Chapter 3 — Accounting for Transfers of Financial Assets

3.4 Transferee's Right to Pledge or Exchange

3.4 Transferee’s Rights to Pledge or Exchange

3.4.1 General

3.4.1.1 Overview of Pledge or Exchange Condition

ASC 860-10

Conditions for a Sale of Financial Assets

40-5 A transfer of an entire financial asset, a group of entire financial assets, or a participating interest in an entire financial asset in which the transferor surrenders control over those financial assets shall be accounted for as a sale if and only if all of the following conditions are met: . . .

b. Transferee’s rights to pledge or exchange. This condition is met if both of the following conditions are met:

1. Each transferee (or, if the transferee is an entity whose sole purpose is to engage in securitization or asset-backed financing activities and that entity is constrained from pledging or exchanging the assets it receives, each third-party holder of its beneficial interests) has the right to pledge or exchange the assets (or beneficial interests) it received.

2. No condition does both of the following:

i. Constrains the transferee (or third-party holder of its beneficial interests) from taking advantage of its right to pledge or exchange

ii. Provides more than a trivial benefit to the transferor (see paragraphs 860-10-40-15 through 40-21).

If the transferor, its consolidated affiliates included in the financial statements being presented, and its agents have no continuing involvement with the transferred financial assets, the condition under paragraph 860-10-40-5(b) is met. . . .

Transferee’s Rights to Pledge or Exchange Transferred Financial Assets

40-15 Many transferor-imposed or other conditions on a transferee’s right to pledge or exchange both constrain a transferee from pledging or exchanging and, through that constraint, provide more than a trivial benefit to the transferor. Judgment is required to assess whether a particular condition results in a constraint. Judgment also is required to assess whether a constraint provides a more-than-trivial benefit to the transferor. If the transferee is an entity whose sole purpose is to engage in securitization or asset-backed financing activities, that entity may be constrained from pledging or exchanging the transferred financial assets to protect the rights of beneficial interest holders in the financial assets of the entity. Paragraph 860-10-40-5(b) requires that the transferor look through the constrained entity to determine whether each third-party holder of its beneficial interests has the right to pledge or exchange the beneficial interests that it holds. The considerations in paragraphs 860-10-40-16 through 40-18 apply to the transferee or the third-party holders of its beneficial interests in an entity that is constrained from pledging or exchanging the assets it receives and whose sole purpose is to engage in securitization or asset-backed financing activities.

40-16 A condition imposed by a transferor that constrains the transferee presumptively provides more than a trivial benefit to the transferor. A condition not imposed by the transferor that constrains the transferee may or may not provide more than a trivial benefit to the transferor. For example, if the transferor refrains from imposing its usual contractual constraint on a specific transfer because it knows an equivalent constraint is already imposed on the transferee by a third party, it presumptively benefits more than trivially from that constraint. However, the transferor cannot benefit from a constraint if it is unaware at the time of the transfer that the transferee is constrained.

40-16A In some circumstances in which the transferor has no continuing involvement with the transferred financial assets, some conditions may constrain a transferee from pledging or exchanging the financial assets. Paragraph 860-10-40-5(b) states that if the transferor, its consolidated affiliates included in the financial statements being presented, and its agents have no continuing involvement with the transferred financial assets, the condition under paragraph 860-10-40-5(b) is met. For example, if a transferor receives only cash in return for the transferred financial assets and the transferor, its consolidated affiliates included in the financial statements being presented, and its agents have no continuing involvement with the transferred financial assets, sale accounting is allowed under paragraph 860-10-40-5(b) even if the transferee entity is significantly limited in its ability to pledge or exchange the transferred assets.

40-21 As discussed in paragraphs 860-10-40-22 through 40-39, some rights or obligations to reacquire transferred financial assets, regardless of whether they constrain the transferee, may result in the transferor’s maintaining effective control over the transferred financial assets, thus precluding sale accounting under paragraph 860-10-40-5(c). For example, an attached call option in itself would not constrain a transferee who is able, by exchanging or pledging the asset subject to that call, to obtain substantially all of its economic benefits. However, an attached call option could result in the transferor’s maintaining effective control over the transferred asset(s) because the attached call option gives the transferor the unilateral ability to cause whoever holds that specific asset to return it.

Transferee Is Significantly Limited in Its Ability to Pledge or Exchange the Transferred Financial Assets With No Continuing Involvement

55-28 An entity transfers financial assets to a transferee that is significantly limited in its ability to pledge or exchange the transferred financial assets (the transferee is not an entity whose sole purpose is to engage in securitization or asset-backed financing activities). The transferor receives cash in return for the transferred financial assets, and has no continuing involvement with the transferred assets. The transfer described in this example meets the condition in paragraph 860-10-40-5(b).

55-29 While the condition in paragraph 860-10-40-5(b) is met in the example described in the previous paragraph, in general, for transfers in which the transferor does have any continuing involvement, an evaluation shall be made as to whether the condition in paragraph 860-10-40-5(b) has been met.

55-30 For a transfer to fail to meet the condition in paragraph 860-10-40-5(b), the transferee must be constrained from pledging or exchanging the transferred financial asset and the transferor must receive more than a trivial benefit as a result of the constraint.

