Chapter 3 — Accounting for Transfers of Financial Assets

3.5 Effective Control

3.5.1 General

3.5.1.1 Overview of Effective-Control 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: . . .

c. Effective control. The transferor, its consolidated affiliates included in the financial statements being presented, or its agents do not maintain effective control over the transferred financial assets or third-party beneficial interests related to those transferred assets (see paragraph 860-10-40-22A). A transferor’s effective control over the transferred financial assets includes, but is not limited to, any of the following:

1. An agreement that both entitles and obligates the transferor to repurchase or redeem the transferred financial assets before their maturity (see paragraphs 860-10-40-23 through 40-25)

2. An agreement, other than through a cleanup call (see paragraphs 860-10-40-28 through 40-39), that provides the transferor with both of the following:

i. The unilateral ability to cause the holder to return specific financial assets

ii. A more-than-trivial benefit attributable to that ability.

3. An agreement that permits the transferee to require the transferor to repurchase the transferred financial assets at a price that is so favorable to the transferee that it is probable that the transferee will require the transferor to repurchase them (see paragraph 860-10-55-42D).

40-5A A repurchase-to-maturity transaction shall be accounted for as a secured borrowing as if the transferor maintains effective control (see paragraphs 860-10-40-24 through 40-24A).

To achieve sale accounting for a transfer of entire financial assets or participating interests, the transferor cannot maintain effective control over the transferred assets. Effective control is maintained in the following situations:

Forward repurchase agreement — The transferor is entitled and obligated to repurchase (1) the transferred financial assets or assets that are substantially the same before their maturity or (2) third-party beneficial interests in the transferred financial assets. See Section 3.5.2 and 3.6.5 for further discussion.
Call option held by transferor — The transferor has the unilateral ability to cause the transferee to return specific financial assets (or third-party beneficial interests in transferred financial assets) through an agreement other than a cleanup call option, and this right provides the transferor with a more than trivial benefit. See Sections 3.5.3 and 3.9 for further discussion.
Put option held by transferee — The transferee has the unilateral ability to cause the transferor to repurchase specific financial assets (or third-party beneficial interests in transferred financial assets) at a fixed price that is so favorable on the date the option is written that exercise of the option is probable. See Sections 3.5.4 and 3.9 for further discussion.

A transferor may need to use judgment to determine whether it maintains effective control over transferred financial assets. In exercising such judgment, the transferor must evaluate whether maintaining such control results from a combination of agreements. When an entity transfers financial assets to a transferee whose sole purpose is to engage in securitization or asset-backed financing activities, the evaluation must take into account whether the transferor maintains effective control over both (1) the transferred financial assets and (2) the third-party beneficial interests in the transferred financial assets. The transferor needs to consider whether it maintains effective control over third-party beneficial interests because the sale accounting conditions are applied by using the beneficial interests as a proxy for the transferred financial assets.

3.5.1.2 Agreements Made Contemporaneously With or in Contemplation of a Transfer

As discussed in Section 3.1.1.3, the recognition of financial assets and financial liabilities should not be affected by the sequence of transactions that result in their acquisition or incurrence unless the effect of those transactions is to maintain effective control over a transferred financial asset. Therefore, ASC 860-10-40-4(c) requires entities to consider all arrangements or agreements made contemporaneously with, or in contemplation of, a transfer, even if they were not entered into at the time of the transfer. As discussed in Section 3.5.1.3, the transferor must consider arrangements or agreements made contemporaneously with, or in contemplation of, a transfer that were entered into with consolidated affiliates and agents of the transferor.

Arrangements or agreements entered into after the transfer date should generally result in a reassessment of the sale accounting conditions unless the changes to the terms of the prior transfer are not substantive. This is the result of the “stickiness” aspect of the sale accounting guidance in ASC 860-10. The guidance in ASC 860-10 on rerecognizing financial assets applies if an amendment or change to the terms of a transfer causes the transferor to have effective control over transferred financial assets. See further discussion in Section 4.3.

There may be a significant amount of time between the original transfer date and the date an agreement is entered into between the transferor and transferee that causes the transferor to have effective control over previously sold financial assets. Although there may be a substantive business purpose for entering into such an agreement, it is extremely difficult to account for such an agreement separately from the transfer of the related financial assets. As a result, the accounting should be the same as when conditional repurchase features become unconditional (i.e., the guidance on rerecognizing previously sold financial assets applies).

3.5.1.3 Involvement of Consolidated Affiliates and Agents

ASC 860-10

Involvement of Agents

40-22A Paragraph 860-10-40-4 states that, to assess whether the transferor maintains effective control over the transferred financial assets, all continuing involvement by the transferor, its consolidated affiliates included in the financial statements being presented, or its agents shall be considered continuing involvement by the transferor. When assessing effective control, the transferor only considers the involvements of an agent when the agent acts for and on behalf of the transferor. If the transferor and transferee have the same agent, the agent’s activities on behalf of the transferee shall not be considered in the transferor’s evaluation of whether it has effective control over a transferred financial asset. For example, an investment manager may act as a fiduciary (agent) for both the transferor and the transferee; therefore, the transferor need only consider the involvements of the investment manager if it is acting on its behalf.

Under ASC 860-10-40-22A, in evaluating whether effective control over transferred financial assets has been maintained, a transferor must consider any continuing involvement of (1) consolidated affiliates included in the financial statements being presented, and (2) its agents, in the same manner in which the transferor would consider its own direct continuing involvement. As discussed in Section 3.1.3.4, a transferor considers the involvement of an agent only when it acts for and on behalf of the transferor.

3.5.2 Forward Contracts

3.5.2.1 Forward to Repurchase Before Maturity

ASC 860-30 — Glossary

Repurchase Agreement

An agreement under which the transferor (repo party) transfers a financial asset to a transferee (repo counterparty or reverse party) in exchange for cash and concurrently agrees to reacquire that financial asset at a future date for an amount equal to the cash exchanged plus or minus a stipulated interest factor. Instead of cash, other securities or letters of credit sometimes are exchanged. Some repurchase agreements call for repurchase of financial assets that need not be identical to the financial assets transferred.

Repurchase Agreement Accounted for as a Collateralized Borrowing

A repurchase agreement (repo) refers to a transaction in which a seller-borrower of securities sells those securities to a buyer-lender with an agreement to repurchase them at a stated price plus interest at a specified date or in specified circumstances. A repurchase agreement accounted for as a collateralized borrowing is a repo that does not qualify for sale accounting under Topic 860. The payable under a repurchase agreement accounted for as a collateralized borrowing refers to the amount of the seller-borrower’s obligation recognized for the future repurchase of the securities from the buyer-lender. In certain industries, the terminology is reversed; that is, entities in those industries refer to this type of agreement as a reverse repo.

ASC 860-10

Effective Control Through Both a Right and an Obligation

40-23 Although paragraph 860-10-40-5 sets forth criteria that must be met to achieve sale accounting, this guidance addresses criteria that must be met for a transfer to fail the condition in paragraph 860-10-40-5(c) through an agreement of the type described in paragraph 860-10-40-5(c)(1) and thus preclude sale accounting and result in accounting for the transfer as a secured borrowing.

40-24 An agreement that both entitles and obligates the transferor to repurchase or redeem transferred financial assets from the transferee maintains the transferor’s effective control over those assets as described in paragraph 860-10-40-5(c)(1), if all of the following conditions are met:

The financial assets to be repurchased or redeemed are the same or substantially the same as those transferred. To be substantially the same, the financial asset that was transferred and the financial asset that is to be repurchased or redeemed need to have all of the following characteristics:
1. The same primary obligor (except for debt guaranteed by a sovereign government, central bank, government-sponsored enterprise or agency thereof, in which circumstance the guarantor and the terms of the guarantee must be the same)
2. Identical form and type so as to provide the same risks and rights
3. The same maturity (or in the circumstance of mortgage-backed pass-through and pay-through securities, similar remaining weighted-average maturities that result in approximately the same market yield)
4. Identical contractual interest rates
5. Similar assets as collateral
6. The same aggregate unpaid principal amount or principal amounts within accepted good delivery standards for the type of security involved. Participants in the mortgage-backed securities market have established parameters for what is considered acceptable delivery. These specific standards are defined by the Securities Industry and Financial Markets Association and can be found in Uniform Practices for the Clearance and Settlement of Mortgage-Backed Securities and Other Related Securities, which is published by the Securities Industry and Financial Markets Association.
See paragraph 860-10-55-35 for implementation guidance related to these conditions.
Subparagraph superseded by Accounting Standards Update No. 2011-03.
The agreement is to repurchase or redeem the financial assets before maturity, at a fixed or determinable price.
The agreement is entered into contemporaneously with, or in contemplation of, the transfer.

