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Changes to Cash Management Arrangements between the Bank of England Asset Purchase Facility and HM Treasury

1: The Context of National Accounts Classification Decisions

The National Accounts provide a framework for describing what is happening in national economies. All institutional units operating within an economy are classified to an institutional sector and all transactions between the sectors of the economy are also categorized as part of the National Accounts framework. Work on the classification of sectors and transactions is a key input in the production of the National Accounts.

This is particularly important in the area of public expenditure, revenues, borrowing and debt. This applies both domestically, and within the European Union. For example, in the European Union statistics based on the European System of Accounts 1995 (ESA95) are used in:

  • the Maastricht Treaty Excessive Deficit Procedure measures of government debt and deficit, where they determine the convergence criteria for monetary union for non-members, and performance against the Growth and Stability Pact for existing member states; and

  • the measurement of Gross National Income (GNI), one of the main determinants of member states' contributions to the European Union's budget.

It is a legal requirement for European Union countries to compile specified statistical returns on the basis of ESA95. The United Kingdom National Accounts are produced by the Office for National Statistics (ONS) on this basis. Further guidance is contained in Eurostat’s Manual on Government Deficit and Debt, and additional clarification is contained in the System of National Accounts (SNA) 1993.

Since 1997, the UK’s fiscal policy frameworks have also been based on the National Accounts. Fiscal policy objectives are in terms of statistics based on National Accounts aggregates. This means that key fiscal targets are dependent on National Accounts definitions and classifications.

Classification decisions for National Accounts purposes are taken by the National Accounts Classification Committee (NACC) within ONS.

2: Changes to Cash Management Arrangements between the Bank of England Asset Purchase Facility and HM Treasury

2.1 About the Bank of England Asset Purchase Facility Fund Ltd

In 2009, the Bank of England established a separate company, Bank of England Asset Purchase Facility Fund Ltd (BEAPFF), as the vehicle to undertake Quantitative Easing (QE). Funded by a loan from the Bank of England, the BEAPFF has since bought assets worth almost £375bn. The vast majority of these assets are UK Government gilts, bought on secondary markets, with a range of maturities.

As a result of these purchases, the BEAPFF receives large coupon (interest) payments from Her Majesty’s Treasury (HMT). Although it also pays interest on the loan from the Bank of England these interest payments have been much lower than the interest received and so the cash has been building up into a cash reserve.

Over time, the expectation has always been that Quantitative Easing will end, and that the gilts will be sold back to the market. The accumulated cash reserve was being retained to cover any losses made by the BEAPFF as Quantitative Easing was unwound.

However, the activities of the BEAPFF are subject to an indemnity (guarantee) from HMT, such that HMT is entitled to any profit the BEAPFF eventually makes and is responsible for any losses it incurs.

On 9 November 2012, the Bank of England and HM Treasury announced jointly that, instead of the net interest payments being held in a cash reserve, they would be transferred to the Treasury. On current government plans, the excess cash that has built up between the start of the BEAPFF activities to March 2013 will be transferred to HMT over 2012/13 and 2013/14, and there will be additional regular quarterly payments to prevent the further build up of reserves.

In the longer term, as Quantitative Easing is unwound, should the BEAPFF make losses, then HMT will transfer over money to cover any loss made.

2.2 Classification of the BEAPFF

With the exception of a short period immediately following its creation in 2009 when it was funded by a loan from HM Treasury, the BEAPFF has been classified by the Office for National Statistics, as if it were simply part of the Bank of England.

The Bank of England is classified as a Public Sector Financial Corporation, and therefore not part of the Government sector.

2.3 Impact of Quantitative Easing on Debt and Deficit Measures

ONS publishes a number of different measures of the Government or public sector debt and deficit.

  • The international measures under the Maastricht Treaty, which ONS publish twice a year in the “Government Deficit and Debt Under the Maastricht Treaty” statistical bulletin. These are General Government Consolidated Gross Debt and General Government Net Borrowing and these measures only include bodies classified within the Government sector.