For a transfer to be accounted for as a sale, the “pledge or exchange” condition in ASC 860-10-40-5(b) must be met. The objective of this condition is for the transferee to have the ability to obtain the economic benefits of the transferred financial asset by pledging or exchanging it. Paragraph 161 of FASB Statement 140 states:

The second criterion [ASC 860-10-40-5(b)] for a transfer to be a sale focuses on whether the transferee has the right to pledge or exchange the transferred assets. That criterion is consistent with the idea that the entity that has an asset is the one that can use it in the various ways set forth in Concepts Statement 6, paragraph 184 (quoted in paragraph 143 of this Statement). A transferee may be able to use a transferred asset in some of those ways but not in others. Therefore, establishing criteria for determining whether control has been relinquished to a transferee necessarily depends in part on identifying which ways of using the kind of asset transferred are the decisive ones. In the case of transfers of financial assets, the transferee holds the assets, but that is not necessarily decisive because the economic benefits of financial assets consist primarily of future cash inflows. The Board concluded that the ways of using assets that are important in determining whether a transferee holding a financial asset controls it are the ability to exchange it or pledge it as collateral and thus obtain all or most of the cash inflows that are the primary economic benefits of financial assets. As discussed in paragraph 173, if the transferee is [an entity whose sole purpose is to engage in securitization or asset-backed financing activities], the ultimate holders of the assets are the beneficial interest holders (BIHs), and the important rights concern their ability to exchange or pledge their interests.

Paragraph 169 of the Basis for Conclusions of FASB Statement 140 further explains that the key concept is “the ability [of the transferee] to obtain all or most of the cash inflows, either by exchanging the transferred asset or by pledging it as collateral.” To determine whether the condition in ASC 860-10-40-5(b) is met, an entity first considers whether it has any continuing involvement in the transferred financial assets. If the transferor, its consolidated affiliates included in the financial statements being presented, and its agents have no continuing involvement with the transferred financial assets other than standard representations and warranties, the condition in ASC 860-10-40-5(b) is met even if the transferee is prohibited, or significantly constrained, from pledging or exchanging the transferred financial assets or beneficial interests in the transferred financial assets (see ASC 860-10-40-16A and ASC 860-10-40-55-28 through 55-30). Under ASC 860-10, the lack of continuing involvement takes precedence in the evaluation of whether a transferee is able to pledge or exchange transferred financial assets. The theory is that if the transferor has no continuing involvement in transferred financial assets, the transferor can obtain no future benefit from the transferred financial assets and therefore should derecognize them in the absence of other conditions preventing sale accounting. However, in most cases, the transferor has continuing involvement in the transferred financial assets. In fact, it is unusual for the transferor not to have continuing involvement when it transfers financial assets to a securitization or asset-backed financing entity since these transactions are typically credit-enhanced through the transferor’s receipt of beneficial interests in the transferred financial assets.

If the transferor, its consolidated affiliates included in the financial statements being presented, or its agents have continuing involvement with the transferred financial assets, an entity must consider the following steps to determine whether the condition in ASC 860-10-40-5(b) is met:

Step 1 — Determine whether the evaluation focuses on the transferee’s ability to pledge or exchange (1) the transferred financial assets or (2) the third-party beneficial interests in the transferred financial assets.
Step 2 — Assess whether the transferee has rights to pledge or exchange the transferred financial assets (or third-party beneficial interests in the transferred financial assets). If yes, go to step 3. If no, the condition in ASC 860-10-40-5(b) is not met.
Step 3 — Evaluate whether there are any constraints on the transferee’s rights to pledge or exchange the transferred financial assets (or third-party beneficial interests in the transferred financial assets). If yes, go to step 4. If no, the condition in ASC 860-10-40-5(b) is met.
Step 4 — Determine whether the constraints on the transferee’s rights to pledge or exchange the transferred financial assets (or third-party beneficial interests in the transferred financial assets) provide a more than trivial benefit to the transferor. If yes, the condition in ASC 860-10-40-5(b) is not met. If no, the condition in ASC 860-10-40-5(b) is met.

The condition in ASC 860-10-40-5(b) is met unless (1) the transferee is constrained from pledging or exchanging the transferred financial assets (or third-party beneficial interests in the transferred financial assets) and (2) that constraint provides the transferor with a more than trivial benefit. Section 3.9 summarizes the effect that options to repurchase financial assets (and third-party beneficial interests in transferred financial assets) have on the evaluation of whether a transferee can pledge or exchange transferred financial assets.

3.4.1.2 Step 1: Perspective From Which Pledge or Exchange Condition Is Evaluated

If financial assets are transferred to an entity whose sole purpose is to engage in securitization or asset-backed financing activities, that entity is generally constrained from pledging or exchanging the assets it receives because they are pledged as collateral on beneficial interests issued by the transferee. Therefore, ASC 860-10 allows transferors to focus the pledge or exchange condition on the rights of third-party holders of beneficial interests in the transferred financial assets. That is, the transferor should “look through” the transferee entity to the third-party holders of beneficial interests in the transferred financial assets and determine whether those holders have rights to pledge or exchange their interests without being constrained from doing so. The ability of third-party beneficial interest holders to pledge or exchange their interests is the equivalent of a transferee’s rights to pledge or exchange the transferred financial assets themselves. Accordingly, a constraint on the transferee that issues those beneficial interests (i.e., the transferee is unable to pledge or exchange the financial assets received) does not mean that the transferor has retained control over the transferred financial assets.

To determine the perspective from which the pledge or exchange condition is evaluated, a transferor should consider whether, by design, the purpose of the transferee is to transfer interests in the financial assets received to investors by issuing beneficial interests in those assets. If that is the case, and the securitization or asset-backed financing entity that received the transferred financial assets is constrained from pledging or exchanging them, the condition in ASC 860-10-40-5(b) should focus on the rights of third-party holders of beneficial interests in the transferred financial assets. If, however, the transferee is not constrained from pledging or exchanging the financial assets received, the condition in ASC 860-10-40-5(b) would be met without the need to consider whether third-party beneficial interest holders can pledge or exchange their interests.

