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Post-Interim Event Repurchase Agreements (Repo) ©2005 Ernst & Young LLP. All rights reserved. This material is proprietary, confidential, and for internal use only. Unauthorized distribution or reproduction of this program or its contents violates firm policy and copyright laws. # Repo Definition Paragraph 10 of International Accounting Standard 39 “Financial Instruments: Recognition and Measurement” defines “repurchase agreement (Repo) as an agreement to transfer a financial asset to another party in exchange for cash or other consideration and a concurrent obligation to reacquire the financial asset at a future date for an amount equal to the cash or other consideration exchanged plus interest”. 2 ©2004 Ernst & Young LLP. All rights reserved. # 1 Executive Event – Financial Statement Audits – 1UYJX4 Post-Interim Event Classic Repo First Leg Sells 100 worth of bond BANK A BANK B Pays 95 cash for bond Second Leg Pays 95 cash plus interest BANK B BANK A Sells 100 worth of stock 3 # Margin • An initial margin is given to the supplier of cash in the transaction. The market value of the collateral is reduced (or given a “haircut”) by the amount of margin when determining the value of cash lent out • Size of the margin depends upon the credit quality of the counterparty, term of the repo, duration and quality of the collateral 4 ©2004 Ernst & Young LLP. All rights reserved. # 2 Executive Event – Financial Statement Audits – 1UYJX4 Post-Interim Event IFRS Implications (IAS 39, AG 51 (a)) • If the financial asset is sold under a repurchase agreement, it cannot be derecognised from the books as the transferor retains substantially all the risks and rewards of ownership. • On-balance sheet: An accounting entry appears as secured loan and not as a “sell” transaction. Bonds given as collateral remain on the balance sheet; corresponding liability is repo cash (opposite for the buyer) • Profit & loss account: Repo interest is treated as payment of interest on accrual basis. 5 # IFRS Implications (IAS 39, AG 51 (a)) • In the books of the borrower, the bonds will be shown as an asset and the cash received from the lender would be shown under the liability side as a “Borrowing under repurchase agreement” 6 ©2004 Ernst & Young LLP. All rights reserved. # 3 Executive Event – Financial Statement Audits – 1UYJX4 Post-Interim Event IFRS Implications for the Counterparty In the books of the lender the bonds purchased subject to commitment to resell them at a future date are not recognised. The amount paid are recognised as deposits/loans and advances to customers/banks. These are shown as assets collateralised by security. 7 # Capital Adequacy Treatment - Borrower Banking Book • The Bank will continue to risk-weight the assets under credit risk rules. • The amount of margin / haircut is subject to counterparty credit risk. • Following approaches are available for the calculation of counterparty risk: 1. Comprehensive Approach under Credit Risk Mitigation 2. VaR Models under Credit Risk Mitigation 3. Expected Positive Exposure under the Internal Models Methods • Counterparty risk on different assets with the same party may be calculated on a net basis 8 ©2004 Ernst & Young LLP. All rights reserved. # 4 Executive Event – Financial Statement Audits – 1UYJX4 Post-Interim Event Capital Adequacy Treatment - Borrower Trading Book • General Market Risk and Specific Risk will be provided under Market Risk rules • Counterparty risk: Same as Banking Book 9 # Capital Adequacy Treatment - Lender • If the counterparty in the Repo is a Bank, it should treat the loan as a “collateralised loan” under normal rules applicable to Banking / Trading Book 10 ©2004 Ernst & Young LLP. All rights reserved. # 5 Executive Event – Financial Statement Audits – 1UYJX4