40-25 With respect to the condition in (a) in paragraph 860-10-40-24 to maintain effective control under the condition in paragraph 860-10-40-5(c) as illustrated in paragraph 860-10-40-5(c)(1), the transferor must have both the contractual right and the contractual obligation to repurchase or redeem financial assets that are identical to those transferred or substantially the same as those concurrently transferred. Transfers that include only the right to reacquire, at the option of the transferor or upon certain conditions, or only the obligation to reacquire, at the option of the transferee or upon certain conditions, may not maintain the transferor’s control, because the option might not be exercised or the conditions might not occur. Similarly, expectations of reacquiring the same securities without any contractual commitments (for example, as in wash sales) provide no control over the transferred securities.

Whether Securities Exchanged Are Substantially the Same

55-35 This guidance addresses criteria that must be met for a transfer to fail the condition in paragraph 860-10-40-5(c) through an agreement of the type described in paragraph 860-10-40-5(c)(1), precluding sale accounting and resulting, instead, in secured-borrowing accounting. The following are examples of whether securities exchanged are substantially the same as discussed in paragraph 860-10-40-24:

The same primary obligor (see paragraph 860-10-40-24(a)(1)). The exchange of pools of single-family loans would not meet this criterion because the mortgages comprising the pool do not have the same primary obligor, and would therefore not be considered substantially the same.
Identical form and type (see paragraph 860-10-40-24(a)(2)). The following exchanges would not meet this criterion:
1. GNMA I securities for GNMA II securities
2. Loans to foreign debtors that are otherwise the same except for different U.S. foreign tax credit benefits (because such differences in the tax receipts associated with the loans result in instruments that vary in form and type)
3. Commercial paper for redeemable preferred stock.
The same maturity (or in the case of mortgage-backed pass-through and pay-through securities, similar remaining weighted-average maturities that result in approximately the same market yield) (see paragraph 860-10-40-24(a)(3)). The exchange of a fast-pay GNMA certificate (that is, a certificate with underlying mortgage loans that have a high prepayment record) for a slow-pay GNMA certificate would not meet this criterion because differences in the expected remaining lives of the certificates result in different market yields.
Similar assets as collateral (see paragraph 860-10-40-24(a)(5)). Mortgage-backed pass-through and paythrough securities must be collateralized by a similar pool of mortgages, such as single-family residential mortgages, to meet this characteristic.

ASC 860-10 precludes sale accounting when a transfer of financial assets is accompanied by an agreement that requires the transferor to repurchase the transferred financial assets or substantially the same assets before their maturity at a fixed or determinable price. Therefore, transferors and transferees generally account for repurchase agreements and securities lending transactions as secured borrowings. If, however, a transferor has only a right, or only an obligation, to repurchase transferred financial assets, the transferor may not maintain effective control over transferred financial assets (see Sections 3.5.3 and 3.5.4). Effective control does not exist if the transferor expects to reacquire the same or substantially the same financial assets without being contractually required to do so.

A repurchase agreement is accounted for as a secured borrowing if the following conditions in ASC 860-10-40-24 are met:

“The financial assets to be repurchased or redeemed are the same or substantially the same as those transferred.”
“The agreement is to repurchase or redeem the financial assets before maturity, at a fixed or determinable price.”
“The agreement is entered into contemporaneously with, or in contemplation of, the transfer.”

The nature or extent of collateral is not relevant.27

ASC 860-10-40-24 and ASC 860-10-55-35 address whether financial assets subject to repurchase are substantially the same as those transferred. While there is no requirement that financial assets be readily obtainable for a transfer to be accounted for as a repurchase agreement (i.e., a secured borrowing), if the financial asset to be returned is not the same as the one transferred, it is unlikely that the financial asset to be returned is substantially the same as the one transferred if it is not readily obtainable. Therefore, the “substantially the same” guidance in ASC 860-10 focuses on readily obtainable financial assets. See Section 3.6.5.1.1.3 for further discussion of the “substantially the same” guidance.

Connecting the Dots

Assume that an entity transfers a non-readily-obtainable financial asset that is accompanied by an agreement requiring the transferor to repurchase either the transferred financial asset or one that is similar to, but not substantially the same as, the transferred financial asset. Although the condition in ASC 860-10-40-5(c) may be considered met because the transferee can transfer back a financial asset that is neither the same nor substantially the same as the one received, the forward repurchase provision may nevertheless require an entity to account for the transfer as a secured borrowing. If there is limited availability to purchase a financial asset that meets the conditions in the resale arrangement (i.e., only other non-readily-obtainable financial assets meet the conditions in the repurchase provision), the transferor has most likely either (1) constrained the transferee from pledging or exchanging the transferred financial asset under ASC 860-10-40-5(b) or (2) maintained effective control over the transferred financial asset under ASC 860-10-40-5(c).

For further discussion of repurchase agreements and securities lending transactions, see Section 3.6.5.

3.5.2.2 Forward to Repurchase at Maturity

ASC 860-10 — Glossary

Repurchase-to-Maturity Transaction

A repurchase agreement in which the settlement date of the agreement to repurchase a transferred financial asset is at the maturity date of that financial asset and the agreement would not require the transferor to reacquire the financial asset.

ASC 860-10

Exception for a Repurchase-to-Maturity Transaction

40-24A Notwithstanding the characteristic in paragraph 860-10-40-24 that refers to a repurchase of the same (or substantially-the-same) financial asset, a repurchase-to-maturity transaction shall be accounted for as a secured borrowing as if the transferor maintains effective control.

A repurchase-to-maturity transaction is always accounted for as a secured borrowing. See Section 3.6.5.1.2 for further discussion of repurchase-to-maturity transactions.

3.5.3 Call Options

3.5.3.1 General

ASC 860-10

Effective Control Through Unilateral Ability

40-28 This guidance addresses whether any of the following agreements maintain effective control under paragraph 860-10-40-5(c)(2):

A call option or other right conveys more than a trivial benefit (that is, fails the condition in paragraph 860-10-40-5(c)(2)(ii)) if the price to be paid is fixed, determinable, or otherwise potentially advantageous, unless because that price is so far out of the money or for other reasons it is probable when the option is written that the transferor will not exercise it.
A transferor’s unilateral ability to cause a securitization entity to return to the transferor or otherwise dispose of specific transferred financial assets, for example, in response to its decision to exit a market or a particular activity, has the characteristic in paragraph 860-10-40-5(c)(2)(i) and, thus, would provide the transferor with effective control over the transferred financial assets if it also has the characteristic in paragraph 860-10-40-5(c)(2)(ii) — that is, if it also provides more than a trivial benefit to the transferor.
A call option on readily obtainable assets at fair value may not provide the transferor with more than a trivial benefit.

Paragraph 860-10-40-35 provides an example in which, due to the combination of arrangements, the transferor would maintain effective control.

40-28A Effective control over transferred financial assets can be present even if the right to reclaim is indirect. For example, if a call allows a transferor to buy back the beneficial interests at a fixed price, the transferor may maintain effective control of the financial assets underlying those beneficial interests. 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 choosing to pledge or exchange the transferred financial assets. In that circumstance, any call held by the transferor on third-party beneficial interests is effectively an attached call on the transferred financial assets. Depending on the price and other terms of the call, the transferor may maintain effective control over the transferred financial assets.

Call Options

40-31 Cash-settled call options do not constrain the transferee, nor do they result in the transferor maintaining effective control because they do not provide the transferor with an opportunity to reclaim the transferred financial assets. Therefore, this guidance addresses call options that can be physically settled.

40-32 An embedded call option would not result in the transferor’s maintaining effective control because it is the issuer rather than the transferor who holds the call option and the call option does not provide more than a trivial benefit to the transferor. For example, a call embedded by the issuer of a callable bond or the borrower of a prepayable mortgage loan would not provide the transferor with effective control over the transferred financial asset.

40-34 Paragraph 860-10-40-5(c)(2) excludes a cleanup call from the general principle that a transferor maintains effective control over transferred financial assets if the transferor has the unilateral ability to cause the holder to return specific financial assets and that ability provides more than a trivial benefit to the transferor. A cleanup call on beneficial interests in the transferred financial assets is permitted because burdensome costs in relation to benefits may arise when the remaining financial assets or beneficial interests fall to a small portion of their original level. Parties other than the servicer cannot hold the option, because only the servicer is burdened when the amount of outstanding financial assets falls to a level at which the cost of servicing the financial assets becomes burdensome — the defining condition of a cleanup call — and any other party would be motivated by some other incentive in exercising a call.

