## d3-treatment-of-collective-investment-institutions

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### Background and current guidance
- Current operational guidelines measure direct investment (DI) in and by collective investment institutions (CIIs) based strictly on the 10 percent equity criteria (BPM6, paragraph 6.13).
- BD4 (paragraph 570) defines CIIs as “incorporated investment companies and investment trusts, as well as unincorporated undertakings (such as mutual funds or unit trusts), that invest in financial assets (mainly marketable securities and bank deposits) and/or nonfinancial assets using the funds collected from investors by means of issuing shares/units (other than equity).”
- BD4 recommends treating an acquisition of at least 10 percent of voting power in a CII in another economy as DI, and similarly when a CII owns at least 10 percent of the voting power of a nonresident entity.
- Survey of WGIIS member countries (May 2016):
  - 12 countries indicated they cover CIIs in DI statistics as direct investment enterprises.
  - 17 countries did not.
  - 3 countries covered them only partially.
- Country practices and illustrative findings:
  - United States: CIIs that involve (directly or indirectly) a 10 percent or greater equity stake in an operating company are included in DI statistics; foreign affiliates of the largest U.S. private equity firms accounted for at least 2.3 percent of employment by all foreign affiliates (a lower-bound estimate).
  - European Union: CIIs mostly refer to investment funds principally engaged in financial intermediation; EU countries consider DI relationships meaningful only in closed-end funds. Closed-end funds were estimated as 0.6 percent of the total market capitalization of CIIs at end-2016 in the EU. EU countries exclude CIIs liabilities from DI statistics and classify them as portfolio investment, except where the 10 percent rule on equity (SNA Financial Asset/Liability F51, including F519) applies.
  - Brazil: investments conveying a voting interest of at least 10 percent are included in DI, though these investments have not been separately identified in statistics.
  - South Africa: mutual funds are legally prohibited from holding more than 10 percent of an unlisted company or more than 5 percent of a listed company; DI by mutual funds is essentially nonexistent and DI in CIIs is classified in portfolio investment.
- Conceptual considerations:
  - Motivations and effects of DI by CIIs may differ from traditional direct investors; decision makers in CIIs may focus on portfolio return rather than managing strategic and day-to-day operations.
  - Exploratory U.S. study findings: U.S. parent CIIs show little evidence of providing headquarters services to affiliates, have a higher tendency to use financial leverage, are less focused on long-term growth of affiliates, yet can provide funding to young, fast-growing, innovative businesses.

### Practical compilation challenges and scale
- CIIs greatly outnumber traditional multinational enterprises, complicating tracking and identification.
- Illustrative counts and estimates:
  - Pratt’s Guide to Private Equity and Venture Capital Sources (2020 edition): over 14,000 private equity firms worldwide.
  - International Investment Funds Association data: over 100,000 regulated open-end mutual funds worldwide.
  - UNCTAD 2020 World Investment Report estimates that the top 5,000 MNEs account for most of global DI.
- Practical challenges for compilers:
  - Inability of many compilers to separate certain asset types (foreign land or real estate, mobile equipment, ships, aircraft, gas and oil drilling rigs).
  - Need for coordination of data collection on DI and on portfolio investment.
  - Complex chains of ownership (master and feeder funds) obscure the decision-making unit.
  - Distinctions between equity control and voting control complicate identification of the ultimate investing economy or statistical unit.
  - “Looking through” fund investments imposes a heavy burden on compilers and reporting entities; limited national capacity and legal/regulatory constraints may make tracing infeasible.

