Standardized guarantees Recommendations Treat the provision for standardized

Standardized guarantees Recommendations Treat the provision for standardized guarantees as financial assets and liabilities. Create a new financial instrument “standardized guarantees” under insurance technical reserves. Standardized guarantees are assets of creditors and liabilities of guarantors. Two options are being considered: (a) Treat similar to insurance (premiums and claims treated as current transfers) (b) Treat simply as financial instruments. 1

Standardized guarantees The output of guarantor, property income, and balance sheet positions are same in both options. Main differences in recording of premiums and claims Insurance approach – current and financial accounts. Financial instrument approach – financial and other flows accounts. As a result, net lending/borrowing will differ. Financial position of the lender is overstated where guaranteed instrument is valued at nominal – loan at nominal value plus expected loss. 2

Standardized Guarantees Simple R/A Premiums Claims Insurance U/L Cur A/C R/A U/L 6 10 Property income Cash G, when sold Fin A/C -10+X X X G, claims inc 10 G, prepaid -6 G, claims paid G, actual claims G, expiry of risk -10 Other flows -10 10 -6 3

Activation of One-off guarantees Not standardized and do not meet the criteria for financial derivatives Examples: parent guarantees debt of a subsidiary, government guarantees of worthy private projects. Recommendation to continue as contingent asset, but with higher prominence of memorandum item. Clarify treatment of flows arising from activation. 4

Activation of One-off guarantees Activation involves flows among three parties. Specific flows arising from activation should be recorded on the basis of contractual arrangements and specific circumstances (such as when the unit concerned no longer exists) either as a capital transfer or a financial transaction (including increases in existing equity participation) or other changes in volume of assets. (Recommendation 13) This recommendation is consistent with existing guidelines that focus only on guarantor, but elaborates the changes in balance sheets of all three involved parties. 5

Activation of One-off guarantees The debtor continues to exist Creditor and guarantor • Creditor acquires financial assets (may be, a loan) on the guarantor, a financial transaction. Original debtor and creditor • The liability of the original debtor is recorded as if repaid (financial transaction). Guarantor and original debtor • Should be determined on the basis of the contractual agreement, if such exists. – Guarantor obtains financial claims, including increase in existing equity, if guarantor obtains such claims as a result of activation. – A capital transfer to debtor, if guarantor does not seek repayment. 6

Activation of One-off guarantees The debtor is liquidated Guarantor’s claim and original debtor’s liability are written-off (other flows). A capital transfer from guarantor to creditor is recorded for the compensation of loss as a result of debtor’s liquidation. 7

Activation of One-off guarantees The activation may or may not require payment at once. Following accrual accounting, the amount of debt assumed will be recorded at the time of activation. Actual settlements (of principal and/or interest accruals) are recorded as they occur. 8

Activation of One-off guarantees Recommendation 14 One-off guarantees granted to corporations in certain welldefined financially distressed situations and with a very high likelihood to be called might be treated as if these guarantees are called at inception. 9