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Classification of Financial Derivatives Involving Affiliated Enterprises in the Balance of Payments Statistics and the International Investment Position (IIP) Statement (231 kb PDF file), 2002

Foreign Direct Investment Statistics: How Countries Measure FDI

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World Map   Direct Investment Methodology: Recommended Treatment of Selected FDI Transactions

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A 1997 review of countries' practices for compiling data on foreign direct investment (FDI) transactions indicated that the treatment of three types of FDI transactions cause confusion among compilers:

  • Transactions with affiliated financial intermediaries

  • Payments associated with the acquisition of a right to undertake a direct investment

  • The shutdown of an FDI enterprise established for natural resources exploration

The IMF subsequently examined these issues and presented a paper to the October 1999 meeting of the IMF Committee on Balance of Payments Statistics (the Committee), a copy of which is posted on the balance of payments website (http://www.imf.org/external/bopage/pdf/clarif.pdf—32Kb PDF file.) The Committee agreed with the recommendations in that paper, but asked for further discussion with interested groups, such as the OECD's Working Party on Financial Statistics (WFS), and the European Central Bank's Working Group on Balance of Payments and External Reserves (WGBP&ER), prior to making a final decision. The final decisions of the Committee are set out below.

Transactions with affiliated financial intermediaries

In the case of the transactions with affiliated financial intermediaries, confusion has arisen for three reasons:

  • The text in paragraph 372 of the fifth edition of the Balance of Payments Manual (BPM5) that limits FDI transactions "between affiliated banks (depository corporations) and affiliated financial intermediaries (e.g. security dealers)" to transactions involving equity and permanent debt could be interpreted as meaning only those transactions between affiliated banks and between affiliated financial intermediaries, and not transactions between affiliated banks and affiliated financial intermediaries.

  • BPM5 and the Balance of Payments Textbook (BOP Textbook) are not clear about what exactly is meant by financial intermediaries.

  • The text in the BOP Textbook (paragraphs 542-544) that specifically excludes from the FDI data all non-equity/permanent debt transactions between a nonfinancial enterprise and an affiliated [Special Purpose Enterprise] (SPE) with the sole purpose of financial intermediation, and specifically includes such transactions between a nonfinancial enterprise and an affiliated SPE with the primary purpose of financial intermediation has also caused concern because of the argument that there is essentially no economic difference between the two types of SPEs.

Following discussions with the OECD WFS and the ECB WGBP&ER, the Committee at its October 2001 meeting reached the following decisions on the recommended treatment of transactions with affiliated financial intermediaries.

  • The BPM5 definition of the scope of enterprises included under "banks and other financial intermediaries such as security dealers" should be clarified as being equivalent to the following SNA93 financial corporations sub-sectors: other depository corporations (other than the central bank); other financial intermediaries, except insurance corporations and pension funds; and financial auxiliaries. As a result, SPEs principally engaged in financial intermediation for a group of related enterprises would be encompassed in that definition.

  • The implications of the above clarification are that financial (and investment income) transactions between two affiliated enterprises that are part of (1) other depository corporations (other than the central bank); (2) other financial intermediaries, except insurance corporations and pension funds; or (3) financial auxiliaries would be excluded from FDI except for transactions in the form of equity capital or permanent debt.

  • Financial transactions between units that are not financial intermediaries and affiliated financial SPEs abroad should be recorded under FDI.

It is important to note that this last recommendation overturns the practice described in the BOP Textbook, which excludes from the FDI data transactions between nonfinancial FDI enterprises and affiliated SPEs with the sole purpose of financial intermediation. The effect of the recommendation is that there will no longer be any difference in the treatment of SPEs that have the sole purpose of financial intermediation and SPEs that have the primary purpose of financial intermediation—the FDI data are to include both (i) transactions between nonfinancial FDI enterprises and affiliated SPEs with the sole purpose of financial intermediation, and (ii) transactions between nonfinancial FDI enterprises and affiliated SPEs with the primary purpose of financial intermediation.

The Committee also agreed that, in light of concerns expressed by some members of the OECD and ECB groups, the decision about the inclusion in the FDI data of financial transactions between units that are not financial intermediaries and affiliated financial SPEs abroad would be re-examined in the context of the next revision of the Balance of Payments Manual. In the meantime, countries that exclude such transactions from the direct investment data are encouraged to explain their practices and if possible to publish memorandum items to facilitate international comparability.

