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Financial asset transfers – Accounting fundamentals · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought leadership from PWC's National Office.
• 0:07
  SPEAKER_02: Hello, and welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_02: I'm Heather Horn.
• 0:12
  SPEAKER_02: In today's episode, we're diving into transfers of financial assets.
• 0:16
  SPEAKER_02: These transactions can take many forms, from selling securities or receivables outright, to transferring only certain cash flows from a loan, or even pledging assets as collateral.
• 0:27
  SPEAKER_02: In this episode, we're going back to the basics.
• 0:30
  SPEAKER_02: And while this area can get very complex, we'll break down the guidance, walk through the fundamentals, and highlight key considerations you need to know.
• 0:42
  SPEAKER_02: Leading today's conversation is our guest host, Diana Stoltzfest, a partner in PWC's National Office.
• 0:48
  SPEAKER_02: She's joined by Chip Curry, also a partner in our national office, who works closely with clients and engagement teams on accounting for financial instruments.
• 0:57
  SPEAKER_02: With that, let's get started.
• 0:59
  SPEAKER_03: Well, Chip, thanks so much for joining me today.
• 1:01
  SPEAKER_03: Today we're focusing on transfers of financial assets.
• 1:05
  SPEAKER_03: So let's start with the basics.
• 1:06
  SPEAKER_03: If I'm looking for guidance on transfers of financial assets, where should I go and what are the basics that our listeners should know before we get into the details?
• 1:15
  SPEAKER_01: Yeah, sure.
• 1:15
  SPEAKER_01: So first of all, thanks for having me here today.
• 1:18
  SPEAKER_01: Um so there's a topic in the codification dedicated just to transfers of financial assets, excitingly enough.
• 1:24
  SPEAKER_01: It's uh it's topic 860 in the codification.
• 1:27
  SPEAKER_01: So when you transfer a financial asset or a portion of a financial asset, 860 determines whether we should de-recognize that asset and take it off the balance sheet and record as a sale or whether that asset stays on the transfer order's balance sheet.
• 1:41
  SPEAKER_01: Um, in most cases, if you don't get sale accounting, if you don't achieve derecognition, then we would account for that transaction as a secured borrowing.
• 1:49
  SPEAKER_01: And I'm sure we'll talk about both of those sale accounting and secured borrowing a lot today.
• 1:54
  SPEAKER_01: Um, okay, so let's talk about what that would look like.
• 1:56
  SPEAKER_01: Um so if I apply 860 and I get d-recognition or sale treatment, I would record it as a sale.
• 2:03
  SPEAKER_01: So I would take the asset off of my balance sheet, recognize any cash or other proceeds that are received, and I'd book any gain or loss on sale.
• 2:10
  SPEAKER_01: That's sale accounting.
• 2:12
  SPEAKER_01: If I don't get sale accounting, um, then the asset that I transferred to you would stay on my balance sheet.
• 2:18
  SPEAKER_01: And I would still recognize any cash that you received, but I would recognize a liability.
• 2:24
  SPEAKER_01: So from an accounting perspective, it looks like that I borrowed money from the transfer E and I pledged the asset as collateral.
• 2:32
  SPEAKER_01: So there's kind of what these two things would look like.
• 2:35
  SPEAKER_01: Um, another important thing to know about 860 is in most cases it's a symmetrical model.
• 2:41
  SPEAKER_01: So if I record something as a sale, the the transferee, so like if I was selling something to you, if I record as a sale, you would record it as a purchase.
• 2:49
  SPEAKER_01: The asset would leave my balance sheet and go to yours.
• 2:52
  SPEAKER_01: If it was treated as secure borrowing, the asset would stay on my balance sheet.
• 2:56
  SPEAKER_01: And like we talked about, it would look like I borrowed money from you.
• 2:59
  SPEAKER_01: And in your financial statements, it would look like you lent money to me.
• 3:02
  SPEAKER_01: Okay.
• 3:03
  SPEAKER_01: Now the other thing you'll hear is 860.
• 3:07
  SPEAKER_01: Sometimes you'll hear it described as an effective control model.
• 3:10
  SPEAKER_01: And so sale accounting depends on whether you maintain effective control or whether you've surrendered that effective control.
• 3:17
  SPEAKER_01: Uh, you hear the word control a lot thrown around in the accounting guidance.
• 3:21
  SPEAKER_01: Um, but 860 is sort of an effective control model.
• 3:25
  SPEAKER_01: So it's it's a little bit of a different model than you might see if you're talking about like consolidation or other areas of gap.
