Memo
To
SCM Approvals Committee
From
Jonathan Zenios
Date
28 November 2006
Subject
Project Berry II – Investment in Index Linked Gilts
1.
SUMMARY Structured Capital Markets (“SCM”) is seeking approval for an increase in the product limit for Project Berry (the “Transaction”) from £3bn to £7bn. The SCM Approvals Committee approved the original Transaction on 11 January 2006 with a product limit of £3bn and an initial transaction tenor of 12 months. The tenor was subsequently extended by an additional 36 months by way of notification to the SCM Approvals Committee on 19 October 2006 (see Annex 6). The Transaction provides an opportunity for the Barclays Bank PLC (“Barclays”) group to invest in additional Index Linked Gilts (“ILGs”). The Transaction enables Barclays to include the investment in ILGs (i) in its’ stock of sterling liquid assets (the “SSLA”) that Barclays is required to maintain to comply with the FSA’s Sterling Stock Liquidity Policy and (ii) to guarantee and collateralise various obligations of Barclays. The proposed increase in the product limit for the Transaction will involve an additional purchase of ILGs by Barclays Aldersgate Investments Limited (“BAIL”), an existing solo-consolidated investment company within the Barclays group which currently holds £3bn of ILGs acquired as part of the original Transaction. It is proposed that the new Transaction to purchase an additional £4bn of ILGs will be executed over multiple tranches aggregating to a total investment in ILGs equal to a cash market value of £7bn in BAIL, although the exact composition of the new portfolio of ILGs is yet to be determined. At present, the only entities whose Eligible Securities (See Annex 2) are permitted to be included in Barclays’ SSLA (see Annex 1) are those held directly by Barclays and Barclays Private Bank Limited (“BPBL”), although this is because of an earlier agreement with the Bank of England / FSA rather than any specific requirement under FSA rules in IPRU Chapter LS. The original SCM Approvals Paper in respect of Project Berry referred to the possibility of adding BAIL to those entities whose assets are permitted to be included in Barclays’ SSLA. Barclays Group Treasury has expressed a preference not to alter the existing agreement with the FSA and therefore, this has not been pursued by SCM. Accordingly, the ILGs held by BAIL will be made available to Barclays in order that they may be included in Barclays’ SSLA or to support the Liquidity Requirement or other business of the Portfolio Management Desk (“PMD”), such as the Bank of England Repo facility. Economic Benefit PMD within Barclays Capital has been tasked by Barclays Group Treasury with managing Barclays’ SSLA and the clearing and payment obligations of Barclays (“Liquidity Requirement”). Given PMD’s existing responsibilities in this area, SCM has agreed with PMD that PMD will be responsible for managing the Barclays group market exposure arising from entering into the Transaction. The cost of managing the market exposure is expected to be between 17 and 20bps per annum. However, for the purposes of this paper, the cost is assumed to be 17.5bps per annum. Key financial data relating to the Transaction is set out below:
Proposed product limit Estimated 2007 PTE revenue based on current inflation estimate
2007 Tax capacity Return on Tax capacity for 2007 WRAs Return on WRA’s 2007 PUG Tenor
Original product limit Additional £4bn proposed Total £7bn cash £3bn increase to product limit investment proposed limit £32.6m p.a. (Pre£48.7m p.a. (Pre£81.3m p.a. (PreProvision) Provision) Provision) £21.2m p.a. (Post£32.0m p.a. (Post£53.2m p.a. (PostProvision) (assuming Provision) (assuming Provision) (assuming provision is 30% of the provision is 30% of the s94 provision is 30% of the s94 s94 adjustment adjustment deduction) adjustment deduction) deduction) £93.5.m £136.9.m £230.4.m 34.8% (Pre-Provision) 35.6% (Pre-Provision) 35.3% (Pre-Provision) 22.7% (Post-Provision) 23.4 (Post-Provision) 23.1% (Post-Provision) £0m (subject to netting £0m (subject to netting per £0m (subject to netting per per section 8.1 below) section 8.1 below) section 8.1 below) N/A (Pre-Provision) N/A (Pre-Provision) N/A (Pre-Provision) N/A (Post-Provision) N/A (Post-Provision) N/A (Post-Provision) £26.5m p.a. (Including £39.0m p.a. (Including £65.5m p.a. (Including Provision) Provision) Provision) 48 months (Original tenor 12 months, extension of 36 months approved)
This Approvals Paper contains a description of all significant tax, credit, market and operational risks. 2.
DETAILED TRANSACTION DESCRIPTION A structure diagram of the Transaction is attached in Annex 4 to this Approvals Paper.
2.1
Closing
2.1.1
Barclays will capitalise BAIL with a further £4bn non-voting preference shares (the “Prefs”) in addition to the £3bn currently in issue. The new Prefs will have a fixed term of 10 years but are redeemable at the option of the holder at short notice. The Prefs entitle the holder to a discretionary dividend determined by the directors.
2.1.2
The Prefs will be funded out of Barclays Group Treasury low-interest bearing current account (“LIBCA”) balances.
2.1.3
Barclays, acting as agent for an undisclosed principal (BAIL), will purchase the additional £4bn portfolio of ILGs. BAIL will use the proceeds from the issuance of the Prefs to fund the purchase of ILGs.
