6.2 Evaluation of Silos

A silo will typically exist, and should be considered for consolidation separately from the legal entity as a whole, when the following characteristics are present:

Essentially all of the assets, liabilities, and equity (if any) related to the subset of activities or assets are separate from the remainder of the legal entity.
Essentially none of the liabilities or claims associated with the subset of assets (activities) being evaluated are payable from the remainder of the assets of the legal entity.
The host entity is a VIE.

6.2.1 The “Essentially All/Essentially None” Threshold

A silo will typically exist when the obligations or claims of the holder of a variable interest in specified assets are not commingled with the obligations or claims of the holders of other variable interests in specified assets or other interests in the legal entity as a whole. To this effect, ASC 810-10-25-58 indicates that a portion of the legal entity should be treated as a silo if essentially all of the assets, liabilities, and equity (if applicable) related to the subset of activities or assets being evaluated are separate from the legal entity and are specifically identifiable. That is, a portion of the legal entity should be treated as a silo if essentially none of the returns of the subset of assets or activities being evaluated can be used by the host entity and essentially none of the liabilities or claims associated with the subset of assets or activities being evaluated are payable from the assets of the host entity. “Essentially all” is not specifically defined; however, we have generally interpreted it to mean that 95 percent or more of the assets, liabilities, and equity of the potential silo are separate from the legal entity and that the related expected losses and expected residual returns inure to the interest holders in the potential silo.

The purpose of the “essentially all/essentially none” threshold is to limit silo identification to instances in which both:

The holder of a liability or other interest in the specified assets or activities does not have the ability to look to the legal entity as a whole for compensation if it has a loss in value or cash flows, and the holder’s risk and return exposure is limited to the specifically identified asset or group of assets.
The legal entity as a whole does not have a significant legal claim on the specified assets or group of assets and is not dependent on the returns of the specified assets to satisfy other claims on the legal entity as a whole. That is, the second condition that must be met for a potential silo to be present is that the assets are segregated from the general claims of the legal entity as a whole and the legal entity as a whole essentially does not participate in changes in fair value or cash flows associated with those assets.

The second characteristic distinguishes interests in specified assets that should be viewed as silos from other interests in specified assets that would be analyzed under ASC 810-10-25-55 and 25-56 (see Section 4.3.11) as part of the host entity.

Example 6-1

Assume that a lessor entity is formed and capitalized with $4 of equity and two $98 loans that have recourse to the entity (the loans are cross-collateralized) and uses the proceeds to purchase two $100 buildings. The entity leases each of the buildings to unrelated lessees. Each lease is classified as a sales-type lease under ASC 842 because it (1) includes a fixed-price purchase option that is reasonably certain to be exercised and (2) provides a residual value guarantee to the lessor entity that, in combination with the present value of the lease payments, exceeds substantially all of the fair value of the underlying building. Assume also that the entity as a whole is a VIE because it lacks sufficient equity investment at risk.

Each sales-type lease represents a variable interest in specified assets because the lease provides the lessee with the ability to participate only in the economic performance of the specified building that is subject to the lease agreement. However, no silos exist because each building is not essentially the only source of payment for the entity’s debt. The expected losses and residual returns of each of the buildings do not inure to a specified liability (the debt, being cross collateralized, absorbs expected losses of the whole entity) or to specified other interests.

Example 6-2

Assume that a lessor entity is formed and capitalized with $4 of equity from two unrelated investors. The entity obtains third-party financing in the form of two $98 nonrecourse loans (Loans A and B) and uses the proceeds of Loan A to purchase Building A for $100 and the proceeds of Loan B to purchase Building B for $100. The rental cash flows from Building A can only be used to repay Loan A, and the rental cash flows from Building B can only be used to repay Loan B. The equity is separate from the overall entity, specifically identifiable, and linked to each building and loan of the entity. The entity leases each of the buildings to unrelated lessees. Each lease is classified as a sales-type lease under ASC 842 because it (1) includes a fixed-price purchase option that is reasonably certain to be exercised and (2) provides a residual value guarantee to the lessor entity that, in combination with the present value of the lease payments, exceeds substantially all of the fair value of the building.

In this example, the entity as a whole does not have any substantive equity investment at risk, because each class of equity participates only in the profits and losses of the building to which it relates. The equity, loan, fixed-price purchase option, and residual value guarantee for each building absorb essentially all of the variability of the specified building, and essentially none of the variability in the specified building accrues to the entity as a whole. Thus, because the essentially all/essentially none criteria have been met, two separate silos exist. Each silo consists of a building, its related nonrecourse debt, and an allocation of equity.

