Chapter 12 - Accounting, Tax and Capital Issues

Abstract

This chapter discusses the accounting and taxation implications of repo for financial institutions. It presents an overview of the basic principles adhered to in most markets. It also considers the capital adequacy rules and their relevance to repo, and discusses the proposed Basel II capital rules. The key issue with regard to accounting treatment is whether the transaction should be treated as an actual sale by the selling counterparty, or treated as a financing instrument in which the asset is used as collateral for a loan of cash. In most jurisdictions, the accounting treatment of repo reflects the business realities of the transaction, which is a secured loan, and ignores its legal definition. In a repo transaction then, while legal title to collateral is transferred to the “buyer”, the accounting treatment recognizes that the economic impact of the collateral remains with the “seller”. The chapter defines that accounting authorities stress that treatment of an entity's business transactions must reflect their commercial substance; this aspect of any transaction is assessed by considering the rewards and risks that are associated with an asset or liability.