  • In the UK, the main statistical measures, which are published in the monthly Public Sector Finances statistical bulletin, are Public Sector Net Debt (PSND) and Public Sector Net Borrowing (PSNB). These measures include all bodies classified in the Government sector, but also public sector controlled companies, referred to as Public Corporations, both Public Non-Financial Corporations (such as Royal Mail, or Manchester Airport Group) and Public Financial Corporations (including the Bank of England, BEAPFF and public sector controlled Banks).

  • Up until 2007, PSND and PSNB were the principal measures used by the UK Government in setting and monitoring its fiscal policy. In response to the unprecedented events and actions taken by the Government following the financial crisis in 2007-8, two new measures were created - Public Sector Net Debt and Public Sector Net Borrowing excluding the temporary effects of financial interventions (PSND ex and PSNB ex). As the names imply, these measures strip out any actions undertaken by the Government or the Bank of England, in response to the financial crisis that are deemed to be temporary, including the activities of the BEAPFF. These two “ex measures” are now used as the main fiscal measures by the UK Government.

The Quantitative Easing undertaken by the BEAPFF has a different effect on each of these different measures:

  • For the Maastricht measures, there has been little impact until now. Prior to the creation of BEAPFF and the start of QE, government gilts were owned by various non-government bodies such as domestic and overseas banks, insurance companies and pension funds. They were government liabilities to bodies outside the government sector. As the BEAPFF is also classified outside of government, this has no impact on levels of government liabilities.

  • For PSND and PSNB there is an effect. Gilts previously owned by the private sector were purchased by the public sector. This means that interest flows for the gilts held by the BEAPFF merely go from one part of the public sector to another and so do not appear in the overall public sector net borrowing (PSNB) (as the flows consolidate out). Similarly, government liabilities to the private sector became government liabilities to other parts of the public sector, which would have meant these also disappeared (as they consolidated out). However, the purchases of gilts by BEAPFF were funded by the Bank of England through the creation of new bank reserves (themselves a form of liability), so as a result of QE, the UK public sector has exchanged one type of liability (the gilts) for another type (the Bank of England bank reserves). The effect is that public sector net debt (PSND) is only impacted by the difference between the value of the Bank of England loan and the face value of the BEAPFF gilt holdings.

  • For PSND ex and PSNB ex (the “ex measures”), the BEAPFF purchases of the gilts and the loan from the Bank of England are outside the ex-measure boundary. However, the interest flows between HMT and the BEAPFF cross the this boundary and so do not consolidate out in PSNB ex as they do in PSNB, which results in PSNB ex being greater than PSNB all else being equal. Similarly, the liabilities of the BEAPFF do not consolidate out in PSND ex as they do in PSND and so what are recorded in PSND ex are the government liabilities to the BEAPFF, that is the face value of the BEAPFF gilt holdings.

The change in cash management arrangements between the BEAPFF and HMT changes the situation:

  • For the Maastricht measures it creates a new flow of money from outside Government to the Government (that if the cash been retained within the BEAPFF, or the gilts remained owned by the private sector, would not take place);

  • There are no direct impacts on PSND and PSNB, as the flows of money all take place within the public sector (although there is an indirect impact on PSND discussed further in section 4);

  • For PSNDex and PSNBex, the change in policy potentially results in a flow of money from outside the ex-measure boundary to inside the boundary, thus potentially affecting these two measures.

The National Accounts Classification Committee (NACC) and the Public Sector Finances Technical Advisory Group (PSFTAG) have been discussing how these flows should be treated in the National Accounts (including the Maastricht Deficit & Debt measures), and the Public Sector Finances measures.

These committees have made a number of recommendations, resulting in decisions by Caron Walker, the ONS Executive Director with overall responsibility for National Accounts, and Jil Matheson, the National Statistician, on how these flows should be treated.

