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37. Is repo used to remove assets from the balance sheet?
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This question has been prompted by incidents such as Lehman Brothers’ ‘Repo 105’ or MF Global’s use of ‘repo-to-maturity’. In both cases, assets sold in repos were accounted for as disposals and removed (temporarily) from the balance sheets of the sellers. This disguised their true leverage. However, in both cases, use was made of provisions specific to US Generally Accepted Accounting Principles (GAAP). These have been closed.

In Europe, such accounting options are not available and repo must be accounted for in the standard way. This follows the principle that balance sheets are intended to measure the value and risk of a company, not the legal form in which it has structured its transactions. In a repo, as the seller in a repo commits to repurchase the collateral at a fixed future repurchase price, he retains the risk and return on that collateral. Accordingly, the collateral remains on the balance sheet of the seller, even though he has sold legal title to the collateral to the buyer. The logic of this accounting treatment is confirmed by the consequence that, because the cash paid for the collateral is added as an asset to the seller’s balance sheet (balanced on the liability side by the repayment due to the buyer at maturity), this will expand, thereby signalling that that seller has increased his leverage by borrowing. In order to make it clear to the reader of a balance sheet which assets have been sold in repos, the International Financial Reporting Standards (IFRS) require that securities out on repo are reclassified from “investments” to “collateral” and are balanced by a “collateralised borrowing” liability.


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