transaction with such conditions that otherwise met the criteria in Box 4 would not be
subject to the pass-through test in Box 5.
However, the existence of conditions relating to the future performance of the asset
might affect the conclusion related to the transfer of risks and rewards (i.e. Box 6 in
Figure 48.1 at 3.2 above) as well as the extent of any continuing involvement by the
transferor in the transferred asset (i.e. Box 9 in Figure 48.1 at 3.2. above).14
These interpretations were also withdrawn by the Interpretations Committee in January
2007 together with the views that had been expressed regarding ‘similar’ assets and
transfers of assets (see 3.3.2 above). Although the IASB repeated them in the April 2009
3902 Chapter 48
Exposure Draft – Derecognition – an entity must take a view that is consistent with its
policies on these matters and, as in these other cases, hold this view consistently when
considering the derecognition of any financial asset.
An example of a two-party offset arrangement is when the original debtor (e.g. a borrower
or customer) has the right to offset amounts it is owed by the transferor (e.g. balances in a
deposit account or arising from a credit note issued by the transferor) against the
transferred asset. If such a right is exercised after the asset is transferred the transferor
would be required to compensate the transferee. This would not, in our view, normally
affect whether the entity has transferred the contractual rights to receive the cash flows
of the original financial asset. Payments made by the transferor to the transferee as a result
of the right of offset being exercised simply transfer to the transferee the value the
transferor obtained when its liability to the original debtor was settled.
3.5.2
Retention of rights to receive cash flows subject to obligation to pay
over to others (pass-through arrangement)
The discussion in this section refers to Box 5 in the flowchart at 3.2 above.
It is common in certain securitisation and debt sub-participation transactions (see 3.6
below) for an entity to enter into an arrangement whereby it continues to collect cash
receipts from a financial asset (or more typically a pool of financial assets), but is
obliged to pass on those receipts to a third party that has provided finance in
connection with the financial asset. Whilst the term ‘pass-through’ for these
arrangements does not actually appear in IFRS 9 it has become part of the language
of the financial markets.
Under IFRS 9, an arrangement whereby the reporting entity retains the contractual
rights to receive the cash flows of a financial asset (the ‘original asset’), but assumes a
contractual obligation to pay the cash flows to one or more recipients (the ‘eventual
recipients’) is regarded as a transfer of the original asset if, and only if, all of the following
three conditions are met:
(a) the entity has no obligation to pay amounts to the eventual recipients unless it
collects equivalent amounts from the original asset. Short-term advances by the
entity with the right of full recovery of the amount lent plus accrued interest at
market rates do not violate this condition (see 3.6.1 and 3.6.2 below);
(b) 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; and
(c) the entity has an obligation to remit any cash flows it collects on behalf of the eventual
recipients without material delay. In addition, the entity is not entitled to reinvest such
cash flows, except in cash or cash equivalents as defined in IAS 7 – Statement of Cash
Flows (see Chapter 36 at 3) during the short settlement period from the collection
date to the date of required remittance to the eventual recipients, with any interest
earned on such investments being passed to the eventual recipients. [IFRS 9.3.2.5].
These conditions are discussed further at 3.6.4 below.
IFRS 9 notes that an entity that is required to consider the impact of these conditions
on a transaction is likely to be either:
Financial
instruments:
Derecognition
3903
• the originator of the financial asset in a securitisation transaction (see 3.6 below); or
• a group that includes a consolidated special purpose entity that has acquired the
financial asset and passes on cash flows to unrelated third party investors. [IFRS 9.B3.2.3].
3.6 Securitisations
Securitisation is a process whereby finance can be raised from external investors by
enabling them to invest in parcels of specific financial assets. The first main type of
assets to be securitised was domestic mortgage loans, but the technique is regularly
extended to other assets, such as credit card receivables, other consumer loans, or lease
receivables. Securitisations are a complex area of financial reporting beyond the scope
of a general text such as this to discuss in detail. However, it may assist understanding
of the IASB’s thinking to consider a ‘generic’ example of such a transaction.
A typical securitisation transaction involving a portfolio of mortgage loans would operate as
follows. The entity which has initially advanced the loans in question (the ‘originator’) will
sell them to another entity set up for the purpose (the ‘issuer’). The issuer will typically be a
subsidiary or consolidated SPE of the originator (and therefore consolidated – see 3.2 above)
and its equity share capital, which will be small, will often be owned by a trustee on behalf of
a charitable trust. The issuer will finance its purchase of these loans by issuing loan notes on
interest terms which will be related to the rate of interest receivable on the mortgages and to
achieve this it may need to enter into derivative instruments such as interest rate swaps. The
swap counterparty may be the originator or a third party. The originator will continue to
administer the loans as before, for which it will receive a service fee from the issuer.