3: Treatment in Maastricht Debt and Deficit Measures

The Maastricht measures follow the underlying rules and guidance for the National Accounts, set out in an International Manual, the European System of Accounts 1995 (ESA 95).

This guidance has been supplemented, since it was published, with additional guidance and rules in the Eurostat Manual on Government Deficit and Debt (MGDD).

This includes specific guidance on how to record flows of money between a Public Corporation and its parent Government, with an entire chapter (Part III) dedicated to this issue, and a separate chapter that covers payments between the Central Bank and Government (Part IV.2).

NACC has decided that the relevant guidance for the flows of money from BEAPFF to HMT is contained in MGDD Part III.5 “Dividends, Super-dividends and Interim Dividends”

NACC has concluded that the relevant guidance for any flows of money in the future from HMT back to BEAPFF as Quantitative Easing is unwound is contained in MGDD Part III.2 “Capital Injections into Public Corporations”.

3.1 Dividends, Super-dividends and Interim Dividends

The guidance in this section of MGDD is dedicated to the question of when a payment from a public corporation to its parent Government can be treated as a dividend. The introduction to this section states:

“III.5.1 Background to the issue

1. Payments made by public corporations to governments as shareholders are usually called "dividends" with reference to commercial law and business accounting. In most cases, these payments are also recorded as property income (dividends, D.42) in the ESA framework. The question addressed in this chapter is if there are payments made by public corporations to governments which, though they might qualify as dividends with reference to business accounting, require a different treatment in the ESA framework, for macro-economic statistics purposes, i.e. whether they need to be recorded differently from property income.”

MGDD provides guidance as to when a payment from a public corporation to government as shareholder can be treated as a dividend, via what is refers to as “the super-dividend test”

“8. Super-dividends: they are different in nature from dividends, as they are paid out of accumulated reserves, accounted for in the own funds of the corporation. Any withdrawal from own funds is to be recorded as a withdrawal of equity (F.5), at least for the amount in excess of the entrepreneurial income of the accounting year.

9. The "super-dividend test" must be applied to all payments that appear to be sizable and potentially out of proportion to the usual rate of return of the corporation. Only the part of the payment equivalent to the entrepreneurial income can be recorded as property income. Any amount in excess to the entrepreneurial income of the corporation is to be recorded as a transaction in equity (F.5). .......... This recommendation applies to all corporations, including the central bank.”

The distinction between flows of money treated as dividends compared to flows of money treated as a withdrawal of equity is important, as dividends are included in the calculation of government income that feeds into the calculation of General Government Net Borrowing, but withdrawals of equity do not. Instead withdrawals of equity are viewed as a change in the government’s balance sheet, the exchange of an equity asset for a cash asset.

A good analogy to explain this logic is to think about household ownership of shares in a company. If a household owns shares and the company pays a dividend to each shareholder, this is income of households. However if an individual sells one of her/his shares, she/he is no wealthier than before. There has merely been a swap of a share for cash of equal value.

So, for the BEAPFF cash transfers, the key issue is how to apply the super-dividend test.

A key factor in applying the test is the calculation of entrepreneurial income for the Bank of England.

3.2 Applying the Super-dividend Test

In reaching the decisions announced this month, ONS has worked with the Bank of England to estimate the Bank’s entrepreneurial income. This is not simply a case of looking at the reported profits of the Bank of England in their published accounts, due to both the way the Bank of England is structured and the differing treatments of National Accounts to commercial accounting.

Legally, the Bank of England is made up of two parts – the Banking Department and the Issue Department. It does not produce a consolidated set of accounts and does not include the BEAPFF in either the Banking Department or Issue Department accounts. Moreover the published accounts are not produced on an ESA 95 basis and therefore do not include entrepreneurial income as this is an ESA 95 concept.

