Euro moan

Eurostat has been handed the unenviable task of handling sovereign securitisations in the Eurozone. Yannis Manuelides gives the story so far

Eurozone countries have assumed the obligation to keep their overall debt and deficit within a certain percentage of their gross domestic product (GDP). But who measures this debt and de-ficit? Private sector enterprises have their accounts prepared and audited in accordance with one or another set of sophisticated standards (notable recent exceptions notwithstanding). Eurozone countries are asked to comply with what are in essence financial covenants. But who measures these and what standards do they use?
Eurostat, the European statistical office, has been given willy-nilly this task, on the suspect logic that if you measure apples you are properly equipped to devise the rules for applehood. Eurostat has risen to the challenge with determination, but in my view not with universal success. It has promulgated succesive versions of the European System of Accounts (ESAs), the latest of which is ESA95. And it has given its opinion/ruling whenever sovereigns sought it.
As is the case with private sector accounting, the real difficulties arise when sophisticated financial instruments are used. Having struggled with PFI and sale and leasebacks, it was time for Eurostat to face sovereign securitisations, especially as it discovered that a number of Eurozone sovereigns were engaged in this yet unclassified type of transaction (as revealed in a Eurostat news release on 21 March, 2002). It promised decisions by the end of June; and on 3 July 2002 it announced four accounting principles for sovereign securitisations.
The four principles
The four principles can be summarised as follows:
•The securitisation of future receivables not corresponding to actual assets on the sovereign balance sheet should be recorded as debt, not as sale.
•If a securitisation is supported by an effective guarantee of the cashflows, then it must be recorded as debt.
•If the assets are sold at a discount greater than 15 per cent from their market price, then the transaction should be recorded as debt, not as sale.
•In any event, where the sale price is not all received up front, the balance should be recorded only at the time of its receipt.
The first principle
Of these principles, only the last one is uncontroversial. The first may appear sound until one discovers that not all income-producing assets that a private company would include on its balance sheet are included by sovereigns. A toll bridge is not such an asset, but even if it were a securitisation of the future tolls to pay for the bridge would not satisfy Eurostat's requirement that the amount raised as sale price must not be less than actual assets on the balance sheet.
This seems to draw an unwarranted distinction between securitisations and PFI/projects transactions, with the latter obtaining off balance sheet treatment where securitisations do not. More importantly, the drawing of this distinction gives Eurostat – an unaccountable European body – the power to force policy choices on governments: the licence fees from licences granted for lottery tickets, for example, can be used to reduce national debt, but securitising the receivables from government-owned lotteries is a borrowing, and as such can never reduce debt. Arguably, this lack of policy choice goes against the ordinary understanding of what the EU – and even the Eurozone – is about.
The second principle
Guarantees from a sovereign should place a transaction on the debt of the sovereign. However, this principle is not applied by Eurostat in other types of transactions. Only in the context of securitisations do guarantees count as debt: sovereigns can, subject to state aid restrictions, provide guarantees without those guarantees being added to their debt figures. Does this signal a turn in Eurostat's approach? Will other state guarantees also come on the balance sheet, as would argue the proponents of treating sovereigns like corporates? And, if this is going to happen, will it mean the end of a certain kind of project financing which, given the magnitude of the risk and uncertainty of the venture, requires a state guarantee able to be financed?
The third principle
It is not immediately obvious why a discount in excess of 15 per cent should classify as debt a transaction that is structured as a sale. Eurostat is probably of the view that retaining too much of an interest in the sold property does not dissociate sufficiently the seller from the asset sold; hence the transaction is more like a secured loan. Surely, however, this must depend on the circumstances. There may be instances where sovereigns can and do interfere although they have disposed of all of their interests (some would argue that Railtrack is a case in point); and there are others when it is not possible for them to interfere, given the nature of the asset.
Reactions to Eurostat's decision
Not surprisingly, Eurostat's decision proved to be controversial with those sovereigns whose debt figures had to be recalculated as a result of the principles. Given the brevity of the decision, Eurostat's reasoning is not always immediately obvious, although the affected member states were consulted extensively prior to the public announcement. Some affected sovereigns may also feel that the application of these principles after the event is harsh. Finally, the internal consistency of the Eurostat principles may become an issue in the future.

More detailed rules on securitisation have been promised for the near future. It is unlikely, however, that these new detailed rules will be the end of the debate on the accounting treatment of structured financing by sovereigns.
Consider the following, all of which promise that the wider debate on debt, deficit and the way they are measured will continue:
•Eurozone members are openly discussing the wisdom of the Maastricht thresholds on debt and deficit. This debate is not going to go away, especially during this period of economic slowdown. This debate is likely to focus not only on the figures for debt and deficit, but also on what the debt and deficit is; who should be mandated to define it; and who should act as auditor.
•Project and structured financing will continue to spread throughout the Eurozone. The accounting treatment of these transactions must be part of a clear, consistent and fair set of rules, or the economic efforts of which they are a part will be thwarted.
•Prospective EU members will inevitably join in the debate. They will want to reform their economies in a manner consistent with the Eurozone principles, and the clarity of principle and fairness of application will be uppermost in their minds.
Yannis Manuelides is a banking partner at Allen & Overy