• 3:32
  SPEAKER_03: Okay.
• 3:32
  SPEAKER_03: Well, great.
• 3:33
  SPEAKER_03: Well, that's a really good overview, Chip.
• 3:35
  SPEAKER_03: So maybe before we get into the details of the model, maybe we can first talk about what kind of transactions would be in scope and fall under this model.
• 3:43
  SPEAKER_01: Yeah, yeah.
• 3:44
  SPEAKER_01: So we said it a couple of times.
• 3:45
  SPEAKER_01: The model applies to transfers of financial assets.
• 3:48
  SPEAKER_01: So there's two important words I want to highlight there.
• 3:51
  SPEAKER_01: One is transfers, and the other is financial assets.
• 3:54
  SPEAKER_01: So financial assets is a defined term, and don't don't worry, I'm not gonna weed that definition.
• 4:00
  SPEAKER_01: You know, the listeners can can look it up in a master glossary.
• 4:03
  SPEAKER_01: But some common examples of financial assets are like loans, accounts receivables, investments in debt or equity securities, you know, of what those are not consolidated subsidiaries where you're investing in the third party.
• 4:16
  SPEAKER_01: Uh, those are common examples of financial assets that people would would would transfer.
• 4:21
  SPEAKER_01: Um, so let's talk about some things that are not in the scope of the 860 model.
• 4:26
  SPEAKER_01: And they're not in scope because the board, when they wrote the 860 model, they thought they wanted other gap to apply to certain transactions.
• 4:33
  SPEAKER_01: So transfers of cash, not in the scope of 860.
• 4:37
  SPEAKER_01: Investments by owners in a company or distributions to owners, not in the scope of 860.
• 4:44
  SPEAKER_01: They didn't want to upset the liability and equity guidance with 860.
• 4:48
  SPEAKER_01: Um, transfers of unrecognized financial assets, not in scope.
• 4:53
  SPEAKER_01: Chapter one of our transfers and servicing guide provides a lot of additional examples of things that are in scope and things are out of scope.
• 4:59
  SPEAKER_01: So that's always a good place to look.
• 5:01
  SPEAKER_01: Now, I said the word transfer was important as well.
• 5:04
  SPEAKER_01: So 860 defines what a transfer is.
• 5:07
  SPEAKER_01: Now, I am gonna quote part of this definition.
• 5:10
  SPEAKER_01: So a transfer is the conveyance of a non-cash financial asset by and to someone other than the issuer of that financial asset.
• 5:18
  SPEAKER_01: So that's the definition of a transfer.
• 5:20
  SPEAKER_03: Okay.
• 5:21
  SPEAKER_03: Well, it seems like some of the things that you've hit on, Chip, that seem really important is that they're transfers to or by and to someone other than the issuer of the financial asset.
• 5:31
  SPEAKER_01: Right.
• 5:32
  SPEAKER_01: Absolutely.
• 5:32
  SPEAKER_01: And so, like that definition of transfer that we talked about, that's the, like you said, the conveyance of a non-cash.
• 5:37
  SPEAKER_01: That's why transferring of cash is is out of scope.
• 5:41
  SPEAKER_01: Buy into some of the issuer that scopes out the, you know, when you're dealing with the issuer of the financial asset, like you're investing in a company or uh they're distributing stuff to the to a holder.
• 5:52
  SPEAKER_01: Um so the definition of a transfer includes a bunch of things.
• 5:57
  SPEAKER_01: So when you're selling an asset, so if I were to transfer legal title, if I was to legally sell an asset to you, that's in scope.
• 6:04
  SPEAKER_01: If I pledge a financial asset as collateral for a borrowing, that is also in scope.
• 6:11
  SPEAKER_01: Um and also in scope is things where you sell assets to securitization trusts.
• 6:16
  SPEAKER_01: We'll talk a little bit about that.
• 6:18
  SPEAKER_01: But again, another example of a transfer that's within the scope.
• 6:22
  SPEAKER_01: Um, it does not include originating a receivable.
• 6:25
  SPEAKER_01: So if I loan you money, that's not a transfer of a financial asset.
• 6:28
  SPEAKER_01: That's the creation of a financial asset.
• 6:31
  SPEAKER_01: So not in scope because it's not a transfer.
• 6:33
  SPEAKER_01: Um, settling a receivable.
• 6:35
  SPEAKER_01: If I pay off money that I owe you, that's not in scope.
• 6:39
  SPEAKER_01: That's not transferring, it's extinguishing.