40-35 A right to reclaim specific transferred financial assets by paying their fair value when reclaimed generally does not maintain effective control if it does not convey a more-than-trivial benefit to the transferor. However, a transferor has maintained effective control if it has such a right and also holds the residual interest in the transferred financial assets. See paragraph 860-10-55-42A for discussion of a related example.

Removal-of-Accounts Provisions

40-36 Many transfers of financial assets that involve transfers of a group of entire financial assets to an entity whose sole purpose is to engage in securitization or asset-backed financing activities empower the transferor to reclaim assets subject to certain restrictions. Such a power is sometimes called a removal-of-accounts provision. Whether a removal-of-accounts provision precludes sale accounting depends on whether the removal-of-accounts provision results in the transferor’s maintaining effective control over transferred financial assets.

40-37 The following are examples of removal-of-accounts provisions that preclude transfers from being accounted for as sales:

An unconditional removal-of-accounts provision or repurchase agreement that allows the transferor to specify the financial assets that may be removed and that provides a more-than-trivial benefit to the transferor, because such a provision allows the transferor unilaterally to remove specific financial assets
A removal-of-accounts provision conditioned on a transferor’s decision to exit some portion of its business that provides a more-than-trivial benefit to the transferor, because whether it can be triggered by canceling an affinity relationship, spinning off a business segment, or accepting a third party’s bid to purchase a specified (for example, geographic) portion of the transferor’s business, such a provision allows the transferor unilaterally to remove specific financial assets.

40-38 The following are examples of removal-of-accounts provisions that do not preclude transfers from being accounted for as sales:

A removal-of-accounts provision for random removal of excess financial assets, if the provision is sufficiently limited so that the transferor cannot remove specific transferred financial assets, for example, by limiting removals to the amount of the transferor’s interests and to one removal per month
A removal-of-accounts provision for defaulted receivables, because the removal would be allowed only after a third party’s action (default) and could not be caused unilaterally by the transferor
A removal-of-accounts provision conditioned on a third-party cancellation, or expiration without renewal, of an affinity or private-label arrangement, because the removal would be allowed only after a third party’s action (cancellation) or decision not to act (expiration) and could not be caused unilaterally by the transferor
A removal-of-accounts provision that does not allow the transferor to unilaterally reclaim specific financial assets from the transferee. For related implementation guidance, see paragraph 860-10-55-41.

40-39 A removal-of-accounts provision that can be exercised only in response to a third party’s action that has not yet occurred does not maintain the transferor’s effective control over financial assets potentially subject to that removal-of-accounts provision.

Rights to Reacquire (Call) Transferred Assets

55-39 Rights or obligations to reacquire transferred financial assets may result in the transferor’s maintaining effective control over the transferred assets, therefore precluding sale accounting under paragraph 860-10-40-5(c). The following guidance addresses how different types of rights of a transferor to reacquire (call) transferred assets affect sale accounting, specifically:

Removal-of-accounts provisions (see paragraphs 860-10-40-36 through 40-39)
Call options (see paragraphs 860-10-40-28 and 860-10-40-34)
Other arrangements.

Removal-of-Accounts Provisions

55-41 The following are examples of application of effective control principles to removal-of-accounts provisions:

An unconditional removal-of-accounts provision that allows the transferor to specify the financial assets that may be removed from a group of financial assets precludes sale accounting for all financial assets in the group that might be specified if such a provision allows the transferor unilaterally to remove specific financial assets and provides a more-than-trivial benefit to the transferor (see paragraph 860-10-40-37(a)), even if the transferor’s right to remove specific financial assets from a group of transferred financial assets is limited, for example, to 10 percent of the fair value of the financial assets transferred and all of the financial assets are smaller than that 10 percent. In that circumstance, none of the transferred financial assets would be derecognized at the time of transfer because no transferred financial asset is beyond the reach of the transferor. If the transferor reclaims all the financial assets it can and thereby extinguishes its option, its control has expired and the rest of the financial assets have been sold at that time.
A removal-of-accounts provision that provides the right to random removal of excess financial assets from a group of transferred financial assets up to 10 percent of the fair value of the financial assets transferred (all financial assets in the group are less than this 10 percent of the fair value of transferred financial assets) does not preclude sale accounting if the transferor has no other interest in the group. The transferor has, in essence, obtained a 10 percent beneficial interest in the group and should account for it as such. This treatment is permitted because the removal-of-accounts provision is sufficiently limited and the transferor cannot unilaterally remove specific transferred financial assets, because the timing of the removal (when the excess develops) and the assets being removed (which are randomly determined) are not under the control of the transferor (see paragraph 860-10-40-38).
A removal-of-accounts provision conditioned on a transferor’s decision to exit some portion of its business precludes sale accounting for all financial assets that might be affected, because it permits the transferor unilaterally to remove specific financial assets and provides a more-than-trivial-benefit to the transferor (see paragraph 860-10-40-37(b)).
A removal-of-accounts provision for defaulted receivables does not preclude sale accounting at the time of transfer, because the removal would be allowed only after a third party’s action (default) and could not be caused unilaterally by the transferor (see paragraph 860-10-40-38(b)). However, once the default has occurred, the transferor would have the unilateral ability to remove those specific financial assets and would need to recognize the defaulted receivable if that ability provides a more-than-trivial benefit to the transferor.
A removal-of-accounts provision conditioned on a third-party cancellation, or expiration without renewal, of an affinity or private-label arrangement does not preclude sale accounting at the time of transfer, because the removal would be allowed only after a third party’s action (cancellation) or decision not to act (expiration) and could not be caused unilaterally by the transferor (see paragraph 860-10-40-38(c)). However, once the cancellation or expiration has occurred, the transferor would have the unilateral ability to remove specific financial assets and would need to recognize those financial assets if that ability provides a more-than-trivial benefit to the transferor.
Because the transferor could not cause the reacquisition unilaterally a transferor does not maintain effective control through a removal-of-accounts provision that obligates the transferor to reacquire transferred financial assets from a securitization entity only after either:
1. A specified failure of the servicer to properly service the transferred financial assets that could result in the loss of a third-party guarantee
2. Third-party beneficial interest holders require a securitization entity to repurchase that beneficial interest.

Call Options

55-42 The following are other examples of the application of effective control principles:

In a loan participation, the lead bank (that is also the transferor) allows the participating bank to resell but reserves the right to call at any time from whoever holds it and can enforce the call option by cutting off the flow of interest at the call date; such a call option precludes sale accounting.
In a securitization, a call option permits the transferor to reclaim all of the transferred financial assets from the securitization entity at any time; such a call option precludes sale accounting unless both of the following conditions exist:
1. The call option is an option to call, at fair value, a financial asset that is readily obtainable in the marketplace.
2. The transferor does not hold a residual beneficial interest in the transferred financial assets (see paragraph 860-10-40-35).
A transferor-servicer transfers a group of entire financial assets to a securitization entity and has the right to call all of the financial assets when the group amortizes to 20 percent of its value (determined at the date of transfer). The transferor-servicer determines that at that level of financial assets, its cost of servicing them would not be burdensome in relation to the benefits of servicing, and therefore that the call option is not a cleanup call. Such a call option precludes sale accounting for the entire group of transferred financial assets (see paragraph 860-10-55-70).
If the third-party beneficial interests contain an embedded option and the transferor holds the residual interest in the securitization entity, the combination has the same kind of effective control as a scheduled auction provision if the transferor holds a residual beneficial interest. Sale accounting would be precluded for all of the transferred financial assets affected by the call option.
If the third-party beneficial interests in a securitization entity pay off first (a so-called turbo structure, where principal payments and prepayments are allocated on a non-pro rata basis, as discussed in paragraph 860-10-05-13), the transferor may not maintain effective control over transferred financial assets (see paragraph 860-10-40-32). To some extent, these repayments are contractual cash flows of the underlying assets, but repayments also result from prepayments in the underlying assets (that is, the prepayment options in the underlying assets are mirrored in the third-party beneficial interests). In this circumstance, call options embedded in the third-party beneficial interests result from the options embedded in the underlying assets (that is, they are held by the underlying borrowers rather than the transferor), and thus do not preclude sale accounting.
A transferor’s contractual right to repurchase, at any time, a loan that is not a readily obtainable financial asset would preclude sale accounting, because the transferor’s contractual right to repurchase is effectively a call option of the type described in paragraph 860-10-40-17(c)(2).