### Alternatives considered (A1–A3 and sub-alternatives)
- Overview:
  - A1. Maintain methodological and presentational status quo: DI defined strictly by the 10 percent equity criterion; CIIs treated the same as other DI.
  - A2. Maintain operational status quo but encourage compilers to separately identify and present additional detail on DI in or by CIIs.
  - A3. Modify operational definition to exclude certain investments in or by CIIs, with sub-alternatives A3.1–A3.3.
- A3.1:
  - Exclude investments in or by CIIs broadly; reclassify some holdings (e.g., foreign listed shares held by CIIs) to portfolio investment.
  - Address treatment of foreign land or real estate held by CIIs and potential implications for links between Financial Assets Classification and Functional Categories (BPM6 table 6.1).
- A3.2:
  - Investment fund shares (F52) always considered Portfolio Investment; investments by investment funds may still qualify as DI under current DI rules.
  - Focus on institutional sectors MMF (S.123) and non-MMF investment funds (S.124).
  - Rationale: collective legal nature implies no single foreign resident has direct control; where the fund as investor takes investment decisions, it could have control over strategic and day-to-day operations (so funds’ direct holdings in operating companies could be DI).
  - Practical rationale: once sector and equity stake size are identified, implementation is straightforward; supports comparability of CPIS and CDIS.
- A3.3:
  - Retain DI definition only for private equity funds or real estate funds; exclude investments in or by CIIs that are not private equity funds or real estate funds.
  - Rationale: control is unlikely to be exercised by managers of all CIIs; private equity funds and perhaps real estate funds are more likely to provide strategic direction (though not day-to-day control).
  - Practical implication: requires compilers to look through investments of private equity funds to identify investee companies and may create asymmetries if a compiler does not identify a fund as private equity or real estate.
  - Sectoring implication: classification by sector of the operating company supports alternative 3.3.

### Outcomes of DITT consultation and preferences
- DITT consultation showed a preference for Alternative 3, with a slight majority for option 3.3.
- Preference breakdown among DITT members expressing a preference:
  - thirteen of 15 DITT members preferred alternative 3.
  - Among those preferring an alternative 3, seven preferred alternative 3.3 and five preferred alternative 3.2.
- Reasons for preferring alternative 3.3:
  - Private equity funds among CIIs appear unique in dual focus on portfolio return and provision of strategic guidance to investee businesses.
  - Recognizes that 10 percent or greater equity stakes in CIIs by entities abroad are more likely to represent an associated group making collective decisions rather than individual passive investors.
  - Need for clear definitions of CII categories in-scope for DI (private equity funds and real estate funds) and guidance on BPM/SNA institutional sector classification to be included in manual updates.
- Rationale for rejecting alternatives:
  - Alternative 1 and Alternative 2 were rejected because they do not recognize that motivations of at least some classes of CIIs are weakly or not at all consistent with BPM6 distinguishing characteristics of DI.
  - Alternative 3.1 was rejected for being overly strict.

### Identification, sectoring, and institutional unit issues
- Identification and regulatory heterogeneity:
  - Some countries have CIIs well identified and regulated; other jurisdictions have an unclear borderline between investment funds and other financial institutions.
  - Hybrids (venture capital and private equity entities) increase complexity for compilers.
  - Existence of day-to-day control over assets indicates those entities are not CIIs.
- Ambiguity of terminology:
  - “CIIs” is an ambiguous term to many practitioners; providing clear definitions of CIIs and subclasses to survey respondents is challenging.
  - A suggested starting point: definitions in the European Central Bank’s Manual on Investment Fund Statistics.
- Sectoring issues:
  - CIIs can involve more than one institutional sector; the note identifies S124 (investment funds), S125 (other financial intermediaries), and S126 (other financial auxiliaries).
  - Utility of sector detail varies by alternative: sector-of-financial-intermediary supports A3.2; sector-of-operating-company supports A3.3.
- European Union guidance summary:
  - In the EU, CIIs are exclusively investment funds principally engaged in financial intermediation.
  - A DI relationship could only be meaningful in closed-end funds; open-end funds blur the concept of control because the 10 percent would change continuously.
  - CIIs may grant intragroup loans, which would be classified as DI unless granted to certain SNA financial institutional sectors—S122 to S125 (BPM6 paragraph 6.28).
- Institutional unit for private equity funds:
  - Question: who is the resident institutional unit for investments by private equity funds — the investors or the fund managers?
  - Argument and counterargument:
    - Investors: funds legally structured as partnerships suggest investors are the institutional units.
    - Fund managers: investors cede decision-making on portfolio composition and day-to-day and strategic management to managers.
  - Interpretation consistent with 2008 SNA (paragraph 4.42–4.46): a private equity firm should be considered a quasi-corporation, a separate institutional unit from its investor; the collective unit headed by fund managers should be considered the resident institutional unit for investments by private equity funds.

### Questions posed for discussion
- Do you agree that adhering to current guidelines on DI in or by CIIs is challenging and somewhat impractical such that further/clearer guidance is needed?
- Do you agree that the motivation for at least some 10 percent or greater equity investments in or by CIIs is so different from the description of the functional category of DI in the BPM6 that the definition of DI should be modified?
- Taking into consideration the strengths and weaknesses of alternative A3.2 and A3.3, which one of the two would you support?