• 6:42
  SPEAKER_01: So that's why those are not within the scope.
• 6:44
  SPEAKER_01: Um, and again, I refer people back to uh our transfers guide.
• 6:48
  SPEAKER_01: Like chapter one has a whole bunch of good examples of what's sort of in scope and what's out of scope.
• 6:53
  SPEAKER_03: Okay.
• 6:53
  SPEAKER_03: Well, I think that's really helpful and help set the stage.
• 6:56
  SPEAKER_03: Seems like we've been talking a lot about transfers of entire financial assets, but I know we also talked about portions of financial assets and that this guidance applies there.
• 7:05
  SPEAKER_03: Maybe you could talk to us a little bit about that.
• 7:07
  SPEAKER_01: Yeah.
• 7:08
  SPEAKER_01: So um the first question that that you need to ask when you're transferring an asset to your point is am I transferring in the entire financial asset or just a portion of the financial asset?
• 7:19
  SPEAKER_01: Um, typically, when you're transferring an entire an entire financial asset transfer occurs when you've given full legal title and ownership of the entire financial asset to somebody else, when you've conveyed that from the transformer to the transferee.
• 7:33
  SPEAKER_01: And after that, the transferee, the person you sold it to, now has legal title to the asset.
• 7:39
  SPEAKER_01: They can exercise any rights associated with that asset directly.
• 7:43
  SPEAKER_01: So, for example, if I were to sell you a loan and I'm selling you the entire loan, you are now the direct creditor of whoever borrowed that money.
• 7:52
  SPEAKER_01: I'm not the lender of record anymore.
• 7:54
  SPEAKER_01: You're you would be the lender of record.
• 7:56
  SPEAKER_01: But there are cases where someone might want to transfer like a portion of a financial asset.
• 8:01
  SPEAKER_01: Um, and so they they transfer like an interest in specific cash flows.
• 8:06
  SPEAKER_01: So if you're doing that, the first thing that you need to do is you need to determine whether when you're transferring a portion, if that portion meets the definition of a participating interest, which is a specific defined term with uh a lot of requirements in in 860.
• 8:21
  SPEAKER_01: Now, this sounds easy, like determining whether or not you're selling an entire asset or a portion of an asset.
• 8:26
  SPEAKER_01: Practice is found in certain areas that distinction could be challenging.
• 8:30
  SPEAKER_01: And in fact, the FASB got some feedback on how challenging that can be as part of their recent invitation to comment.
• 8:37
  SPEAKER_03: Okay.
• 8:38
  SPEAKER_03: Well, maybe we can, you said there's very specific guidance on what is a participating interest.
• 8:43
  SPEAKER_03: So maybe I know as we talked about, and we've talked about this before, it can be really complicated.
• 8:47
  SPEAKER_03: So maybe we can get a little bit into how we would think through this guidance.
• 8:50
  SPEAKER_01: Yeah, it is pretty complicated, but so for now, let's just stick with the basics.
• 8:55
  SPEAKER_01: Um so as I said, to meet the definition of a participating interest, you've got to meet a whole bunch of requirements.
• 9:02
  SPEAKER_01: And and the conditions are a lot of rules.
• 9:05
  SPEAKER_01: And so you might have features that don't have a tremendous amount of economic value, but they can cause you to not meet that definition.
• 9:14
  SPEAKER_01: Um, so the first criteria that that is there is when you transfer an interest in that asset, it has to be a proportionate interest in the entire financial asset.
• 9:23
  SPEAKER_01: So with a few limited exceptions, any cash flow that's received on the entire financial asset must be proportionally divided among all of the participating interest holders.
• 9:35
  SPEAKER_01: The rights of the participating interest holders all have to have the same priority.
• 9:40
  SPEAKER_01: And nobody can have the ability to pledge or exchange the entire asset unless all of the participating interest holders agree.
• 9:48
  SPEAKER_01: Um, so those are the general rules, and there's a lot of specifics underneath those things.
• 9:53
  SPEAKER_01: Um, but maybe to bring it to light a little bit.
• 9:55
  SPEAKER_01: So if I were to sell you a senior interest in a loan, so if I was to make make a loan to somebody and I wanted to sell you the senior interest in that loan, that would not qualify under the participating interest guidance because you and I don't have the same priority.
• 10:10
  SPEAKER_01: Right.
• 10:10
  SPEAKER_01: You would have a senior priority, I would have a subordinate priority.
• 10:13
  SPEAKER_01: If I had a loan and I wanted to sell you the cat the interest cash flows and keep the principal cash flows, that would also not meet the definition of a participating interest because we are not proportionally dividing all cash flows.
