Major Changes to the Financial Account and International Investment Position Workshop on the Sixth Edition of the Balance of Payments and International Investment Position Statistics Manual – BPM6 Beirut March 24-26, 2015

Changes from BPM5 BPM6 Appendix 8  Chapter 5: Classification of Financial Assets and Liabilities  Chapter 6: Functional Categories  Chapter 7: International Investment position (IIP)  Chapter 8: Financial Account  Chapter 9: Other Changes in Financial Assets and Liabilities Account 2

Direct Investment Direct investment arises when an investor resident in one economy makes an investment that gives control or a significant degree of influence on the management of an enterprise that is resident in another economy (para 6.9) – Control is determined to exist if the investor owns more than 50 percent of the voting power in the enterprise that is resident in another economy; – A significant degree of influence is determined to exist if the investor owns from 10 to 50 percent of the voting power in the enterprise that is resident in another economy. “10 percent rule” remains in BPM6. 3

Direct Investment Direct investor: an entity or group of related entities that is able to exercise control or influence over another entity resident in another economy Direct investment enterprise (DIE): an entity subject to control or influence Fellow enterprises – those enterprises that are under the control or influence of the same immediate or indirect investor, but neither fellow enterprise controls or influences the other fellow enterprise Control and/or influence may be direct or indirect, as described in the Framework for Direct Investment Relationships

 In this example, B and C are fellows: they are both 100 percent owned by A so they are related even though they have no equity in each other Direct investment Fellow enterprises 5

Direct Investment Intercompany Debt Debt instruments cover intercompany borrowing and lending – Intercompany debt between selected affiliated financial corporations is not classified as DI debt because it is not considered to be so strongly connected to the direct investment relationship – these debt positions are included under portfolio or other investment, as appropriate.

Direct Investment Reverse Investment Reverse investment occurs when direct investment enterprises acquire financial claims on their direct investors – There are two different treatments, depending on the nature and magnitude of the reverse investment If the direct investment enterprise acquires at least 10% of the voting power of the direct investor: – two direct investment relationships are established, and claims between the enterprises are recorded as direct investment assets and direct investment liabilities in both directions – Using the directional principle, these would be recorded as direct investment abroad and liabilities would be recorded as direct investment in the reporting economy

Direct Investment Reverse Investment If the direct investment enterprise owns less than 10% of the voting power in its direct investor: –the provision of a loan or the acquisition of equity is recorded as: assets of direct investment enterprises in its direct investor Assets and liabilities between fellows are not considered to be reverse investment

Example of Reverse Investment and Investment in Fellow Enterprises Two enterprises (B and C) have same immediate or ultimate direct investor (A), but neither is a direct investor in the other. – Reverse investment (C lends 100 to A); – Investment in fellow enterprises (C lends 250 to B) 10

Direct Investment In BPM6, direct investment is presented on an assets and liabilities basis, compared to the directional principle presentation in BPM5. The differences in value and sign between BPM5 and BPM6 figures for direct investment are therefore due to the re- arrangement of reverse investment. Following is an example of the recording of direct investment in BPM5 and BPM6.

BPM5 CreditDebit Direct investment-13 Abroad-23 Equity capital-10 Claims on affiliated enterprises-10 Liabilities to affiliated enterprises (reverse)0 Reinvested earnings-3 Other capital-10 Claims on affiliated enterprises-15 Liabilities to affiliated enterprises (reverse) (increase in liability)5 In reporting economy10 Equity capital5 Claims on direct investors (reverse)0 Liabilities to direct investors5 Reinvested earnings (loss)-2 Other capital7 Claims on direct investors (reverse) (decrease in asset)6 Liabilities to direct investors1

BPM6Q1BPM6Q1 Direct investment Net acquisition of financial assets Net incurrence of liabilities 9.00 Equity and investment fund shares Equity and investment fund shares 3.00 Equity other than reinvestment of earnings Equity other than reinvestment of earnings 5.00 Direct investor in direct investment enterprises Direct investor in direct investment enterprises 5.00 Direct investment enterprises in direct investor (reverse investment) 0.00 Direct investment enterprises in direct investor (reverse investment) 0.00 Between fellow enterprises 0.00 Between fellow enterprises 0.00 Reinvestment of earnings 3.00 Reinvestment of earnings Debt instruments 9.00 Debt instruments 6.00 Direct investor in direct investment enterprises Direct investor in direct investment enterprises 1.00 Direct investment enterprises in direct investor (reverse investment) Direct investment enterprises in direct investor (reverse investment) 5.00 Between fellow enterprises 0.00 Between fellow enterprises 0.00