The structure might therefore be as shown in this diagram:
Charitable trust
Investors
equity
shares
issues loan notes
Swap
Originator
Issuer
sells loans
counterparty
makes loans
Mortgagors
Potential investors in the mortgage-backed loan notes will want to be assured that their
investment is relatively risk-free and the issue will normally be supported by obtaining
a high rating from a credit rating agency. This may be achieved by using a range of credit
enhancement techniques which will add to the security already inherent in the quality
of the mortgage portfolio. Such techniques can include the following:
• limited recourse to the originator in the event that the income from the mortgages
falls short of the interest payable to the investors under the loan notes and other
expenses. This may be made available in a number of ways: for example, by the
3904 Chapter 48
provision of subordinated loan finance from the originator to the issuer; by the
deferral of part of the consideration
for the sale of the mortgages; or by the
provision of a guarantee (see 3.6.1 below);
• the provision of loan facilities to meet temporary shortfalls as a result of slow
payments of mortgage interest (see 3.6.2 below); or
• insurance against default on the mortgages (see 3.6.3 below).
The overall effect of the arrangement is that outside investors have been brought in to
finance a particular portion of the originator’s activities. These investors have first call
on the income from the mortgages which back their investment. The originator is left
with only the residual interest in the differential between the rates paid on the notes
and earned on the mortgages, net of expenses. Generally, this profit element is extracted
by adjustments to the service fee or through the mechanism of interest rate swaps. It
has thus limited its upside interest in the mortgages, while its remaining downside risk
on the whole arrangement will depend on the extent to which it has assumed obligations
under the credit enhancement measures.
3.6.1
Recourse to originator
The conditions in 3.5.2 above clearly have the effect that an arrangement that does not
transfer the contractual rights to receive the cash flows but provides for direct recourse
to the originator does not meet the definition of a ‘transfer’ for the purposes of pass-
through and therefore does not qualify to be considered for derecognition. Direct
recourse would include an arrangement whereby part of the consideration for the
financial asset transferred was deferred depending on the performance of the asset.
In our view, however, certain techniques for providing indirect recourse do not breach
the conditions for transfer. These include, for example, the provision of certain types of
insurance (see 3.6.3 below).
3.6.2
Short-term loan facilities
Enhancing a securitised asset with the provision of loan facilities to meet temporary
shortfalls as a result of slow payments from the asset would not preclude an arrangement
being regarded as a pass-through (see 3.5.2 above), but only where the loans:
• are made on a ‘short-term’ basis;
• are repayable irrespective of whether the slow payments are eventually received; and
• bear interest at market rates.
The purpose of these restrictions is to ensure that IFRS 9 allows derecognition of assets
subject to such facilities only where the facilities are providing a short-term cash flow
benefit to the investor, and not when they effectively transfer slow payment risk back
to the originator (as would be the case if the originator made significant interest-free
loans to the investor). Clearly, therefore, the circumstances in which such funds can be
advanced must be very tightly defined if pass-through is to be achieved.
3.6.3 Insurance
protection
The conditions for ‘transfer’ are not, in our view, breached by the originator purchasing an
insurance contract for the benefit of investors in the event of a shortfall in cash collections
Financial
instruments:
Derecognition
3905
from the securitised assets, provided that the investors’ only recourse is to the insurance
policy. In other words, the originator cannot give a guarantee to investors to make good
any shortfalls should the insurer become insolvent, nor can the originator provide any
support to the insurer through a guarantee arrangement or a reinsurance contract.
The implications of the derecognition and pass-through requirements of IFRS 9 for
transfers of groups of financial assets including insurance contracts have been
reconsidered by the Interpretations Committee and the IASB but their tentative
conclusions were withdrawn. For a discussion of the issues and the alternative
interpretations of ‘similar’ assets, see 3.3.2 above.
