FASB proposal topic 860: accounting for repurchase agreements

¶ … repurchase agreements. Encapsulated in that topic will be prior actions on the subject of repurchase agreements, up to and including the actions and deliberations of the Financial Accounting Standards Board. The Financial Accounting Standards Board, often referred to as the FASB, has weighed in quite a bit over the least twenty to thirty years on the subject of repurchase agreements, often known as repo agreements, and how risky/speculative they tend to be and they have also weighed in on the accounting tactics and mechanisms that can and should be used when accounting for them.

The dimensions looked at include a literature review and summary of the topic which includes a summary of the proposal, why the proposal is important, the determination of effective control vis-a-vis repurchase agreements, the general direction that the current and prior proposals are leading to and other similar topics. A reaction to the proposal as well as the theoretical frameworks and hypotheses that are in play will be discussed. Finally, there will be a conclusion which will include a reflection by the author of this paper (FASB, 2013).

Literature Review

Summary of the Proposal

Before getting too much in the minutia of what exactly Financial Accounting Standards Board Proposal Topic 860 is, why it's important and what it means to the future, the general definition and clarification of what a repurchase agreement is should first be discussed. Repurchase agreements are often known by other terminology including repo, RP or sale and repurchase agreements. Regardless of what they are call, repurchase transactions relate to a certain type of buying/selling of investment products known as securities (FASB, 2013).

This proposal is yet another proposal in a long line of major or even incremental updates that have occurred since the Financial Accounting Standards Board inception in 1973 ("Exposure drafts," 1984)("FASB Issues Bulletins," 1986). This proposal covers a lot of the same material that was addressed in 1996 when the Financial Accounting Standards Board was also addressing the accounting and reporting of financial asset transfers from one company to another, whether they be temporary or permanent ("FASB ED changes," 1996)(Nurnberg & Largay, 1996)(FASB Issues ED, 1994). Proposals by the Financial Accounting Standards Board and/or other entities along these lines go as far back as at least 2002 when hedge accounting and transfers of financial instruments were also up for discussion (Ryan et al., 2002). A more recent report, as offered in 2011, noted that debt restructuring and shifting should be reviewed and repurchase agreements are certainly part of that subject ("Current developments," 2011). The recent "Great Recession" incurred a grand call to action and the idea that even standard-setters like Financial Accounting Standards Board should be held to account for the collapse of firms like Lehman Brothers (Sanderson, 2010).

What is unique about repurchase agreements is that is technically a form of lending as it relates to Financial Accounting Standards Board standards and requirements, even if the buying and selling parties do not look at it that way. Regardless, a repurchase agreement is generally accepted to be and is considered a secured loan. The interest rate behind this loan is at a fixed rate. A repurchase agreement is when a seller sells a security to a buyer with an agreement in advance to buy the securities back at a later date (FASB, 2013).

Since the initial seller has to pay back the sum and usually with interest or some other sort of gratuity tacked on, it is effectively a form of borrowing by the initial seller by using the securities exchanging hands as a form of collateral if the seller does not make way with what they owe when the agreed-upon time horizon to pay back the funds lapses. Just about any security can be used in a repurchase agreement but most buyers (i.e. The money lender) in a repo agreement will general want something that is highly liquid (i.e. easily turned into cash) just in case the agreement is broken if/when the seller does not pay back the loan (FASB, 2013).

Now that the definition is out of the way, it should be noted that the rule change proposed by the Financial Accounting Standards Board would clarify the guidance for distinguishing repurchase transactions as either sales or secured borrowings, and this is because this distinction matters greatly in the account world. Another benefit of the proposal, if enacted and executed as is desired, is that it would improve the properness and timeliness of disclosures as made by entities that engage in repurchase transactions so that proper reporting transparency and honestly is revealed in what security-trading organizations reveal to their shareholders and stakeholders (FASB, 2013).

Why Proposal is Important

The end of the prior section segues nicely into the overall reasons that the proposal is important, that being that the current rules for accounting vis-a-vis repurchase agreements does not completely and concisely clarify the obligations and risks that are present for the different parties involved at any given time and this should be corrected. The two main points that could and should be answered as it relates to the above are as follows (FASB, 2013).

First, the transferor has a credit risk related to the transferred asset and this should be made quite clear in the accounting and reporting as it relates to the transaction. The second and final main point to be clarified and fleshed out is the fact that the transferor retains the benefits of the transferred asset and not the transferee. These two distinctions and points are very vital and important to understand as it relates to timely and correct accounting reporting and the current framework apparently does not address that concern in full (FASB, 2013).

Determining Effective Control

Effective control of a repurchase agreement asset is something that is not easy to figure out on first glance because it can vary a lot based on the value of the asset, when it is transferred, when it is scheduled to transfer back and what the current date is relative to the last two items just mentioned. In short, a repurchase agreement security is considered to be retained and under the control of the transferor so long as two different conditions are met (FASB, 2013).

The first is that that transaction is considered secured borrowing if the agreement to repurchase the security is for the same or "substantially the same" as what was conveyed during the transaction and it has to be before the maturity of the security in question. The second point to keep in mind is that it is considered a sale, and not a secure loan, if the asset matures before the repurchase agreement expires (FASB, 2013).

