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3.4 Continuing involvement with transferred financial assets
Publication date: 30 Sep 2020
us Transfers of financial assets guide
As described in ASC 860-10-40-4, a transferor’s sale accounting analysis should take into account its "continuing involvement" with the transferred financial assets. This assessment should consider not only the transferor’s involvement, but also those of its consolidated affiliates and agents. When making this determination, all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer should be considered.
Inventorying all forms of a transferor’s continuing involvement with transferred financial assets can be one of the most challenging aspects of the sale accounting analysis. This is generally because "continuing involvement" is an expansive concept and can assume many forms, as explained in the following sections.
3.4.1 Forms of continuing involvement
Continuing involvement encompasses any arrangement that entitles a transferor to receive cash flows (or other benefits) attributable to transferred financial assets or, conversely, could obligate the transferor to provide additional cash flows or other assets to the transferee (and/or any party related to the transfer). A transferor’s continuing involvement may stem from or consist of rights acquired and obligations assumed in transfer and servicing agreements, derivative instruments, or beneficial interests in transferred financial assets that have been securitized (e.g., debt securities issued by the transferee).
Forms of continuing involvement that a transferor may have with transferred financial assets include:
- Providing recourse, or writing guarantees or indemnities, to the transferee
- Servicing the financial assets
- Holding beneficial interests in the transferred financial assets (equity or debt instruments)
- Writing (or acquiring) put/call options on the transferred financial assets (or on beneficial interests in those assets)
- Agreements to purchase or redeem transferred financial assets
- Pledges of collateral
Recourse, a common form of continuing involvement, is defined in ASC 860-10-20.
Definition from ASC 860-10-20
Recourse: The right of a transferee of receivables to receive payment from the transferor of those receivables for any of the following:
- Failure of debtors to pay when due
- The effects of prepayments
- Adjustments resulting from defects in the eligibility of the transferred receivables
It is not uncommon for a transferor to have one or more forms of continuing involvement with transferred financial assets, considering the broad swath of these arrangements. Despite this involvement, the transferor may conclude that the transfer qualifies for sale accounting. Derecognition under ASC 860 is not predicated on the absence of a transferor’s continuing involvement with transferred assets, but rather on whether control over those assets has been ceded to the transferee. However, continuing involvement on the part of the transferor must be considered in connection with the legal isolation analysis, and that involvement may also allow the transferor to maintain control over the transferred assets.
Question TS 3-2 illustrates how to consider normal course representations and warranties in the context of continuing involvement.
Question TS 3-2
A transferor will frequently represent (assert) that transferred financial assets have certain characteristics – for example, that they are valid, free and clear from any liens or counterclaims, and enforceable in accordance with their terms. The transferor will also represent that it has good title to the assets and is their sole owner. If any of these represented conditions are later found not to be true and cannot be cured, the transferee typically has the right to revoke the transfer and/or to seek damages from the transferor.
Do “normal course” representations and warranties constitute a form of continuing involvement that precludes sale accounting?
A transferor will frequently represent (assert) that transferred financial assets have certain characteristics – for example, that they are valid, free and clear from any liens or counterclaims, and enforceable in accordance with their terms. The transferor will also represent that it has good title to the assets and is their sole owner. If any of these represented conditions are later found not to be true and cannot be cured, the transferee typically has the right to revoke the transfer and/or to seek damages from the transferor.
Do “normal course” representations and warranties constitute a form of continuing involvement that precludes sale accounting?
PwC response
No, we do not believe that normal course representations and warranties about the characteristics of a transferred financial asset constitute a form of continuing involvement that precludes sale accounting. Normal course representation and warranties do not violate any of the criteria for transfer of control over the transferred assets since they do not impact legal isolation, the transferee’s right to pledge or exchange the transferred asset, or the transferor’s effective control over it – all they do is assert that the financial asset is what it is purported to be at the transfer date.
Sometimes transferors are obligated to buy back loans that default shortly after the transfer. In cases when the period in which a default of the loans will trigger a buy back is short, in practice this could be considered part of normal course representations and warranties. The reasoning is that if the period in which a default of the loans will trigger a buy back is short, it can be reasonably presumed that the receivables were already faulty at the transfer date, and hence the buy back is part of normal representations and warranties. However, if that period is extended, the default may have occurred after the transfer date. Indemnifying defaults occurring after the transfer date would not be included in normal representations and warranties. Hence, they would be considered a form on continuing involvement with the transferred assets, and would need to be considered in the analysis of the three control criteria.
3.4.2 Relevant agreements and arrangements
When assessing the extent and nature of a transferor’s continuing involvement with transferred financial assets, a transferor should consider all arrangements or agreements made contemporaneously with, or in contemplation of, a transfer. In connection with this assessment, ASC 860-10-55-79A emphasizes that all available evidence is to be considered, including, but not limited to, the following:
- Explicit written arrangements
- Communications between the transferor and the transferee or its beneficial interest holders
- Unwritten arrangements customary in similar transfers
Concluding whether agreements and arrangements between a transferor and transferee should be considered to have been made in contemplation of a transfer may entail judgment. In certain instances, consultation with legal counsel may be appropriate, as the legal isolation analysis should include all agreements and arrangements that a court or receiver might consider when evaluating a transfer in the context of the transferor’s bankruptcy or similar proceeding. In any event, conclusions reached in this regard will depend on the individual facts and circumstances.
3.4.3 Continuing involvement: exceptions
There are two narrow instances when a transferor does not need to consider all forms of continuing involvement with transferred financial assets (and all contemporaneous agreements) in connection with its sale analysis:
- If a transfer of a financial asset is accompanied by a related repurchase financing, as defined in ASC 860-10-20, the parties should account for the two transactions separately, without consideration of the other. See ASC 860-10-40-4C and TS 3.4.3.1.
- In a transfer of financial assets between two subsidiaries of a common parent, ASC 860-10-40-4 clarifies that the transferor-subsidiary would not consider the parent’s involvements with the transferred financial assets when evaluating whether, in its standalone financial statements, the transaction should be reported as a sale.
3.4.3.1 Repurchase financing transactions
Repurchase financing transactions are transactions in which a financial asset is transferred from an initial transferor to an initial transferee, and contemporaneously the same counterparties (or their consolidated affiliates) enter into a repurchase agreement on the same asset. Under the repurchase agreement, the initial transferee (the borrower) transfers back the financial asset as collateral to the initial transferor (the lender) and is obligated to repurchase it (or substantially the same asset) at a fixed price within a prescribed time period. These transactions are described in detail in ASC 860-10-55-17A through ASC 860-10-55-17C.
Excerpt from ASC 860-10-55-17A
ASC 860-10-40-4C requires that for such transactions, the transferor and the transferee should separately account for the initial transfer of the financial asset and the related repurchase agreement. Once those transactions are not linked and are accounted for separately, the accounting result that is often achieved is that the initial transferor accounts for the initial transfer as a sale of a financial asset (if all derecognition criteria are met), and the initial transferee accounts for the initial transfer symmetrically as a purchase. Both parties account for the repurchase agreement component of the transaction as a secured borrowing. In other words, after step 1 of the transaction takes place, the initial transferor gets the asset off its books and, before step 3 of the transaction takes place, presents a repurchase receivable from the initial transferee, whereas the initial transferee includes the asset on its balance sheet in addition to a repurchase liability.
This accounting applies regardless if the first two steps are net settled. It should not be analogized to for other transactions outside the scope of ASC 860-10-40-4C.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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