6.2.2 Determining Whether a Host Entity Is a VIE

For a silo to exist, a reporting entity must determine that the legal entity being evaluated for consolidation is a VIE. However, as discussed in ASC 810-10-25-55 through 25-57, variability that is absorbed by a variable interest in specified assets or by a silo (explained in more detail below) is generally excluded from the legal entity before the assessment of whether the host entity itself is a VIE. Because a silo is reflective of variable interests in specified assets, the variability associated with the silo must be excluded from the legal entity before an assessment of whether the legal entity is a VIE can be performed. However, a silo cannot exist if the legal entity is not a VIE.

In determining whether a silo exists, a reporting entity should, as part of its evaluation of the sufficiency of the equity investment at risk and of the primary beneficiary associated with the host entity, exclude the variability associated with the silo if the first two conditions noted in Section 6.2 have been met. Similarly, the reporting entity can deduct the fair value of the silo’s assets, regardless of whether the silo has a primary beneficiary. In evaluating whether the host entity is a VIE, the reporting entity must exclude the variability associated with specified assets absorbed by the holder of the variable interest in the specified assets (see Section C.3.6 for further discussion of this calculation).

Example 6-3

Entity A’s balance sheet is as follows (on a fair value basis):

Reporting Entity B leases a commercial real estate asset that is approximately 59 percent of the fair value of Entity A’s assets. The remaining assets are cash and other assets. The lease contains a first-loss residual value guarantee of the building and a fixed-price purchase option to acquire the property for the option price at the end of the lease term. The lease is considered an interest in specified assets under ASC 810-10-25-55. Reporting Entity B (the lessee) does not have any other interests in A. The debt of $155 has full recourse to the building in the event of default.

The building and debt are considered a silo because (1) B is required to provide a first-loss residual value guarantee if the fair value of the leased building is below the option price; (2) the debt, which is only recourse to the building, represents essentially all (greater than 95 percent) of the building’s financing ($155 of debt ÷ $160 of building = 97%); and (3) all of the residual returns associated with the building inure to the lessee because of the fixed-price purchase option in the lease.

After the amounts associated with the silo (building and debt) are removed, the assets are $110 and the liabilities are $15. On the basis of a qualitative assessment, it is determined that A’s equity at risk is sufficient. As long as A has not met the two other conditions in ASC 810-10-15-14, A would not be a VIE. Therefore, since A (exclusive of the silo) is not a VIE, B does not need to consider whether it should consolidate the silo.

Some have asserted that the requirement to exclude variability absorbed by variable interests in specified assets, or silos, from the legal entity before the evaluation of whether the host entity is a VIE, effectively permits the conclusion that the legal entity as a whole is not a VIE and obviates the need for an assessment of whether identified silos must be consolidated on their own. This is because if a silo exists, once it is excluded from the legal entity as a whole, the host entity that remains after the potential silo is excluded is often a shell company with little or no activities of its own. Because a shell company, by definition, needs little or no equity investment at risk to conduct its activities, and few, if any, decisions must be made to direct the activities that will significantly affect its economic performance, some have asserted that the characteristics in ASC 810-10-15-14(a) and (b) are not present, and accordingly, that the legal entity as a whole will not be a VIE.

We have generally disagreed with this assertion because it would effectively render the silo guidance irrelevant. The purpose of that guidance is to identify situations in which segregated portfolios of activities have been aggregated into a single legal entity with the potential goal of avoiding consolidation by the reporting entity that would otherwise be the primary beneficiary of an individual segregated portfolio. Furthermore, if more than one portfolio of activities is conducted in a single legal entity, but the power to direct those activities and the risks and rewards associated with the activities have been isolated from one another, the variable interests in specified assets, in the aggregate, may absorb essentially all of the economic performance of the legal entity as a whole while no individual variable interest participates significantly in the profits and losses (see Section 5.2.2.1), or has the power to direct the activities, of the legal entity as a whole. Such a scenario would be strong evidence that the characteristics in ASC 810-10-15-14(a) or (b) are present and, accordingly, that the legal entity as a whole is a VIE. If a contrary conclusion were reached, the legal entity as a whole would be a voting interest entity. Since the silo concept does not exist for voting interest entities and, therefore, the silos would never be considered for consolidation, we do not believe this would be an appropriate outcome.