• 10:27
  SPEAKER_01: You're keeping the interest cash flows, I'm taking the principal cash flows.
• 10:31
  SPEAKER_01: Um okay, so so what?
• 10:33
  SPEAKER_01: Okay, so if you don't meet the definition of a participating interest when you're selling a portion, it means no sale accounting.
• 10:40
  SPEAKER_01: You go directly to jail, do not PASCO, do not collect$200, no sale accounting.
• 10:47
  SPEAKER_01: Now, if you do meet the definition of a participating interest, we're not done.
• 10:53
  SPEAKER_01: That just means we don't have to go directly to jail.
• 10:55
  SPEAKER_01: And then what we would then do is move to the general sale accounting criteria that gets applied to everything.
• 11:02
  SPEAKER_01: So if you're selling a portion, first participating interest definition, then sale accounting rules.
• 11:08
  SPEAKER_01: If you're telling, if you're selling an entire financial asset, we go right to the sale accounting rules.
• 11:12
  SPEAKER_03: Okay.
• 11:13
  SPEAKER_03: So should we do that?
• 11:14
  SPEAKER_03: Should we go to the sale accounting rules then?
• 11:16
  SPEAKER_01: Yeah, more rules to talk about.
• 11:18
  SPEAKER_01: Okay, so we probably said this a couple times, but you might hear 860 referred to as an effective control model.
• 11:24
  SPEAKER_01: Um, and that's appropriate because one of the criteria is creatively titled effective control.
• 11:30
  SPEAKER_01: Okay.
• 11:31
  SPEAKER_01: So sale accounting.
• 11:32
  SPEAKER_01: So again, selling an entire financial asset or a portion that meets the definition of participating interest, there's three criteria that we have to pass in order to get sale accounting.
• 11:42
  SPEAKER_01: If any of the criteria are not met, no sale, no derecognition, secured borrowing accounting.
• 11:49
  SPEAKER_01: So this is a one-strike-out model.
• 11:53
  SPEAKER_01: Okay.
• 11:54
  SPEAKER_01: So the first criteria is legal isolation.
• 11:57
  SPEAKER_01: So legal isolation is not really an accounting concept as implied by the word legal isolation.
• 12:03
  SPEAKER_01: Um and it really depends on the legal analysis.
• 12:06
  SPEAKER_01: So what's what's the punchline?
• 12:08
  SPEAKER_01: So what you're looking for is that the asset that you transferred has been beyond the reach of the transfer, any of my consolidated affiliates, even if I go bankrupt or enter receivership.
• 12:21
  SPEAKER_01: Receivership being for entities that don't go through the bankruptcy code, like banks and other financial institutions.
• 12:28
  SPEAKER_01: Um, the legal analysis is based on all relevant laws and regulations.
• 12:33
  SPEAKER_01: So the analysis could be different for a transaction that's done in the US versus one that's done, you know, in a non-US jurisdiction.
• 12:41
  SPEAKER_01: When you're doing the analysis, you have to consider all arrangements or an agreement made in connection with that transfer, even if the agreement involves like a consolidated affiliate.
• 12:50
  SPEAKER_01: So sometimes we'll hear these other arrangements being referred to as continuing involvement.
• 12:56
  SPEAKER_03: Okay.
• 12:56
  SPEAKER_01: This might be a good time to point out that 860 is not a risk and rewards model.
• 13:02
  SPEAKER_01: So you're not going to hear me say the risk and reward criteria because it doesn't exist.
• 13:06
  SPEAKER_01: Um, that doesn't mean necessarily it's irrelevant because I in some cases, when a lawyer is looking at whether or not the asset's been legally isolated and whether it's a true sale, they will consider, you know, have the risk and rewards of the assets been transferred.
• 13:21
  SPEAKER_03: Okay.
• 13:21
  SPEAKER_03: Well, you mentioned continuing involvement chip, and it comes up a few times in 860.
• 13:26
  SPEAKER_03: So maybe we should touch on the concept of continuing involvement before we move on.
• 13:29
  SPEAKER_01: Yeah, I guess now's good a time as any to try to hit it.
• 13:32
  SPEAKER_01: So continuing involvement is sort of a broad concept and can take a whole bunch of different forms.
• 13:38
  SPEAKER_01: And and because of that, it can make creating an inventory of your continuing involvement in a transaction a bit challenging.
• 13:45
  SPEAKER_01: So messages, look wide, think about everything you're doing.