When the condition in ASC 860-10-40-5(b) focuses on the rights of third-party beneficial interest holders to pledge or exchange their interests, the following should be considered in the evaluation:

In two-step securitization transactions, the transferred financial assets for which beneficial interests have been issued represent the assets transferred from the BRSPE to the securitization entity. If an entity has transferred entire financial assets to a BRSPE, but that BRSPE transfers interests in those entire financial assets received to a securitization entity, those interests must meet the definition of a participating interest for sale accounting to be possible.
A transferor may need to “look through” more than one transferee to identify the third-party holders of beneficial interests in transferred financial assets (e.g., if an entity transfers financial assets to a multiseller conduit that is designed to sell interests in the assets it receives to third-party investors). The objective is to identify the ultimate third-party holders of beneficial interests in the transferred financial assets regardless of the number of entities that a transferor “looks through” in a securitization or asset-backed financing transaction. ASC 860-10 is clear that constraints on the ability to pledge or exchange financial assets received by entities designed solely as part of a securitization or asset-backed financing activity serve to protect the beneficial interest holders and do not preclude the condition in ASC 860-10-40-5(b) from being met. There is no limit on the number of “down-stream” entities the analysis “looks through” to identify the ultimate third-party beneficial interest holders.

Connecting the Dots

Assume that an entity transfers entire trade receivables to a BRSPE that, in turn, transfers those receivables to an unconsolidated intervening SPE whose sole purpose is to engage in securitization or asset-backed financing activities. Further assume that the intervening SPE transfers senior interests in the trade receivables received to multiple other SPEs that issue CP to third parties to finance such purchases. The intervening SPE is generally prohibited from taking any action with respect to the trade receivables received other than transferring senior interests in those receivables to the SPEs that issue CP. In addition, the SPEs that acquire those senior interests from the intervening SPE cannot freely pledge or exchange those interests since they must be pledged as collateral on the CP issued by these SPEs. If the evaluation of ASC 860-10-40-5(b) focused on the intervening SPE, this condition for sale accounting would not be met. However, it is appropriate to “look through” to the ultimate third-party beneficial interest holders in the transferred receivables, which are the investors in the CP issued by the SPEs that acquired interests from the intervening SPE. Provided that the investors in the CP are not restricted in their ability to pledge or exchange those interests, the condition in ASC 860-10-40-5(b) would be met for the transferor of the trade receivables. We have discussed this issue informally with the FASB staff.

Situations similar to the one described above can exist in resecuritization transactions. See Example 3-12 for an illustration.
A transferor only needs to consider whether third-party holders of beneficial interests may pledge or exchange their interests without being constrained from doing so. The fact that the transferor, its consolidated affiliates included in the financial statements being presented, or its agents are unable to pledge or exchange their beneficial interests in the transferred financial assets, or are constrained from pledging or exchanging those interests, has no impact on the evaluation of whether the condition in ASC 860-10-40-5(b) is met. There is no requirement that the transferor, its consolidated affiliates included in the financial statements being presented, or its agents be able to pledge or exchange any beneficial interests held. In many cases, such interests serve as a credit enhancement and may not be pledged or exchanged or can be pledged or exchanged only if certain conditions are met.

Connecting the Dots

Any involvement of an agent of a transferor is considered in the same manner as if the involvement was with the transferor. Therefore, any beneficial interests in transferred financial assets held by an agent on behalf of the transferor are not subject to the pledge or exchange condition in ASC 860-10-40-5(b). In transfers of financial assets by subsidiary entities, it is common for other entities within the same commonly controlled group to hold beneficial interests on behalf of the subsidiary-transferor.
In some cases, an entity involved in securitization or asset-backed financing activities may receive financial assets, or interests in financial assets, from multiple transferor entities. In those situations, the beneficial interests issued may represent interests in specified financial assets or interests in the entity as a whole. When beneficial interests represent interests in specified financial assets, entities can elect to apply either of the following views as an accounting policy in determining whether the condition in ASC 860-10-40-5(b) is met:
- “Asset view” — Only third-party holders of beneficial interests in the financial assets transferred by the transferor need to meet the pledge or exchange condition in ASC 860-10-40-5(b). According to this view, in securitization or asset-backed financing transactions involving multiple sellers, any beneficial interests received as proceeds by other third-party transferors are not relevant if those interests do not derive any of their cash flows from the financial assets transferred by the transferor.
- “Entity view” — All third-party holders of beneficial interests issued by a securitization or asset-backed financing entity must meet the condition in ASC 860-10-40-5(b). According to this view, in securitization or asset-backed financing transactions involving multiple sellers, any beneficial interests received as proceeds by other third-party transferors (i.e., those that are not consolidated affiliates or agents of the transferor) must be able to pledge or exchange their interests without being constrained from doing so to meet the condition in ASC 860-10-40-5(b).
The acceptability of these alternative views has been discussed informally with the FASB staff. Examples 3-8 and 3-12 illustrate the “asset view,” which we believe is most often applied in practice.

