Close
Close

On the Horizon: Derecognition of CMBS ‘B-piece’ sold to third-party purchasers

RFP
Contents Current reporting issue       Derecognition of CMBS ‘B-piece’ sold to third-party purchasers

FASB       ASU amends recognition and measurement guidance for financial instruments
      Proposal addresses implementation costs in certain cloud computing arrangements
      U.S. GAAP Taxonomy updated for ASU 2018-02 and SAB 118

AICPA       Interpretation on attestation engagements under two standard sets revised
      Auditing Standards Appendix B and AU-C section 610 updated
      New description criteria standards issued for SOC 2 reports

IASB       IFRS Foundation reappoints two committee members



Current reporting issue Derecognition of CMBS ‘B-piece’ sold to third-party purchasers The Dodd-Frank Act introduced risk retention rules for issuers of asset-backed securities via securitization vehicles. These rules generally require certain qualified sponsors to retain 5 percent of the credit risk of the securitization and prohibit these sponsors from transferring the 5 percent risk retention piece for some period of time. However, for commercial mortgage-backed securities (CMBS), the securitization sponsor may be able to transfer the 5 percent risk retention piece to a third-party purchaser that becomes subject to the same restrictions on transfer, thereby satisfying the qualified sponsor’s risk retention requirement.

In a letter dated December 4, 2017, the Securities Industry and Financial Markets Association (SIFMA) confirmed its understanding of the SEC staff’s position regarding a prior SIFMA submission questioning whether the restrictions on the transfer of the 5 percent risk retention piece held by a third-party purchaser would prevent a securitization sponsor from derecognizing the collateral transferred to the securitization vehicle. The SEC staff’s view is that the restriction on transfer imposed on a third-party purchaser under Dodd-Frank does not, in and of itself, cause the transfer of collateral from the securitization’s sponsor to the securitization vehicle to fail the sale accounting criteria in ASC 860-10-40-5, Transfers and Servicing.

CMBS securitizations are typically accomplished using a two-step securitization model (as described in ASC 860-10-55-22), in which the securitization sponsor transfers commercial mortgage loans (the collateral) to a “depositor.” The depositor is typically a wholly owned subsidiary or affiliate of the securitization sponsor, but is structured as a bankruptcy-remote special purpose entity, thereby legally isolating the collateral from the sponsor in the event of the sponsor’s bankruptcy. The collateral is then transferred to a trust in exchange for beneficial interests in the trust, and the beneficial interests are simultaneously sold to third-party investors, at which point, the collateral is derecognized by the sponsor.

Under Dodd-Frank, the “risk retention interest” (that is, 5 percent of the credit risk of the securitization) may be structured in one of three ways:

  • A vertical interest representing 5 percent interest in the par value of each tranche of the securitization
  • A horizontal interest representing the most subordinate class or classes of tranches in the securitization in an amount equal to 5 percent of the fair value of all tranches issued
  • An “L-shape” structure, which is any combination of vertical and horizontal risk retention set forth in the preceding two bullets that totals 5 percent

Typically, the risk retention interest must be retained until the latest of the following three events:

  1. The reduction of the unpaid principal balance of the securitization collateral reaches 33 percent of the original unpaid principal balance as of the securitization cut-off date.
  2. The reduction of the unpaid principal balance of the securitization securities issued reaches 33 percent of the original principal balance as of the securitization closing date.
  3. Two years after the securitization closing date.

However, a qualified sponsor of a CMBS may satisfy the risk retention requirements by transferring a qualifying risk retention interest (commonly referred to as “the B-piece”) to a third-party purchaser contemporaneously with the closing of the securitization. The B-piece may either be a horizontal structure or an L-shape structure. The risk retention rules do not permit selling a vertical interest to a third-party purchaser. The B-piece purchased by the third-party purchaser, who is generally involved in the underwriting and design of the securitization, is subject to the same risk retention requirements as if the qualified sponsor retained the B-piece directly.

The guidance in ASC 860-10-40-5 sets out the three basic requirements that must be met for a transferor to derecognize a financial instrument:

  • The transferred assets must be legally isolated from the transferor in the case of bankruptcy.
  • The transferee (or, in the case of a securitization, any third-party holders of beneficial interests in the securitization vehicle) must be free to pledge or exchange the transferred financial instrument.
  • The transferor must not retain effective control over the transferred financial instrument.
The issue raised to the SEC staff is whether a transfer of the B-piece to a third-party purchaser resulting in a third-party holder of a beneficial interest that is prohibited from pledging or exchanging the beneficial interest would preclude the securitization sponsors from derecognizing the collateral transferred to the securitization pursuant to ASC 860-10-40-5b. If the sponsor retains the B-piece, the restrictions on transferring it would not preclude derecognition of the collateral transferred to the securitization by the sponsor because the B-piece is not held by a third party.

The SEC staff did not object to a conclusion that the transfer of a horizontal or L-shape B-piece to a third-party purchaser does not jeopardize the securitization sponsor’s derecognition of the collateral transferred to the securitization vehicle. The staff based this conclusion on the unique facts and circumstances described in the SIFMA submission arising from the change in regulation brought on by the Dodd-Frank risk retention rules. The staff’s conclusion was based on a set of broad considerations, not solely limited to the provisions of ASC 860, and should not be analogized to other fact patterns.