Direct Investment Valuation BPM6 recommends that: –market values be used to value: direct investment financial flows income transactions equity and marketable debt instruments stock positions (IIP) –nominal value be used to value: debt stock positions (other than marketable securities)

Direct Investment Valuation When market value is not available, BPM6 (para 7.16) and BD4 suggest 6 proxies: – Recent transaction price – Net asset value – Present value of future earnings – Market capitalization method – Own funds at book value – Apportioning global value to local activities (using appropriate indicator such as value added)

Direct Investment Valuation – Example: Own funds at book value (OFBV)—values taken from the books of the DIE [para 7.16(e)] – Sum of: paid-up capital all types of reserves identified as equity in the enterprise’s balance sheet cumulated reinvested earnings holding gains or losses included in own funds in the accounts, whether as revaluation reserves or profits/losses – Coordinated Direct Investment Survey (recommended method for unlisted equity)

Portfolio Investment Portfolio investment is defined as cross-border transactions and positions involving debt or equity securities, other than those included in direct investment or reserve assets. (para 6.54) The characteristic feature of securities is their negotiability. – that is, their legal ownership is readily transferable from one unit to another unit by delivery or endorsement. (para 5.15) Negotiable instruments are designed to be traded on organized and other markets. (para 5.15)

Portfolio Investment Equity may be split into listed and unlisted shares Investment fund shares and money market shares are separately identified Portfolio InvestmentQ Net acquisition of financial assets (NAFA) Equity and investment fund shares Equity securities other than investment fund shares Listed Unlisted Investment fund shares of which: reinvestment of earnings of which: money market fund shares or units

Net Recording Recording of financial account transactions on a net basis means that purchases and sales of a particular asset within a reporting period are netted out. Portfolio Investment Net acquisition of financial assets (NAFA)50 Equity and investment fund shares50 Purchases100 Sales-50

Portfolio Investment A treatment for short positions is provided – Short positions occur when an institutional unit sells securities for which it is not the economic owner. For example, a security subject to a repurchase agreement may be on-sold by the security-receiving party – The party with the short position records a negative value for the holding of the asset. The short position is shown as a negative asset, rather than a liability.

Financial Derivatives (other than reserves) and Employee Stock Options ● A financial derivative contract is a financial instruments that is: ● linked to another specific financial instrument, or indicator or commodity; ● through which specific financial risks, such as: ● interest rate risk, ● foreign exchange risk, ● equity and commodity price risks, ● credit risk, and so on ● can be traded in their own right in financial markets (para 5.80) ● Employee stock options are recognized as an instrument

OTHER INVESTMENT Other investment is a residual category, comprising all transactions not included under direct investment, portfolio investment, financial derivatives, and reserve assets. Reflects the following instruments: – other equity – currency and deposits – loans – insurance, pension, and standardized guarantees schemes – trade credits and advances – other accounts receivable/payable – and special drawing rights (SDR allocations)

Other Investment Instrument breakdown Other equity equity not in the form of securities, or reserve assets not included under direct investment Examples: subscription to international organizations e.g. World Bank and BIS subscription in regional international organizations, e.g. CB of monetary union or participations (voting power) of less than 10 percent

Other Investment Instrument breakdown Loans include: Financial leases Repurchase agreements (Repos) and gold swaps Debt assumption Credit and loans with the Fund Currency and deposits: New in BPM6 are Interbank positions, that can be shown as a separate component of deposits – In some cases the instrument classification of interbank positions may be unclear, e.g. loans, transferable/non- transferable deposits. Therefore, by convention, to assure symmetry, all interbank positions other than securities and accounts receivable/payable are classified under deposits (para 5.42.)

