5.2 Recognition of a Transfer as a Secured Borrowing

The transferor is required to consolidate the transferee (ASC 860-10-55-17D).

The transfer does not meet the conditions for a sale (ASC 860-10-40-5).

The transferred financial asset represents a portion of an entire financial asset (or assets) (i.e., a portion of an entire financial asset [or assets] that represents less than a 100 percent participation in that asset [or group of assets]) that does not meet the definition of a participating interest (ASC 860-10-40-4E).

Repurchase agreements — Repurchase agreements are generally entered into for short-term financing and investing purposes.4 In a repurchase agreement, an entity (the transferor-borrower) sells a debt security to a third party (the transferee-lender) and simultaneously agrees to repurchase the same (or substantially the same) security at a future date. Most repurchase agreements are structured to give the transferee legal title to the securities for the term of the transaction. However, the transferor is obligated to repurchase the security or a security that is substantially the same at a future date at a repurchase price that is generally equal to the sales price plus interest. The collateral (i.e., debt security) that secures a repurchase agreement is generally subject to adjustment based on collateral posting thresholds.

The terms of repurchase agreements vary significantly. Many repurchase agreements are short-term arrangements (e.g., overnight, days, weeks, or months), but some are longer-term (e.g., one year or more). Long-term repurchase agreements are often referred to as “term repos.” Some repurchase agreements allow the transferee to sell or repledge the securities during the term of the agreement, while others do not give the transferee such a right. Repurchase agreements may be specified-delivery, tri-party, or held-in-custody arrangements. In a specified-delivery transaction, the security must be delivered to the transferee as of the transaction date and then transferred back to the transferor at maturity. In a tri-party arrangement, a third party acts as an agent or intermediary between the two parties during the term of the repurchase agreement to facilitate services such as collateral selection, payment and settlement, and custody and management. Tri-party arrangements include parties that centrally clear repurchase agreements between broker-dealers in securities. In these arrangements, a central counterparty clearing house provides clearing and settlement services and takes on counterparty credit risk between the parties to the arrangement. A held-in-custody repurchase agreement is one in which the transferor-borrower does not deliver the security to the transferee-lender but keeps the security in a separate account on behalf of the transferee. In these arrangements, while the transferor retains control of the security and services the security throughout the term of the repurchase agreement, it holds the security as a custodial agent on behalf of the transferee.

Dollar-roll repurchase agreements — An entity (the transferor-borrower) sells an MBS (typically one guaranteed by the FHLMC, FNMA, or GNMA) to a third party (the transferee-lender) and simultaneously agrees to repurchase an MBS at a future date that is similar to, but not necessarily the same as, the MBS sold. The repurchase price is generally the sales price plus interest. A dollar-roll repurchase agreement that is within the scope of ASC 860-10 is generally accounted for as a secured borrowing if the securities that must be returned are substantially the same.5

Securities lending transactions — Securities lending transactions are generally initiated by (1) broker-dealers in securities or other financial services entities that need specific securities to cover a short sale or a customer’s failure to deliver securities sold or (2) entities that own securities as a means of financing (i.e., to obtain access to cash that is posted as collateral by the borrower). In a typical securities lending transaction, an entity (the transferor) lends a security to a securities borrower (the transferee). Securities lending often involves equity securities but may involve debt securities. Most securities lending transactions provide the borrower with legal title to the securities lent; however, at the end of the agreement, the borrower must return the security to the lender. As legal owner of the security, the borrower receives any dividends or interest paid on the borrowed security but may be required to pay those amounts or fees to the lender depending on the negotiated terms of the arrangement.

The securities borrower must post collateral, which is generally in the form of cash but could be a letter of credit or other securities. If the collateral is cash, the securities lender generally earns a return by investing the cash at a rate that is higher than the rate rebated to the securities borrower. If the collateral is not cash, the securities lender generally charges the securities borrower a fee. To provide protection to the securities lender, the fair value of the collateral posted by the securities borrower generally exceeds the fair value of the lent security. The collateral posted is subject to adjustment as the fair value of the lent securities changes. Legally, the securities lender obtains a security interest in any securities posted as collateral. However, any securities received by the securities lender as so-called collateral may be considered the proceeds of a secured borrowing (see Section 5.3.3.3.1).

Unlike repurchase agreements, many securities lending agreements are open ended with no stated maturity date. Either party may unwind or settle the transaction upon notice to the other party. Securities custodians or other agents commonly carry out securities lending transactions on behalf of clients. Because of the protection provided by the collateral posted (i.e., the collateral is typically valued daily and adjusted frequently for changes in the market price of the securities lent), most securities lending transactions do not impose significant credit risks on either party. However, other risks may arise from what the parties do with the assets they receive. For example, investments made with cash received as collateral may subject the securities lender to market risks or credit risks.

In a securities lending transaction, the identification of the transferor and transferee can seem nonintuitive. The transferor-lender of the security in a securities lending transaction is actually treated as the obligor-transferor for accounting purposes and the transferee-borrower of the security is treated as the creditor-transferee. However, if securities are posted as collateral, the transferor could be viewed as being both a lender and a borrower (i.e., the lender of the security lent and the borrower of the security received as collateral). In these situations, the same may be true for the transferee (i.e., the transferee may be considered the borrower of the security lent and the lender of the security posted as collateral). The table below provides more information on each party’s involvement in a securities lending transaction.