Weak ‘Repos’ Amended in Newly Issued Accounting Standards
The Financial Accounting Standards Board (FASB) has updated the accounting standards for the financial reporting of repurchase agreements, the same ‘repos’ that brought Lehman Brothers down in the height of the 2008 global financial crisis.
In the case of Lehman Brothers, it was called “Repos 105″ where investigators found some $50 billion taken by Lehman Brothers from its balance sheet that was being claimed as securities when the amount was actually sum of loans, which in effect made the investors to believe the bank was still safe at the time.
The accounting standards update No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements, is said to improve how repurchase agreements are to be reported. The update also covers other agreements that authorize and obligate a transferor to repurchase or redeem financial assets before they mature.
According to FASB Chairman Leslie Seidman, the revision came after the Board reviewed its standards on transfers and servicing as a response to the many concerns raised by financial statement users who sought improvement in the criteria for determining effective control for repos.
Seidman said the accounting standards update is intended to improve “transparency by eliminating consideration of the transferor’s ability to fulfill its contractual rights and obligations from the criteria in determining effective control.”
A typical repo transaction is where an entity transfers its assets to another party and receives cash in exchange and makes agreement with the counter-party that the same asset will be returned or a fixed price will be paid in the future.
Topic 860, Transfers and Servicing, gives prescription signaling when an entity will be allowed recognize a sale upon the transfer of financial assets subject to repo agreements or when it will not be. The prescription is partially based on the condition that the entity has maintained effective control over the transferred financial assets.
The accounting standards update is said to remove from the assessment of effective control the criterion that requires the transferor to have the ability to repurchase or redeem the financial assets, including the implementation guidance thereof.
FASB initially planned to revise the accounting standards regarding repurchase agreement on November 2010 following criticisms it received from the public.