A City of London tale has it that when those writing
the rules of the International Accounting Standards Board
(IASB) reached rule 39 they ran out of energy. They invited
views on what the standard should include and bunched them
together. The result was a muddle that, some lawyers argue,
would make 95% of asset-backed transactions impossible.
No-one worried because deals were executed under national
accounting procedures.
The EC has decided that all EU companies must impose IAS by
2005. Standard 39, which determines when assets transferred to
another entity can be removed from a balance sheet, must be
applied. So the rule makers are changing the rules. The IASB has
developed the concept of continuing involvement to determine
whether assets should be left on the books of an originator in a
securitization or not. But few in the financial industry consider
that the proposals are an improvement."The banks are apoplectic
about this," says a partner at a US law firm in London.
The proposed rule says an originator must relinquish all
continuing interests in the cashflows from the assets in question
to secure derecognition. For example, the originator must abandon
provisions allowing it to regain control of the assets or requiring
it to pay for changes in their value. Though apparently
straightforward, the proposals would make derecognition impossible
on most deals.
Deloitte&Touche partner David Barnes says: "Take a trade
receivables securitization with a pool of income worth $100
million. You sell bonds worth $90 million. But the receivables pay
more than you expected and that extra money flows back to the
originator. The deal would not pass the continuing involvement
test.
"There is an argument to suggest that because the originator has
a potentially continuing involvement in each and every one of the
trade receivables then it is not appropriate to derecognize any of
the assets."
Nor would an originator taking an option to buy back defaulted
assets be able to derecognize, even though this is possible in the
US. This would be the case regardless of the likelihood that the
option would be exercised. Likewise, an originator that provided a
guarantee to a special-purpose vehicle (SPV) would be unable to
remove assets from its balance sheet in so far as these might be
covered by the guarantee.
Threat of
reversal
Further changes to IAS 39 aim
to rectify a problem created by another IASB rule, Sic 12,
which sets rules for putting assets back onto a balance
sheet. No-one disputes that Sic 12 is a problem. The rule
requires many SPVs to be consolidated by the originator at a
group level. As such it threatens to reverse the effects of
derecognition under IAS 39. Assets transferred to an SPV in a
securitization jump to the vehicle's books under IAS 39 and
then back to the originator's under Sic 12.
The proposed pass-through amendments to IAS 39 could allow
securitizers to derecognize assets from both their own balance
sheets and those of SPVs on the basis that funds from the assets
pass straight through the vehicle to investors. Originators would
still have to consolidate under Sic 12. There would simply be
nothing to consolidate.
To qualify, SPVs must not be obliged to pay bondholders unless
they collect equivalent cash from the assets. They must not be able
to use the assets for their own benefit. And they must be obliged
to forward cash received from the asset to investors on a timely
basis.
But securitizers have criticized the drafting of the rules,
saying the pass-through criteria are too narrow and will leave many
SPVs unable to qualify for derecognition. Deals that use a
liquidity facility or a swap to make payments to investors or where
there is a delay in passing cashflows to bondholders will not match
the requirements. In these deals payments to bondholders do not
come direct from the cashflows generated by the assets. As many as
half of the deals include some feature in the SPV that would
prevent it shifting the assets from its balance sheet.
Deloitte's Barnes says: "Actively managed collateralized bond
obligations would be caught by the same rule, because the fund
manager on these deals buys and sells securities from the asset
portfolio to maximize the income of the special purpose
vehicle."
The European Securitization Forum wants the wording of the
pass-through rule to be changed, and it seems probable the rule
makers will agree. In a letter commenting on the proposals, the
Forum says: "There needs to be a clear distinction depending on
whether the transferor is the originator or a special purpose
entity. Where it is the latter, we suggest that the entity be
permitted to use all its available cashflows to make payments, to
sell or pledge the assets and hold any cashflows for a period of
time and invest in risk-free assets."
Wayne Upton, the research director leading the review of IAS 39,
says: "Continuing involvement is not like anything anyone else has
come up with. There are no exceptions, no special pleadings. It
will test how much people want simplicity versus how much they want
answers."
The market remains wary. Mark Nicolaides, a partner at Mayer
Brown Rowe&Maw, says: "The concept of continuing involvement is
a compromise. It seems the Board can't resolve the conflict over
derecognition. Its solution is neither fish nor fowl."
Rob Mannix (rmannix@iflr.com) is editor of Euromoney's sister
publication International Financial Law Review