. access to Bottle Co.’s low cost bottling process and distribution network, while providing Bottle Co. access to Fruit Co.’s supply of organic fruit.
Next, Fruit Co. must determine which activities of Juice Co. most significantly impact its economic performance and determine whether it has the power to direct those activities. The party with the power to direct those activities would meet the power criterion.
Fruit Co. has determined the activities which most significantly impact Juice Co.’s economic performance are as follows:
Activity
Agricultural
Production/Bottling
Distribution
Next, Fruit Co. must determine which party has the power over the activities that most significantly impact the economic performance of Juice Co. Fruit Co has determined the parties with the power to direct activities which most significantly impact Juice Co.’s economic performance as follows:
Activity
Responsible party
Agricultural
Fruit Co.
Production/Bottling
Bottle Co.
Distribution
Bottle Co.
If each of the significant activities identified above carried the same importance in determining Juice Co.’s economic performance (which may be very difficult to demonstrate in practice), Bottle Co. would be deemed to meet the power criterion as it has the power to direct more of the activities that most significantly impact the economic performance relative to Fruit Co.

5.2.7 VIEs with limited or no ongoing significant activities

Highly structured entities with limited activities (e.g., securitization vehicles and special purpose entities) may be established with all key decisions predetermined at formation. The remaining activities conducted by the VIE throughout its life may be limited to activities that are purely administrative in nature (e.g., collecting and distributing cash to the interest holders). When such activities do not significantly impact the economic performance of the VIE, questions may arise as to which party, if any, has power over the VIE.
If a VIE was established to have a limited life with no significant ongoing decision-making requirements, we believe the power analysis should focus on the key decisions of the VIE that were made at formation (or upon the redesign of the entity). Determining which variable interest holder, if any, has power requires consideration of the purpose and design of the VIE, each party’s involvement in determining the VIE’s activities, and how those activities will be carried out. A variable interest holder’s involvement in the design of the VIE may indicate that it has the opportunity and incentive to establish arrangements through which it can exercise power over the VIE. We believe a variable interest holder’s incentive to establish arrangements through which it can exercise power will increase as its exposure to the VIE’s benefits and losses increases.
When a VIE’s ongoing decision making relates to activities that significantly impact the economic performance of the VIE, an analysis should be performed to determine which party can direct such activities. In circumstances when the VIE’s ongoing activities are limited to a single significant activity, we believe the party with power over that activity would likely meet the power criterion, although each variable interest holder’s involvement in the design of the VIE should also be considered.
The analysis described above should consider each variable interest holder’s current ability to exercise power, even though they may not actively do so.

5.2.8 Significant decisions made upon a contingent event

The analysis to determine which reporting entity can make the most significant decisions of the entity becomes challenging when one or more of the significant decisions are only made upon the occurrence of a contingent event(s). In addition to considering the purpose and design of the entity and its significant activities, the reporting entity should consider the likelihood of the contingent event occurring, including the reporting entity’s ability to influence the occurrence of the contingent events. The greater the likelihood of the contingent event occurring, the more weight should be given to those contingent significant decisions when making the determination as to which reporting entity can make the most significant decisions. The reporting entity should also consider whether the contingent significant decisions can be made concurrent with other significant decisions of the entity (e.g., servicing of performing loans and servicing of loans in default) or whether the contingent significant decisions can only be made in sequence and are dependent on the success of previous significant decisions (e.g., research and development activities followed by production and marketing activities).
In situations where the contingent significant decisions can be made concurrent with other significant decisions, the assessment of which reporting entity has the power should consider all significant decisions, including the contingent significant decisions and their likelihood of occurring. The reporting entity with the ability to make the most significant decisions of the entity would meet the power characteristic. Because the assessment of power considered all significant decisions, including the contingent ones, there would likely not be a change in the determination of which reporting entity met the power criterion when the contingencies are resolved.
In situations when the contingent significant decisions are made in sequence and dependent on the success of previous significant decisions, the assessment of which reporting entity has the power over the most significant decisions of the entity should first focus on the likelihood of the contingent significant decisions being made. If it is unlikely, the assessment of the most significant decisions should only consider the current significant decisions until the contingency has occurred. The reporting entity with the ability to make the current significant decisions would likely meet the power characteristic. In these situations, there would likely be a change in the reporting entity with power if a different reporting entity is able to make the significant decisions once the contingency occurs.
Alternatively, if it is likely or relatively certain that the contingent significant decisions will be made, the assessment of the most significant decisions should include all significant decisions, including the contingent ones, in a manner similar to the evaluation of concurrent contingent significant decisions. These assessments are described in:
  • Example CG 5-4, Assessing the impact of activities that are contingent upon a future event
  • Example CG 5-5, Multiple unrelated parties sequentially direct different activities
  • Example CG 5-6, Multiple unrelated parties sequentially direct different activities when there is significant uncertainty
  • Example CG 5-7, Evaluating the impact of a contingent shift in power

