7.2 Transfers of Financial Assets

Under U.S. GAAP, derecognition of a financial asset is based on a control approach. Under this approach, an entity recognizes the financial assets it controls and derecognizes a financial asset only when control is surrendered. ASC 860-10-40-4 through 40-5A provide specific criteria that must be met for control over a financial asset to be considered surrendered and for sale accounting (or derecognition) to be appropriate (see below for differences between the definition of control under U.S. GAAP and that under IFRS Accounting Standards). If control over a transferred financial asset is not surrendered, the entity must continue to recognize the financial asset and must recognize an associated secured borrowing that is equal to the consideration received.

Under IFRS Accounting Standards, derecognition is a multistep analysis (1) in which the risks and rewards of ownership are always considered and (2) that may include an assessment of control over a transferred financial asset. Paragraph 3.2.6 of IFRS 9 indicates that if the contractual rights to the cash flows of a financial asset are transferred, an entity must first consider whether substantially all the risks and rewards of ownership of that financial asset are transferred or retained to determine whether derecognition of the transferred asset is appropriate. If substantially all the risks and rewards of ownership of a financial asset are transferred to a third party, derecognition is appropriate. However, if substantially all the risks and rewards of ownership of a financial asset are retained by the transferor, derecognition of the financial asset is not appropriate.

While derecognition under IFRS 9 first requires an entity to consider the risks and rewards of ownership of the transferred financial asset, if substantially all the risks and rewards are neither transferred nor retained by the transferor, the entity must consider whether the transferor continues to control the financial asset after the transfer. In such cases, derecognition of the entire transferred asset is only appropriate if control over the transferred financial asset is surrendered. If control is not surrendered, the transferor derecognizes the financial asset to the extent that it does not have continuing involvement in the transferred asset.

If the contractual rights to the cash flows of a particular financial asset are retained, derecognition may still be appropriate if the entity enters into an offsetting contractual obligation to transfer the cash flows received from that asset to one or more third parties. This is often referred to as a “pass-through arrangement.” See below for the specific conditions that must be met for derecognition to be appropriate if the contractual rights to the cash flows of an asset are retained.

Because IFRS 9 is primarily a risks-and-rewards model, a transferor can transfer substantially all the risks and rewards of ownership of a particular asset while still retaining control over the transferred asset and achieve derecognition. However, under U.S. GAAP, if a transferor continues to control a transferred financial asset, it must continue to recognize the asset until control is surrendered, regardless of whether substantially all the risks and rewards of that asset are transferred to a third party. For example, if the transferee does not have the ability to freely pledge or exchange the transferred financial assets and the transferor obtains more than a trivial benefit from such an inability, control over the financial assets is not surrendered and derecognition is not appropriate under U.S. GAAP, even if substantially all the risks and rewards of ownership have been transferred.

Conversely, under IFRS 9, a transferor may surrender control and still not achieve derecognition if it has retained substantially all the risks and rewards of ownership of the transferred asset (e.g., if a transferor transfers an asset that is readily obtainable in the market and enters into a net-cash-settled repurchase contract). Under U.S. GAAP, if a transferor has surrendered control, it would derecognize the asset transferred.

If any of the above conditions are not met, a transfer of financial assets is not considered a sale and derecognition is not appropriate. Rather, the transferor must continue to recognize the transferred financial assets along with an associated secured borrowing for the consideration received. In addition, there is an exception for repurchase-to-maturity transactions in U.S. GAAP, under which such transactions must be accounted for as secured borrowings.

Under IFRS Accounting Standards, paragraph 3.2.9 of IFRS 9 indicates that control over a transferred financial asset depends on whether the transferee has the unilateral ability to sell the transferred asset. Specifically, this paragraph states:

The most notable difference between U.S. GAAP and IFRS Accounting Standards in this area is that IFRS 9 does not include a notion of legal isolation. Under IFRS Accounting Standards, control of a financial asset may be surrendered regardless of whether the transferor’s creditors have the ability to reclaim the transferred asset in the event of bankruptcy.

Another notable difference is that the assessment of control under IFRS Accounting Standards focuses solely on whether the transferee has the ability to unilaterally sell the transferred assets (i.e., the assessment solely considers whether the transferee controls the transferred asset). If the transferee cannot sell the asset at its sole discretion because of a restriction placed on the transferred asset or because the market in which the asset is traded is not active and the transferee needs access to that asset to meet obligations to the transferor, the transfer would fail to qualify for derecognition under IFRS Accounting Standards to the extent of the transferor’s continuing involvement unless substantially all the risks and rewards of the asset have been transferred.

IFRS Accounting Standards do not explicitly discuss whether a transferee has the ability to pledge the transferred asset or whether the transferor maintains effective control over the transferred asset. However, a transferred asset may not necessarily qualify for derecognition under IFRS 9 even if control has been surrendered. For example, if an entity sells an asset that is readily obtainable in the market and enters into a net-cash-settled repurchase contract with the transferee, derecognition would not be appropriate under IFRS 9 if the transferor has retained substantially all the risks and rewards of ownership of the transferred asset. In this case, the retention of substantially all the risks and rewards of ownership prohibits derecognition, irrespective of whether the transferor controls the asset.