Entrepreneurial income for the combined Bank of England has been estimated as the difference between the interest received and the interest paid by the three parts of the Bank. ONS have estimated this using detailed interest flow data to calculate the entrepreneurial income of the BEAPFF and Issue Department, taking into account flows between BEAPFF and the Issue Department to / from the Banking Department. We have assumed that the entrepreneurial income of the Banking Department is zero.

ONS has worked with published data to estimate the amounts of entrepreneurial income for the years since the BEAPFF was established. These are shown in the table below:

2009-10

2010-11

2011-12

2012-13

Total Entrepreneurial Income

£6.1bn

£6.1bn

£9.1bn

£12bn (based on latest estimates)

Amounts of money transferred from the Bank up to these amounts are permitted to be treated as dividends, under the super-dividend test, as long as they are paid over within a defined period (usually within the following 12 months)

This means that under the super-dividend test, a significant proportion of the BEAPFF cash transfers to HMT cannot be recorded as dividends, but instead have to be recorded as the withdrawal of equity.

In applying the super-dividend test, ONS has also had to take into account other flows of money from the various parts of the Bank to HMT. Both the Banking Department and Issue Department make regular payments to HMT, and so these regular payments “use up” some of the entrepreneurial income available to be recorded as dividends. In particular there was a large payment of £2.3bn from the Banking Department to HMT in April 2012, relating to final profits of the Special Liquidity Scheme, that is already being recorded as Government income. Up until now this has been recorded as a capital transfer rather than a dividend or super-dividend, However in examining the BEAPFF, the National Accounts Classification Committee also looked at the other payments from the Bank of England to HM Treasury and concluded that the Special Liquidity Scheme should also be considered as being subject to the same guidance on dividends and super-dividends. Under the super-dividend test rules for the Asset Purchase Facility the Special Liquidity Scheme “uses up” some of the available 2011/12 entrepreneurial income for dividend payments made in 2012/13.

Consequently, although the BEAPFF is expected to transfer all of its excess cash reserves to HMT (which are estimated to be of the order of £35bn at the end of March 2013) in instalments in 2013, not all of this transferred cash can be recorded as dividends.

The super dividend guidance notes that there can be both final dividends and interim dividends. Final dividends are paid out of the previous years entrepreneurial income, whereas interim dividends are defined in MGDD as:

“...the case where the corporation makes a payment to the shareholder during the accounting year, before the final annual result of the corporation is known”

Eurostat have advised that all payments from the Bank of England to HMT should be regarded as final dividends, meaning all flows of money from the Bank to HMT need to be assessed against the previous year’s entrepreneurial income.

In 2012-13, the various parts of the Bank of England have transferred or are planning to transfer £14bn to HMT. However the combined Bank had only £9.1bn of entrepreneurial income in 2011-12 available to be recorded as dividends. Some of this has already been used up by the £2.3bn SLS payment and payments totalling £0.4bn from the Issue Department. Consequently, although on current plans £11.5bn is being transferred from the BEAPFF in 2012-13, just £6.4bn of this can be recorded as dividends, and therefore reduce the deficit (£9.1bn of entrepreneurial income minus the £2.3bn already recorded as dividends relating to the SLS minus the £0.4bn of payments from the Issue Department also already recorded as dividends).

On current government plans substantial cash transfers from the BEAPFF to HMT will take place as well as unknown further amounts from the Banking Department and Issue Department. Whatever are the final amounts of cash transferred in 2013/14, under the super-dividend test rules only £12bn can be recorded as dividends based on the £12bn estimate for the 2012/13 combined Bank’s entrepreneurial income. Any amounts transferred in excess of this amount are treated as super-dividends, with no impact on the deficit.

3.3 Capital Injections into Public Corporations

Both HMT and the Bank of England recognise that the transfer of cash from the BEAPFF to HMT will not be irreversible.

The Bank of England Governors Letter to the Chancellor in November 2012 states:

"While transferring the APF's net income to the Exchequer will result initially in payments from the APF to the Government, it is likely to lead to the need for reverse payments from the Government to the APF in the future as Bank Rate increases and the APF's gilt holdings are unwound by the Monetary Policy Committee (MPC). Indeed, under reasonable assumptions it is likely that the majority of any transfer of funds to the Government will eventually need to be reversed."

