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:
|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.