• 13:50
  SPEAKER_01: Um, so you need to think about the transfer's continuing involvement as well as any other consolidated affiliates or agents.
• 13:56
  SPEAKER_01: Typically, what continuing involvement is, is an arrangement that allows the transfer to receive cash flows or other benefits associated with the transferred financial assets, or might obligate the transfer to provide additional cash flows to the person we've we transferred the asset to in support of that asset.
• 14:18
  SPEAKER_01: It can come from many different locations, uh different forms.
• 14:21
  SPEAKER_01: You can find continuing involvement.
• 14:22
  SPEAKER_01: Um, it might be in the sale agreement itself.
• 14:26
  SPEAKER_01: It might be in freestanding agreements, like agreements to service the financial assets that I transfer.
• 14:33
  SPEAKER_01: They could be in derivative arrangements, beneficial interest issued by securitization trusts.
• 14:38
  SPEAKER_01: All of these are forms of continuing involvement.
• 14:43
  SPEAKER_01: Um, one of the most common ones is obviously servicing.
• 14:46
  SPEAKER_01: Servicing is where I transfer like a loan to you, but I agree to do all the servicing, the cash processing.
• 14:53
  SPEAKER_01: I'm the one who follows up if there's a default.
• 14:56
  SPEAKER_01: Um, I'm the one that's sort of servicing the loan.
• 14:59
  SPEAKER_01: So continuing involvement doesn't necessarily preclude sale accounting.
• 15:03
  SPEAKER_01: It just means you need to consider it when going through all of the steps, the participating interest steps as well as the steps that we've been talking about.
• 15:12
  SPEAKER_01: You know, so for example, with the legal isolation analysis would continue continued involvement.
• 15:17
  SPEAKER_03: Okay.
• 15:17
  SPEAKER_03: So now that we've have a better understanding of continuing involvement, maybe we should jump back to legal isolation.
• 15:22
  SPEAKER_03: So in my experience with a lot of these transactions, companies typically get a legal opinion related to this assertion.
• 15:30
  SPEAKER_01: Yeah, that's right.
• 15:31
  SPEAKER_01: And and and the guidance talks about when you're getting a legal opinion is typically a wood-level legal opinion.
• 15:37
  SPEAKER_01: Um and what the opinion addresses will depend on the facts of the transaction.
• 15:42
  SPEAKER_01: So for example, sometimes the legal opinion will have to cover both whether or not the transfer is a true sale and whether the there is substantive consolidation.
• 15:51
  SPEAKER_01: Uh, what is substantive consolidation?
• 15:53
  SPEAKER_01: There's not an accounting term.
• 15:55
  SPEAKER_01: So, you know, don't worry about it for consolidation or 805.
• 15:59
  SPEAKER_01: It's not that.
• 15:59
  SPEAKER_01: It's um it's a legal concept.
• 16:01
  SPEAKER_01: It's the concept that if I transferred an asset to somebody, that if I went bankrupt, the person I transferred the asset would be consolidated into my bankruptcy estate.
• 16:12
  SPEAKER_01: And therefore, by consolidating the entity I transferred it to, the asset's not legally isolated because it's coming back for that.
• 16:19
  SPEAKER_03: Right.
• 16:20
  SPEAKER_01: Um, that's the concept of substantive consolidation.
• 16:22
  SPEAKER_01: Um, one really important thing about legal opinions is to make sure all of the relevant facts are contemplated in the opinion and review any assumptions that are made by counsel in rendering the opinion.
• 16:35
  SPEAKER_01: So that's very, very important.
• 16:37
  SPEAKER_03: Okay.
• 16:38
  SPEAKER_03: Very helpful.
• 16:39
  SPEAKER_03: So now that we've talked through legal isolation, let's move to the second condition for sale accounting.
• 16:44
  SPEAKER_01: All right.
• 16:44
  SPEAKER_01: Condition number two, the right to freely pledge your exchange.
• 16:48
  SPEAKER_01: So company, you know, after assessing legal isolation, the next thing you look at is does the transfer E, the person you'd sold the transfer the asset to, have the right to sell, pledge, exchange the transfer asset.
• 17:02
  SPEAKER_01: If they do, the criterion's better.
• 17:04
  SPEAKER_01: If the transferree is constrained, and that constraint would provide more than a trivial benefit to the transfer, then no sale accounting.
• 17:13
  SPEAKER_01: Strike.
• 17:13
  SPEAKER_01: We we we fail the um we failed the second criteria.
