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Rule Makers Tighten Accounting for ‘Repos’; Under New FASB Rule, to Take Effect in 2015, Most Repos Will Be Treated as Borrowings

Rule Makers Tighten Accounting for ‘Repos’

Under New FASB Rule, to Take Effect in 2015, Most Repos Will Be Treated as Borrowings

MICHAEL RAPOPORT

Updated June 12, 2014 5:45 p.m. ET

Rule makers on Thursday closed a loophole in the accounting for a key form of financing used by securities firms and that both Lehman Brothers Holdings Inc. and MF Global Holdings Inc. used to make themselves appear healthier before they collapsed.

The Financial Accounting Standards Board, which sets accounting rules for U.S. companies, agreed to tighten the accounting for repurchase agreements, or “repos,” in which securities firms borrow money on a short-term basis and put up securities as collateral with the promise to buy them back later.

Repos typically are accounted for as borrowings, and so a company that raises money using repos has to account for them on its balance sheet.

Both Lehman and MF Global tinkered with the terms of the transactions to be able to classify some of their repo transactions as sales. Such treatment allows a firm to take assets off its balance sheet and book quick profits, and can make the firm look less risk-laden than it actually is, authorities have said.

Under the new rule, which takes effect in 2015, most repos will be treated as borrowings—including “repos to maturity,” a variation on traditional repos that was a central part of MF Global’s strategy.

The new rule also will require companies to disclose more about their repos, including disclosures about what kind of collateral they have pledged and about any of their transactions that are economically similar to repos.

Lehman used transactions it called “Repo 105s” that were accounted for as sales to take $50 billion in assets off its balance sheet and make itself look less leveraged, particularly in 2007 and 2008, according to a report by Lehman bankruptcy examiner Anton Valukas. Lehman collapsed in September 2008.

MF Global had billions of dollars in repos to maturity, which extended the duration of its repo financing so that it matured at the same time as the securities it used as collateral. That arrangement enabled the firm to avoid having to repeatedly refinance its borrowings, and it allowed for sale treatment under which MF Global could record profits on the transactions immediately.

But MF Global’s trades were backed by risky European sovereign debt, and that helped prompt regulatory concerns, ratings downgrades and margin calls—demands that MF Global put up more cash to cover losses on its investments—that played a role in the firm’s October 2011 collapse once it ran short of funds.

 

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About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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