Guarantees: Activation

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Guarantees Activation

• Comments by Robert Dippelsman

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Types of Guarantees

• Guarantor and Debtor are related entities
• Government and government-owned enterprises.
• Private companies and their subsidiaries.
• Guarantor and Debtor are at arms length
• Bankers acceptances and other guarantees on a
  fee basis.
• Government support for worthy private projects.

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Current Treatment

• (a) Before activation, guarantees are contingent
  assets and therefore outside the system.
• (b) No specific guidance on classification of
  flows on activation in BPM5 or SNA. However
• GFSM has injection of equity for continuing
  subsidiaries and capital transfer otherwise and
• ESA95 has injection of equity and capital
  transfer cases also mentions other volume
  changes when the original debtor disappears.
• For bank guarantees, from general practice, it
  appears that service charge when issued other
  volume changes if not recovered.

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BOPCOM and AEG

• BOPCOM and AEG considered these issues
• On (a), for the creation of the guarantee
• BOPCOM supported the existing treatment, but with
  memorandum items where significant. The Committee
  concluded that it was premature to recognize
  guarantees before their activation because the
  implications of expanding the asset boundary to
  contingencies were wide and had not yet been
  explored beyond the public sector.
• AEG decided to leave the issue open.

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BOPCOM and AEG

• Last year, BOPCOM and AEG considered these
  issues
• On (b), for the activation of the guarantee
• Issues Paper suggested a mix of capital
  transfers, other changes, acquisition of equity,
  and acquisition of debt, according to motivation.
  (Extension of existing treatments in GFSM and ESA
  95.)
• In October 2004, BOPCOM decided although with
  some differing views, to regard activation as an
  other change in volumes in all cases to avoid the
  case-by-case consideration.
• In December 2004, AEG decided to treat activation
  as involving capital transfers in all cases.

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BOPCOM and AEG

• On (b), for the activation of the guarantee
• In June 2005, BOPCOM concluded that the
  preliminary AEG position on the treatment of
  flows arising from the activation of a guarantee
  as capital transfers in all cases would have
  problems. The Committees preferences are, first,
  other changes entries in all cases or, failing
  that, a case-by-case basis classifying flows as a
  capital transfer, financial claim, or other
  change according to specific criteria.

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• TFHPSA has new proposals.
• The recognition of an asset before activation in
  two of the three cases would make this issue
  inoperative.
• The issue of activation would apply only to
  one-off guarantees if TFHPSA approach is adopted.

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• On the activation of a guarantee, if Debtor still
  exists, three steps occur
• Creditors liability of Debtor is eliminated.
• Guarantors liability to Creditor is created.
• Debtors liability to Guarantor is (usually
  created).
• If each is a transaction, each activation would
  involve three capital transfers.

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Concerns

• Quid pro quo
• If Guarantor is owner of Debtor, the guarantee
  improves the balance sheet of its subsidiary and
  therefore its own assets.
• If Guarantor is unrelated to Debtor, the
  guarantee usually creates a new claim on Debtor,
  and therefore the Guarantor gains a non-equity
  financial asset.

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Concerns

• Proliferation of commercially-motivated and
  mutually offsetting capital transfers.
• Write-offs of debt by banks are currently other
  changes in volumes. Why should write-offs by
  banks under guarantees be different?

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