Fitch: FASB Revisit of Repo Accounting Could Close Loophole

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings believes the Financial Accounting Standards Board's (FASB) review of repurchase agreement (repo) accounting rules could help close a major loophole used by some in repo accounting. We continue to believe that greater transparency in this area of accounting is important.

FASB is once again examining repo accounting and disclosure requirements following the collapse of MF Global. The standard setter had visited the subject after the Lehman bankruptcy to address and eliminate the repo transactions dubbed repo 105. Some firms are known to have used repo-to-maturity (RTM) transactions to transfer assets and liabilities off balance sheets while retaining both credit and market risk. This effectively masks the overall financial risk the firm is actually taking and could also set regulators off track.

The accounting treatment of repos, specifically RTMs, is the focus of discussion. Repos can be treated as either sales or financing arrangements based on effective control over transferred assets. Sales arrangements allow assets and liabilities to go unrecognized.

In an RTM, the firm is long the underlying collateral and retains much of the risk. While RTMs are disclosed in the footnotes, the securities underlying an RTM may not be. We believe excluding those long securities from leverage calculations can understate leverage. This practice has not been widely used, but we believe a stressed environment could provide an incentive for some to utilize it in order to hide debt or adverse financial conditions.

We believe the accounting model for repo to maturity is flawed and FASB's revisit has been widely expected. The revision is expected to change the assessment of effective control and will likely disallow RTMs in the future. The revision should be finalized over the coming year.

Additional information is available on www.fitchratings.com

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