The Bank of England expect that, as QE is unwound, the BEAPFF will make losses (i.e. as the gilts it owns are sold or mature, they will be worth less than they were bought for, resulting in accounting losses).

The MGDD chapter on Capital Injections into Public Corporations provides guidance on how to record such transfers.

This guidance recognises that government injections of funds to public corporations could be treated as either injections of equity or as Capital Transfers. Similarly to dividends and withdrawals of equity, this distinction matters as injections of equity (like withdrawals of equity) have no impact on the calculation of government net borrowing, but Capital Transfers are included in the calculation of government expenditure and feed into the calculation of government net borrowing.

Therefore, if a capital injection is deemed to be an injection of equity, it will have no impact on general government net borrowing, but if it is judged to be a Capital Transfer, it will worsen general government net borrowing.

The MGDD chapter on capital injections sets out a number of tests for when to record a capital transfer, and asks three questions:

  • Is the government acting alone?

  • Has the public corporation accumulated net losses or exceptional losses?

  • Is it likely that the government will receive a sufficient rate of return on its investment?

In the case of payments from HMT to BEAPFF under the indemnity, the answers to these questions are “Yes”, “Yes” and “No”. The guidance under this scenario is that the payments be recorded as capital transfers.

4: Treatment in Public Sector Finances

As discussed in section 2.3, the change in cash management arrangements between the BEAPFF and HMT has no direct impact on the long standing UK fiscal measures, Public Sector Net Debt (PSND) and Public Sector Net Borrowing (PSNB). This is because the Bank of England, BEAPFF and HMT are all within the public sector, and so the flows of money all consolidate out (that is, cancel out). There is, however, an indirect impact on PSND as up until now the government has been borrowing money in order to pay gilt coupons (i.e. interest) to the BEAPFF. By drawing additional cash from the BEAPFF into government the government does not need to borrow so much money to meet its obligations and so, all things being equal, PSND will grow more slowly than it would if the cash transfers to government were not taking place. The reverse effect on the growth of PSND is likely to be observed when cash starts to be transferred from government to the BEAPFF.

The Public Sector Finances include not only public sector measures but also separate measures for Central, Local and General Government. As the Public Sector Finances are based on ESA 95, the flows of money between the BEAPFF and HMT are treated in exactly the same way as discussed in the previous section for the National Accounts – i.e. as dividends and super-dividends and capital transfers. This means that central and general government net borrowing and net debt are directly impacted by the cash flows from and to the BEAPFF.

However, to establish the impact of the flows on the main fiscal measures, Public Sector Net Debt and Public Sector Net Borrowing excluding the temporary effects of financial Interventions (PSND ex and PSNB ex), it is necessary to know whether the new cash flow arrangements should be considered as permanent or temporary effects of financial interventions.

Decisions on PSNB ex and PSND ex, the “ex-measures”, or any other areas where Public Sector Finances departs from ESA 95 principles, are informed by a body called the Public Sector Finances Technical Advisory Group (PSFTAG).

In light of the new arrangements PSFTAG considered both whether it was still correct to consider BEAPFF itself as a temporary effect of the financial crisis, and whether the cash moving to and from HMT should be treated as a temporary or permanent effect.

PSFTAG recommended firstly that the BEAPFF as a whole should continue to be treated as a temporary effect of financial interventions. Secondly, PSFTAG recommended that the cash flows between the Bank of England and Treasury should be treated as permanent effects and therefore (in accordance with the super-dividend test) impact on the headline deficit measure (PSNB ex).