3.4.1.3 Step 2: Rights to Pledge or Exchange

The agreements involving transfers of financial assets will generally contain transfer or assignment provisions that indicate whether the transferee (or a third-party holder of beneficial interests in transferred financial assets) may pledge or exchange its interests. If the agreements indicate that a transfer, assignment, or pledge is prohibited, the condition in ASC 860-10-40-5(b) is not met. If the agreements involving the transfer are silent on the ability of the transferee (or a third-party holder of beneficial interests in transferred financial assets) to pledge or exchange its interests, the evaluation of whether the transferee (or a third-party holder of beneficial interests in transferred financial assets) has such rights is a legal determination that should be made on the basis of the relevant laws that would apply in the circumstances. The certification of a beneficial interest is not a prerequisite for meeting the condition in ASC 860-10-40-5(b).

3.4.1.4 Step 3: Constraints on Transferee’s Rights to Pledge or Exchange

ASC 860-10

Transferee’s Rights to Pledge or Exchange Transferred Financial Assets

40-17 All of the following are examples of conditions that both constrain the transferee and presumptively provide the transferor with more than trivial benefits:

A provision that prohibits selling or pledging a transferred loan receivable. This condition not only constrains the transferee but also provides the transferor with the more-than-trivial benefit of knowing who holds the financial asset (a prerequisite to repurchasing the financial asset) and of being able to block the financial asset from being transferred to a competitor for the loan customer’s business.
Transferor-imposed contractual constraints that narrowly limit timing or terms, for example, allowing a transferee to pledge only on the day assets are obtained or only on terms agreed to with the transferor.
Some rights or obligations to reacquire transferred financial assets or beneficial interests, including all of the following:

1. A freestanding call option written by a transferee to the transferor. Such an option may benefit the transferor and, if the transferred financial assets are not readily obtainable in the marketplace, is likely to constrain a transferee because the transferee might have to default if the call option was exercised and the transferee had pledged or exchanged the financial assets.

1a. A call option to repurchase third-party beneficial interests at the price paid plus a stated return if the third-party holders of its beneficial interests are constrained from pledging or exchanging their beneficial interests due to that call option.

2. A call option written by a transferee to the transferor that is sufficiently deep-in-the-money, if the transferred financial assets are not readily obtainable in the marketplace, because the transferee would be more likely to have to hold the assets to comply with a potential exercise of the call option.

3. A freestanding forward purchase-sale contract between the transferor and the transferee on transferred financial assets not readily obtainable in the marketplace would benefit the transferor and is likely to constrain a transferee.

4. Subparagraph superseded by Accounting Standards Update No. 2009-16.

40-18 All of the following are examples of conditions that presumptively would not constrain a transferee from pledging or exchanging the transferred financial asset:

A transferor’s right of first refusal on the occurrence of a bona fide offer to the transferee from a third party, because the right in itself does not enable the transferor to compel the transferee to sell the financial asset and the transferee would be in a position to receive the sum offered by exchanging the financial asset, albeit possibly from the transferor rather than the third party
A requirement to obtain the transferor’s permission to sell or pledge that is not to be unreasonably withheld
A prohibition on sale to the transferor’s competitor if other potential willing buyers exist
A regulatory limitation such as on the number or nature of eligible transferees (as in the circumstance of securities issued under Securities Act Rule 144A or debt placed privately)
Illiquidity, for example, the absence of an active market
Subparagraph superseded by Accounting Standards Update No. 2009-16.
Freestanding rights to reacquire transferred assets that are readily obtainable.

40-19 Judgment is required to assess the significance of some conditions. For example, a prohibition on sale to the transferor’s competitor would be a constraint if that competitor were the only potential willing buyer other than the transferor.

Transferee’s Right to Pledge or Exchange Transferred Financial Assets

55-26 The following provides implementation guidance on the application of the condition in paragraph 860-10-40-5(b) related to the transferee’s right to pledge or exchange transferred assets in certain circumstances and transactions, specifically:

Transferee is precluded from exchanging the transferred financial assets but has the unconstrained right to pledge them.
Transferee is significantly limited in its ability to pledge or exchange the transferred financial assets.
Transferor’s approval is required for transferee’s subsequent transfers or pledges.
Transactions involving Rule 144A securities.

Transferee Is Precluded From Exchanging the Transferred Financial Assets but Has the Unconstrained Right to Pledge Them

55-27 In a transaction in which a transferee (that is not an entity whose sole purpose is to engage in securitization or asset-backed financing activities) is precluded from exchanging the transferred financial assets but obtains the unconstrained right to pledge them, the determination of whether the sale condition in paragraph 860-10-40-5(b) is met depends on the facts and circumstances. In a transfer of financial assets, a transferee’s right to both pledge and exchange transferred financial assets suggests that the transferor has surrendered its control over those financial assets. However, more careful analysis is warranted if the transferee may only pledge the transferred financial assets.

Transferor’s Approval Required for Transferee’s Subsequent Transfers or Pledges

55-31 Judgment is necessary to determine whether a requirement to obtain the transferor’s permission to sell or exchange should preclude sale accounting. For example, in certain loan participation agreements involving transfers of participating interests, the transferor is required to approve any subsequent transfers or pledges of the interests in the loans held by the transferee. Whether that requirement would be a constraint that would prevent the transferee from taking advantage of its right to pledge or to exchange the transferred financial asset and, therefore, accounting for the transfer as a sale, depends on the nature of the requirement for approval.

55-32 A prohibition on sale to the transferor’s competitor may or may not constrain a transferee from pledging or exchanging the financial asset, depending on how many other potential buyers exist. If there are many other potential willing buyers, the prohibition would not be constraining. In contrast, if that competitor were the only potential willing buyer (other than the transferor), then the condition would be constraining.