Under IFRS Accounting Standards, a portion of a financial asset may be assessed for derecognition only if at least one of the conditions in paragraph 3.2.2(a) of IFRS 9 is met. If none of these conditions are met, the entire financial asset must be assessed for derecognition. The conditions are as follows:

• “The part comprises only specifically identified cash flows from a financial asset (or a group of similar financial assets).”
• “The part comprises only a fully proportionate (pro rata) share of the cash flows from a financial asset (or a group of similar financial assets).”
• “The part comprises only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or a group of similar financial assets).

For example, if an entity transfers all the cash flows related to the interest receivable from a financial asset (i.e., an IO strip), that portion of the asset may qualify for derecognition under IFRS Accounting Standards. However, under U.S. GAAP, since the portion of the transferred asset would not meet the definition of a participating interest (because the cash flows would not be divided proportionately among the participating interest holders), derecognition would not be appropriate.

Under IFRS Accounting Standards, if the contractual rights to the cash flows of a financial asset are retained, an entity may still derecognize that financial asset if an offsetting obligation to pass though the cash flows to third parties exists, provided that three conditions are met. For example, if an entity transfers assets to a SPE that it establishes and is required to consolidate, the consolidated entity continues to retain the contractual rights to the cash flows of the transferred assets. However, in this case, the consolidated entity would derecognize the transferred assets if it has an offsetting obligation to third parties outside of the consolidated entity that meets the three specified conditions.

Paragraph 3.2.5 of IFRS 9 states, in part, that when an entity retains the contractual rights to an asset’s cash flows, it must derecognize that asset if the following three conditions are met:

• “The entity has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the original asset.”
• “The entity is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to the eventual recipients for the obligation to pay them cash flows.”
• “The entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay.”

In the situation described above, although the transferor is required to consolidate the SPE, it is still allowed to derecognize the transferred financial assets if the conditions in paragraph 3.2.5 of IFRS 9 are met at the consolidated-entity level.

Under IFRS Accounting Standards, a specific exception for cleanup calls does not exist. If a transferor that is the servicer retains a cleanup call on transferred financial assets, that call option may prevent derecognition. In this case, derecognition is not appropriate if (1) the call option results in the transferor’s retaining substantially all the risks and rewards of ownership of the financial asset or (2) control over the transferred assets is retained and substantially all the risks and rewards are neither retained nor transferred. See paragraph B3.2.16(m) of IFRS 9.

In addition, there is an exception for repurchase-to-maturity transactions in U.S. GAAP, under which such transactions must be accounted for as secured borrowings. ASC 860-10-40-24A states:

Under IFRS Accounting Standards, IFRS 9 does not provide restrictive derecognition guidance that is specifically related to repurchase arrangements. Rather, an entity that transfers a financial asset subject to a repurchase arrangement must consider the derecognition provisions in paragraph 3.2.3 of IFRS 9, as it would for any financial asset transfer. In this case, derecognition is not appropriate if the repurchase arrangement results in the transferor’s retaining substantially all the risks and rewards of ownership of the transferred financial asset.

Because, under U.S. GAAP, financial assets that will be returned to the transferor as part of a repurchase agreement must be substantially the same as the original financial assets transferred for the transferor to maintain effective control, and because derecognition under IFRS 9 focuses first on risks and rewards of ownership, similar repurchase arrangements may be accounted for differently under U.S. GAAP than they would be under IFRS Accounting Standards.

ASC 860 does not provide specific guidance on the subsequent measurement of the secured borrowing after initial recognition. The transferor must instead look to other applicable GAAP. ASC 405-20 provides guidance on when a financial liability is considered extinguished. An entity should consider the provisions of ASC 405-20-40-1 when determining whether a transferor can derecognize the secured borrowing.

Under IFRS Accounting Standards, the recognition and measurement of a secured borrowing depend on whether derecognition is prohibited because substantially all the risk and rewards of ownership of the transferred asset are retained or because control over the transferred financial asset is not surrendered.

Under paragraph 3.2.15 of IFRS 9, if derecognition of a transferred financial asset is prohibited because the transferor retains substantially all the risks and rewards of ownership of the financial asset, an entity’s recognition and measurement of the secured borrowing would be the same under IFRS Accounting Standards as under U.S. GAAP. In this case, the transferor would continue to recognize the transferred financial asset in its entirety and to recognize an associated secured borrowing that is equal to the consideration received in the transfer.

Under paragraph 3.2.16 of IFRS 9, if derecognition of a transferred financial asset is prohibited because substantially all the risks and rewards of ownership of the transferred financial asset are neither retained nor transferred and the transferor retains control over the transferred financial asset, the transferor must continue to recognize the transferred asset to the extent of its continuing involvement with the asset. In this case, the transferor does not continue to recognize the transferred financial asset in its entirety; rather, the transferor is considered to have continuing involvement in the asset to “the extent to which it is exposed to changes in the value of the transferred asset” in accordance with the guidance in IFRS 9 (e.g., if the transferred asset has been guaranteed by the transferor, the amount of the continuing involvement is limited to the maximum amount of the consideration received that the transferor could be required to repay). Similarly, in such a situation, an associated secured borrowing measured in accordance with paragraph 3.2.17 of IFRS 9 is recognized.

Unlike (1) a secured borrowing under U.S. GAAP or (2) a scenario in which the transferor retains substantially all the risks and rewards of ownership of the transferred asset under IFRS Accounting Standards, the transferred asset that the transferor continues to recognize to the extent of its continuing involvement and the associated secured borrowing are subsequently measured on the basis of the rights and obligations that the entity has retained. Paragraph B3.2.13 of IFRS 9 contains detailed guidance on the application of this principle in certain situations.