The Financial Accounting Standards Board has issued proposed guidance clarifying when derivatives are allowed in QSPEs. According to DW sister publication Securitization News, transactions that use derivatives not meeting the criteria may not result in off-balance sheet treatment. The Standards Setter is responding to concerns about two situations--the impact of unexpected events, such as unanticipated prepayments, and market making or other trading activities, said Lisa Filomia-Aktas, partner at Ernst & Young.
Derivatives cannot be speculative in nature and need to reduce risk. As a result, questions arose as to whether QSPEs would be disqualified after derivatives become excessive due to unanticipated events, such as prepayments. This was an issue because securitizers didn't know whether to evaluate this initially or through an ongoing test, Aktas said, adding that it is a good sign for the market that the FASB is clarifying that the size of the derivative should be evaluated only initially.
In addition, there were concerns that a QSPE could be disqualified if a transferor, also acting as a market maker, purchased beneficial interests in a QSPE that it sponsors. This question arises because the notional amount of the derivative cannot exceed the amount of beneficial interests held by outside parties. "Here the industry relief does not come from this proposal as it doesn't allow the reduction of risk on all interests planned to be sold to investors," Aktas said.
FASB said it will address this issue in its upcoming exposure draft to FASB 140, but this may not be soon enough, Aktas noted. The upcoming exposure draft will tackle three areas--QSPEs and legal isolation, hybrid instruments and bifurcation of embedded derivatives, and servicing rights. It will be released later this month.
