Jim Low, FS Audit Partner / Leader Americas FS Center of Excellence, KPMG LLP (US)

Signed into law in July 2010, the Dodd-Frank Act places regulation of the financial industry in the hands of the federal government. With its overarching goals of promoting the financial stability of the United States through improved accountability and transparency, and protecting consumers, certain provisions of the Act will have accounting implications for financial (and indirectly, some non-financial) companies. Although subject to change as U.S. regulators and lawmakers hash things out, let’s take a quick look at several of the provisions and their accounting consequences, as they stand today.

Asset-backed Securities

Section 941 of the Act requires any securitizer to retain an economic interest in a portion of the credit risk for any asset it transfers, sells or conveys to a third party through the issuance of asset-backed securities (ABS). Six federal agencies have proposed a rule that would require ABS sponsors to retain at least five percent of the credit risk of the assets underlying the securities, unless certain exceptions are met. And under the proposed rule, securitizers would be prohibited from directly or indirectly hedging the credit risk they are required to retain.

Potential accounting implications:

• If a company that normally sells loans and receivables through securitizations determines the risk retention provisions apply to its current programs, it must then decide whether the financial assets transferred to the securitization vehicle must be derecognized.
• In assessing derecognization, the company must first assess whether the securitization vehicle requires consolidation. It must then determine whether it should derecognize the financial assets transferred (or participating assets transferred) under the requirements in ASC Topic 860, Transfers and Servicing.

 Executive Compensation

Seven federal agencies have proposed a rule that would implement Section 956 of the Act, wherein covered financial institutions with more than $1 billion in assets would be prohibited from adopting incentive-based compensation programs that would expose them to inappropriate risks or material financial loss. Additionally, larger financial institutions – those with consolidated assets of $50 billion or more, or $10 billion or more for credit unions – would be required to defer payment of at least 50 percent of covered employees’ annual incentive-based compensation for at least three years.

Potential accounting implications:

• Institutions implementing the minimum three-year deferral period proposal should analyze – via ASC Topic 718 – how to account for share-based compensation, including when the delivery of the underlying shares is restricted beyond the vesting date. Affected financial institutions should also clarify deferral and clawback provisions, which may impact the determination of the grant date for share-based compensation arrangements.
• Companies making modifications to existing compensation arrangements will need to consider the applicable ASC Topic 718 guidance related to beneficial and non-beneficial modifications of equity-settled awards.

 Over-the-Counter Derivatives

Under the Act, many swaps that are currently executed in the over-the-counter (OTC) market will be required to be cleared through derivatives clearing organizations, unless the organizations do not accept the swap for clearing. Swaps not cleared through a clearing organization would be reported to the Commodity Futures Trading Commission, the Securities and Exchange Commission or a swap repository. Although the function of clearing organizations is still being determined, it is believed they will become central counterparties to many swaps.

Potential accounting implications:

• To the extent clearing organizations become central counterparties to swap transactions and/or collateral maintenance is required, fair value measurements of swaps will be different as they will need to take into account counterparty credit risk and collateral.
• Use of clearing organizations as central counterparties may also impact a company’s eligibility to offset swaps in its balance sheet.
• An assessment will need to be made to determine whether the exchange of one counterparty to the swap for a different counterparty would result in the swap being accounted for as the continuation of the existing swap or an extinguishment of the existing swap combined with the issuance of a new swap.

 For more details on the above provisions and their potential accounting implications, as well as discussions on The Volcker Rule, Living Wills and Conflict Materials, please read the KPMG paper, “The Dodd-Frank Act: Could there be Accounting Consequences?”

Filed under: Financial Services Industry by EquaTerra