Variable Interest EntitiesVariable Interest Entities (VIEs): DefinedVariable Interest Entities (VIEs): “Variable Interest Relationships”Variable Interest Entities (VIEs): “Contractual Arrangements”Variable Interest Entities (VIEs): Most are “SPEs”Variable Interest Entities (VIEs): “SPEs”QSPE = a trust of another legal vehicle thatVariable Interest Entities (VIEs): Potential Variable InterestsVariable Interest Entities (VIEs): The Primary BeneficiaryFilling the BucketsHow to Tell if I am NOT a VIEPrimary Beneficiary CascadeSlide 13Variable Interest Entities (VIEs): Determining if an Entity is a VIESlide 15Determining if an Entity is a VIE (cont.)Slide 17Reconsideration TriggersDisclosures Required When Involved with VIEsVariable Interest Entities (VIEs): Disclosures Required When InvolvedPWC publication “SIC-12 and FIN 46R”FSP FIN 46R-6FSP FIN 46R-6 – Para. 5Variable Interest Entities (VIEs): Consolidation ProceduresCase 06-1 ObjectivesFIN 46R – Appendix BFor Part 2 of Case 06-1Variable Interest EntitiesFIN 46 (Revised Dec. 2003)Complexity of issues is confirmed by the issuance of several FSPs including FASB Staff Position No. FIN 46(R)-6, “Determining the Variability to Be Considered In Applying FASBInterpretation No. 46(R)” which has some really helpful examplesLatest: FSP FIN 46(R)-7—Application of FASB Interpretation No. 46(R) to Investment Companies (May 11, 2007)Variable Interest Entities (VIEs): DefinedVIE: A less than majority-owned entity that is subject to consolidation under the provisions of FASB Interpretation 46R.If certain conditions exist, the entity must be consolidated.An entity that has a variable interest in a VIE—an interest that changes with changes in the VIE’s net assets—must determine if it must consolidate the VIE.Variable Interest Entities (VIEs):“Variable Interest Relationships”Variable Interest Relationships:Situations in which an entity:Receives benefits and/or is exposed to risks similar to those received from having a majority ownership interest.Result from contractual arrangements.Appendix B has illustrations of various types of variable interestsVariable Interest Entities (VIEs): “Contractual Arrangements”Contractual Arrangement Types:Options (e.g., written put options)Leases (with guarantee of value, etc)Guarantees of asset recovery valuesGuarantees of debt repaymentContractual arrangements may exist simultaneously with a less than majority ownership in a VIE.May exclude a “business” (Appendix C for definition somewhat different from that in EITF 98-3)Variable Interest Entities (VIEs):Most are “SPEs”Special Purpose Entities:Legally structured entities to serve a specific, predetermined, limited purpose.May be a corporation, partnership, trust, or some other legal entity.Creator is called the “sponsor.”Usually thinly capitalized. Most commonly used for securitizations (of receivables).Variable Interest Entities (VIEs):“SPEs”Special Purpose Entities:Not subject to consolidation provisions of FIN 46 if sales recognition criteria of FAS 140 is met for transfer of assets to SPE.If met, SPE is called a “Qualifying SPE.” (If not met, the proceeds from the transfer are treated as a loan.)FAS 140 prohibits transferors from consolidating QSPEs (because risk exposure is considered insignificant).QSPE = a trust of another legal vehicle thatIs demonstrably distinct from transferorHas restrictions on its permitted activitiesHas restrictions on assets and derivatives it may holdHas restrictions on the way it can sell or dispose of non-cash financial assetsHas restrictions on agreements entered into between it and the transferorHas restrictions on the ability to reissue beneficial interestsVariable Interest Entities (VIEs):Potential Variable InterestsPotential Variable Interests:Subordinated loans to a VIE.Equity interests in a VIE (50% or less).Guarantees to a VIE’s lenders or equity holders (that reduce the true risk of these parties).Written put options on a VIE’s assets held by a VIE or its lenders or equity holders.Forward contracts on purchases and sales.Variable Interest Entities (VIEs):The Primary BeneficiaryPRIMARY BENEFICIARY of a VIE must consolidate the VIE.PRIMARY BENEFICIARY is the entity that:Will absorb a majority (more than 50%) of the VIE’s expected losses and/orWill receive a majority (more than 50%) of the VIE’s expected residual returns.Expected losses are given more weight than expected residual returns in certain situations.Filling the BucketsProbability Probability Weighted Weighted ScenariosScenariosExpectedExpectedLossesLossesExpectedExpectedResidual ReturnsResidual Returns+ Fees+ FeesFrom Deloitte & Touche PresentationHow to Tell if I am NOT a VIETotal equity investment greater than Expected LossesSome equity holder has voting or other rights like a shareholder or General Partner, and as a group, equity holders can directly or indirectly make decisions on entity’s activitiesEquity holders as a group will absorb expected losses and benefit from expected residual returns without guarantee or cap“Subordinated Financial Support” is something that will absorb some of the expected losses, if they occurFrom Deloitte & Touche PresentationPrimary Beneficiary CascadeIf anyone holds Variable Interests that expose them to a majority of the expected losses, they are the Primary Beneficiary, otherwiseIf anyone holds Variable Interests that would enjoy a majority of the expected residual returns, they are the Primary Beneficiary, otherwiseThere is no Primary Beneficiary“Variable Interests” are financial interests that change in value with changes in the entity’s net asset valueFrom Deloitte & Touche PresentationVariable Interest Entities (VIEs):The Primary BeneficiaryOnly one PRIMARY BENEFICIARY can exist for a VIE (by definition).Potential for Erroneously Determined Multiple Primary Beneficiaries Does Exist:When one or more variable interest holders (VIH) has incomplete information about the VIE’s other VIH.Different VIH make different judgments about their variable interests.Variable Interest Entities (VIEs):Determining if an Entity is a VIECondition #1: Equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support (SFS). SFS is defined as variable interests that will absorb some or all of an entity’s expected losses (example: a debt guarantee or an equity