Other Investment Instrument breakdown Insurance technical reserves, pension fund entitlements, and provisions for calls under standardized guarantees  Insurance reserves and pension entitlements are recognized as assets and liabilities  The accrued obligations of unfunded pension schemes are also recognized as economic assets and liabilities  Provisions for calls under standardized guarantees are identified and treated similarly to insurance technical reserves  An overview is given in Appendix 6c of BPM6 Allocations of Special Drawing Rights  The allocation of SDRs to IMF member countries is shown in the incurrence of liabilities of the recipient under SDRs in other investment with a counter-entry under SDRs in reserve assets  Other acquisitions and sales of SDRs are included in reserve assets (SDR Holdings)

Reserve Assets Monetary gold is defined in terms of gold bullion (which includes allocated gold accounts) and unallocated gold account The treatments of gold lending, repos, special purpose government funds, pooled assets, central bank swap arrangements, and pledged assets in reserve assets are elaborated. Frozen assets are discussed Working balances of government agencies are not included in reserve assets Reserve Assets Monetary gold Gold bullion Unallocated gold accounts

Reserve-related liabilities Reserve-related liabilities are defined as foreign currency liabilities to nonresidents associated with reserve assets of the monetary authorities, – i.e., liabilities in foreign currency that can be regarded as direct claims by nonresidents on the reserve assets of a country. Short-term reserve-related liabilities are a memorandum item to the IIP.

International Investment Position The IIP is a statistical statement that shows, at a point in time, the value and composition of: – the financial assets that are claims on nonresidents or gold bullion held as reserve assets – the liabilities of residents of an economy to nonresidents. A point in time, usually refers to the beginning of the period (opening value) or end of period (closing value). Details of currency composition and remaining maturity are included for selected position data in memorandum and supplementary tables

Other Changes in Financial Assets and Liabilities BPM6 Chapter 9 Even if you don’t compile this account, you need to understand it: – to distinguish between transactions and non- transactions; – to understand the causes of changes in balance sheets over time.

Other Changes in Financial Assets and Liabilities  Integrated IIP Statement: beginning-of-period value; + changes during period:  transactions (financial account);  non-transaction changes (other changes in financial assets and liabilities account):  other changes in volume;  revaluation due to:  exchange rate movements;  other price changes; = end-of-period value.

Integrated IIP Statement

Revaluation Because of importance of instruments denominated in foreign currencies in international accounts, revaluation is split between: – revaluation due to changes in the exchange rate; – revaluation due to other price changes.

Total change-2,455.9 Financial Flows0.1 Valuation Adjustments-2,456.0 Price changes-1,954.3 Exchange-rate changes Other valuation changes Total change Financial Flows534.1 Valuation Adjustments Price Changes Exchange-rate changes Other valuation changes Changes in U.S.-Owned Assets Abroad, Excluding Financial Derivatives*, 2008 (billions of dollars) Changes in Foreign-Owned Assets in the U.S. Excluding Financial Derivatives*, 2008 (billions of dollars) Bureau of Economic Analysis - Survey of Current Business, July 2009 – The International Investment Position of the United States at Yearend Note: The current-cost method is used to value direct investment. *With Direct Investment at Current Cost

Total change1,749.7 Financial Flows140.5 Valuation Adjustments1,609.2 Price changes1,066.1 Exchange-rate changes Other valuation changes Total change961.9 Financial Flows305.7 Valuation Adjustments656.2 Price Changes543.2 Exchange-rate changes 81.2 Other valuation changes 31.8 Changes in U.S.-Owned Assets Abroad,* excluding Financial Derivatives, 2009 (billions of dollars) Changes in Foreign-Owned Assets in the U.S.,* excluding Financial Derivatives, 2009 (billions of dollars) Bureau of Economic Analysis - Survey of Current Business, July 2010 – The International Investment Position of the United States at Yearend Note: The current-cost method is used to value direct investment. *With Direct Investment at Current Cost

Other Changes in the Volume  Examples of other changes in volume:  debt cancellation and write-offs;  reclassifications (including monetization and demonetization of gold bullion);  financial assets and liabilities of persons and other entities changing residence;  Changes in insurance reserves, pension entitlements, and provisions for standardized guarantee schemes because of changes in actuarial assumptions.