FASB ASU amends recognition and measurement guidance for financial instruments The FASB has issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses issues prompted by stakeholders related to ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities.

ASU 2016-01 makes targeted improvements to the guidance that an entity should follow when it recognizes, measures, presents, and discloses financial instruments, and is effective for public business entities in fiscal years beginning after December 15, 2017 and in interim periods within those fiscal years. As a result, public business entities that report based on a calendar year are required to adopt ASU 2016-01 during the first quarter ending March 31, 2018. For all other entities, ASU 2016-01 is effective in fiscal years beginning after December 15, 2018 and in interim periods for fiscal years beginning after December 15, 2019.

All entities are required to apply the amendments in ASU 2016-01 on a modified retrospective basis, with a cumulative-effect adjustment to beginning retained earnings in the period of adoption, except for the amendments and disclosure requirements related to securities without readily determinable fair values, which should be applied prospectively to equity investments existing on the adoption date.

The amendments in ASU 2018-03 clarify the following aspects of the guidance issued in ASU 2016-01:

  • Equity securities without a readily determinable fair value – discontinuation: After an entity applies the new measurement alternative to an equity security under ASC 321-10-35-2, Investments – Equity Securities, it is permitted to make an irrevocable election to change the measurement approach for this equity security, from the measurement alternative to fair value; however, if an entity makes an election to change the measurement approach, it must apply it to that security and to all identical or similar investments of the same issuer. Further, the entity should measure all future purchases of identical or similar instruments of the same issuer at fair value.
  • Equity securities without a readily determinable fair value – adjustments: Adjustments made to an equity security under the new measurement alternative should reflect the fair value of the security as of the date when the observable transaction for a similar security took place.
  • Equity securities without a readily determinable fair value – forward contracts and purchased options: An entity should remeasure the entire value of forward contracts and purchased options when observable transactions occur on the underlying equity securities without a readily determinable fair value for which the measurement alternative in ASC 321-10-35-2 is applied.
  • Fair value option liabilities – presentation: When an entity elects the fair value option to measure a financial liability, the guidance in ASC 825-10-45-5, Financial Instruments, should be applied, regardless of whether the fair value option was elected under either ASC 825-10 or ASC 815-15, Derivatives and Hedging: Embedded Derivatives.
  • Fair value option liabilities – denominated in a foreign currency: If an entity elects the fair value option for certain financial liabilities, the change in fair value that relates to the instrument-specific credit risk should first be measured in the currency in which the instrument is denominated. An entity should then remeasure both the instrument-specific credit risk and other component of the change in fair value using the entity’s functional currency by applying end-of-period spot rates.
  • Equity securities without a readily determinable fair value – transition: An entity should apply the prospective transition approach in ASU 2016-01 (as discussed above) for equity securities without a readily determinable fair value only to those equity securities for which the new measurement alternative is applied. An insurance entity that applied the guidance in ASC 944-325, Financial Services – Insurance: Investments – Other, should apply a prospective transition method to the equity securities without a readily determinable fair value that are measured using the measurement alternative in ASC 321-10-35-2. An insurance entity should recognize the amounts in other comprehensive income related to such equity investments prospectively. The ASU does not prescribe a method for insurance entities to prospectively recognize the amounts in other comprehensive income upon transition, but the method chosen by an insurance entity should be applied consistently.

ASU 2018-03 is effective for public business entities for fiscal years beginning after December 15, 2017 and in interim periods within those fiscal years beginning after June 15, 2018. As a result, public business entities with fiscal years beginning between December 15, 2017 and June 15, 2018 are not required to adopt the amendments until the interim period beginning after June 15, 2018. However, if a public business entity reports based on a calendar year and adopts ASU 2018-03 during its third quarter ending September 30, 2018, it would still recognize any cumulative-effect adjustment as of January 1, 2018.

Public business entities with fiscal years beginning between June 15, 2018 and December 15, 2018 are not required to adopt ASU 2018-03 before adopting ASU 2016-01.
For all other entities, the effective date and transition requirements for ASU 2018-03 are the same as those for ASU 2016-01.
All entities may early adopt the amendments in fiscal years beginning after December 15, 2017, and in interim periods within those fiscal years, if they have already adopted ASU 2016-01.

Proposal addresses implementation costs in certain cloud computing arrangements The Board issued a proposed ASU, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract; Disclosures for Implementation Costs Incurred for Internal-Use Software and Cloud Computing Arrangements (a consensus of the FASB Emerging Issues Task Force). The proposal would clarify how a customer accounts for implementation costs in a cloud computing arrangement (CCA) that is a service contract and would expand the disclosure requirements related to implementation costs for internal-use software and CCAs.

The proposal results from an EITF consensus-for-exposure on Issue 17-A, “Customer’s Accounting for Implementation, Setup, and Other Upfront Costs (Implementation Costs) Incurred in a Cloud Computing Arrangement That Is a Service Agreement,” which was recently ratified by the Board (see the January 25 On the Horizon for a summary of Issue 17-A).

