This method aims to quantify the additional risk borne by the guarantor by estimating the value of the expected loss that the guarantor incurs by providing the guarantee (loss given default). Alternatively the expected cost could be determined by reference to the capital required to support the risks assumed by the guarantor.
TPG2022 Chapter X paragraph 10.178
Posted on | By OECD
Category: OECD Transfer Pricing Guidelines (2022), TPG2022 Chapter X: Transfer Pricing Aspects of Financial Transactions | Tag: Cost approach, Financial guarantee, Financial transactions, Loan guarantee, Loss of guarantor, Pricing guarantees, Treasury functions
« Prev |
Next » Related Guidelines
- 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 10.179There are a number of possible models for estimating the expected loss and capital requirement. Popular pricing models for this approach work on the premise that financial guarantees are equivalent to another financial instrument and pricing the alternative, for example, treating the guarantee as a put option and using option...
- 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 10.165A 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...
- 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 10.155In 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 10.148These 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 10.177The result of this analysis sets a maximum fee for the guarantee (the maximum amount that the recipient of the guarantee will be willing to pay), namely, the difference between the interest rate with the guarantee and the interest rate without the guarantee but with the benefit of implicit support...
- TPG2022 Chapter X paragraph 10.181The valuation of expected loss method would estimate the value of a guarantee on the basis of calculating the probability of default and making adjustments to account for the expected recovery rate in the event of default. This would then be applied to the nominal amount guaranteed to arrive at...
- 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...