• 17:17
  SPEAKER_01: Um there's some special rules around this criteria for securitization entities.
• 17:20
  SPEAKER_01: Whoop, we're not gonna cover those.
• 17:22
  SPEAKER_01: Um, but you know, and you might find constraints either in the transfer agreement, you might find them in other agreements that are entered into contemporaneously, other agreements of continuing involvement.
• 17:34
  SPEAKER_01: So you have to look up for that.
• 17:35
  SPEAKER_01: Um, so so what are things that constrain a transfer and presumptively provide more than a trivial benefit?
• 17:42
  SPEAKER_01: The the the guidance gives you some examples.
• 17:44
  SPEAKER_01: So, for example, if I sold you an asset and you had to get my approval to sell it to someone else, that's good, you don't have the right to freely pledge your exchange.
• 17:53
  SPEAKER_01: If you have to come to me and I have to give you the approval, I can't unreasonably withhold the approval, that might not be a problem.
• 18:01
  SPEAKER_01: But if you can't sell it unless I say yes, that's a problem.
• 18:05
  SPEAKER_01: Um, if I tell you you can sell it, but you can only sell it to a very limited number of people, only in a very specific period of time.
• 18:14
  SPEAKER_01: No good.
• 18:14
  SPEAKER_01: No good.
• 18:15
  SPEAKER_01: You don't have control, you don't have the right to pledge your exchange.
• 18:18
  SPEAKER_01: Um, there are other things that aren't as intuitive.
• 18:21
  SPEAKER_01: So let's say I sell you an asset and it's not a readily obtainable asset, and I have the right to buy it back from you.
• 18:28
  SPEAKER_01: I have a call option.
• 18:29
  SPEAKER_01: Um, that would also constrain your ability to pledge your exchange because if you were to sell the asset and then I called it back, well, there would be a problem because you wouldn't have it and it's not readily obtainable, you wouldn't be able to get it.
• 18:41
  SPEAKER_01: So it would cause you to default on the call option.
• 18:44
  SPEAKER_01: So you're probably not going to really sell it because you don't want to run the risk of defaulting.
• 18:48
  SPEAKER_01: So there are also lists of things in the standard that don't necessarily create problems under the pledge exchange guide.
• 18:55
  SPEAKER_01: So one we already mentioned if you have to ask me permission to pledge your exchange, but I can't unreasonably withhold it, that's okay.
• 19:01
  SPEAKER_01: Um, if there's broad regulatory restrictions.
• 19:04
  SPEAKER_01: So for example, I own a debt security, I'm selling it to you, but that can only be, you know, it's a 144 debt security.
• 19:12
  SPEAKER_01: There's limitations on who can hold it, that doesn't create a problem.
• 19:15
  SPEAKER_01: That wasn't constraint that I created.
• 19:17
  SPEAKER_01: Um illiquidity, you know, that the the if there's not like an active quoted market.
• 19:22
  SPEAKER_01: Like if I sold you equity in a private company, for example, okay, it may be difficult for you to sell it and and you might have to go through a process, but I'm not constraining you doing that.
• 19:32
  SPEAKER_01: So things like that are examples of things that are not problems under that.
• 19:36
  SPEAKER_03: Okay.
• 19:37
  SPEAKER_03: I like to think about this as the transferee can do whatever they want with the asset.
• 19:41
  SPEAKER_01: Good way to think about it.
• 19:42
  SPEAKER_03: Okay.
• 19:42
  SPEAKER_03: So should we go to the third criteria now?
• 19:45
  SPEAKER_01: Yeah.
• 19:45
  SPEAKER_01: So two down, one to go.
• 19:46
  SPEAKER_01: We're on the home stretch now.
• 19:48
  SPEAKER_01: So this is the effective control.
• 19:50
  SPEAKER_01: So we've mentioned a couple of times that you know this is an effective control model.
• 19:54
  SPEAKER_01: Um, and so what you're looking for is do you maintain effective control over the asset?
• 19:59
  SPEAKER_01: Um, so we won't go through all of the effective control rules, but maybe a couple of them, right?
• 20:05
  SPEAKER_01: Just to highlight the concept.
• 20:06
  SPEAKER_01: So any agreement that provides the transfer, um, the unilateral right to cause someone to return assets that are either the same assets or substantially the same.
• 20:16
  SPEAKER_01: So if I'm entitled and obligated to repurchase the same or substantially the same asset for you before that asset matures, that maintains effective control.