*Source: IMF Direct Investment Task Team (DITT) — SECTION I: THE ISSUE; Annexes III–V.*

### SECTION I: THE ISSUE

### d3-treatment-of-collective-investment-institutions - SECTION I: THE ISSUE

### Background and current guidance
- Current operational guidelines measure direct investment (DI) in and by collective investment institutions (CIIs) based strictly on the 10 percent equity criteria (BPM6, paragraph 6.13).
- BD4 (paragraph 570) defines CIIs as “incorporated investment companies and investment trusts, as well as unincorporated undertakings (such as mutual funds or unit trusts), that invest in financial assets (mainly marketable securities and bank deposits) and/or nonfinancial assets using the funds collected from investors by means of issuing shares/units (other than equity).”
- BD4 recommends that when an investor in one economy acquires at least 10 percent of the voting power in a CII in another economy, the investment should be regarded as DI, and similarly when a CII owns at least 10 percent of the voting power of a nonresident entity.
- Survey of WGIIS member countries (May 2016): 12 countries indicated they cover CIIs in DI statistics as direct investment enterprises, 17 countries did not, and 3 countries covered them only partially.
- Country practices described:
  - United States: international investment by CIIs that involve (directly or indirectly) a 10 percent or greater equity stake in an operating company are included in DI statistics; similarly 10 percent or greater nonresident equity stakes in CIIs that make such investments are treated as DI. Exploratory research found foreign affiliates of the largest U.S. private equity firms accounted for at least 2.3 percent of employment by all foreign affiliates (a lower-bound estimate).
  - European Union: CIIs mostly refer to investment funds principally engaged in financial intermediation. EU countries consider DI relationships meaningful only in closed-end funds (funds where no additional shares are issued and the fund itself won't redeem shares). Closed-end funds were estimated as 0.6 percent of the total market capitalization of CIIs at end-2016 in the EU. Based on that outcome, EU countries exclude CIIs liabilities from DI statistics and classify them as portfolio investment, except where the 10 percent rule on equity (SNA Financial Asset/Liability F51, including F519) applies (including real estate).
  - Brazil: any relevant international investment in or by CIIs that conveys a voting interest of at least 10 percent is included in DI, though these investments have not been separately identified in statistics; available source data would allow separate identification of CIIs.
  - South Africa: national laws prohibit mutual funds from holding more than 10 percent of an unlisted company or more than 5 percent of a listed company; DI by mutual funds is essentially nonexistent and DI in CIIs is classified in portfolio investment for practical and conceptual reasons.
- Conceptual uncertainty: motivations and effects of DI by CIIs may differ from traditional direct investors—decision makers may focus on portfolio return rather than managing strategic and day-to-day operations of investee businesses. Example: venture capital firms’ internationalization may be at variance with both conventional portfolio and DI models [Guler and Guillén (2010): p. 185].
- Exploratory U.S. study: U.S. parent CIIs show little evidence of providing headquarters services to affiliates, have a higher tendency to use financial leverage, and are less focused on long-term growth of affiliates; yet CIIs can provide funding to young, fast-growing, innovative businesses (gazelles or unicorns).

### Practical compilation challenges
- CIIs greatly outnumber traditional multinational enterprises, making tracking and identification difficult.
- Pratt’s Guide to Private Equity and Venture Capital Sources (2020 edition): over 14,000 private equity firms worldwide.
- International Investment Funds Association data: over 100,000 regulated open-end mutual funds worldwide.
- UNCTAD 2020 World Investment Report estimates that the top 5,000 MNEs account for most of global DI.
- Practical challenges include inability of many compilers to separate certain asset types (foreign land or real estate, mobile equipment, ships, aircraft, gas and oil drilling rigs) and the need for coordination of data collection on DI and on portfolio investment.

### Issues for discussion and alternatives
- Three major alternatives and three sub-alternatives were developed to address conceptual and practical issues.

A1. Alternative 1
- Maintain methodological and presentational status quo: DI defined strictly by the 10 percent equity criterion; CIIs treated the same as other DI because significant equity stakes can imply influence over management.

A2. Alternative 2
- Maintain operational status quo but encourage compilers to separately identify and present additional detail on DI in or by CIIs, reflecting conceptual differences in motivations (portfolio-return focus versus strategic/day-to-day management).