The amendments in the proposed ASU would be applied either (1) prospectively to hosting arrangements that are entered into, renewed, or materially modified on or after the effective date of the proposed amendments, or (2) retrospectively to all hosting arrangements, with the cumulative effect of applying the proposed amendments to hosting arrangements entered into before the beginning of the earliest period presented in the financial statements recognized in the opening retained earnings of the earliest period presented.

The Board will determine the effective date and whether an entity may early adopt the proposed amendments after the EITF considers stakeholders’ feedback on the proposal.

The FASB staff also issued proposed taxonomy improvements related to the proposed ASU.

Comments on the proposed ASU and on the related proposed taxonomy improvements are due April 30.

U.S. GAAP Taxonomy updated for ASU 2018-02 and SAB 118 The FASB staff issued improvements and implementation guidance to the U.S. GAAP Taxonomy related to reporting requirements included in the following new guidance:

  • ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
  • SEC Staff Accounting Bulletin (SAB) 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act

These improvements and implementation guidance will be included in the 2019 U.S. GAAP Taxonomy, along with illustrative examples on how to tag disclosures for both ASU 2018-12 and SAB 118.



AICPA Interpretation on attestation engagements under two standard sets revised The AICPA revised Attest Interpretation 4, Performing and Reporting on an Attestation Engagement Under Two Sets of Attestation Standards, of AT-C Section 105, Concepts Common to all Attestation Engagements. The revised interpretation takes into account the incremental reporting requirements under AT-C Section 205, Examination Engagements; AT-C Section 210, Review Engagements; and AT-C Section 215, Agreed-Upon Procedures Engagements. It also provides new illustrative reports to use with the form of attestation report in PCAOB Interim Attestation Standards, adjusted to indicate that the engagement was also performed in accordance with the AICPA clarified standards.

Auditing Standards Appendix B and AU-C section 610 updated The AICPA also updated Auditing Standards Appendix B, Substantive Differences Between the International Standards on Auditing and Generally Accepted Auditing Standards, and AU-C Section 610, Using the Work of Internal Auditors, to reflect recent authoritative guidance.

New description criteria standards issued for SOC 2 reports The AICPA issued new description criteria standards for SOC 2 reports to be used in preparing and evaluating the description of a service organization’s system in a SOC 2 examination. The new professional standards are in two parts:

  • Description Criteria (DC) Section 200, Description Criteria for a Description of a Service Organization’s System in a SOC 2® Report
  • DC Section 200A, 2015 Description Criteria for a Description of a Service Organization’s System in a SOC 2® Report


  • DC Section 200 (the 2018 Description Criteria) presents description criteria for use in a SOC 2 examination but does not address trust services criteria. The 2018 Description Criteria provides guidance on the following:

    • The availability and suitability of the description criteria, including its relevance, objectivity, measurability, and completeness
    • Preparation and evaluation of the presentation of the description of the service organization’s system in accordance with the description criteria
    • Materiality considerations when preparing and evaluating whether the description is presented in accordance with the description criteria
    • Description criteria and implementation guidance in columnar format

    The guidance in DC Section 200 should be used in conjunction with the 2017 trust services criteria set forth in TSP Section 100, 2017 Trust Services Criteria for Security, Availability, Processing Integrity, Confidentiality, and Privacy, in a SOC 2 report.

    DC Section 200A (the 2015 Description Criteria) reproduces paragraphs 1.26–.27 of the 2015 edition of the AICPA Guide, Reporting on Controls at a Service Organization Relevant to Security, Availability, Processing Integrity, Confidentiality, or Privacy (SOC 2®). The AICPA intends for DC Section 200A to be used in conjunction with the 2016 trust services criteria of TSP Section 100A, Trust Services Principles and Criteria for Security, Availability, Processing Integrity, Confidentiality, and Privacy (2016) (AICPA, Trust Services Principles), in a SOC 2 report.

    To determine which description criteria section should be used, DC Section 200A notes that the “2015 description criteria may be used when preparing a description of the service organization’s system as of December 15, 2018, or prior to that date (type 1 examination) or a description for periods ending as of December 15, 2018, or prior to that date (type 2 examination).” For “a description of the service organization’s system as of or after December 16, 2018, (type 1 examination) or a description of the system for periods ending as of or after that date (type 2 examination), the 2018 description criteria should be used.”

    During the transition period between the two standards, DC Section 200A provides that management should identify in the description whether the 2018 or 2015 description criteria is used.

    IASB IFRS Foundation reappoints two committee members The IFRS Foundation announced the reappointment of Jongsoo Han and Robert Uhl to the IASB’s IFRS Interpretations Committee (IFRIC) for their second three-year terms, effective July 1, 2018. IFRIC is the interpretative body of the IASB.



    © 2018 Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP On the Horizon provides information and comments on current accounting and SEC reporting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in this publication. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this publication. For additional information on topics covered in this publication, contact a Grant Thornton client-service partner.