Enlargement of the financial corporations sector: Classification of holding companies and other captive institutions

1. Enlargement of the financial corporations sector: Classification of holding companies and other captive institutions Methodological questions and practice in Hungary OECD Working Party on Financial Statistics Béla Simon 24-27October 2011

2. Content of the presentation • Changes in the methodological rules (SNA, ESA) • Differences between SNA 2008 and ESA 2010 • Decision-making autonomy as a key question • Content of the new financial corp. sub-sector • Significance of special entities in Hungary • Practical decisions made (to be applied from 2014) • Reasons behind the practical decisions

3. Changes in methodological rules (SNA, ESA) Extension of the financial corporations sector SNA 1993, ESA 1995: • Financial corporations sector (S.12) = Financial intermediaries + Financial auxiliaries • Financial intermediation is a service for the public SNA 2008, ESA 2010: • Financial corporations sector (S.12) = Financial intermediaries + Financial auxiliaries + other (captive) financial corporations • Corporations with passive holding or financing functions become part of the financial sector Sector classification of holdings and captive institutions - Béla Simon

4. Differences between SNA 2008 and ESA 2010 According to the rules, the new financial sub-sector (S.127) should contain holding companies, SPEs and lending companies having limited partners. But definition of these entities contains differences in the Manuals. ESA 2010 (2.14): Head offices and holding companies are institutional units. (No test required?) SNA 2008 does not contain the same statement. SNA 2008 (4.56): SPEs are often resident in a territory other than territory of the related corporations. ESA 2010 defines SPEs as units only having links to non-residents (the „often” is missing). 4 Sector classification of holdings and captive institutions - Béla Simon

5. Decision-making autonomy as a key question According to the general rules, all economic entities have to be examined whether they are independent institutional units or not. SNA and ESA underline that an entity that cannot act independently of its parent and is simply a passive holder of assets and liabilities is not treated as a separate institutional unit unless it is resident in an economy different from that of its parent. SNA and ESA explicitly states that SPEs, captive financial institutions and artificial subsidiaries with no independence of action are to be allocated to the sector of their controlling body. (ESA 2010: 2.20) 5 Sector classification of holdings and captive institutions - Béla Simon

6. Content of the new financial corp. sub-sector In our view, holding companies and other group financing entities are substantially SPEs. (No employees, no non-financial assets, no production, little physical presence, relation with other corporations.) The new financial sub-sector „S.127 Captive financial institutions and money lenders” can be composed of (substantially) SPEs which are controlled by non-residents. Otherwise, SPEs are not treated as independent units and will be kept in the sector of the related units, according to our understanding of the new rules. 6 Sector classification of holdings and captive institutions - Béla Simon

7. Significance of special entities in Hungary Foreing controlled SPEs having financial links only with non-residents represent 1/3 of the total assets of the non-financial corporations sector (124% of GDP). The total assets of holding companies and other group financing units (classified until now as non-financial corporations) amount to 8-9% of the GDP. Out of this, foreign controlled holding and other group financing companies are less signifinant (5% of GDP) 7 Sector classification of holdings and captive institutions - Béla Simon

8. Practical decisions made (to be applied from 2014) Foreing controlled SPEs connected exclusively to non-residents will be reclassified into the financial corporations sector (sub-sector S.127). The reclassification will cause a significant decrease in the total assets of non-financial corporations sector (and increase in the financial sector). Holding and other group financing companies will be kept in the sector of related corporations (mainly non-financial corporations sector) and will be consolidated. The consolidation will cause some decrease in the balance-sheet of the non-financial corporations sector. 8 Sector classification of holdings and captive institutions - Béla Simon

9. Reasons behind the practical decision Most of Hungarian holding companies are parts of an ownership chain through which foreign owners control resident non-financial corporations. The reclassification of these holding companies would split the investment links between the foreign investors and the ultimate subsidiary corporations (usually non-financial corporations engaged in production). Most of Hungarian holding companies control only one single subsidiary corporation and they exist due to administrative reasons. They do not fulfil the criteria of „holding assets of a group of subsidiary corporations” (ISIC/NACE 6420). 9 Sector classification of holdings and captive institutions - Béla Simon

10. Thank you for the attention! The floor is open for questions.