SIFMA and AMIAPG formally discussed this concept with the SEC staff in the context of international series funds in which each series represents a silo. After those discussions, SIFMA and AMIAPG sent a letter in January 2016 to the SEC staff to confirm the staff’s views on determining whether the host entity is a VIE. The letter also generally confirmed our view above and states, in part:

If the individual series funds do not meet the definition of a legal entity for consolidation purposes, then the umbrella should be assessed to determine whether it is a voting interest entity or a variable interest entity (VIE). In performing this assessment, the guidance on interests in specified assets and silos in ASC 810-10-25-55 through 25-58 should be applied.

Accordingly, if the umbrella has no assets, liabilities or equity other than that which relates to individual series (e.g., the fair value of the specified assets of each of the individual series within the umbrella is not more than half of the total fair value of the umbrella’s assets) the SEC Staff would not object to a view that the umbrella is a VIE. Under this view, the variable interests in specified assets (i.e., the equity of each series) would generally not represent equity investment at risk of the umbrella for purposes of applying the guidance in ASC 810-10-15-14. Consequently, the umbrella would meet the condition of ASC 810-10-15-14b since interests other than equity investment at risk (i.e., equity of each series) provide the holders of that investment with power, and, accordingly, the umbrella would be considered a VIE.

If the umbrella is a VIE, then each silo (i.e., individual series fund) would be evaluated for consolidation as a separate VIE in accordance with ASC 810-10-25-57.

The letter continued to state, in part:

The SEC Staff noted that preparers with views that differ from those outlined above (e.g., preparers that intend to continue to apply an alternative view regarding the assessment of equity-at-risk at the umbrella that results in a conclusion that the umbrella has equity consistent with a voting interest entity) are encouraged to formally consult with the SEC Staff to review their specific facts and circumstances.

Although the SEC staff did not formally object to an alternative view that the host entity could be considered a voting interest entity in these circumstances, on the basis of comments made by the SEC staff, we do not believe that a public company should take this position without formal consultation with the staff. This guidance applies to private companies as well.

Because a silo cannot be a VIE unless the host entity is a VIE, if it is determined that the host entity is not a VIE, the silo would no longer be viewed as a separate entity, and the entire entity would be evaluated for consolidation under other consolidation guidance. We believe that if the host entity is a VIE, the silo will generally be a VIE as well and that a primary-beneficiary analysis should therefore be performed for both the silo and host entity (see Section 6.3). To the extent that a reporting entity believes that a silo is not a VIE, the reporting entity should also consider consulting with its professional accounting advisers.

6.2.3 Silos in the Insurance and Asset Management Industries

Given the nature of the essentially all/essentially none characteristics described in Section 6.2.1, the existence of silos tends to be fairly limited outside of the insurance and asset management industries. In the insurance industry, the regulatory and legal constructs are designed and commonly used to reduce the regulatory and financial burden on industry participants by allowing for the creation of a single legal entity while legally segregating separate and distinct pools of activities or assets from one another. In such instances, the activities of each pool are conducted on behalf of variable interest holders in the individual pools. Specifically, it is common for reinsurers to use “segregated cell structures” (commonly referred to as “rent a cell” or “rent a captive”) to allow investors and reinsurers to participate in specific pools of insurance risk without needing to establish a new insurance company for each pool. Instead, the larger legal entity that houses all of the pools is the only legal entity that must establish itself as an insurer.

Similarly, in the asset management industry it is common to use a “series trust” structure to allow for the creation of new investment fund “series” within the larger series trust to provide shared use of the series trust infrastructure while also letting holders of shares issued by each series participate only in the economic performance of the series that has issued their shares. See Section 3.2.1 for further discussion of series trusts.

It is also our experience that in segregated cell companies, the legal or regulatory construct that allows for the effective segregation of the various pools of activities also causes the legal entity as a whole to be a VIE. This is because although the legal entity as a whole typically issues a nominal amount of common shares, substantially all of the equity interests of the cell company are issued by individual cells, and such equity interests participate only in the returns and losses of the issuing cell. Thus, in the evaluation of the legal entity as a whole to ascertain whether it is a VIE, the legal entity as a whole is typically lacking any substantive equity investment at risk since if a legal entity is composed almost entirely of various cells, no individual group of equity meets the requirement in ASC 810-10-15-14(a)(1) that equity investments participate significantly in the legal entity’s profits and losses (see Section 5.2.2.1). Similarly, because essentially none of the returns of the cell accrue to the legal entity as a whole, the legal entity as a whole typically does not have any substantive activities once the activities of the cells have been stripped out.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.