55-42A This guidance illustrates the concept in paragraph 860-10-40-35 that a transferor maintains effective control if it has a right to reclaim specific transferred assets by paying fair value and also holds the residual interest in the transferred financial assets. If a transferor holds the residual interest in securitized financial assets and can reclaim the transferred financial assets at termination of the securitization entity by purchasing them in an auction, and thus at what might appear to be fair value, then sale accounting for the transfer of those financial assets it can reclaim would be precluded. Such circumstances provide the transferor with a more-than-trivial benefit and effective control over the financial assets, because it can pay any price it chooses in the auction and recover any excess paid over fair value through its residual interest in the transferred financial assets.

Transfer Involving Certain Transferor Powers

55-67 If the transferor has the ability to dissolve a securitization entity (for example, through the beneficial interests that it holds) and reassume control of the financial assets at any time, the transferor is precluded from accounting for the transfer as a sale for the following reason:

Subparagraph superseded by Accounting Standards Update No. 2009-16.
The transferor’s current ability to dissolve the securitization entity and reassume control of the transferred financial assets entitles it to unilaterally cause the return of the transferred financial assets, indicating that the transferor has maintained control over the transferred financial assets which precludes sale accounting under paragraph 860-10-40-5(c).

Transferor Option to Repurchase Individual Financial Assets

55-68 In certain transactions, the transferor is entitled to repurchase a transferred amortizing, individual (specific) financial asset when its remaining principal balance reaches some specified amount, for example, 30 percent of the original balance. To exercise that call option, the transferor would pay the remaining principal balance. Paragraph 860-10-40-5(c)(2) states that a transferor maintains effective control through a call option, other than through a cleanup call, that provides the transferor with both:

The unilateral ability to cause the holder to return specific financial assets
A more-than-trivial-benefit attributable to that ability.

55-68A Such a call option on the remaining portion of an entire financial asset precludes sale accounting for the entire financial asset. Paragraph 860-10-40-5 applies to an entire financial asset, a group of entire financial assets, or a participating interest. Paragraph 860-10-40-4A states that, to be eligible for sale accounting, an entire financial asset cannot be divided into components before a transfer unless all of the components meet the definition of a participating interest. That paragraph states also that an entity shall not account for a transfer of an entire financial asset or a participating interest in an entire financial asset partially as a sale and partially as a secured borrowing.

55-70 If a transferor holds a call option to repurchase at any time a few specified, individual loans from an entire group of loans transferred in a securitization transaction, then sale accounting is precluded only for the specified loans subject to the call option, not the whole group of loans. In contrast, if the transferor holds a call option to repurchase from the group any loans it chooses, up to some specified limit, then sale accounting is precluded for the transfer of the entire group while that option remains outstanding. See paragraphs 860-10-55-39 through 55-42 for related guidance.

There are several different types of repurchase options that may exist for transferred financial assets (or third-party beneficial interests in transferred financial assets), including:

Unilaterally exercisable options that permit a transferor to repurchase transferred financial assets (or third-party beneficial interests in transferred financial assets) at any time or at a future date.
ROAPs that allow a transferor to specify the transferred financial assets that may be removed, including default ROAPs, which allow a transferor to reclaim transferred financial assets that become past due or delinquent or are in default (e.g., EPD call options).
Other conditionally exercisable call options that allow a transferor to reclaim transferred financial assets (or third-party beneficial interests in transferred financial assets) upon the occurrence of a specified condition or an event outside the transferor’s control.
Cleanup call options.

Effective control is maintained over transferred financial assets if the transferor, its consolidated affiliates included in the financial statements being presented, or its agents have the unilateral ability to cause the return of specific assets and that right provides the transferor with a more than trivial benefit.28 ASC 860-10-40-28A explains that effective control over transferred assets can be present even if the right to reclaim is indirect. For example, if a call option allows a transferor to purchase third-party beneficial interests issued by a securitization entity at a fixed price, the transferor is considered to have effective control over the financial assets underlying those beneficial interests.29 An exception is provided for cleanup call options.

ASC 860-10 contains principles, primarily through discussion of specific types of repurchase options, related to whether a transferor has maintained effective control over transferred financial assets (or third-party beneficial interests in transferred financial assets). A transferor must evaluate the relevant facts and circumstances to determine whether a repurchase option maintains effective control over transferred financial assets (or third-party beneficial interests in transferred financial assets). In determining whether a call option maintains its effective control over transferred financial assets, the transferor must consider the following:

The type of call option (i.e., freestanding, embedded, or attached, and whether the option is cash-settled or physically settled) (see Section 3.5.3.1.1).
Whether the transferor has the unilateral ability to exercise the option (see Section 3.5.3.1.2).
Whether the financial asset that may be reclaimed is readily obtainable (see Section 3.5.3.1.3).
Whether the call option pertains to specific financial assets (see Section 3.5.3.1.4).
Whether the transferor receives a more than trivial benefit from the call option (see Section 3.5.3.1.5).
Whether the call option is a clean-up call option (see Section 3.5.3.1.6).

Throughout the remaining discussion in this section, “transferor” includes consolidated affiliates of the transferor included in the financial statements being presented and agents of the transferor.30

3.5.3.1.1 Type of Call Option

3.5.3.1.1.1 Freestanding, Embedded, and Attached Call Options

ASC 860-10 — Glossary

Attached Call Option

A call option held by the transferor of a financial asset that becomes part of and is traded with the underlying instrument. Rather than being an obligation of the transferee, an attached call option is traded with and diminishes the value of the underlying instrument transferred subject to that call option.

Embedded Call Option

A call option held by the issuer of a financial instrument that is part of and trades with the underlying instrument. For example, a bond may allow the issuer to call it by posting a public notice well before its stated maturity that asks the current holder to submit it for early redemption and provides that interest ceases to accrue on the bond after the early redemption date. Rather than being an obligation of the initial purchaser of the bond, an embedded call option trades with and diminishes the value of the underlying bond.

Freestanding Call Option

A call option that is neither embedded in nor attached to an asset subject to that call option.

ASC 860-10 describes three types of call options. Freestanding call options are traded separately and apart from the underlying financial asset. The determination of whether a freestanding call option causes the transferor to maintain effective control over transferred financial assets depends on whether the option is unilaterally exercisable, the exercise price, and whether the transferred financial assets are readily obtainable.

Embedded call options are included in the original terms of a transferred financial asset. Such options are part of, and are traded with, the financial asset. The issuer of the financial asset is a counterparty to an embedded call option. An example would be a callable bond or prepayable mortgage loan receivable. If the option is exercised, the issuer must repay the outstanding principal amount of its obligation. As discussed in ASC 860-10-40-32, an embedded call option cannot cause the transferor to maintain effective control over a transferred financial asset.

Attached call options are similar to embedded call options in that they are traded with the underlying financial asset. However, attached call options are unlike embedded call options in that the issuer of the financial asset is not a counterparty to the option. Rather, the option is “attached” to the financial asset in conjunction with a transfer. The counterparty to the option is the current holder of the asset or beneficial interest. An example is a nonprepayable loan receivable that the transferor can require the current holder to return at a specified price. As discussed in ASC 860-10-40-28A, call options on third-party beneficial interests in transferred financial assets are generally attached call options.31 Since attached call options are imposed by the transferor, they presumptively provide a more than trivial benefit and cause the transferor to maintain effective control over the transferred financial assets.

3.5.3.1.1.2 Cash-Settled and Physically Settled Call Options

Only call options that may result in the return of transferred financial assets (or third-party beneficial interests in transferred financial assets) may provide the transferor with effective control. A call option on transferred financial assets (or third-party beneficial interests in transferred financial assets) that requires net-cash settlement in all circumstances in which it is exercised does not cause a transferor to maintain effective control over transferred financial assets (or third-party beneficial interests in transferred financial assets) because settlement of the option would not allow the transferor to actually reclaim transferred financial assets. See ASC 860-10-40-31.

3.5.3.1.2 Unilateral Ability

ASC 860-10 — Glossary

Unilateral Ability

A capacity for action not dependent on the actions (or failure to act) of any other party.

A call option does not maintain the transferor’s effective control over transferred financial assets (or third-party beneficial interests in transferred financial assets) if it is not unilaterally exercisable. A transferor has the unilateral ability to exercise a call option if there are no conditions or contingencies outside the transferor’s control that must be met for the transferor to elect to exercise the option. An option to repurchase or reclaim transferred financial assets (or third-party beneficial interests in transferred financial assets) that is exercisable only upon the occurrence of a specified condition or event that is not within the sole control of the transferor does not cause the transferor to maintain effective control over transferred financial assets regardless of the likelihood that the condition or event will occur. However, if the condition or event occurs, and the transferor has the right to repurchase or reclaim transferred financial assets (or third-party beneficial interests in transferred financial assets), the transferor has regained control over previously sold financial assets. See Section 4.3 for further discussion.