3.6.4
Treatment of collection proceeds
Securitisation contracts rarely require any amount received on the securitised assets to
be immediately transferred to investors. This is for the obvious practical reason that it
would be administratively inefficient, in the case of a securitisation of credit card
receivables for example, to transfer the relevant portion of each individual, and
relatively small, cash flow received from the hundreds, if not thousands, of cards in the
portfolio. Instead, it is usual for transfers to be made in bulk on a periodic basis (e.g.
weekly or monthly). This raises the question of what happens to the cash in the period
between receipt by the issuer and onward transfer to the investors.
IFRS 9 requires cash flows from transferred financial assets for which derecognition is
sought to be:
• passed to the eventual recipients ‘without material delay’; and
• invested only in cash or cash equivalents as defined in IAS 7 entirely for the benefit
of the investors (see condition (c) in 3.5.2 above).
These requirements mean that many securitisation arrangements may well fail to satisfy
the pass-through test in 3.5.2 above, as explained below.
Suppose that a credit card issuer wishes to raise five year finance secured on its portfolio
of credit card receivables. The assets concerned are essentially short term (being in most
cases settled in full within four to eight weeks), whereas the term of the borrowings
secured on them is longer. In practice, what generally happens is that, at the start of the
securitisation, a ‘pool’ of balances is transferred to the issuer. The cash receipts from that
‘pool’ are used to pay interest on the borrowings, and to fund new advances on cards in
the ‘pool’ or to purchase other balances. Such an arrangement, commonly referred to as
a ‘revolving’ structure, appears to breach the requirement of the pass-through tests to:
• pass on cash receipts without material delay (since only the amount of cash
receipts necessary to pay the interest on the borrowings is passed on, with the
balance being reinvested until the principal of the borrowings falls due); and
• only invest in cash or cash equivalents as defined in IAS 7 in the period prior to
passing them onto the investor. This is because the cash not required to pay
interest on the borrowings is invested in further credit card receivables, which are
not cash or cash equivalents as defined in IAS 7.
The Interpretations Committee confirmed in November 2005 that ‘revolving’ structures
do not meet the requirements of the pass-through test for funds to be passed on without
material delay and to be invested only in cash and cash equivalents.15
3906 Chapter 48
In practice, we have observed the pass-through tests are applied very strictly such
that any arrangement that provides for even a small tranche of the interest from such
short-term deposits to be retained by or for the benefit of the originator will not satisfy
the criteria for transfer under IFRS 9. Moreover, IFRS 9 requires that the reporting
entity ‘is not entitled’ to invest the cash other than in cash or cash equivalents as
described above. Thus, it appears that the criteria for transfer are not satisfied merely
where the entity does not in fact invest the cash in any other way – it must be
contractually prohibited from doin
g so. In practice, this is often achieved by having
the funds paid into a trustee bank account that can be used only for the benefit of the
providers of finance.
The IASB does not expand further on the term ‘without material delay’. It is not, in our
view, intended to require settlement to noteholders on an unrealistically frequent basis
such as daily, although we would normally expect payments to be made by the next
quarterly coupon payment date to meet this condition.
The strict requirements of IFRS 9 in respect of cash received from assets subject to a
pass-through arrangement raise the related, but broader, issue of the appropriate
treatment of client money which is discussed at 3.7 below.
3.6.5
Transfers of non-optional derivatives along with a group of financial
assets
As discussed at 3.3.2 above, interest rate swaps that are transferred along with a group
of non-derivative financial assets may be derecognised only when any associated
obligation is discharged, cancelled or expires (see 6 below). This, however, does not
occur in most securitisations.
In a securitisation transaction involving the equitable transfer of an interest rate swap
to an SPE, the swap would continue to be recognised by the transferor. The ongoing
accounting consequences of this are less clear. The swap must clearly continue to be
measured at fair value through profit or loss in accordance with the general requirement
of IFRS 9 for the measurement of derivatives not in a hedging relationship (see
Chapter 42). However, this would have the effect that the reporting entity reflected
gains and losses in the income statement for a derivative in which it no longer has a
beneficial interest. In such a case, the entity should presumably recognise the notional
back-to-back swap which it has effectively entered into with the transferee, so as to
offset the income statement effect of the original swap.
3.6.6
‘Empty’ subsidiaries or SPEs
If an entity enters into a transaction whereby:
• the entity transfers an asset to a subsidiary or SPE; and
• the subsidiary or SPE transfers the asset to noteholders on terms that satisfy the
pass-through derecognition criteria in IFRS 9 discussed at 3.5.2 and 3.6 above,
the overall effect will be that the individual financial statements of the subsidiary or SPE
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 772