United States: West Coast Real Estate Update: Jan. 25, 2016

Susan Booth, Karl Lott and Douglas Praw are Partners, Ashley Jason and Paul Park are Associates in Holland & Knight's Los Angeles office.
Stacie Goeddel is a Partner in Holland & Knight's San Francisco office.

Reporting Leases on the Balance Sheet

The International Accounting Standards Board (IASB) announced on Jan. 13, 2016, a new ¬– and materially different – manner of accounting for leases. The new standard, IFRS 16 Leases, effectively eliminates the long-standing distinction between a lessee's accounting treatment of a "capital lease" and an "operating lease." A capital lease is reflected on the lessee's balance sheet and is economically similar to an asset purchase. An "operating lease" is not reflected on the lessee's balance sheet but instead treated, for accounting purposes, in a manner similar to that of a service contract. There is little change to the accounting treatment of leases by a lessor.

Under IFRS 16, a lessee will be required to reflect all of its leases on its balance sheet, both as an asset and a liability. IFRS 16 will become effective on Jan. 1, 2019 and supersedes IAS 17 Leases. One of the primary factors behind the change was concerns about the lack of transparency resulting from approximately $1.25 trillion of off-balance sheet leases, the majority of leases. The transparency provided by the new standard makes it easier for stakeholders to accurately assess both the assets and liabilities associated with a lease and to effectively compare the financial situations of companies.

The Financial Accounting Standards Board (FASB) has also raised concerns about the disparate treatment between "capital leases" and "operating leases," and has been working with the IASB in its study and evaluation of the matter. FASB is expected to announce a new standard similar to IFRS 16 Leases with respect to the definition of a lease, the balance sheet reporting requirement and the measurement of lease liability.

Reporting All-Cash Residential Real Estate Sales: Is California Next?

Officials at the U.S. Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) believe that they can reduce money laundering if they know exactly who is using cash to buy residential real estate. FinCEN's recent Geographic Targeting Orders (GTO), which take effect on March 1, 2016, focus on all-cash purchases of residential real estate in the Manhattan borough of New York City when the purchase price exceeds $3 million and in Florida's Miami-Dade County when the purchase price exceeds $1 million. In both of those instances, if the buyer is a legal entity, the title company is required to identify and report the actual "beneficial owner" – i.e., individual person(s) – of such legal entity.

Implementation of the GTO may be quite burdensome for the title companies. The large number of residential properties in New York and Miami that have values in excess of the purchase price threshold imposed by the GTO and the significant number of affluent buyers who opt to purchase homes in cash mean that a large number of transactions could be subject to the new reporting requirements. More challenging for the title companies will be that many residential properties are purchased by entities precisely because the beneficial owners desire to remain anonymous.

It will be interesting to see how effective the GTO is in practice. It may be that the current GTO is intended as a test case, which is why the geographic scope is limited to New York and Miami, and why it is effective only from March 1, 2016, to Aug. 27, 2016. If FinCEN determines that the GTO is effective, it seems likely that it will be extended beyond its current expiration date and that the geographic scope will be expanded to include other high-end residential real estate markets, such as Los Angeles and San Francisco.

Changes in Market Risk Capital Requirements

Earlier this month, the Basel Committee on Banking Supervision (BCBS) announced changes to the minimum capital requirements for market risk. The revisions focus on the following:

  • establishing a definitive boundary between the regulatory banking and trading books in order to discourage arbitrage
  • introducing new internal models for approaching market risk, which, among other things, will provide for a more consistent identification and capitalization of key elements of risk among banks
  • creating a new standardized approach to market risk that is more risk sensitive than the prior approach
  • changing value at risk to an expected shortfall measure of risk under stress in order to ensure capital adequacy when the market is notably stressed
  • incorporating the risk of market illiquidity into the analysis to reduce the risk of an unexpected and significant loss of liquidity across various asset markets

Although the revisions do not take effect until Jan. 1, 2019, BCBS conducted an analysis in June 2015 in an effort to determine the effect of the changes. Under the new framework, market risk for risk-weighted assets (RWAs) would increase from the current level of approximately 6 percent to less than 10 percent of total RWAs and would result in a median increase in the total market risk capital by approximately 22 percent. The BCBS provided an explanatory note of the changes to the minimum capital requirements for market risk.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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