The table below provides examples of when a transferor has the unilateral ability to exercise a call option.

Table 3-6

Unilateral Ability Exists	Unilateral Ability Does Not Exist
An entity can specify the financial assets that may be removed (repurchased) at its discretion.	An entity can repurchase a transferred financial asset once it becomes past due or is in default.(e)
An entity owns all the equity interests in a securitization trust and can liquidate the trust and obtain some or all of the underlying financial assets.(a)	An entity can repurchase a transferred financial asset if, upon using its best efforts, a remarketing is unsuccessful.(f)
An entity has a right to rescind a transfer of financial assets.(b)	An entity can repurchase a transferred financial asset if interest rates increase to an objectively defined level.(g)
An entity can repurchase transferred financial assets if it defaults under the terms of an agreement to service those financial assets.(c)	An entity can repurchase transferred financial assets if a third-party servicer defaults under the terms of an agreement to service those financial assets.(g)
An entity can repurchase transferred financial assets when it decides to exit some portion of its business (i.e., by canceling an affinity relationship, spinning off a business segment, or accepting a third party’s bid to purchase a specified portion of the entity’s business)(d)	An entity can repurchase a financial asset if a customer does not renew an agreement in accordance with a stated unconditional renewal option that can be exercised by the customer.(h)
An entity can cause a securitization entity to return to the transferor or otherwise dispose of specific transferred financial assets in response to the entity’s decision to exit a market for a particular activity.(d)	An entity can repurchase a transferred financial asset if the transferee proposes to sell it to the entity’s competitor.(g)
An entity transfers a municipal bond to a trust. The trust liquidates before maturity of the bond. At maturity of the trust, or earlier upon the occurrence of certain events within the transferor’s control, there is a mandatory tender event, which requires the bond to be sold and the proceeds distributed to the beneficial interest holders. The transferor can bid on the municipal bond and holds a residual interest in the trust (therefore, the transferor can pay any price to reclaim the bond since any excess paid will be recovered through the residual beneficial interest).	An entity has the first right of refusal if a transferee proposes to sell a transferred financial asset or a third-party beneficial interest holder proposes to put its interests back to a securitization entity.(g),(i)
Notes to Table: (a) A transferor could have the right to dissolve a securitization entity through beneficial interests it owns or other rights it obtained in a transfer. ASC 860-10-55-67 indicates that a “transferor’s current ability to dissolve [a] securitization entity and reassume control of the transferred financial assets entitles it to [the unilateral ability to reclaim] transferred financial assets.” If a transferor can only dissolve a securitization entity with the consent of other parties, the transferor would not be considered to have the unilateral ability to reclaim transferred financial assets unless the other parties for which consent must be obtained are related parties or agents. See Example 3-20 for an illustration. (b) An entity maintains effective control over transferred financial assets if it has the unilateral ability to require the transferee to return specific financial assets by rescinding the transfer and paying an amount other than fair value to reclaim the transferred financial assets. When a transferor has the right to rescind a transfer, the legal isolation condition in ASC 860-10-40-5(a) would also generally not be met and the transferee would be constrained from pledging or exchanging the transferred financial assets unless they are readily obtainable. A common example of a transfer of a financial asset with a rescission right is a tender option bond structure. (c) Although the repurchase right is unilaterally exercisable, depending on the consequences of defaulting on the servicing agreement, the right may not provide the transferor with a more than trivial benefit. See also ASC 860-10-55-41(f)(1). (d) A transferor’s decision to exit a particular business or market is within its control. See also ASC 860-10-40-28(b), ASC 860-10-40-37(b), and ASC 860-10-55-41(c). (e) ASC 860-10-55-41(d) indicates that a ROAP on defaulted receivables does not preclude sale accounting when the removal of transferred financial assets is allowed only after a third party’s action (e.g., the borrower’s default) that is outside the transferor’s control. However, once the default has occurred, the transferor has the unilateral ability to remove specific financial assets and would rerecognize those financial assets unless the repurchase right does not provide the transferor with a more than trivial benefit. See Section 4.3 for further discussion of regaining control over previously sold financial assets. (f) If the entity is required to use its best efforts to remarket a transferred financial asset, the failure of such remarketing would be outside the entity’s control. (g) Once the event occurs and the transferor has the ability to repurchase transferred financial assets, if the transferor obtains a more than trivial benefit from this repurchase right, it must rerecognize the transferred financial assets. See Section 4.3 for further discussion of regaining control over previously sold financial assets. (h) ASC 860-10-40-38(c), ASC 860-10-40-39, and ASC 860-10-55-41(e) indicate that a ROAP conditioned on a third-party cancellation or expiration, without renewal, of an affinity or private-label arrangement does not maintain the transferor’s effective control over transferred financial assets if the third party’s decision has not yet been made because the transferor’s repurchase right is conditional. However, once the cancellation or expiration has occurred, the transferor would have the unilateral ability to remove specific financial assets and would need to rerecognize those financial assets unless the repurchase right does not provide the transferor with a more than trivial benefit. See Section 4.3 for further discussion of regaining control over previously sold financial assets. (i) ASC 860-10-55-41(f) indicates that a transferor does not have the unilateral ability to repurchase transferred financial assets if this repurchase may occur only after third-party beneficial interest holders require a securitization entity to repurchase those beneficial interests.

See Example 3-17 for an illustration of a conditionally exercisable call option.

3.5.3.1.3 Readily Obtainable Financial Assets

A transferor does not maintain effective control over transferred financial assets when it has a freestanding call option that gives it the unilateral ability to repurchase those assets if they are readily obtainable in the marketplace and the exercise price of the option equals the fair value of the assets on the date the assets are purchased.32 ASC 860-10 does not define what constitutes a readily obtainable financial asset, and ASC 860-10 provides little interpretive guidance on this concept. In determining whether a financial asset is readily obtainable, an entity must use judgment and consider the specific facts and circumstances. Factors to consider in this determination include the following:

Paragraphs A13 and A14 of FSP FAS 140-3 indicate that, to be readily obtainable, a financial asset must be marketable and cannot be unique.
A financial asset that has a quoted price in an active market (i.e., a fair value measurement for the asset would be classified in Level 1 of the fair value hierarchy in ASC 820) is readily obtainable.
For the financial asset to be considered readily obtainable, the fair value measurement of a financial asset does not need to be classified in Level 1 of the fair value hierarchy but there does need to be sufficient trading activity in the marketplace (i.e., illiquid financial assets are not readily obtainable). The evaluation of the level of market activity for an asset should focus on the willingness of market participants to transact for the asset at fair value (i.e., not on the assessment of whether market participants would transact “at the right price” or in a distressed sale) and should take into account the nature of transactions occurring in the marketplace.33 In performing this evaluation, an entity should not focus solely on the availability of an asset without considering the volume of transactions in the asset. To determine whether a financial asset is readily obtainable, an entity should consider evidence from all available and relevant sources related to the volume of market activity in light of current market conditions.34 The determination of whether a financial asset is readily obtainable could change depending on market conditions (i.e., there may be less liquidity in times of economic uncertainty).
If the transferee is the only party that holds a financial asset, the asset cannot be considered readily obtainable.

Examples of financial assets that are readily obtainable may include:

U.S. Treasury securities.
Agency MBSs.
Certain TBA on Agency MBSs.
Certain municipal bonds.
Corporate bonds of large public companies that are actively traded.
Other securities that are classified in Level 1 of the fair value hierarchy.

Examples of financial assets that are not readily obtainable may include:

A specific commercial loan receivable.
A debt security collateralized by a single commercial real estate property.
Nonagency MBSs (e.g., beneficial interests in subprime mortgage loans).

Connecting the Dots

The fact that two assets are substantially the same does not necessarily mean that each of them is readily obtainable. Generally, a financial asset would need a Committee on Uniform Securities Identification Procedures (CUSIP) number to be considered readily obtainable.

Attached call options on transferred financial assets and third-party beneficial interests in transferred financial assets maintain the transferor’s effective control over transferred financial assets if they are unilaterally exercisable unless they represent fixed-price options that are so far out-of-the-money when written that it is probable that they will not be exercised. As a result, if attached call options are unilaterally exercisable by the transferor, the condition in ASC 860-10-40-5(c) is not met for the affected transferred financial assets regardless of whether those assets are readily obtainable.