• 20:26
  SPEAKER_01: Um any agreement that um would enable me to force you to give me that asset back, um, you know, a specific asset that gives me more than a trivial benefit, that maintains effective control because I can always get the asset back.
• 20:40
  SPEAKER_01: Um Yeah, there's also things like if um I sell you an asset and you have the right to make me buy it back and it's at a price that's so favorable that we know it's gonna get exercised, I still maintain effective control of that asset because I I know it's coming back.
• 20:55
  SPEAKER_01: So there's a lot more details on each one of those types of arrangements um in the standard.
• 21:01
  SPEAKER_01: But for the purpose of today, that's a good start around what effective control is.
• 21:05
  SPEAKER_01: Um, so similar to what we talked about in legal isolation and right to freely pledge or exchange, when thinking about whether you maintain effective control, you have to look at cast a broad net.
• 21:17
  SPEAKER_01: Look, do you is there a specific contractual provision that gives me effective control?
• 21:23
  SPEAKER_01: Or is it more indirect where I have a couple of different elements of continuing involvement?
• 21:29
  SPEAKER_01: And when you look at them all together in combination, I maintain effective control.
• 21:34
  SPEAKER_01: Um, so again, emphasis on you always have to really understand all the different forms of continuing involvement and and assess them both individually and collectively.
• 21:44
  SPEAKER_01: That's true of this criteria as it is of the other two.
• 21:47
  SPEAKER_03: Another area of judgment and gap.
• 21:49
  SPEAKER_01: Another area.
• 21:50
  SPEAKER_03: Okay.
• 21:51
  SPEAKER_03: Well, maybe Chip, can you help bring this concept to life and maybe give us some examples and some different types of transactions or agreements where we see the transfer?
• 22:00
  SPEAKER_03: Uh retain effective control?
• 22:01
  SPEAKER_01: Yeah.
• 22:02
  SPEAKER_01: So one good example, which we've touched on a couple of times, is call options.
• 22:05
  SPEAKER_01: If I sell you an asset uh and and I have the right to repurchase that asset, it's not readily obtainable.
• 22:11
  SPEAKER_01: That actually might create two strikes.
• 22:13
  SPEAKER_01: Um it might likely maintain effective control.
• 22:17
  SPEAKER_01: So we fail the third criteria.
• 22:18
  SPEAKER_01: And like we talked about, it also might prohibit you from really having the right to pledge your exchange because you need the asset in case I call it.
• 22:25
  SPEAKER_01: Uh as you said, you only need one striker out, but some things cause two strikes.
• 22:29
  SPEAKER_01: Um another very common one for those of you in the financial services space are repo agreements.
• 22:35
  SPEAKER_01: So repo agreements are agreements where the transfer transfers a financial asset, you know, typically like a high quality debt security, like a treasury bond, um in exchange for cash.
• 22:46
  SPEAKER_01: And at the same time, I agree to buy that treasury security back at a fixed price in the future.
• 22:51
  SPEAKER_01: Um, that would be an arrangement that would maintain effective control of that financial asset.
• 22:57
  SPEAKER_01: And so um we would not get sale accounting, you know.
• 23:00
  SPEAKER_01: So banks, dealers, other financial institutions, um, corporate investors, they, they, they, they very commonly use repos as ways to finance the security inventory, get short-term funding.
• 23:13
  SPEAKER_01: Um, so that's, you know, repos are certainly a big example that people cite of transactions that fail the effective control criteria.
• 23:21
  SPEAKER_01: Um, and so they're reported as secured borrowings.
• 23:24
  SPEAKER_03: Okay, great.
• 23:25
  SPEAKER_03: Well, we've covered a lot today.
• 23:27
  SPEAKER_03: We've talked about the scope of assets, the type of transactions that are covered by transfers under ASC 860.
• 23:34
  SPEAKER_03: We've gone through the three criteria that you need to meet sale accounting or derecognition.
• 23:40
  SPEAKER_03: So legal isolation, the right to freely pledge or exchange, and effective control.
• 23:45
  SPEAKER_03: And you mentioned the model, as we've said a number of times now, one strike and you're out.
• 23:50
  SPEAKER_03: And so if one criteria is not met, no sale accounting.
• 23:54
  SPEAKER_03: So maybe just going back to the beginning, as you can just re remind us again around what the difference is between getting sale accounting and not getting sale accounting.
• 24:03
  SPEAKER_01: Yeah.
• 24:03
  SPEAKER_01: Yeah.
• 24:04
  SPEAKER_01: So if I get through all the 860 criteria and we qualify for derecognition or sale accounting, I would you we record that as a sale.
