By: TD Securities ( e-mail: Tamara Paton), June 2000

In response to an international trend to harmonize accounting practices across borders, the Accounting Standards Board (AcSB) of the Canadian Institute of Chartered Accountants (CICA) has issued a new guideline for the transfer of receivables. Implementation of the policy is expected to be effective for transactions closing after December 31, 2000, but the proposal is consistent with the current U.S. standards so the guideline's consequences can be contemplated. Under the CICA draft guideline, the criteria for obtaining sale treatment differs for qualifying versus non-qualifying special purpose entities. Consequently, parties to a securitization transaction¹ may be concerned with the purchaser's status under the Qualifying Special Purpose Entity ²(QSPE) criteria. 

The concepts underlying the new guideline relate to the identification of the party with control over the SPE's assets and activities. If a Seller maintains substantial control over the SPE, sale treatment is unlikely. On the other hand, asset transfers to an SPE whose activities are governed by pre-established guidelines are more likely to be perceived as independent of the Seller. The issue of whether an SPE can be classified as a qualifying SPE helps determine the level at which the SPE's independence should be gauged. If the entity is a QSPE, the sale treatment criteria³ consider the control held by the beneficial interest holders of the entity. If the entity is not considered a QSPE, sale treatment can still be obtained, but is tested at the level of the entity itself, rather then the beneficial interest holders. Accordingly, one must first classify the entity within the definition of a QSPE.

What is a Qualifying Special Purpose Entity?

A QSPE is defined as a trust or legal entity that meets the criteria outlined below. 

Legal Isolation
A QSPE must have a distinct standing from the Seller and cannot be dissolved, wound up or terminated by the Seller. The entity's activities are governed by guidelines set by at least a majority of the beneficial interest holders, other than the Seller and its affiliates. This requirement minimizes the Seller's control over the entity's activities on an ongoing basis.

Eligible Assets
A QSPE may hold assets that satisfy the following criteria:

• The transferred assets do not give the Seller significant influence over the entity's financial and operating policies. 
• Derivative instrument agreements must be entered into at the time of SPE establishment or receivables transfer.
• The entity may hold financial assets that insure against failure by others to service the assets or make payments. 
• The entity may hold servicing rights related to the assets that it holds.
• The entity may temporarily hold non-financial assets obtained in connection with the financial assets it holds. 
• The entity may hold cash collected from financial assets and investments purchased prior to distribution to beneficial interest holders (investments must be relatively debt-free, without options and mature no longer than the expected distribution date).          Return to article

Control over the Assets
The entity may be required to sell the transferred assets to parties other than the Seller only after the occurrence of one of the following events:

• A decrease in asset value from fair value by a specified amount. The QSPE cannot benefit from the sale of the assets. 
• Termination of the QSPE or at maturity of the beneficial interests.
• A put of the beneficial interests back to the QSPE.
  Some examples of circumstances where the QSPE would be permitted to sell assets include a failure by the Seller to properly service the transferred assets that results in a loss of a substantial third-party credit guarantee, a downgrade by a major rating agency and insolvency of the Seller. 

Criteria for Sale Treatment

A Seller can achieve sale treatment by fulfilling the following requirements:
(a)     The transferred assets must be isolated from the Seller (bankruptcy remote).
(b)      If transferring to a QSPE:

(i) Holders of beneficial interests in QSPEs have the right to pledge or exchange those interests and no condition both constrains them from taking advantage of that right and provides more than a trivial benefit to the Seller. 

(ii) Seller does not maintain effective control over the transferred assets through the ability to cause the QSPE to return specific assets, other than through a clean up call. 

(c) If the entity is not a QSPE:

(i) The entity has the right to pledge or exchange those interests and no condition both constrains them from taking advantage of that right and provides more than a rivial benefit to the Seller. 

(ii) The Seller does not maintain control over the transferred assets through an agreement that entitles and obligates the Seller to repurchase or redeem them before their maturity.        Return to article

The Effect of QSPE Guidelines on Securitization

As the guideline comes into effect, parties to existing securitization transactions will need to revisit their structures to determine their eligibility under the new sale treatment criteria. Fortunately, some degree of grandfathering is likely so existing transactions should not be affected. Going forward, however, the securitization community must be mindful of the guideline, particularly when structuring single-seller deals.

Although accounting guidelines governing securitization are becoming more complex, it is important to remember that the market size is not diminishing as a consequence. In fact, very similar regulations are already in place in the U.S., whose securitization market continues to grow at an exponential rate every year. It is clearly important to be aware of the issues surrounding the new guidelines, although growth in the Canadian securitization market will not be greatly impaired as a result.     

For more information contact:  TD Securities (e -mail: Tamara Paton).

By: TD Securities ( e-mail: Tamara Paton), June 2000