# Commission Regulation (EC) No 2086/2004 of 19 November 2004 amending Regulation (EC) No 1725/2003 on the adoption of certain international accounting standards in accordance with Regulation (EC) No 1606/2002 of the European Parliament and of the Council as regards the insertion of IAS 39 (Text with EEA relevance), Division: Derecognition of a Financial Asset (paragraphs 15-37)

Extent: E+W+S+N.I.

AG36. The following flow chart illustrates the evaluation of whether and to what extent a financial asset is derecognised.
Arrangements under which an entity retains the contractual rights to receive the cash flows of a financial asset, but assumes a contractual obligation to pay the cash flows to one or more recipients (paragraph 18(b))
AG37. The situation described in paragraph 18(b) (when an entity retains the contractual rights to receive the cash flows of the financial asset, but assumes a contractual obligation to pay the cash flows to one or more recipients) occurs, for example, if the entity is a special purpose entity or trust, and issues to investors beneficial interests in the underlying financial assets that it owns and provides servicing of those financial assets. In that case, the financial assets qualify for derecognition if the conditions in paragraphs 19 and 20 are met.
AG38. In applying paragraph 19, the entity could be, for example, the originator of the financial asset, or it could be a group that includes a consolidated special purpose entity that has acquired the financial asset and passes on cash flows to unrelated third party investors.
Evaluation of the transfer of risks and rewards of ownership (paragraph 20)
AG39. Examples of when an entity has transferred substantially all the risks and rewards of ownership are:
(a) an unconditional sale of a financial asset;
(b) a sale of a financial asset together with an option to repurchase the financial asset at its fair value at the time of repurchase;
and
(c) a sale of a financial asset together with a put or call option that is deeply out of the money (ie an option that is so far out of the money it is highly unlikely to go into the money before expiry).
AG40. Examples of when an entity has retained substantially all the risks and rewards of ownership are:
(a) a sale and repurchase transaction where the repurchase price is a fixed price or the sale price plus a lender’s return;
(b) a securities lending agreement;
(c) a sale of a financial asset together with a total return swap that transfers the market risk exposure back to the entity;
(d) a sale of a financial asset together with a deep in-the-money put or call option (ie an option that is so far in the money that it is highly unlikely to go out of the money before expiry);
and
(e) a sale of short-term receivables in which the entity guarantees to compensate the transferee for credit losses that are likely to occur.
AG41. If an entity determines that as a result of the transfer, it has transferred substantially all the risks and rewards of ownership of the transferred asset, it does not recognise the transferred asset again in a future period, unless it reacquires the transferred asset in a new transaction.
Evaluation of the transfer of control
AG42. An entity has not retained control of a transferred asset if the transferee has the practical ability to sell the transferred asset. An entity has retained control of a transferred asset if the transferee does not have the practical ability to sell the transferred asset. A transferee has the practical ability to sell the transferred asset if it is traded in an active market because the transferee could repurchase the transferred asset in the market if it needs to return the asset to the entity. For example, a transferee may have the practical ability to sell a transferred asset if the transferred asset is subject to an option that allows the entity to repurchase it, but the transferee can readily obtain the transferred asset in the market if the option is exercised. A transferee does not have the practical ability to sell the transferred asset if the entity retains such an option and the transferee cannot readily obtain the transferred asset in the market if the entity exercises its option.
AG43. The transferee has the practical ability to sell the transferred asset only if the transferee can sell the transferred asset in its entirety to an unrelated third party and is able to exercise that ability unilaterally and without imposing additional restrictions on the transfer. The critical question is what the transferee is able to do in practice, not what contractual rights the transferee has concerning what it can do with the transferred asset or what contractual prohibitions exist. In particular:
(a) a contractual right to dispose of the transferred asset has little practical effect if there is no market for the transferred asset;
and
(b) an ability to dispose of the transferred asset has little practical effect if it cannot be exercised freely. For that reason:
(i) the transferee’s ability to dispose of the transferred asset must be independent of the actions of others (ie it must be a unilateral ability);
and
(ii) the transferee must be able to dispose of the transferred asset without needing to attach restrictive conditions or ‘strings’ to the transfer (eg conditions about how a loan asset is serviced or an option giving the transferee the right to repurchase the asset).
AG44. That the transferee is unlikely to sell the transferred asset does not, of itself, mean that the transferor has retained control of the transferred asset. However, if a put option or guarantee constrains the transferee from selling the transferred asset, then the transferor has retained control of the transferred asset. For example, if a put option or guarantee is sufficiently valuable it constrains the transferee from selling the transferred asset because the transferee would, in practice, not sell the transferred asset to a third party without attaching a similar option or other restrictive conditions. Instead, the transferee would hold the transferred asset so as to obtain payments under the guarantee or put option. Under these circumstances the transferor has retained control of the transferred asset.

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Source: https://www.legislation.gov.uk/eur/2004/2086/annex/3/division/5/division/2 (the official version)
Page: https://openlegislation.uk/eu-regulation-2004-2086/annex-3/division-5/division-2
Contains public sector information licensed under the Open Government Licence v3.0. Source: legislation.gov.uk, The National Archives.