3.5.3.1.4 Specific Financial Assets

ASC 860-10-40-5(c)(2) indicates that a right, other than a cleanup call option, that provides a transferor with the “unilateral ability to cause the holder to return specific financial assets” maintains the transferor’s effective control over transferred financial assets unless that right does not provide a more than trivial benefit to the transferor. ASC 860-10-40-38(d) indicates that a ROAP that does not allow the transferor to unilaterally reclaim specific financial assets may not cause the transferor to maintain effective control over transferred financial assets. For example, a ROAP for random removal of excess financial assets would not cause the transferor to maintain effective control over transferred financial assets if the provision is sufficiently limited so that the transferor cannot remove specific financial assets (see ASC 860-10-40-38(a) and ASC 860-10-55-41(b)). As noted in the guidance, the term “specific financial asset” does not mean a non-readily-obtainable asset. Rather, a readily obtainable asset may also be a “specific financial asset” when the condition in ASC 860-10-40-5(c) is evaluated.

Attached call options always pertain to specific financial assets. A freestanding call option pertains to specific financial assets unless, upon exercise, the transferor will receive randomly selected financial assets.

Connecting the Dots

ASC 860-10-55-70 explains the importance of identifying the rights that a freestanding call option conveys to a transferor when groups of financial assets are transferred. If a freestanding call option allows the transferor to purchase only specific financial assets transferred (i.e., only certain transferred financial assets), other transferred financial assets would not be affected by this right. For example, if an entity transfers five loan receivables from five different issuers and retains a freestanding option to repurchase only the loan receivable from a specific issuer, only that transferred loan receivable could fail to meet the condition in ASC 860-10-40-5(c). If, however, an entity transfers a group of financial assets and retains a freestanding option to reclaim some, but not all, of the transferred financial assets, the option causes the transferor to maintain effective control over all the transferred financial assets if the transferor can specify the assets to be returned and receives a more than trivial benefit from the option (see ASC 860-10-55-41(a)). For example, if an entity transfers five non-readily-obtainable loan receivables from five different issuers and retains a fixed-price freestanding call option to repurchase any two of the transferred loan receivables it chooses, that call option causes the transferor to maintain effective control over all five transferred loan receivables until the option is exercised or expires.

3.5.3.1.5 More Than Trivial Benefit

3.5.3.1.5.1 General

ASC 860-10-40-28(a) indicates that “[a] call option or other right conveys more than a trivial benefit . . . if the price to be paid is fixed, determinable, or otherwise potentially advantageous, unless because that price is so far out of the money or for other reasons it is probable when the option is written that the transferor will not exercise it.” The focus is on whether there is any potential economic or other benefit to the transferor. As discussed in Section 3.4.1.5, the threshold for a more than trivial benefit is extremely low. The evaluation of whether a more than trivial benefit exists is not based solely on the transferor’s intent regarding whether it would exercise an option to repurchase transferred financial assets or third-party beneficial interests in transferred financial assets. For example, a call option could not be considered as not providing a transferor with a more than trivial benefit on the basis that the transferor does not have the liquidity necessary to repurchase transferred financial assets.

Attached call options provide a more than trivial benefit to the transferor because they are created by the transferor during the transfer of financial assets.35 Therefore, unilaterally exercisable attached call options provide the transferor with effective control over transferred financial assets (see Section 3.5.3.1.3).

Whether a freestanding call option provides a transferor with a more than trivial benefit is determined on the basis of the following:

The pricing of the call option (i.e., fair value vs. not fair value) and whether the exercise price is deep-out-of-the-money when written.36
Whether the financial asset that can be repurchased is readily obtainable.

3.5.3.1.5.2 Fair Value Call Options

As discussed in ASC 860-10-40-28(c) and ASC 860-10-40-35, a freestanding call option that allows a transferor to repurchase readily obtainable transferred financial assets by paying fair value on the exercise date does not provide the transferor with a more than trivial benefit unless the transferor also owns a residual interest in the transferred financial assets. In this situation, the call option is evaluated as a non–fair value call option because the amount paid to reclaim the transferred financial assets is not relevant. For example, if a transferor holds the residual interest in securitized financial assets and can reclaim the transferred financial assets by purchasing them in an auction, sale accounting is precluded for the transferred financial assets that the transferor may reclaim because it can pay any price it chooses in the auction and recover any excess amount paid over fair value through its residual interest (see ASC 860-10-55-42(b) and (d), and ASC 860-10-55-42A).37

A freestanding call option that allows a transferor to repurchase non-readily-obtainable transferred financial assets by paying fair value on the exercise date provides a more than trivial benefit because the transferor could not readily purchase those assets elsewhere. If the transferor can unilaterally exercise a freestanding option to reclaim non-readily-obtainable financial assets, the condition in ASC 860-10-40-5(c) is not met and sale accounting is precluded for the transferred financial assets subject to the call option. See Example 3-16 for an illustration.

3.5.3.1.5.3 Non–Fair Value Call Options

As discussed in ASC 860-10-40-28(a) and ASC 860-10-55-42(b), a freestanding call option with a fixed or determinable exercise price that does not represent the fair value of the financial assets on the date they are reclaimed provides a more than trivial benefit because the call option is potentially advantageous to the transferor. A more than trivial benefit exists regardless of whether the financial assets to be reclaimed are readily obtainable (see Example 3-16 for an illustration). Therefore, if a transferor has a freestanding call option with a non–fair value exercise price that gives it the unilateral ability to reclaim transferred financial assets, the transferor maintains effective control over those assets and sale accounting is precluded. As a limited exception, a more than trivial benefit does not exist if, when written, the call option is deep-out-of-the-money.

3.5.3.1.6 Cleanup Call Options

ASC 860-10 — Glossary

Cleanup Call Option

An option held by the servicer or its affiliate, which may be the transferor, to purchase the remaining transferred financial assets, or the remaining beneficial interests not held by the transferor, its affiliates, or its agents in an entity (or in a series of beneficial interests in transferred financial assets within an entity) if the amount of outstanding financial assets or beneficial interests falls to a level at which the cost of servicing those assets or beneficial interests becomes burdensome in relation to the benefits of servicing.

ASC 860-10

Call Options

55-42B Sale accounting is not appropriate if a cleanup call on a group of financial assets in a securitization entity is held by a party other than the servicer. A transferor’s call option on the transferred financial assets in the securitization entity is not a cleanup call for accounting purposes because it is not the servicer or an affiliate of the servicer. [Sometimes] the fair value of beneficial interests obtained by a transferor of financial assets that is not the servicer or an affiliate of the servicer is adversely affected by the amount of transferred financial assets declining to a low level.

55-42C In a securitization transaction involving not-readily-obtainable financial assets, a transferor that is also the servicer may hold a cleanup call if it enters into a subservicing arrangement with a third party without precluding sale accounting. Under a subservicing arrangement, the transferor remains the servicer from the perspective of the securitization entity because the securitization entity does not have an agreement with the subservicer (that is, the transferor remains liable if the subservicer fails to perform under the subservicing arrangement). However, if the transferor sells the servicing rights to a third party (that is, the agreement for servicing is between the securitization entity and the third party after the sale of the servicing rights), then the transferor could not hold a cleanup call without precluding sale accounting.

ASC 860-10-40-34 offers an exception to the effective-control guidance in ASC 860-10-40-5(c)(2) for cleanup call options. To qualify for this exception, the option must be (1) held by the servicer and (2) exercisable only when the amount of outstanding financial assets or beneficial interests falls to a level at which the cost of servicing those assets or beneficial interests becomes burdensome in relation to the benefits of servicing. An option held by a transferor cannot meet the definition of a cleanup call option if the transferred financial assets are serviced by a third party.

The determination of whether an option held by the servicer represents a cleanup call option is made as of the transfer date on the basis of the relevant facts and circumstances. ASC 860-10 does not specify the level at which the cost of servicing financial assets or third-party beneficial interests becomes burdensome in relation to the benefits of servicing. However, ASC 860-10-55-41(c) does indicate that the transferor-servicer’s right to call all of the transferred financial assets when the group amortizes to 20 percent of its value as of the transfer date is not a cleanup call option. ASC 860-10-55-68 and 55-68A contain another example of a call option on an amortized balance of a transferred financial asset that does not meet the definition of a cleanup call option. In practice, a call option for 10 percent or less of the original pool of financial assets transferred is often considered sufficiently low to meet the definition of a cleanup call option. However, a servicer should be prepared to support such an assertion because there is no “bright line” or “safe harbor” that indicates when the costs of servicing financial assets or beneficial interests becomes burdensome in relation to the benefits of servicing.