A3. Alternative 3 (modify operational definition to exclude certain investments in or by CIIs), with sub-alternatives A3.1–A3.3
- Rationale: motivations of CIIs for acquiring 10 percent or greater equity stakes can differ from traditional direct investors and may vary by class of CII.

A3.1. Alternative 3.1
- Change operational definition to exclude investments in or by CIIs broadly; reclassify some holdings (e.g., foreign listed shares held by CIIs) to portfolio investment; address treatment of foreign land or real estate held by CIIs and potential implications for links between Financial Assets Classification and Functional Categories (BPM6 table 6.1).

A3.2. Alternative 3.2
- Investment fund shares (F52) always considered Portfolio Investment; investments by investment funds may qualify as DI under current DI rules. Focuses on institutional sectors MMF (S.123) and non-MMF investment funds (S.124). Rationale: collective legal nature of investment funds implies no single foreign resident has direct control; however, where the fund as investor takes investment decisions, it could have control over strategic and day-to-day operations of investee businesses (so funds’ direct holdings in operating companies could be DI). This is the current EU approach and could improve comparability of CPIS and CDIS.

A3.3. Alternative 3.3
- Retain operational DI definition only for private equity funds or real estate funds; exclude investments in or by CIIs that are not private equity funds or real estate funds. Rationale: control is unlikely to be exercised by managers of all types of CIIs; private equity funds, and perhaps real estate funds, are more likely to provide strategic direction (though not day-to-day control). Requires compilers to look through investments of private equity funds to identify investee companies and may create asymmetries if a compiler does not identify a fund as private equity or real estate.

### Outcomes of DITT consultation
- Consultation within the Direct Investment Task Team (DITT) showed a preference for Alternative 3, with a slight majority for option 3.3.
- DITT noted BPM6 paragraph 6.2: functional categories consider aspects of relationships and motivation for investment; paragraph 6.4 describes DI as related to control or significant influence, lasting relationships, provision of know-how, technology, management, marketing, and a greater likelihood of trade and financing between enterprises in a DI relationship.
- DITT members strongly agreed that some 10 percent or more equity investments in CIIs should be classified as portfolio rather than DI because primary investor motivation appears focused on portfolio return rather than managing investee strategic and day-to-day operations.
- Preference breakdown among DITT members expressing a preference: thirteen of 15 DITT members preferred alternative 3. Among those preferring an alternative 3, seven preferred alternative 3.3 and five preferred alternative 3.2.
- Majority preference for alternative 3.3 rests on three factors:
  - Private equity funds among CIIs appear unique in dual focus on portfolio return and provision of strategic guidance to investee businesses.
  - Alternative 3.3 recognizes that 10 percent or greater equity stakes in CIIs by entities abroad are more likely to represent an associated group making collective decisions rather than individual passive investors.
  - Need for clear definitions of CII categories in-scope for DI (private equity funds and real estate funds) and guidance on BPM/SNA institutional sector classification to be included in manual updates.
- Alternative 1 and Alternative 2 were rejected because they do not recognize that motivations of at least some classes of CIIs are weakly or not at all consistent with BPM6 distinguishing characteristics of DI. Alternative 3.1 was rejected for being overly strict.

### Questions for discussion (as posed)
- Do you agree that adhering to current guidelines on DI in or by CIIs are challenging and somewhat impractical such that further/clearer guidance is needed?
- Do you agree that the motivation for at least some 10 percent or greater equity investments in or by CIIs is so different from the description of the functional category of DI in the BPM6 that the definition of DI should be modified?
- Taking into consideration the strengths and weaknesses of alternative A3.2 and A3.3, which one of the two would you support?

*Source: IMF Direct Investment Task Team (DITT) — SECTION I: THE ISSUE*

### 2.      In some countries CIIs are well identified and regulated while in other jurisdiction the

### d3-treatment-of-collective-investment-institutions - 2.      In some countries CIIs are well identified and regulated while in other jurisdiction the

### Identification and regulatory heterogeneity
- Some countries: CIIs are well identified and regulated.
- Other jurisdictions: the borderline between investment funds and other financial institutions is not well defined.
- Increasing presence of hybrids (venture capital and private equity entities) complicates compiler work because additional information is required to identify them as CIIs.
- Example indicator: existence of day-to-day control over the assets in which the capital is invested will indicate that they are not CIIs.