Payments associated with the acquisition of a right to undertake a direct investment

In many developing or transition economies, the government requires the payment of a fixed amount of money by direct investors for the right to undertake a direct investment in the host economy. Often, but not always, these operating or concession rights are related to the extraction of natural resources. In transition economies, compilers refer to these payments as "bonuses". They are legal transactions and should not be associated with poor governance. The issue was to determine whether or not such bonuses constitute direct investment transactions and to recommend a common recording practice for such transactions.

Following consultations with the OECD and ECB groups, the Committee decided at its October 2001 meeting that the recommended treatment of payments for the right to undertake a direct investment is to be as follows:

  • The contra-entry to the payment of a rent (bonus) by a non-resident investor to the government authorities should be recorded under direct investment when there is a clear intention to establish a direct investment enterprise (such as in the case of a contractual arrangement between the investor and the government).

  • The contra-entry to the payment of a rent by a non-resident enterprise, when no direct investment enterprise is or will be established, should be recorded under "income; investment income; other investment" until a "rent" sub-component of income is included in the balance of payments manual. Rent would be paid by non-resident enterprises when they make payments to exploit movable natural resources such as in the case of tree cutting rights or fishing rights in a country's territorial waters.

The shutdown of an FDI enterprise established for natural resources exploration

The recommendation in paragraph 383 of BPM5 is that "expenditures of direct investment enterprises established for exploration of minerals and other natural resources in an economy are treated as capital expenditures (fixed capital formation)." In addition, the text stipulates that "if the exploration proves unsuccessful and results in a shutdown of the enterprise, no further balance of payments entries are recorded. Rather, a negative stock adjustment is made in the direct investment position of the direct investor in the host economy, and an equal reduction is made in the liability position of that economy to that of the direct investor. (Both adjustments fall under the heading other adjustments in the international investment position.)" Paragraph 60 of the OECD Benchmark Definition of Foreign Direct Investment (Benchmark) uses similar language.

However, some balance of payments compilers have argued that a stream of negative reinvested earnings flows should be recorded in the current account of the host economy over a number of years until the stock of fixed capital corresponding to the total exploration expenditures of the direct investment enterprise has been fully amortised as consumption of fixed capital, with corresponding entries recorded for the investing economy. Such treatment would be consistent with the System of National Accounts 1993 (SNA93), paragraph 10.91 of which recommends that the capitalized exploration costs should be amortized as consumption of fixed capital over the average service lives of such exploration assets. According to that argument, the direct investment enterprise continues to exist and the equity value remains until it is fully amortized. Each year, the direct investment enterprise will have negative reinvested earnings equivalent to the amortization of the exploration asset. If the amortization approach is not adopted, there is an asymmetric treatment of unsuccessful expenditures in natural resources exploration in the host economy's national balance sheets, as such expenditures of "national" enterprises would be amortized whereas those of direct investment enterprises would be written-off.

The paper presented to the Committee in 1999 argued that there were three possible approaches to treating the shutdown of an FDI enterprise established for natural resources exploration:

  • The first approach would be the amortization method envisaged above. However, this is an unsatisfactory approach in a balance of payments context, as following the shut-down of the enterprise the direct investor does not have a claim on the host economy and, symmetrically, the host economy does not have a liability to the investor. Thus, the flows of reinvested earnings that are recorded are purely artificial and cannot be associated with any nonresident claims or liabilities.

  • A second approach, which would also satisfy the requirements of the SNA93, would be to record a capital transfer, by the direct investor to the host economy, that corresponds to the residual value of the natural resources exploration costs, which would be the contra-entry for the equity capital withdrawal by the direct investor that follows the shutdown of the operation and would correspond to a transfer of know-how to the host economy equal to the value of the exploration expenditure not yet depreciated under consumption of fixed capital. However, this is not the preferred approach as the direct investor did not willingly transfer the know-how concerning the location of dry holes, in the instances of oil exploration, but was simply faced with non-profitable operations and forced to write-off these expenditures.

  • The third approach, which is the one set out in BPM5 and the Benchmark, is to use the other adjustments heading of the International Investment Position (IIP) statement, even though this approach creates an asymmetry in the treatment of the natural resources exploration expenditures that cannot be resolved under the framework of the SNA93.

In light of the concurrence of the OECD and ECB groups, the Committee decided that the recommended treatment in instances of the shutdown of an FDI enterprise established for natural resources exploration is that the transactions should be recorded in accordance with the approach set out in BPM5 and the Benchmark, namely, to use the other adjustments heading of the IIP statement to show the reduction in assets, and to show no further entries in the balance of payments statistics.