A cleanup call option may have an exercise price equal to the fair value of the remaining transferred financial assets. Alternatively, the price may equal the sum of (1) the unpaid principal balance of the remaining financial assets, (2) accrued interest, (3) the fair value of any real estate owned, and (4) unreimbursed servicing advances.

3.5.3.2 Interpretive Guidance

3.5.3.2.1 Freestanding Options on Transferred Financial Assets

Q&A 3-49 Non-Fair-Value Call Options

Question

Why do all unilaterally exercisable, freestanding non–fair value call options on transferred financial assets other than fixed-price options that are deep-out-of-the-money when written cause the transferor to maintain effective control over the specific financial assets subject to the options?

Answer

ASC 860-10-40-5(c)(2) indicates that a transferor maintains effective control over transferred financial assets if the transferor, its consolidated affiliates included in the financial statements being presented, or its agents have:

An agreement, other than through a cleanup call (see paragraphs 860-10-40-28 through 40-39), that provides the transferor with both of the following:

The unilateral ability to cause the holder to return specific financial assets
A more-than-trivial benefit attributable to that ability.

Only certain freestanding call options that allow a transferor, its consolidated affiliates included in the financial statements being presented, or its agents to reclaim readily obtainable financial assets by paying fair value for those financial assets do not cause the transferor to maintain effective control over the transferred financial assets.39 See Q&A 3-51.

Q&A 3-50 Call Options on Non-Readily-Obtainable Financial Assets

Question

Why do all unilaterally exercisable, freestanding call options on non-readily-obtainable transferred financial assets other than fixed-price call options that are deep-out-of-the-money when written cause the transferor to maintain effective control over those specific financial assets?

Answer

An agreement, other than through a cleanup call (see paragraphs 860-10-40-28 through 40-39), that provides the transferor with both of the following:

The unilateral ability to cause the holder to return specific financial assets
A more-than-trivial benefit attributable to that ability.

Thus, when the transferor, its consolidated affiliates included in the financial statements being presented, or its agents have the unilateral ability to cause the transferee to return specific financial assets, effective control is maintained unless that right does not provide a more than trivial benefit. The threshold for whether a more than trivial benefit is obtained is very low. A call option on non-readily-obtainable financial assets that is not a deep-out-of-the-money fixed-price option when written always provides a more than trivial benefit to the transferor, regardless of whether the exercise price is fair value, because such a call option allows the transferor to obtain financial assets that are not readily available for purchase in the market and to know who owns such financial assets. Thus, regardless of its price, a unilaterally exercisable option to reclaim non-readily-obtainable financial assets maintains the transferor’s effective control over transferred financial assets (see ASC 860-10-55-42(f)). As discussed in Section 3.4.1.4, freestanding call options on non-readily-obtainable transferred financial assets also prevent the transfer from meeting the condition in ASC 860-10-40-5(b).

Only certain freestanding call options that allow a transferor, its consolidated affiliates included in the financial statements being presented, or its agents to reclaim readily obtainable transferred financial assets by paying fair value for those financial assets would not cause the transferor to maintain effective control over the transferred financial assets.40 See the Q&A below.

Q&A 3-51 Fair Value Call Options on Readily Obtainable Financial Assets

Question

Do unilaterally exercisable, freestanding call options on readily obtainable transferred financial assets that have an exercise price equal to the fair value of the financial assets on the exercise date cause the transferor to maintain effective control over those specific financial assets?

Answer

It depends. ASC 860-10-40-5(c)(2) indicates that a transferor maintains effective control over transferred financial assets if the transferor, its consolidated affiliates included in the financial statements being presented, or its agents have:

An agreement, other than through a cleanup call (see paragraphs 860-10-40-28 through 40-39), that provides the transferor with both of the following:

The unilateral ability to cause the holder to return specific financial assets
A more-than-trivial benefit attributable to that ability.

A freestanding call option that allows a transferor, its consolidated affiliates included in the financial statements being presented, or its agents to reclaim readily obtainable transferred financial assets by paying fair value for those financial assets would generally not result in a more than trivial benefit for the transferor (see ASC 860-10-40-28(c)). However, as discussed in ASC 860-10-40-35, if a transferor has a unilateral right to reclaim a readily obtainable financial asset by paying fair value when the asset is reclaimed and also holds a residual interest in the transferred financial assets, the fair value call option causes the transferor to maintain effective control over the transferred financial assets because it is evaluated in the same manner as a non–fair value call option.41 Anytime a transferor has the right to require the sale of transferred financial assets through any mechanism within its control and also owns a residual interest in the transferred financial assets, the transferor is deemed to maintain effective control over the transferred financial assets unless the relevant agreements either prohibit the transferor from bidding on the asset or only allow the transferor to pay the highest price of a substantive bid from a third party.

Q&A 3-52 Readily Obtainable Financial Asset Becomes Non-Readily-Obtainable

Question

Would a freestanding fair value call option on readily obtainable financial assets that did not preclude sale accounting as of the original transfer date result in the failure to qualify for sale accounting at a later date if the transferred financial asset becomes illiquid (i.e., is no longer readily obtainable)?

Answer

No. The assessment of whether the transferor maintains effective control over a transferred financial asset, including whether a more than trivial benefit is obtained, is made as of the transfer date and does not change solely as a result of market events, such as changes in market prices or illiquidity in a financial asset that was readily obtainable on the transfer date. However, if a sale agreement was modified, the transferor would need to reevaluate the impact of a freestanding call option to determine whether the effective-control condition in ASC 860-10-40-5(c) is met.

Q&A 3-53 Call Options on Amortized Portions of Entire Financial Assets

An entity transfers prepayable loan receivables to a third party. After the balance of each transferred loan receivable amortizes to 30 percent of its balance as of the transfer date, the entity has a unilateral right to repurchase it at the unpaid principal balance. Assume that this freestanding call option provides a more than trivial benefit because the loan receivables are not readily obtainable in the marketplace.

Question

Does the entity maintain effective control over transferred financial assets?

Answer

Yes. Although possible credit losses or prepayments may affect when the entity can exercise the option, it will become exercisable upon the passage of time. Because this option is not a cleanup call option, sale accounting is precluded. Under ASC 860-10-55-68, a freestanding call option that gives the transferor the unilateral ability to return the remaining portion of an entire financial asset and provides a more than trivial benefit precludes sale accounting for the entire financial asset. ASC 860 does not permit an entity to account for a transfer of an entire financial asset as partially a sale and partially a financing.

If, however, a transferor holds a freestanding call option that allows it only to reclaim a few specific transferred loan receivables from a larger group of loan receivables, effective control would be maintained only for the loan receivables that may be reclaimed (i.e., the specific loan receivables that can be repurchased at the transferor’s option). In contrast, if a transferor holds a freestanding call option to repurchase from a group of loan receivables any loan that it chooses, up to a specified limit, sale accounting is precluded for the entire transfer while that option remains outstanding unless that option does not provide a more than trivial benefit to the transferor.

Q&A 3-54 Call Options on Prepayable Financial Assets

Question

Is a freestanding call option on a prepayable financial asset considered conditionally, as opposed to unilaterally, exercisable because the financial asset could be prepaid before the option may be exercised?

Answer

No. A freestanding call option exercisable upon the passage of time is treated the same for effective-control purposes regardless of whether the related financial assets are prepayable. The fact that an issuer of a financial asset may prepay it before the transferor can reclaim it does not make the call option contingently exercisable in the evaluation of effective control. See Example 3-18.

Q&A 3-55 Call Options Exercisable After Maturity of a Financial Asset

Question

How should an entity treat a freestanding call option that is exercisable only after maturity of a financial asset?

Answer

A right to repurchase a transferred financial asset only after its maturity would generally be treated as a default ROAP because the transferor can reclaim the transferred financial asset only if the borrower does not repay the amounts due at maturity (i.e., the borrower defaults on repayment).

3.5.3.2.2 More Than Trivial Benefit

Q&A 3-56 Assessment of More Than Trivial Benefit for Default ROAPs

Question

On what date should an entity evaluate whether a default ROAP on transferred financial assets provides a more than trivial benefit?