EXAMPLE CG 5-4
Assessing the impact of activities that are contingent upon a future event
A VIE is created for the purpose of purchasing commercial mortgage loans from a third-party transferor. The VIE finances the purchase of the commercial mortgage loans by issuing fixed-rate debt to third-party investors, and equity to a third party that will also perform special servicing. The transferor retains primary servicing responsibilities over the mortgage loans. Upon the occurrence of a delinquency or default of a mortgage loan, the administration of the loan is transferred to the special servicer. In assessing the purpose and design of the entity, it was concluded that the servicing of loans that are delinquent or in default is the only ongoing significant activity of the VIE.
Which party has the power to direct the activities of the VIE that most significantly impact its economic performance?
Analysis
In this example, the VIE’s activities that most significantly impact its economic performance involve the management of assets that are delinquent or go into default, which is the responsibility of the special servicer. Although the special servicer cannot exercise power over this activity until a contingent event occurs (i.e., the default or delinquency of the mortgage loans), the special servicer would likely be deemed to have power, as this activity has the most significant impact on the VIE’s economic performance.
The special servicer would be deemed to have power because the activity of managing assets that go into default is likely to occur and can also occur concurrent with all other significant activities. Therefore, this activity is included in the assessment of which activities most significantly impact the economic performance of the entity.
EXAMPLE CG 5-5
Multiple unrelated parties sequentially direct different activities
An entity is formed by Company A and Company B for the purpose of building a manufacturing facility. Company A and Company B each own a 50% equity interest in the entity, which was determined to be a VIE. Once construction is complete, the VIE will operate the facility and sell the manufactured goods to third parties unrelated to Company A and Company B. Company A is responsible for directing the significant activities during the construction of the manufacturing facility, while Company B will direct the significant activities related to manufacturing and sales of the finished product after construction of the facility is complete. All the appropriate approvals for the manufacturing site have been obtained (e.g., permits). Company A and Company B have collaborated on similar projects in the past with each party having the responsibility for similar activities. In each case, the construction phase was successfully completed in accordance with the business plan. In addition, Company B was able to begin manufacturing and selling the finished product in accordance with the entity’s original business plan.
The decisions made during both the construction phase and the subsequent manufacturing and sales stage are determined to have a significant impact on the economic performance of the entity. Neither Company A nor Company B have any other variable interests in the VIE.
Which party would be deemed to meet the power criterion?
Analysis
Given Company A’s positive historical experience in completing similar projects and the expectation that construction will be successfully completed, Company B may be deemed to meet the power criterion throughout the life cycle of the entity (even during the construction phase) since the activities over which it has power (manufacturing and sales) are more likely key drivers of the entity’s economic performance. Even though the significant activities are sequential and the manufacturing and sales activities are dependent on the successful completion of the construction activities, the significant activities in both phases should be included in the assessment of power.
If, on the other hand, significant uncertainties existed with respect to the construction (e.g., zoning and design issues) and/or Company A did not have positive historical experience in successfully completing similar projects, Company A may be deemed to meet the power criterion during the construction phase with the power shifting to Company B at or near completion. In this case, only the construction activity would be included in the initial assessment of which reporting entity can make the most significant decisions of the entity since there is significant uncertainty about the completion of the construction phase of the project.
EXAMPLE CG 5-6
Multiple unrelated parties sequentially direct different activities when there is significant uncertainty
An entity is formed for the purpose of developing, manufacturing, and distributing a pharmaceutical drug candidate. The entity is determined to be a VIE. The VIE obtains legal title to the drug candidate and plans to perform further research and development in order to obtain approval from the FDA for commercialization of the drug. The drug is currently in Phase I clinical trials and there is significant uncertainty regarding the likelihood of the drug reaching FDA approval.
Company A, a variable interest holder, is responsible for all decisions regarding the activities of the VIE throughout the FDA approval process. Company B, a variable interest holder, will be responsible for all significant activities once FDA approval is received, including manufacturing, marketing, and distribution of the drug. It is determined that the activities performed during both the initial stage (research and development) and subsequent stage (manufacturing, marketing, and distribution) will have a significant impact on the economic performance of the VIE.
Which party would be deemed to meet the power criterion?
Analysis
Both Company A and Company B have the power to direct significant activities of the VIE that will impact its economic performance. However, Company B’s power is contingent upon the successful development of the drug and receipt of the required approvals.
Since there is significant uncertainty regarding FDA approval at the assessment date, and the manufacturing, marketing, and distribution activities are sequential and dependent on the success of the research and development activities, the determination of power should be based on the significant activities that exist during the initial stage (i.e., research and development activities). Therefore, it is likely that Company A would meet the power criterion during the initial stage since it has the power to direct the activities that will have the most significant impact on the VIE’s economic performance during that initial stage.
Once the uncertainty regarding the receipt of FDA approval has lapsed, the determination of which variable interest holder meets the power criterion should focus on which party has the power to direct the significant activities during the remaining life of the entity (i.e., manufacturing, marketing, and distribution), which is likely to be Company B in this example. In other words, once the FDA approval contingency has been met, it is likely that the party determined to meet the power criterion will change.
EXAMPLE CG 5-7
Evaluating the impact of a contingent shift in power
A VIE is created for the purpose of purchasing fixed-rate residential mortgage loans from a transferor. The entity finances the purchase of the mortgage loans by issuing three tranches of securities, a senior tranche that is guaranteed by an unrelated financial guarantor (FG Company), a subordinate tranche, and a residual interest. The transferor (and holder of the residual interest) retains servicing responsibilities over the mortgage loans. Upon a substantive predefined event of default (which is triggered based upon a significant amount of delinquencies of the underlying assets), FG Company has the right to remove the transferor and assume the role of servicer.
Which party would be deemed to meet the power criterion?
Analysis
As servicer, the transferor is responsible for servicing the non-performing loans, which includes contacting borrowers in default, determining if and when a borrower should be granted a loan modification, as well as determining when to foreclose on the collateral underlying a delinquent mortgage loan. Based on the purpose and design of the VIE, servicing of non-performing loans may be determined to have the most significant impact upon the economic performance of the entity. If that is the case, the transferor, in its role as servicer, would meet the power criterion.
However, once the predefined event of default is triggered, FG Company would meet the power criterion. FG Company would be deemed to meet the power criterion because it would have the ability to replace the transferor as servicer at any time once the predefined event of default is triggered. As a result, there would be a change in the party with power.

