2.13 Subordinated Financial Support

Subordinated financial support refers to a variable interest that absorbs a portion of a legal entity’s expected losses. If the terms of the arrangement cause the variable interest to absorb expected losses before or at the same level as the most subordinated interests (e.g., equity, subordinated debt), or the most subordinated interests are not large enough to absorb the entity’s expected losses, the variable interest would generally be considered subordinated financial support. Examples may include non-investment-grade debt, contracts with terms that are not normal or customary, guarantees, derivatives, or a commitment to fund losses. The determination of whether a variable interest is subordinated financial support will be based on how that interest absorbs expected losses compared with other variable interests in a legal entity.

Understanding which variable interests constitute subordinated financial support can help a reporting entity determine the following in its evaluation under the VIE model:

• Which party has provided a potential VIE’s subordinated financial support in the evaluation of whether the potential VIE qualifies for the business scope exception (see Section 3.4.4.9).
• Whether the potential VIE’s total equity investment at risk is sufficient to permit the legal entity to finance its activities without additional subordinated financial support (see Section 5.2.3).
• Whether a de facto agency relationship exists (see Section 8.2.3.1).