Transactions Involving Rule 144A Securities

55-33 Issuing beneficial interests in the form of securities issued under Rule 144A presumptively would not constrain a transferee’s ability to transfer those beneficial interests for purposes of this Subtopic. The primary limitation imposed by Rule 144A is that a potential buyer must be a sophisticated investor. If a large number of qualified buyers exist, the holder could transfer those securities to many potential buyers and, thereby, realize the full economic benefit of the assets. In such circumstances, the requirements of Rule 144A would not be a constraint that precludes sale accounting under paragraph 860-10-40-5(b).

An entity must use judgment in determining whether a holder’s right to pledge or exchange transferred financial assets (or beneficial interests in the transferred financial assets) is constrained and whether that constraint affects the evaluation of the condition in ASC 860-10-40-5(b). The guidance on this topic in ASC 860-10-40-17 through 40-19, ASC 860-10-55-26 and 55-27, and ASC 860-10-55-31 through 55-33 should be considered.

As noted in ASC 860-10-55-27, the condition in ASC 860-10-40-5(b) is more likely not to be met if the transferee is unable to exchange (i.e., sell) a transferred financial asset. That is, if the transferee is only able to pledge the asset, the transferee’s ability to obtain access to the economic benefits of the transferred financial asset is significantly limited. See Q&A 3-44 for further discussion of what constitutes a pledge.

When a transferee is able to exchange a transferred financial asset (or third-party beneficial interest in transferred financial assets) but the entity’s ability to obtain the economic benefits of the asset is limited, an entity must consider whether the constraint is relevant to the evaluation of the condition in ASC 860-10-40-5(b). This will generally depend on whether the limitation is inherent in the asset being transferred or arises because of the transfer. The former is less likely to cause the condition in ASC 860-10-40-5(b) not to be met than the latter.

Certain limitations on a transferee’s ability to pledge or exchange transferred financial assets that arise from the nature of the transferred assets (or third-party beneficial interests in the transferred financial assets) presumptively do not prevent the condition in ASC 860-10-40-5(b) from being met. Examples of such limitations include the following:

Lack of liquidity for the transferred financial asset (see ASC 860-10-40-18(e)).
A regulatory limitation on the sale of beneficial interests in transferred financial assets (see ASC 860-10-40-18(d) and ASC 860-10-55-33).

Connecting the Dots

Limitations on the ability to transfer a financial asset that are inherent in the asset (i.e., that do not arise from the transfer) will generally not represent constraints that preclude a transfer from meeting the condition in ASC 860-10-40-5(b). However, this is not always true. For example, assume that a transferee would incur a significant negative tax consequence from further transferring a financial asset (e.g., a BOLI asset) because of how that subsequent transfer would be treated under income tax law. This would be likely to result in a constraint that prevents the condition in ASC 860-10-40-5(b) from being met.

As discussed in ASC 860-10-40-15, transferor-imposed constraints on an entity’s ability to pledge or exchange transferred financial assets (or third-party beneficial interests in transferred financial assets) that arise from the terms of the transfer generally cause the condition in ASC 860-10-40-5(b) not to be met. However, a condition that allows a transferee to pledge or sell transferred financial assets (or third-party beneficial interests in transferred financial assets) only with the transferor’s consent is not considered a constraint if such consent cannot be unreasonably withheld unless there is evidence to the contrary regarding how such a condition would be interpreted under the relevant laws governing this requirement.25 Other conditions representing constraints that would not be expected to cause the condition in ASC 860-10-40-5(b) not to be met include the following:

A transferor’s right of first refusal related to the occurrence of a bona fide offer to the transferee from a third party, because this right in itself does not allow the transferor to compel the transferee to sell the financial asset and the transferee would be in a position to receive the sum offered by exchanging the financial asset, albeit possibly from the transferor rather than the third party (see ASC 860-10-40-18(a)).26
A prohibition on a sale to a competitor of the transferor if other potential willing buyers exist (see ASC 860-10-40-18(c) and ASC 860-10-55-32).
A constraint that the transferor is not aware of at the time of the transfer (ASC 860-10-40-16).
Certain rights or obligations to reacquire the transferred financial assets (see below).

The following examples will generally represent constraints that preclude the transferor from meeting the condition in ASC 860-10-40-5(b):

The inability of the transferee to pledge or exchange the asset received without the transferor’s consent, which can be withheld for any reason.
Transferor-imposed contractual constraints that narrowly limit the timing or terms of pledges or exchanges (e.g., allowing a transferee to pledge or sell transferred financial assets only on the day those assets are received or only on terms the transferor specifically agrees to). See Examples 3-14 and 3-15 for related illustrations.
A prohibition on sale to the transferor’s competitor if there are no or only a few other willing buyers.
A constraint imposed by a third party if the transferor is aware of the constraint and would have imposed a similar constraint in the absence of the constraint’s existence.
Certain rights or obligations to reacquire the transferred financial assets.

The determination of whether rights or obligations to reacquire transferred financial assets constitute constraints that prevent the condition in ASC 860-10-40-5(b) from being met depend on the nature of such rights or obligations. Some rights and obligations to reacquire transferred financial assets (or third-party beneficial interests in transferred financial assets) represent constraints that prevent the condition in ASC 860-10-40-5(b) from being met. Other rights and obligations to reacquire transferred financial assets (or third-party beneficial interests in transferred financial assets) do not represent constraints; however, such rights or obligations could still prevent sale accounting because the transferor maintains effective control over the transferred financial assets (see Section 3.5). The table below discusses how rights and obligations to reacquire transferred financial assets (or third-party beneficial interests in transferred financial assets) affect the evaluation of the condition in ASC 860-10-40-5(b).