5.2.9 Power—board governance and separate venture partner contract

If an entity is governed by a board of directors and one of the venture partners has the ability to make decisions through a separate arrangement (e.g., a management contract, managing member interest, or general partner interest), an analysis should be performed to determine at what level power is exercised (i.e., by the VIE’s board of directors or the manager/managing member/general partner). To make this determination, a reporting entity should consider, among other things, the following:
  • At what level the significant decisions of the VIE are made
  • At what level the significant activities of the VIE are carried out
  • Whether the board makes decisions at a granular level, thereby establishing narrow parameters that the manager must operate within when carrying out decisions made by the board
  • Whether decisions made by the board are at a high level, thereby giving the manager significant latitude and discretion in carrying out such decisions
  • If the board directs the entity’s most significant activities, whether each party is required to consent to the decisions made by the board that relate to the VIE’s significant activities

If the entity’s significant operating and capital decisions are made by the board, then the manager would not have power. In such cases, the manager would generally have limited authority as to how such decisions are carried out. In other words, the manager would be acting as an agent of the board. This is often the case when decisions made by the board are detailed and narrow parameters are specified as to how such decisions should be implemented.
Alternatively, if decisions made by the board are very high level in nature and the manager (1) makes decisions that most significantly impact the entity’s economic performance, or (2) has significant discretion carrying out decisions made by the board, then the manager may have power.
This analysis becomes more challenging when the VIE outsources decision making to one of the venture partners through a separate contractual arrangement. In such situations, an analysis must be performed to determine whether that venture partner is able to exercise power over the entity.
Example CG 5-8 illustrates the determination of whether power is shared through an entity’s board of directors when an entity’s day-to-day operations are managed by one of the venture partners.
EXAMPLE CG 5-8
Determining whether power is shared through an entity’s board of directors when an entity’s day-to-day operations are managed by one of the venture partners
Company A and Company B, unrelated parties, form a new entity, Company X. Company X is governed by its board of directors, which consists of four directors, two appointed by each party. All significant decisions of Company X are made by its board of directors and require the consent of both Company A and Company B.
Company X also entered into a contractual arrangement with Company B to manage Company X’s day-to-day operations. Company B’s decision-making ability is limited to carrying out operating decisions approved by Company X’s board. Company X’s board is actively involved in overseeing the operations of Company X. The board’s decisions are specific and its operating and capital budgets are prepared and approved at a granular level. Company B is not able to unilaterally direct any of Company X’s significant activities through the management agreement.
Does Company B meet the power criterion by virtue of its separate management agreement?
Analysis
No. The significant decisions of Company X are made by its board of directors. In addition, these decisions are made at a granular level. Since Company B’s day-to-day operating activities are limited to carrying out the significant decisions made by the board and Company B is not able to unilaterally direct any of the board’s decisions, Company B does not have power. Rather, power would be considered shared since the board has power and any significant decisions made by the board require the consent of both Company A and Company B.

