The classification of holding companies and head offices Problems encountered by the ICBS Prepared by Mrs Noemi Frisch Tsekhman 25 October

Background and definitions in SNA2008 Problems with the implementation of the updated definitions An example from the Israeli economy Conclusions 2 Content

Background and definitions in SNA2008 Reasons for introducing changes in the definitions and classification of holding companies and head offices: 1. Deviation of the ESA95 and the MFSM 2000 from the SNA Development of the financial markets. 3. Monetary and financial stability analysis. 3

Definitions in SNA Two quite different types of units exist that are both often referred to as holding companies. The first is the head office that exercises some aspects of managerial control over its subsidiaries. These may sometimes have noticeably fewer employees, and more at a senior level, than its subsidiaries but it is actively engaged in production. These types of activities are described in ISIC Rev. 4 in section M class 7010 as follows: This class includes the overseeing and managing of other units of the company or enterprise; undertaking the strategic or organizational planning and decision making role of the company or enterprise; exercising operational control and manage the day-to-day operations of their related units. Such units are allocated to the non-financial corporations sector unless all or most of their subsidiaries are financial corporations, in which case they are treated by convention as financial auxiliaries in the financial corporations sector. 4

Definitions in SNA The type of unit properly called a holding company is a unit that holds the assets of subsidiary corporations but does not undertake any management activities. They are described in ISIC Rev. 4 in section K class 6420 as follows: This class includes the activities of holding companies, i.e. units that hold the assets (owning controlling-levels of equity) of a group of subsidiary corporations and whose principal activity is owning the group. The holding companies in this class do not provide any other service to the enterprises in which the equity is held, i.e. they do not administer or manage other units. Such units are always allocated to the financial corporations sector and treated as captive financial institutions even if all the subsidiary corporations are non- financial corporations. 5

Problems with the implementation of the definitions 1.What is the level of management control required for a head office ? Can a holding company be engaged in financial managing of the group (issuing bonds, giving loans …) ? 2.What is the level of the decision making role and the day to day operations ? 3.The holding company definition seems very restrictive. 6

Problems with the implementation of the definitions 4.Can both kind of companies hold their subsidiaries and collect management fees? 5.Is the only income of the holding companies from earnings (losses) from subsidiaries ? 7

Example – IDB Group Principle companies held by IDB Holdings 8 100% 13.4% 73.5%60.5% 55% 63%

Example – IDB Group Some information and quotations from the financial report : IDB Holdings is one of the Israeli largest holding companies (invests in financial and non financial companies). The owner sets the policy of the Company and the Group, directs the activity and leads its business strategy… managing and supervising on an ongoing basis the activity of the Company and the Group. 9

Example – IDB Group All six companies have a small number of employees at a senior level. Some of the companies share manpower and some provide management services to the other companies. Structure of the financial accounts: Assets : - Investments in investee companies. - Loans provided to subsidiaries. 10

Example – IDB Group Liabilities: - Bonds - Loans from banks and subsidiaries Income: - Net earnings (losses) from investee companies - Management fees (small amount). 11

Example – IDB Group 12 Company Total assets (annual report stand alone basis) Number of employees (annual report stand alone basis) IDB Holdings0.9 billion US$A few IDB Development2.6 billion US$ 51 – senior positions Koor industries1.8 billion US$ 10 - senior positions Discount investment3.9 billion US$ 33 - senior positions Clal industries1.4 billion US$ 35 - senior positions Clal insurance enterprises holdings 1.3 billion US$Not available

Example – IDB Group Holding Company or Head Office ? Holding CompanyHead Office Has no significant production at its own Providing part of the management services The owner of the Group does not undertake the day- to-day operations at the enterprise level The owner of the Group sets the policy, directs its activity, leads its business strategy and manages on an ongoing basis the activity of the Company and the Group The main asset is investment in investee companies Few employees at a senior level 13

Example – IDB Group Holding Company or Head Office ? Holding CompanyHead Office The main income is earnings (losses) from investee companies Issue bonds and provide loans to the subsidiaries 14 Currently, in the balance sheets, these kind of companies have been classified as Holding Companies under the financial sector, in the other financial intermediaries subsector and will be classified as captive financial institutions according to SNA2008.

A few numbers from the balance sheets of Israel – financial assets Year Financial sector as part of the total economy Other financial intermediaries subsector as part of the financial sector Other financial intermediaries subsector excluding different funds as part of the financial sector Holding Companies as part of the Other financial intermediaries subsector excluding different funds Holding compani es as part of the total economy %24%9%80%2.8% %30%18%n.a. Total assets of the economy is 1,916 billion US$ (9.4 times GDP in year 2009). The total assets of the financial sector is 530 billion US$ (28% of the total economy and 36% from the financial assets).

Conclusions Companies which mainly hold subsidiaries and engage in some financial activity have been classified as Holding Companies in the Captive financial institution and money lender subsector although the owner controls, sets the policy and makes the decisions for many of the subsidiaries. Other statistical agencies may classify differently. The ambiguity will make it difficult to compare the data. Therefore, more specific guidance is needed. It would be useful to make a sub-classification of the holding companies (financial and non-financial holdings) 16

Thank you for your attention ! 17