Derivatives Implementation Group
Statement 133 Implementation Issue No. A13
| Title: |
Definition of a Derivative:
Whether Settlement Provisions That Require a Structured Payout
Constitute Net Settlement under Paragraph 9(a) |
| Paragraph
references: |
6(c), 9(a),
57(c)(1) |
| Date cleared by
Board: |
December 6, 2000 |
| Date revision posted to website: |
May 1, 2003 |
| Affected by: |
FASB Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities
(Revised March 26, 2003) |
QUESTIONS
Question 1
Upon settlement of a contract, in lieu of immediate net cash
settlement of the gain or loss under the contract, the holder may
receive a financial instrument involving terms that would provide
for the gain or loss under the contract to be received or paid over
a specified time period. Does a contract meet the characteristic of
net settlement in paragraph 9(a) (and related paragraph 57(c)(1))
of Statement 133 if it provides for a structured payout, rather
than immediate payout, of the gain or loss resulting from that
contract?
Question 2
Would the answer to Question 1 change if, instead, the holder were
required to invest funds in or borrow funds from the other party so
that the party in a gain position under the contract can obtain the
value of that gain only over time as an adjustment of either the
yield on the amount invested or the interest element on the amount
borrowed?
BACKGROUND
Paragraph 6 of Statement 133 states, in part:
A derivative instrument is a financial
instrument or other contract with all three of the following
characteristics...
- Its terms require or permit net settlement, it can readily be
settled net by a means outside the contract, or it provides for
delivery of an asset that puts the recipient in a position that is
not substantially different from net settlement.
Paragraph 9(a) states, in part: "Neither party is
required to deliver an asset that is associated with the underlying
and that has a principal amount, stated amount, face value, number of
shares, or other denomination that is equal to the notional
amount...."
Paragraph 57(c)(1) states, in part: "Net settlement
may be made in cash or by delivery of any other asset, whether or
not it is readily convertible to cash."
RESPONSES
Question 1
Yes. A contract that provides for a structured payout of the gain
(or loss) resulting from that contract meets the characteristic of
net settlement in paragraph 9(a) (and related paragraph 57(c)(1))
of Statement 133 if the fair value of the cash flows to be received
(or paid) by the holder under the structured payout are
approximately equal to the amount that would have been received (or
paid) if the contract had provided for an immediate payout related
to settlement of the gain (or loss) under the contract. The fact
that a contract accomplishes settlement by requiring the party in a
loss position under the contract to make cash payments over a
specified timeframe to the party in a gain position (in lieu of
immediate cash settlement of the gain) does not preclude the
contract from meeting the characteristic of net settlement in
paragraph 9(a). Paragraph 57(c)(1) contemplates that net settlement
may be made in the form of cash or any other asset (such as the
right to receive future payments), which need not be readily
convertible to cash.
Question 2
Generally, yes, the different facts assumed under Question 2
results in a conclusion that differs from the answer to Question 1.
The structured payout discussed in Question 1 is substantively
different from contractual terms that require one party to the
contract to invest funds in or borrow funds from the other party so
that the party in a gain position under the contract can obtain the
value of that gain only over time as a traditional adjustment of
the yield on the amount invested or the interest element on the
amount borrowed. A fixed-rate mortgage loan commitment is an
example of a contract that requires the party in a gain position
under the contract to borrow funds at a below-market interest rate
at the time of the borrowing in order to obtain the benefit of that
gain. A contract that requires such additional investing or
borrowing to obtain the benefits of the contract's gain only over
time as a traditional adjustment of the yield on the amount
invested or the interest element on the amount borrowed does not
meet the characteristic of net settlement in paragraph 9(a).
Contracts that require one party to the contract to
invest funds in or borrow funds from the other party so that the
party in a gain position under the contract can obtain the value of
that gain over time as a nontraditional adjustment of the
yield on the amount invested or the interest element on the amount
borrowed may meet the characteristic of net settlement in paragraph
9(a). A structured payout of the gain on a contract (as discussed
in Question 1) could also be described as an abnormally high yield
on a required investment or borrowing in which the overall return
is related to the amount of that contract's gain, in which case the
contract would be considered to have met the characteristic of net
settlement in paragraph 9(a). For example, if a contract required
the party in a gain position under the contract to invest $100 in
the other party's debt instrument that paid an abnormally high
interest rate of 5,000 percent per day for a term whose length is
dependent on the changes in the contract's underlying, an analysis
of those terms would lead to the conclusion that the contract's
settlement terms were in substance a structured payout of the
contract's gain (as discussed in the Response to Question 1) and
thus that contract would be considered to have met the
characteristic of net settlement in paragraph 9(a).
The above response has been authored by the FASB
staff and represents the staff's views, although the Board has
discussed the above response at a public meeting and chosen not to
object to dissemination of that response. Official positions of the
FASB are determined only after extensive due process and
deliberation.
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