• 24:12
  SPEAKER_01: So that means the transfer takes it off of their balance sheet.
• 24:16
  SPEAKER_01: They recognize any cash they received or other assets that they received as proceeds.
• 24:21
  SPEAKER_01: They would recognize any other liabilities that were incurred as a result of that transaction.
• 24:26
  SPEAKER_01: Generally, we record those at fair value.
• 24:29
  SPEAKER_01: And then we would book any gain or loss, you know, through through earnings.
• 24:32
  SPEAKER_01: That's the sale accounting.
• 24:34
  SPEAKER_01: So what if I don't get sale accounting, right?
• 24:36
  SPEAKER_01: So let's hit that one again.
• 24:38
  SPEAKER_01: So if I don't get sale accounting, asset stays on my balance sheet.
• 24:41
  SPEAKER_01: Um, I would still recognize any cash or assets or proceeds received, but I would recognize the liability along with any other liabilities that I incurred.
• 24:50
  SPEAKER_01: So it looks like I borrowed money and I pledged this asset as collateral.
• 24:54
  SPEAKER_01: And we would be here if we fail one of the three criteria or if we transferred an interest in an asset that didn't meet the participating interest guidance.
• 25:02
  SPEAKER_01: And the last thing to probably mention about that is in some cases, in addition to the asset saying on the balance sheet and be recording as a secure borrowing, you might have to reclassify that asset on your balance sheet from like securities to securities pledged.
• 25:16
  SPEAKER_03: Okay.
• 25:16
  SPEAKER_03: Well, that's really helpful.
• 25:18
  SPEAKER_03: That's a helpful recap.
• 25:19
  SPEAKER_03: We've covered a lot today.
• 25:20
  SPEAKER_03: So maybe the last thing, anything you want to highlight, but also where can our listeners find more information on this topic?
• 25:27
  SPEAKER_01: Yeah.
• 25:27
  SPEAKER_01: So the PWC transfers and servicing guy, we've mentioned that a couple of times on the podcast.
• 25:31
  SPEAKER_01: That that's a great resource.
• 25:33
  SPEAKER_01: Uh, there's a a chapter on scope, there's a chapter on participating interests, um, and there's a chapter on the three criteria that we discussed.
• 25:42
  SPEAKER_01: There's also a whole chapter on how to account for transactions that are sales, and a different chapter on ones with borrowing.
• 25:48
  SPEAKER_01: So there's a chapter on each of the topics that we talked about today.
• 25:51
  SPEAKER_01: Um, and maybe this is because I just came back from vacation from Iceland, but this is just the tip of the iceberg, right?
• 25:57
  SPEAKER_01: Uh, that what we covered today.
• 25:58
  SPEAKER_01: Um, and 860 provides guidance on other topics as well.
• 26:02
  SPEAKER_01: So, for example, how to account for servicing assets um and liabilities when you enter into when you sell assets and you have servicing arrangements.
• 26:10
  SPEAKER_01: Um so maybe a couple things to leave you with or leave our listeners with.
• 26:15
  SPEAKER_01: 860 is a prescriptive standard.
• 26:17
  SPEAKER_01: The specific provisions, the structure of the transaction, that matters.
• 26:22
  SPEAKER_01: Form to it matters when you're when you're valuing the 860.
• 26:26
  SPEAKER_01: Um, and again, we talked a lot about whether the transfer gets sale accounting or does not get sale accounting, but again, it's a symmetrical model.
• 26:34
  SPEAKER_01: So transfer ours need to think about 860, but also purchasers of assets need to think about 860 as well.
• 26:40
  SPEAKER_01: The last thing I'll leave you with is it's not always a day one analysis.
• 26:44
  SPEAKER_01: Events can happen after the transfer that result in the transfer or regain control of the asset.
• 26:50
  SPEAKER_01: And in that case, we'll have to re-recognize it.
• 26:53
  SPEAKER_01: We'll have to, and generally, what we do is we've re-recognize it at then current fair value.
• 26:58
  SPEAKER_03: Okay.
• 26:58
  SPEAKER_03: Well, I think that's a really important point that this isn't just one and done, that you it can require continuous assessment.
• 27:04
  SPEAKER_03: So thanks so much for joining me today, Chip, and sharing this great information to our listeners.
• 27:10
  SPEAKER_03: We hope you found this conversation informative and engaging, and stay tuned for our next episode in the series until take care.
• 27:18
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• 27:41
  SPEAKER_02: From Thought Leadership at PwC, I'm Heather Horn.
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