Table 3-5

Repurchase Feature	Discussion
A freestanding call option written by the transferee (or third-party beneficial interest holder) to the transferor that allows the transferor to repurchase the transferred financial assets (or third-party beneficial interests in the transferred financial assets). Note that while call options on beneficial interests may be freestanding options, they are generally considered attached to the beneficial interests.	If the financial assets or beneficial interests that may be repurchased are not readily obtainable, the freestanding call option would constrain the transferee because it would have to default on the option if it was exercised and the transferee had previously transferred the financial assets or beneficial interests. This is the case regardless of whether (1) the exercise price is fixed or variable or (2) the transferor asserts that exercise of the option is remote (unless that is due to the exercise price being deep-out-of-the-money as of the date the option is written). A freestanding call option would not constrain a transferee (or third-party beneficial interest holder) in the following situations: The call option requires net cash settlement or can be net-cash-settled at the option of the transferee (or third-party beneficial interest holder). See Example 3-13. The transferred financial assets or third-party beneficial interests are readily obtainable. Regardless of the exercise price, freestanding rights to reacquire assets that are readily obtainable presumptively do not constrain the holder of those assets. However, such options could still prevent sale accounting because the transferor may retain effective control over the transferred financial assets (see Section 3.5). As of the date the option is written, the exercise price is so far out-of-the-money that it is probable that the option would not be exercised. Note that such circumstances would be unusual.
An attached call option written by the transferee (or third-party beneficial interest holder) to the transferor that allows the transferor to repurchase the transferred financial assets (or beneficial interests). Unlike a freestanding option, an attached option is transferred with the asset if it is sold to a third party.	Attached call options generally do not constrain a transferee or third-party beneficial interest holder from pledging or exchanging the asset subject to the option because the holder can obtain all or substantially all of the economic benefits of the asset by transferring it to a third party that becomes subject to the call option. However, as discussed in ASC 860-10-40-21, attached call options generally cause the transferor to maintain effective control over the transferred financial assets (see Section 3.5.3).
A freestanding put option written by the transferor that allows the transferee to require the transferor to repurchase the transferred financial assets (or third-party beneficial interests in the transferred financial assets).	A freestanding put option generally does not constrain a transferee or third-party beneficial interest holder because it can forgo exercising the option and sell the asset to a third party. See Section 3.5.4 for discussion of the effect that freestanding put options have on the condition in ASC 860-10-40-5(c).
Freestanding forward contracts that require the transferor to repurchase transferred financial assets (or third-party beneficial interests in transferred financial assets).	Unless the financial assets (or beneficial interests) to be purchased are readily obtainable, regardless of whether the forward price is fixed or at fair value, the condition in ASC 860-10-40-5(b) is not met because the transferee (or beneficial interest holder) cannot pledge or exchange its interests and meet the resale requirement. If the financial assets to be repurchased by the transferor are readily obtainable, but they are the same or substantially the same as the transferred financial assets, sale accounting is generally still precluded because the condition in ASC 860-10-40-5(c) is not met. See Section 3.5.2 for further discussion of forward repurchase agreements.

The above table discusses unilaterally exercisable repurchase features. The determination of whether conditionally exercisable repurchase features constrain the transferee’s right to pledge or exchange the transferred financial assets depends on the circumstances (i.e., the nature of the condition and whether the transferred financial assets are readily obtainable). If such a feature is determined to constrain the transferee, the transferor should consider Section 3.4.1.5. Such conditionally exercisable repurchase features will generally not cause the condition in ASC 860-10-40-5(b) not to be met.

3.4.1.5 Step 4: Transferor’s Ability to Benefit From Constraints on a Transferee’s Rights to Pledge or Exchange

If a transferee can freely pledge or exchange the transferred financial assets (or third-party beneficial interests in the transferred financial assets) or any limitation is not a constraint as discussed in Section 3.4.1.4, the condition in ASC 860-10-40-5(b) is met. Otherwise, an entity must consider whether the constraint provides the transferor with a more than trivial benefit. The threshold for what constitutes a more than trivial benefit is extremely low. The focus is on whether there is any potential economic or other benefit to the transferor from a constraint on the transferee’s ability to pledge or exchange the transferred financial assets (or third-party beneficial interests in transferred financial assets). Therefore, any time a transferor has a unilaterally exercisable fixed-price option to repurchase transferred financial assets, such an option provides the transferor with a more than trivial benefit unless it is deep out-of-the-money when written. However, the mere fact that a repurchase option held by the transferor does not have a fixed exercise price does not mean that such an option does not provide the transferor with a more than trivial benefit. A transferor cannot assert that a more than trivial benefit does not exist because it does not intend to enforce a constraint (e.g., it does not have the funding to purchase the transferee’s interest).

If the constraint was imposed by the transferor, it would provide a more than trivial benefit to the transferor in the absence of compelling evidence to the contrary. (see ASC 860-10-40-16). We believe that it would be rare for an entity to conclude that a transferor-imposed constraint does not provide the transferor with a more than trivial benefit. In some cases, it may be clear whether a constraint not imposed by the transferor would provide the transferor with a more than trivial benefit; in other cases, an entity may need to use judgment in performing this assessment. As part of this evaluation, an entity should consider whether the transferor refrained from imposing a constraint because it knows that an equivalent constraint is already imposed by a third party. However, constraints that the transferor is not aware of cannot provide it with a more than trivial benefit (see ASC 860-10-40-16).

