A similar issue arises in respect of cross-guarantees, where two or more entities in an MNE group guarantee each other’s obligations. From the lender’s perspective, it has access to the assets of every cross-guaranteeing entity in the event of a default by a guaranteed borrower. This potentially gives the lender greater comfort than a single guarantee as it can choose where within the cross-guaranteeing MNE group it seeks, if necessary, to make its recoveries. The effect of a cross-guarantee from a borrower’s perspective is that it now has multiple guarantees on its borrowings and may stand as guarantor for multiple borrowings itself. This can give rise to questions on how to evaluate each guarantee. Not only is this complex from the perspective of potentially large numbers of guarantees to be evaluated but also because each party providing a guarantee may in turn be guaranteed by the party for whom it is now acting as guarantor. Evaluating the effect of a cross-guarantee arrangement is difficult and as the number of parties involved increases, may be practically impossible. It may not be possible to determine the effect of the guarantee between any two parties where the same risk is subject to multiple guarantees. An analysis of the facts may lead to the conclusion that such an arrangement does not enhance the credit standing of an MNE group member beyond the level of passive association, in which case any support in the event of default from another MNE group member should then be regarded as a capital contribution.
TPG2022 Chapter X paragraph 10.165
Posted on | By OECD
Category: OECD Transfer Pricing Guidelines (2022), TPG2022 Chapter X: Transfer Pricing Aspects of Financial Transactions | Tag: CFC loan guarantee, Cross-guarantee agreement, Cross-guarantees, Financial guarantee, Financial transactions, Passive association, Treasury functions
« Prev |
Next » Related Guidelines
- TPG2022 Chapter X paragraph 10.161Where the effect of a guarantee is to permit a borrower to borrow a greater amount of debt than it could in the absence of the guarantee, the guarantee is not simply supporting the credit rating of the borrower but could be acting both to increase the borrowing capacity and...
- TPG2022 Chapter X paragraph 10.164A borrower would not generally be prepared to pay for a guarantee if it did not expect to obtain an appropriate benefit in return. Even an explicit guarantee will not necessarily confer a benefit on the borrower; for example, banking covenants applicable to a parent or other MNE group member’s...
- TPG2022 Chapter X paragraph 10.148These cross-guarantees and set-off rights are a feature of an arrangement which would not occur between independent parties. Each guarantor is providing a guarantee for all members of the pool but will not have control over membership of the pool, has no control over the quantum of the debt which...
- TPG2022 Chapter X paragraph 10.167A lender would benefit from the stronger credit rating of the guarantor (compared to the borrower’s credit rating) and/or the guarantor’s asset pool (in addition to the borrower’s asset pool), and the borrower accordingly may expect a benefit in the form of a lower interest rate. Thus, based on facts...
- TPG2022 Chapter X paragraph 10.163By providing an explicit guarantee the guarantor is exposed to additional risk as it is legally committed to pay if the borrower defaults. Anything less than a legally binding commitment, such as a “letter of comfort” or other lesser form of credit support, involves no explicit assumption of risk. Each...
- TPG2022 Chapter X paragraph 10.158From the perspective of a lender, the consequence of one or more explicit guarantees is that the guarantor(s) are legally committed; the lender’s risk would be expected to be reduced by having access to the assets of the guarantor(s) in the event of the borrower’s default. Effectively, this may mean...
- TPG2022 Chapter X paragraph 10.155In general, a financial guarantee provides for the guarantor to meet specified financial obligations in the event of a failure to do so by the guaranteed party. There are various terms in use for different types of credit support from one member of an MNE group to another. At one...
- TPG2022 Chapter X paragraph 10.87A guarantee from another party may be used to support the borrower’s credit. A lender placing reliance on a guarantee or guarantees would need to evaluate the guarantor(s) in a similar way to that in which it evaluates the original borrower. For the lender to take a guarantee into account...
- TPG2022 Chapter X paragraph 10.182The capital support method may be suitable where the difference between the guarantor’s and borrower’s risk profiles could be addressed by introducing more capital to the borrower’s balance sheet. It would be first necessary to determine the credit rating for the borrower without the guarantee (but with implicit support) and...
- TPG2022 Chapter X paragraph 10.168Likewise, the financial capacity of the guarantor to meet its obligations requires an analysis of the correlation between the guarantor’s and borrower’s businesses. In situations where the guarantor and the borrower operate under similar market conditions, an adverse market event that affects the performance of the borrower and increases its...