These recommendations were based on published criteria3 for temporary or permanent effects of financial interventions. An important part of the rationale for the recommendations was the statement in the published criteria that “Bank of England run schemes indemnified by central government…are only regarded as having a permanent effect when there is an impact on the central government finances.” In the case of the BEAPFF (which is indemnified by central government), there is no direct impact on central government finances by its day to day operations, in which it purchases assets from the private sector (mainly gilts) and manages those assets. Therefore, the BEAPFF itself can be seen as a temporary effect of financial interventions. However, the new cash flows between the BEAPFF and HMT clearly have an impact on the central government finances and as such these flows can be seen as permanent effects of financial interventions.

The view of PSFTAG on continuing to treat the BEAPFF as a temporary effect was further supported by the argument that in the case of the Asset Purchase Facility overall, it is not clear when it will come to an end, how it will be wound down or whether at that point it will be in profit or loss . All these factors support treatment as a temporary effect of financial interventions.

The view of PSFTAG on treating the flows as permanent effects was further informed by desire for consistency of treatment with other financial interventions. An example of this is the treatment of fees paid to HMT by public sector banks under the credit guarantee and asset protection schemes. The fees from the public sector banks into central government are treated as permanent (and so included in PSNB ex and PSND ex) when they occur even though they originate from bodies deemed to be temporary effects of the financial interventions. Under the published criteria3 any guarantee payouts by government would similarly be treated as permanent effects. This treatment is analogous to that for the cash flows from and to the BEAPFF.

5: Size of Impact

As a result of the decisions reached, the immediate impact on the different fiscal measures is as follows:

General Government Net Borrowing (GGNB) under the Maastricht definitions

- reduction of GGNB by an estimated £6.4bn in 2012-13 (based on a 2011-12 Entrepreneurial Income of £9.1bn, the Special Liquidity Scheme transfer of £2.3bn in April 2012 and in year transfers of £0.4bn from the Issue Department)

- reduction of GGNB by an estimated £12bn in 2013-14 (based on a 2012-13 Entrepreneurial Income of £12bn and transfers from the BEAPFF in excess of this – HMT has indicated plans to transfer significantly more than £12bn from the BEAPFF in 2013-14)

Public Sector Net Borrowing excluding temporary effects of financial interventions (PSNB ex)

- reduction of PSNB ex by an estimated £6.4bn in 2012-13 (as for GGNB)

- reduction of PSNB ex by an estimated £12bn in 2013-14 (as for GGNB)

Public Sector Net Borrowing including temporary effects of financial interventions (PSNB)

- no change to PSNB (due to consolidation within the public sector)

General Government Net Debt (GGND) under the Maastricht definitions

- no direct impact on GGND (as no direct change to government liabilities)

- GGND will grow more slowly than it would if the cash transfers were not taking place due to the additional cash held by the Government

Public Sector Net Debt excluding temporary effects of financial interventions (PSND ex)

- reduction of PSND ex by an estimated £11.3bn by the end of 2012-13 (as net debt is defined as gross debt minus liquid assets and therefore all the transferred cash, which is a liquid asset, will reduce net debt)

- reduction of PSND ex by the end of 2013-14 will be the accumulated sum of all cash transfers from the BEAPFF during 2012-13 and 2013-14

Public Sector Net Debt including temporary effects of financial interventions (PSND)

- no direct impact on PSND (due to consolidation within the public sector)

- PSND will grow more slowly than it would if the cash transfers were not taking place due to the additional cash held by the Government

Central Government Net Cash Requirement (CGNCR)

- reduction of CGNCR by an estimated £11.3bn in 2012-13 (as all the transferred cash will reduce government cash requirements)

- reduction of CGNCR in 2013-14 will be equivalent to all cash transferred from the BEAPFF during 2013-14

Public Sector Net Cash Requirement (PSNCR)

- no change to PSNCR (due to consolidation within the public sector)

6: References

1. European System of Accounts 1995 (ESA 95) – Eurostat

2. Manual on Government Deficit and Debt – Eurostat

3. Public Sector Finances Excluding Financial Interventions (166.8 Kb Pdf) - ONS

Content from the Office for National Statistics.
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