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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
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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