Connecting the Dots

Sale accounting is precluded if a transferee is constrained from selling or pledging transferred financial assets (or third-party beneficial interests in transferred financial assets) and the constraint, whether imposed by the transferor or a third party, provides a more than trivial benefit to the transferor. Rights or obligations to reacquire transferred financial assets (or third-party beneficial interests in transferred financial assets) may not constrain the transferee but may still cause the transferor to maintain effective control over the transferred financial assets under ASC 860-10-40-5(c). See Section 3.5 for more information.

3.4.2 Interpretive Guidance

3.4.2.1 Transition to ASU 2009-16

Q&A 3-43 Continued Relevance of QSPE Concept

Before ASU 2009-16, some transfers met the condition in ASC 860-10-40-5(b) because financial assets were transferred to QSPEs. ASU 2009-16 eliminated the QSPE concept. The transition provisions of ASU 2009-16 are prospective (i.e., they apply to transfers that occur after the effective date).

Question

Should an entity that transferred financial assets to a QSPE before adoption of ASU 2009-16 continue to evaluate whether the transferee is a QSPE?

Answer

Considering the transition provisions of ASU 2009-16, entities would continue to determine whether transferees are QSPEs. However, for practical purposes, if there was a substantive transaction or event (e.g., a modification of terms) that caused a transferee to no longer be a QSPE, the transferor could consider the change as resulting in a new transfer and apply the current guidance in ASC 860-10-40-5(b). Note that this Q&A would not be relevant to QSPEs that were consolidated upon adoption of ASU 2009-17.

3.4.2.2 Pledges of Financial Assets

Q&A 3-44 Meaning of Pledge

The condition in ASC 860-10-40-5(b) is met if each transferee (or third-party beneficial interest holder in transferred financial assets) has the right to “pledge or exchange” the assets (or beneficial interests) received and is not constrained from doing so.

Question

What is the meaning of “pledge” in ASC 860-10-40-5(b)?

Answer

A pledge exists only if the transferee can obtain all or nearly all of the economic benefits from the financial asset (i.e., the transferee can monetize and realize the benefits as if it sold the financial asset). For this purpose, the transferee would need to obtain 95 percent or more of the economic benefits from the financial asset. In contrast to a security interest, in a pledge, an entity generally transfers custody and legal title of the financial asset to the secured party, which generally can repledge the financial asset.

The granting of a security interest in a financial asset is not the same as pledging a financial asset as collateral. The ASC master glossary defines a security interest as “[a] form of interest in property that provides that upon default of the obligation for which the security interest is given, the property may be sold to satisfy that obligation.” Therefore, the condition in ASC 860-10-40-5(b) is not satisfied if a transferee is only able to grant a security interest in the financial asset. In a security interest, the counterparty is unable to repledge the financial asset because it must wait until a default on the obligation has occurred to take control of the asset.

3.4.2.3 Scope

Q&A 3-45 Transfers of Participating Interests

Question

Does the condition in ASC 860-10-40-5(b) apply to transfers of participating interests?

Answer

Yes. ASC 860-10-40-5(b) applies to all transfers of financial assets within the scope of ASC 860-10. ASC 860-10-40-5 and ASC 860-10-55-31 indicate that this condition applies in transfers of participating interests.

Q&A 3-46 Guarantee Fees

Conforming mortgage loans are often transferred in transactions that involve a guarantee provided by the FHLMC or FNMA. As guarantor, the FHLMC and FNMA receive guarantee fees from the coupon on transferred mortgage loans. The evaluation of ASC 860-10-40-5(b) for these transactions generally focuses on whether third-party beneficial interest holders have the right to pledge or exchange their interests.

Question

Does the condition in ASC 860-10-40-5(b) apply to guarantee fees receivable by the FHLMC or FNMA?

Answer

No. The definition of a beneficial interest in ASC 860-10-20 includes “premiums due to guarantors.” However, we do not believe that a transferor should conclude that a transfer of financial assets does not meet the condition in ASC 860-10-40-5(b) because the FHLMC or FNMA cannot pledge or exchange its guarantee fees or would be significantly constrained in doing so. The basis for this conclusion is that if the pledge or exchange condition were applied to the guarantee fees receivable by the FHLMC or FNMA, most transfers of mortgage loans involving the FHLMC or FNMA would fail to meet the conditions for sale accounting. We do not believe that this was the FASB’s intent. Rather, we believe that it is acceptable to focus on the FHLMC’s and FNMA’s guarantee obligation collectively, including the guarantee fees for accepting this obligation, and conclude that the obligation as a whole is not a beneficial interest in the transferred financial assets. The same conclusion would apply to any guarantee fees involved in GNMA securitization transactions. This conclusion should not, however, be applied by analogy to other transactions.

3.4.2.4 U.S. Risk Retention Requirements

Q&A 3-47 Application of ASC 860-10-40-5(b) to CMBS Securitization Transactions Subject to U.S. Risk Retention Rules

Commercial mortgage loans may be securitized into commercial mortgage-backed securities (CMBS). Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act contains risk retention rules that require sponsors to retain a specified percentage of the credit risk associated with commercial mortgage loans that are securitized into CMBS. Sponsors of issuances of CMBS are generally required to retain 5 percent of the credit risk of the underlying commercial mortgage loans securitized for a certain period after the securitization closing date. Such risk is retained by holding beneficial interests in the CMBS, which may consist of a 5 percent interest in each tranche of the CMBS, a subordinated interest in an amount equal to 5 percent of the fair value of all beneficial interests issued, or a combination of the two that is a 5 percent interest in the aggregate. A given transaction may have multiple sponsors; in such a transaction, each sponsor transfers commercial mortgage loans into the securitization but only one of the sponsors acts as the retaining sponsor under the rules (the “Retaining Sponsor”). During the risk retention period, the Retaining Sponsor and other permitted TPPs must hold the risk interest (the “Risk Retention Interest”) and may not transfer such interest, enter into certain credit hedges, or borrow against the interest on a full nonrecourse basis.