In many situations where the consent of two or more parties is required in order for an entity to make a decision, the governing documents contain dispute resolution provisions clarifying what process will be undertaken if a “deadlock” occurs (i.e., when the parties are unable to agree on a specific decision or course of action). If one of the parties can break the deadlock by casting a tie-breaking vote, it may be deemed to have the power over the entity and power would not be considered shared.

5.2.10 Decision making is outsourced through a third-party contract

There may be circumstances where a single decision maker can direct the activities of the VIE that most significantly impacts its economic performance through a management or services contract. If the decision-making contract does not qualify as a variable interest, then the decision maker or service provider should be presumed to be acting in an agency capacity on behalf of the VIE’s interest holders. In other words, the decision maker or service provider would not have power because it is acting in a fiduciary capacity. Refer to CG 3.4 and CG 5.5.4 for further detail regarding the evaluation of decision maker or service provider fee arrangements. In such cases, a reporting entity should assess power held by interest holders other than the outsourced decision maker to determine whether or not there is a primary beneficiary. For example, if the decision maker is acting in an agency capacity, the equity holders at risk may be deemed to have the power to direct the VIE’s most significant activities. If a single equity holder at risk has power through holding the majority voting interest in the VIE, we believe that equity holder at risk may have power provided the other equity holders at risk do not have substantive participating rights. If a single equity holder at risk (or a related party group of equity holders at risk with majority voting interest) does not have the ability to exercise power, we believe there would be no primary beneficiary.
Example CG 5-9 illustrates the assessment of outsourced decision-making arrangements when the fee does not represent a variable interest.
EXAMPLE CG 5-9
Assessing outsourced decision-making arrangements when the fee does not represent a variable interest
A VIE is created for the purpose of purchasing fixed-rate residential mortgage loans from a transferor. The entity finances the purchase of the mortgage loans by issuing three tranches of securities, a senior tranche, a subordinate tranche, and a residual interest. The transferor that holds the residual interest directs the VIE to engage Reporting Entity as servicer of the mortgage loans. In addition, Reporting Entity holds a small interest in the senior tranche of securities issued by the VIE. Reporting Entity determined it has “power” to make decisions that most significantly impact economic performance of the VIE through its servicing contract. Reporting Entity has determined that its service contract is not a variable interest despite the senior interest it holds in the entity when assessing under ASC 810-10-55-37 (see CG 3.4).
Would Reporting Entity be the primary beneficiary of the VIE?
Analysis
In this fact pattern, since the power exists in a contract that is not a variable interest, Reporting Entity would be viewed as acting as an agent for the other variable interest holders. Therefore, Reporting Entity would not be the primary beneficiary of the VIE. In some instances, the transferor may have the ability to remove and replace Reporting Entity as servicer without cause. In such cases, the transferor may be viewed as the primary beneficiary.

5.2.11 Disproportionality–stated power vs. economic exposure

In some cases, a variable interest holder may lack stated power while holding an economic interest in a VIE that exposes that variable interest holder to greater than a majority of the VIE’s benefits and losses.

ASC 810-10-25-38G

Consideration shall be given to situations in which a reporting entity’s economic interest in a VIE, including its obligation to absorb losses or its right to receive benefits, is disproportionately greater than its stated power to direct the activities of a VIE that most significantly impact the VIE’s economic performance. Although this factor is not intended to be determinative in identifying a primary beneficiary, the level of a reporting entity’s economic interest may be indicative of the amount of power that reporting entity holds.

The VIE model calls for increased skepticism in these situations. As the level of disparity between a variable interest holder’s level of stated power and exposure to benefits and losses increases, so too should a reporting entity’s level of skepticism around the substance of that variable interest holder’s apparent lack of stated power. In these situations, judgment should be applied and an understanding of the purpose and design of the VIE will be necessary.
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