Pass-through conditions Best 2 go in fine reading

Pass-through conditions – A ‘pass-through’ transfer is a transaction where an entity keeps the legal title and rights to the cash flows from a financial asset (hence condition in IFRS 9.3.2.4(a) is not met), but enters into an arrangement with a third party under which those cash flows will be passed to this third party. Securitisation is a typical example of a ‘pass-through’ transfer.

Food for thoughtPass-through conditions

Most revolving securitisation transactions that involve a consolidated SPE fail to meet the pass-through conditions. This is because the cash flows from the assets are not passed on to eventual recipients without material delay and are reinvested in new assets that are not cash and cash equivalents, before being passed onto eventual recipients.

The effect of meeting all three pass-through conditions above is that the transferor does not have the rights to particular cash flows arising from the asset (sec).

Securitisation is accounted for as a transfer of the original asset if, and only if, all the three conditions (pass-through conditions) are met (IFRS 9.3.2.5):

This criterion has the effect that all transactions where cash flows are passed-through to a third party, but that third party has recourse to the transferor, do not qualify as transfers under IFRS 9.

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Paragraph IFRS 9.3.2.5(a) clarifies that short-term advances by the entity with the right of full recovery of the amount lent plus accrued interest at market rates do not violate this condition.

2) The entity is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to the eventual recipients for the obligation to pay them cash flows.

Pass-through transfers often concern groups of financial assets and it would be impracticable to remit cash flows on a daily basis from every individual financial asset. IFRS 9 does not allow a ‘material delay’, therefore an ‘immaterial delay’ is allowed. An exactly defined period is of course not given, but, in practice, payments on a quarterly basis are not considered to be a material delay in practice.

In addition, in order to fulfill the criterion being discussed, the entity cannot be entitled to reinvest cash flows received from financial assets in question, except for investments in cash or cash equivalents during the short settlement period from the collection date to the date of required remittance to the eventual recipients, and interest earned on such investments is passed to the eventual recipients.

The effect of meeting all three pass-through conditions above is that the transferor does not have the rights to particular cash flows arising from the asset (second and third conditions) or a liability to pass on those particular cash flows (first condition), as defined in the Framework.

In these situations, the transferor may act more as an agent of the eventual recipient than the owner of the asset. Therefore, when those conditions are met, the arrangement is treated as a transfer of the contractual rights to the cash flows and considered for derecognition (ie, is subject to the risks and rewards and control tests – see below). When the conditions are not met, the transferor acts more as an owner of the asset, with the result that the asset should continue to be recognised. In this case, the transferor still has the rights to the particular cash flows arising from the asset.

Maybe it helps a reader to refer to the decision tree for the derecognition of financial assets in IFRS 9 B3.2.1. The pass-through question/condition is part of this decision tree: Has the entity assumed an obligation to pay the cash flows from the asset that meets the conditions in IFRS 9 3.2.5.

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Also read: Pass-through conditions

Pass-through conditions

Pass-through conditions

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