As an alternative to directly owning the Risk Retention Interest, the Retaining Sponsor may satisfy the risk retention requirements by having one or two TPPs purchase the most subordinate class or classes of securities issued in the offering in an amount equal to 5 percent of the fair value of all of the CMBS issued in the offering. In the event that the TPPs do not purchase enough subordinated interests in the CMBS to meet the full 5 percent fair value requirement, the Retaining Sponsor can satisfy the 5 percent risk retention requirement by retaining an incremental interest in the CMBS. The risk retention requirements cannot be met by a TPP owning other than subordinated interests in the CMBS.

In the event that a TPP is used to satisfy all or a portion of the 5 percent risk retention requirement, the TPP is subject to the same requirements to which the Retaining Sponsor would have been subject, including constraints on sale and certain restrictions on hedging and pledging on a nonrecourse basis. In particular, the TPP is generally precluded from pledging or exchanging its interests for five years. (Note that while certain pledges may be permissible, a TPP is unable to obtain nearly all of the economic benefits of its interests by pledging them on a nonrecourse basis.)

CMBS transactions typically occur through two-step securitization transactions. In a single-transferor CMBS, if the Retaining Sponsor entirely meets the risk retention requirements, the condition in ASC 860-10-40-5(b) would generally be met because third-party holders of beneficial interests in the CMBS would not be constrained from pledging or exchanging their interests. However, in the following two situations, from the transferor’s perspective, third-party owners of beneficial interests would be constrained from pledging or exchanging their interests:

In a single-transferor CMBS securitization transaction, if a TPP is used to meet the risk retention requirements, the TPP will be constrained from pledging or exchanging its subordinated interests.
In a multiple-transferor CMBS, even if TPPs are not used to meet the risk retention requirements, unless there is only a single Retaining Sponsor, the other sponsors will be constrained from pledging or exchanging the interests they own to meet the risk retention requirements.

For the question below, assume that (1) entire commercial mortgage loan receivables are transferred to a CMBS securitization entity and (2) the Retaining Sponsor is not required to consolidate the CMBS securitization entity.

Question

Do the constraints on the ability of a TPP or other sponsors in a CMBS securitization prevent a transferor from meeting the condition in ASC 860-10-40-5(b) for commercial mortgage loans transferred in CMBS securitization transactions subject to the risk retention requirements of Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act?

Answer

No. In 2017, the Securities Industry and Financial Markets Association (SIFMA) submitted a preclearance letter to the SEC’s Office of the Chief Accountant regarding this question. In response, the staff of the SEC’s Office of the Chief Accountant indicated that it would not object to SIFMA’s conclusion that the condition in ASC 860-10-40-5(b) is met regardless of the restrictions imposed by U.S. law on the ability of a TPP or other sponsor of a CMBS securitization transaction to pledge or exchange its interests during the risk retention period. The staff did not say why it did not object to this view but indicated that its decision was based on the unique facts and circumstances associated with the regulation of the U.S. securitization market. The staff further noted that the conclusion cannot be analogized to.

Although the staff did not give its rationale, we believe that the basis for its view may be that an entity would consider the TPP or other sponsors in CMBS securitization transactions to represent agents of the transferor in performing the evaluation under ASC 860-10-40-5(b). As discussed in Section 3.4.1.2, agents of a transferor do not need to be able to pledge or exchange their interests to meet the condition in ASC 860-10-40-5(b).

3.4.2.5 Reassessment

Q&A 3-48 Change in Assessment After the Transfer Date

Question

Can the evaluation of the condition in ASC 860-10-40-5(b) change after the transfer date?

Answer

Yes. The condition in ASC 860-10-40-5(b) is typically evaluated as of the transfer date and does not change. However, in the following circumstances, this condition could change after the transfer date:

The contractual terms of the transfer change in such a way that the transferee (or third-party beneficial interest holder) becomes constrained from pledging or exchanging its assets or is no longer constrained from doing so.
A change in law causes a transferee (or third-party beneficial interest holder) to become constrained.
A constraint included in the terms of the transfer expires after the passage of time.

In the absence of a substantive modification to the terms of a transfer, the assessment of whether a constraint provides the transferor with a more than trivial benefit is performed only as of the transfer date and does not change because of changes in market prices. This view has been confirmed in discussions with the staff of the SEC’s Office of the Chief Accountant. However, if, after the transfer date, the transferor determines that a constraint does provide it with a more than trivial benefit and there were no amendments to the agreements involving the transfer, the benefit was more than trivial as of the transfer date and sale accounting therefore was inappropriate as of this date. This is because any benefit identified after the transfer date was a potential benefit as of the transfer date.

Footnotes

If the contractual documents specifically state that the consent cannot be unreasonably or unduly withheld and there are no other factors indicating that the consent constrains the transferee, the consent does not result in a constraint. A consent would result in a constraint if the transaction documents do not specifically state that the consent may not be unreasonably or unduly withheld.

However, if the transferor (or a consolidated affiliate included in the financial statements being presented or an agent) has the right to require the asset be put up for sale, the combination of this right and the right of first refusal would place the transferor in a position to unilaterally cause the return of specific transferred financial assets and the condition in ASC 860-10-40-5(c) would not be met.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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.