Reaction to Proposal

The Financial Accounting Standards Board proposal is not written in stone yet. The main reason for this is that the Financial Accounting Standards Board is allowing for some time is to allow for investors and companies to provide their feedback to the Financial Accounting Standards Board regarding the current framework and feel of the proposals. The two main points of feedback asked for with the proposal is what people and investors think about the proposal and what would they prefer to happen to the rules and reporting requirements. The current deadline for the feedback is March 29th, 2013 (FASB, 2013).

Theoretical Model & Hypotheses

The basic question and issue being address by the Financial Accounting Standards Board as it relates to repurchase agreements is quite clear and is made much more so by consulting the Financial Accounting Standards Board documentation on the topic. They note that the permanent transfer of securities or other things of financial value are not the least bit controversial or chaotic when the transfer of goods is one way and is not contingent on a future transaction that resembles repayment for a loan in any way, shape or form. On the other hand, how to handle transactions where a transfer of goods is temporary and/or the transfer of goods will be reversed at a future date with anything that resembles interest is obviously up for debate and worthy of future review by accountants and other stakeholders that focus on the accounting and auditing reports for a firm (FASB, 2013).

There are a couple of hypotheses that the author of this report would offer. First, it is highly likely that there will be some detractors to the new policy framework but it is also likely that a lot of industry figureheads and leaders will view the proposal as being a good one and will support the framework update as a result. Second, the author of this paper will predict that the proposal will be adopted with little to no changes as there is nothing controversial or wrong-headed about the change as it makes perfect sense for transactions to be recorded based on what they effectively are. Even if a repurchase agreement is not technically a loan, it effectively is and that is the point to be taken from the form and function of the rules (FASB, 2013).

Even with the general agreement on the proper handling of repurchase agreements, the questions surrounding how to account for and administer such transactions is by no means uniform and homogenous and there are people that, legitimately or not, are concerned with how to properly account for such transactions and these people largely do not find the topic of repurchase agreements and the associated accounting handling a settled matter (Chircop, Kiossie & Peasnell, 2012). Given the unsettled nature of these questions, this is why the question is explained and shown in the theoretical framework/hypothesis section of this report.

The reason getting this question right is so very important is because financial institutions make rather heavy use of these transactions. As such, giving the reporting requirements a proper and compliant feel is very important. Taking this string a bit further, many people think the repurchase agreement tactic had a large role to play in the creating and aggravation of the global financial crisis that occurred from 2007 to 2009 both in the United States and around the rest of the world including Europe and other financial centers of the world (Chircop, Kiossie & Peasnell, 2012).

Perhaps one example of this in motion, and the reason for the earlier mention of even holding the accounting standards boards accountable, was the practice of Lehman Brothers (the failed financial firm that self-destructed massively during the Great Recession of 2007 to 2009) to funnel their repurchase agreement transactions through the London office, rather than the United States, so as to avoid the standard enforced by the Financial Accounting Standards Board for United States-oriented and -- initiated transactions (Chircop, Kiossie & Peasnell, 2012).

Part and parcel of what can go terribly wrong when a repurchase agreement is made is when the party extending the collateral and receiving the "loan" is unable to afford buying back the instrument they disbursed when the "note" becomes due. This is known in the industry as a "repo fail." The amount of repo fails from 1990 to roughly 2001 was fairly inconsequential. However, there were four spikes in repo fails in 2001, 2003, 2004 and 2007. However, there was a huge spike in 2008 that roughly doubled that of any other single spike in the four years mentioned before.

Reflection

First, the people and entities will likely complain and kvetch about the proposed regulations but anyone being honest and intellectually sound should admit that the standards being proposed are common-sense and proper and that there's nothing wrong with accounting reporting matching and completely stating what is going on. With the advent of nefarious firms like Enron, MCI WorldCom, and the like, honestly and completeness is always the best policy and leaving things off a report that investors have a right to know, even if it's supported or allowed for by current (or lacking) regulations, that does not make it right and it makes it all the more easier to obfuscate and otherwise pretty up a proverbial pig that should be presented as a pig and not a swan or left off the report to begin with.

The proposal is a good one, in the view of the author of this paper, and despite any reservations or complaints about the proposal, it probably will (and should be) enacted exactly as written as there is nothing improper or over the top about the proposal. The author of this paper is sensitive to the argument that overt and excessive government regulation is a bad thing but this regulation proposal is not an example of this and instead is focused on honest and complete reporting about the transaction itself as well as the nature of the transaction. If a transaction is effectively a secured loan, it should be treated as such…no more, no less.

Conclusion

In conclusion, intellectual and fair-minded people can disagree about how to properly regulate, account for and report repurchase agreements, but it is obvious in light of the Great Recession and other happenstances that something must be done to force the hand of agencies that either do not know or do not care to know how to properly report and track repurchase agreements. The trust of stakeholders and shareholders is at stake and the proper way to do repurchase agreement should be defined and standardized so that no firm can feign ignorance or there not being defined rules and this would then make them accountable to authorities as well as interested stakeholders and investors.