### Ambiguity of terminology and implications for data collection
- Compilers face difficulty because "CIIs" is an ambiguous term to many practitioners.
- Providing survey respondents with clear definitions of CIIs and their subclasses is challenging.
- A suggested starting point: definitions in the European Central Bank’s Manual on Investment Fund Statistics.

### Measuring ownership and tracing investment chains
- Investments by CIIs often use complex chains of ownership, including master and feeder funds, complicating identification of the decision-making unit in the CII structure.
- Distinctions can exist between the level of equity control and the level of voting control.
- Challenges for compilers:
  - Determining the ultimate investing economy or the ultimate statistical unit within an economy.
  - "Looking through" fund investments to collect details on portfolio companies imposes a heavy burden on compilers and/or reporting entities.
  - Limited national capacity (staff and resources) may make such detailed tracing infeasible.
  - National or supranational statistical regulations may prohibit following investments to the entity within an economy that ultimately receives the funds.
- References preserved: master and feeder funds (see chapter 6 of European Central Bank (2017)).

### Sectoring issues and alternatives (Annex III)
- The note integrates recommendations with guidance on sectoral breakdown of direct investment (GN D.7) and nonbank financial intermediation (F.6) but finds:
  - The recommended level of sectoral breakdown in those notes is less detailed than required here.
  - CIIs can involve more than one institutional sector; this note identifies S124 (investment funds), S125 (other financial intermediaries), and S126 (other financial auxiliaries).
  - Utility of sector detail varies by alternative.

- Alternative 3.2 (summary of proponents' view)
  - Conceptual rationale:
    - Treats 10 percent or greater equity stakes in CIIs as portfolio investment because CIIs are "collective" investments and it is unlikely any individual investor holds that size alone.
    - Treats 10 percent or greater equity stakes by CIIs as direct investment based on the notion that fund managers, rather than individual participants, are the investors.
  - Practical rationale:
    - Once the sector of the entity making or receiving the investment is identified and the size of the equity stake is identified, implementation of alternative 3.2 is straightforward.
  - Sectoring implication: classification by sector (sector: Financial intermediary) supports alternative 3.2.

- Alternative 3.3 (summary of proponents' view)
  - Conceptual rationale:
    - Identification of the sector alone is insufficient; the 10 percent or greater equity investment must be in an operating company rather than a holding company or another investment fund.
    - Concept of direct investment based on intent to influence strategy and/or day-to-day management of the target company.
    - Favor including in direct investment only classes of CIIs where there is evidence of an intent to be an active business manager (namely, private equity funds and real estate funds).
  - Practical implications:
    - Even with sector detail for CIIs, on the liability side a foreign CII investing in a nonfinancial domestic business means the sector of the inward direct investment gives no information about the role of foreign CIIs in supporting domestic investment.
  - Sectoring implication: classification by sector of the operating company (sector: Sector of operating company) supports alternative 3.3.

### European Union conceptual guidance (Annex IV)
- EU WG ES discussions in 2017 concluded:
  - In the EU context, CIIs are exclusively investment funds principally engaged in financial intermediation, issuing investment fund shares or units and investing primarily in financial assets and in nonfinancial assets (usually real estate).
  - A DI relationship could only be meaningful in closed-end funds (funds where no additional shares are issued and the fund itself won't redeem shares) because the logic of control can be more easily established given the usually reduced number of shareholders.
  - In open-end funds, investment policy is fixed in advance and the concept of control is blurred; the 10 percent would change continuously, making tracking difficult and complicating linking investment decisions with influence or control.
  - CIIs may grant intragroup loans, which would be classified as DI unless granted to certain SNA financial institutional sectors—S122 to S125 (BPM6 paragraph 6.28).

### Identification of the institutional unit in private equity funds (Annex V)
- Question: Who is the resident institutional unit for investments by private equity funds?
  - One argument: the investors in the fund (funds typically legally structured as partnerships).
  - Counterargument: the fund managers, because individual investors cede decision-making on portfolio composition and day-to-day and strategic management to managers.
- Interpretation consistent with 2008 SNA (paragraph 4.42–4.46):
  - A private equity firm should be considered a quasi-corporation, a separate institutional unit from its investor.
  - The collective unit, headed by the fund managers, should be considered the resident institutional unit for investments by private equity funds.

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_Source: https://www.imf.org/-/media/files/data/statistics/bpm6/ditt/d3-treatment-of-collective-investment-institutions.pdf_