Answer

The evaluation of whether a conditionally exercisable call option provides a more than trivial benefit should be performed in accordance with ASC 860-10-40-28, which states that a call option conveys a more than trivial benefit “if the price to be paid is fixed, determinable, or otherwise potentially advantageous, unless because that price is so far out of the money or for other reasons it is probable when the option is written that the transferor will not exercise it.” This assessment focuses on whether, on the basis of the pricing of the option, there is a reasonably possible future scenario in which the call price is advantageous compared with the cost of exercising it. The holder’s liquidity position (i.e., its ability to exercise the option) should not be taken into account in this assessment. The transferor evaluates whether a conditionally exercisable repurchase right conveys a more than trivial benefit as of the date on which sale accounting for the transferred financial assets is achieved, which could be later than the original transfer date. The conclusion is not reconsidered because of a change in market prices or market conditions. This is consistent with (1) ASC 860-10-40-28(a), which indicates that the assessment of probability for a deep-out-of-the-money option is performed when the option is written, and (2) ASC 860-20-25-9(b), which indicates that a change in market prices should not affect a transferor’s assessment of whether it has regained control over specific transferred financial assets. Because the threshold for determining whether a repurchase option conveys a more than trivial benefit is very low, it would be rare for a transferor not to rerecognize specific financial assets previously considered sold when it subsequently regains control over them.

3.5.3.2.3 Options on Beneficial Interests in Transferred Financial Assets

Q&A 3-57 Put Option on Beneficial Interests Held by Transferor

An entity transfers $100 million of corporate bonds of 10 different issuers to an entity whose sole purpose is to engage in securitization activities. The bonds are traded in denominations of $1,000. In return for the transferred bonds, the entity receives cash and a beneficial interest in the transferred bonds. The entity has a right, at any time, to put its beneficial interest to the securitization entity in return for any of the transferred bonds. Each dollar amount of the beneficial interest can be put for a dollar of unpaid principal amount on the transferred bonds.

Question

Does the put option cause the entity to maintain effective control over the transferred bonds?

Answer

Yes. The entity maintains effective control over all the transferred bonds because it can choose to reclaim any of the 10 transferred bonds by putting its beneficial interest and this option provides a more than trivial benefit to the entity since it contains a non–fair value exercise price. The fact that the transferor cannot reclaim all the transferred bonds because its beneficial interest is less than the unpaid principal amount of all the transferred bonds does not matter. See also Example 3-20.

Q&A 3-58 Call Options on Third-Party Beneficial Interests

Question

How should a transferor evaluate whether a call option on third-party beneficial interests causes it to maintain effective control over transferred financial assets?

Answer

A call option on third-party beneficial interests is generally evaluated as an attached call option on transferred financial assets. If the call option is unilaterally exercisable, it precludes sale accounting for the transferred financial assets regardless of whether the transferor can actually reclaim the transferred financial assets underlying the beneficial interests. When financial assets are transferred to an entity whose sole purpose is to engage in securitization or asset-backed financing activities, the beneficial interests in the transferred financial assets are treated as proxies for the transferred financial assets themselves in accordance with the accounting conditions in ASC 860-10-40-5(b) and (c).

Although atypical, it is possible for a transferor to enter into a separate contract with a third-party beneficial interest holder that allows the entity to repurchase that third party’s beneficial interests, but the option is not transferred with the beneficial interests if they are sold by the third-party holder. In these situations, the call option is evaluated in the same manner as a freestanding call option on transferred financial assets regardless of whether the transferor can actually reclaim the transferred financial assets underlying such beneficial interests.

3.5.4 Put Options

ASC 860-10

Other Arrangements

55-42D This implementation guidance addresses the application of paragraph 860-10-40-5(c)(3) through the following examples:

A put option written to the transferee generally does not provide the transferor with effective control over the transferred financial asset under paragraph 860-10-40-5(c)(3).
A put option that is sufficiently deep in the money when it is written would, under that paragraph, provide the transferor effective control over the transferred financial asset because it is probable that the transferee will exercise the option and the transferor will be required to repurchase the transferred financial asset.
A sufficiently out-of-the-money put option held by the transferee would not provide the transferor with effective control over the transferred financial asset if it is probable when the option is written that the option will not be exercised.
A put option held by the transferee at fair value would not provide the transferor with effective control over the transferred financial asset.

The focus of the effective-control condition in ASC 860-10-40-5(c) is on whether the transferor can reclaim or repurchase transferred financial assets. Put options written by a transferor to a transferee give the transferee the ability to require the transferor to repurchase transferred financial assets (or third-party beneficial interests in transferred financial assets). With one exception, put options do not cause the transferor to maintain effective control over transferred financial assets (or third-party beneficial interests in transferred financial assets) because the transferee, not the transferor, decides whether the transferor repurchases the transferred financial assets (or beneficial interests in transferred financial assets). ASC 860-10 indicates that when a put option is sufficiently deep-in-the-money that it is probable when written that it will be exercised by the transferee, it functions, in substance, as a call option. ASC 860-10 includes this guidance as an anti-abuse condition. For a put option to function as a call option and preclude a transfer from meeting the condition in ASC 860-10-40-5(c), the following conditions must be met:

The exercise price is not fair value (i.e., it is fixed, determinable, or subject to a formula that allows the exercise price to exceed the fair value of the financial asset or third-party beneficial interest).
The option is unilaterally exercisable by the transferee.
As of the date the option is written (e.g., the transfer date), it is probable that it will be exercised.42

A put option cannot prevent a transfer from meeting the condition in ASC 860-10-40-5(c) if it is more than remote that the option will not be exercised (i.e., reasonably possible that exercise would not occur). Because this is a low threshold, put options rarely preclude sale accounting in practice. See Example 3-19 for an illustration.

Footnotes

While it is common by contract or custom for there to be collateral sufficient to (1) fund all or substantially all of the cost of purchasing replacement assets if the transferee (lender) defaults and (2) repay the obligation if the transferor (borrower) defaults, such collateral does not need to exist for a transferor to conclude that it maintains effective control when it is required to repurchase transferred financial assets or substantially the same assets. ASU 2011-03 eliminated the requirement for entities to consider whether a transferor has the ability to repurchase the transferred financial assets in a repurchase agreement.

A call option may be entered into after the transfer date, or a conditionally exercisable call option entered into as of the transfer date may later become unilaterally exercisable. In these situations, the transferor does not maintain effective control over transferred financial assets (or third-party beneficial interests in transferred financial assets) as of the original transfer date. Rather, it regains control over previously sold financial assets. See Section 4.3 for further discussion.

As discussed in Section 3.5.3.1.1.1, a call option held by the transferor on third-party beneficial interests in securitized financial assets that is part of, and transferred with, the beneficial interests is an attached call option on the transferred financial assets.

See Example 3-8 for an illustration of the evaluation of effective control for transfers of financial assets from a subsidiary entity to a securitization entity that is consolidated by the parent.

See ASC 860-10-55-42 for an exception to this general principle.

See Section 3.5.3.1.5.2 for guidance on situations in which the transferor holds a residual interest in securitized financial assets.

For example, if the only transactions occurring in the marketplace are repurchase financing transactions, the underlying financial asset is not readily obtainable.

Evidence may be obtained from published trading activity or from discussions with dealers in the financial asset.

One exception is when the exercise price is fixed and is so far out-of-the-money when written that it is probable that the transferor will not exercise it.

ASC 860-10 discusses call options that contain fixed or determinable prices. This means that the option’s exercise price is not at fair value on the date the financial asset is reclaimed. Call options with fixed or determinable prices are also referred to herein as “non–fair value” options.

If a securitization entity offers to sell the remaining financial assets as of the maturity or termination date of the securitization entity, and the transferor is precluded from bidding an amount that exceeds bona fide offers from unrelated third parties, the transferor’s ability to participate in the auction would not be viewed as the equivalent of holding a non–fair value call option.

Even a right to reclaim a readily obtainable financial asset from the transferee at a fixed price provides the transferor with effective control over that financial asset because the transferee cannot sell that asset without having to potentially incur a loss in the future from the requirement to repurchase that same asset in the marketplace at a higher price.

This view is consistent with comments made by board members at the March 4, 2009, FASB meeting. These comments are discussed in paragraphs 13 and 14 of the official minutes of this meeting.

See footnote 39.

If a transferred financial asset is not readily obtainable, a transferor would maintain effective control over the transferred asset if it holds a unilaterally exercisable, freestanding fair value call option even if it did not hold a residual interest in the transferred asset. See Q&A 3-50.

For put options that are exercisable at a future date, the exercise price must be deep-in-the-money as of the date the option is written and the volatility of the financial asset must be low enough to conclude that the option will be in-the-money as of the date it can be exercised.

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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.