2.1.4
The purchase of the ILGs will probably be executed in multiple tranches over a period of several days due to availability constraints and in order to minimise the market impact of the Transaction.
2.1.5
As each tranche of ILGs is purchased, Barclays will enter into a short-term cash settled total rate of return swap (“TRS”) with a market counterparty to be determined in respect of each tranche of ILGs acquired from the market. Under each TRS, Barclays will pay away any coupons and any appreciation in respect of the ILGs and receive a LIBOR based return minus a spread, which is expected to be in the region of 30bps, and any depreciation in respect of the ILGs. It is anticipated that each TRS will have a term of anywhere between two weeks and one month, although this will depend on market conditions at the time of execution.
2.1.6
The choice of BAIL as the purchaser of the ILGs, rather than Barclays, allows SCM to ‘ring fence’ the economic positions in the ILGs, thereby facilitating the monitoring of their pre-tax investment performance and the calculation of the RPI uplift in the ILGs for the purposes of corporation tax.
2.1.7
Since only those Eligible Securities held directly by Barclays or BPBL are currently permitted to be included in Barclays’ SSLA, Barclays and BAIL will enter into an agreement at the time of closing under which BAIL will make the ILGs available to Barclays. Consequently, the ILGs purchased
Page 2 of 15
under the Transaction will be available to PMD to be included in Barclays’ SSLA to support the Liquidity Requirement or to be used by Barclays in the Bank of England Repo facility (see Annex 1). The ILGs will then be reported on Barclays Sterling Liquidity Return (“SLR1”). Note the SLR1 will only include those ILGs which are not used to guarantee payment obligations. 2.1.8
The agreement under which BAIL will transfer the ILGs to Barclays will be by way of a pledge with title transfer, a stock loan or a reverse repo (the “Stock Loan”), under which Barclays will post cash collateral (the “Collateral”) to BAIL.
2.1.9
BAIL will deposit the Collateral with Barclays Group Treasury, thereby earning interest income. In turn, BAIL will make interest payments to Barclays in respect of the Collateral less an arm’s length fee for the use of the ILGs, and Barclays will make manufactured payments to BAIL representing the coupons on the ILGs.
2.1.10 Once Barclays has taken title to the ILGs under the Stock Loan, PMD will utilise them for their business as described in section 2.1.7. 2.1.11 SCM will pay PMD a fee of approximately 17.5bps for managing the market exposure, associated with holding the ILGs, in accordance with their normal trading procedures. 2.2
Interim Steps
2.2.1
On the date of maturity of each TRS, Barclays, through PMD, may enter into a new TRS, a reverse repo or a stock loan over similar ILGs with the market in order to effect settlement of the original TRS.
2.2.2
In such a scenario, the ILGs acquired under a reverse repo or stock loan by Barclays will be sold into the market by PMD and each TRS unwound at the price at which Barclays is able to effect the sale of the ILGs. As a result of entering into a reverse repo or stock loan over ILGs, Barclays will achieve a short position with respect to the ILGs whilst BAIL will maintain a long position with respect to the ILGs.
2.2.3
It should be noted that since SCM will be paying PMD a fee for managing the market exposure associated with holding the ILGs, PMD will be entirely responsible for determining how this risk is managed on an on-going basis.
2.3
Maturity
2.3.1
The Transaction will mature at the end of 2009, following the 36 month extension in the tenor approved in October 2006, or on the occurrence of certain specified events to be agreed by the directors of BAIL, such as a change in law. At maturity, BAIL may be invited to accept cash settlement of Barclays’ obligation to return the ILGs to BAIL under the Stock Loan.
Page 3 of 15
3.
ECONOMICS AND ECONOMIC DRIVERS
3.1
The Barclays Inflation Research desk estimates UK RPI level to be at Dec 06: 201.3, Jan 07: 200.7 and Dec 07: 207.2. These figures are used in calculating the economic benefit below. As mentioned above, PMD will be responsible for managing the market exposure of holding the ILGs. PMD has indicated that the cost of managing this exposure will be between 17 and 20bps per annum. The following economics assume a cost of 17.5bps per annum. Assuming the market exposure is managed by PMD, the benefit from entering into the Transaction the Barclays group will be the value of the s94 adjustment deduction less the initial cost of each TRS less the ongoing cost of managing the market exposure of holding the ILGs. Assumptions Cash Investment in ILGs : (a) Hedging Cost (in BPS) : (b) Estimated RPI at start Estimated RPI at end of 2007 Applicable change in RPI s 94 Adjustment : (d)=(a * c) (e) Applicable 1- Month LIBOR : (f) Blended Coupon Rate on ILGs : Provision Rate : (g) UK Corporation Tax Rate : (h) TRS (in BPS) : (i)
Original Tranche £3,000,000,000 17.5 Dec 06: 201.3 Dec 07: 207.2 2.941% £88,226,528 5.164% 2.252% 30% 30% 0
New Tranche £4,000,000,000 17.5 Jan 07: 200.7 Dec 07: 207.2 3.249% £129,945,192 5.164% 2.252% 30% 30% 30
Total £7,000,000,000
Illustrative Annual Benefit Calculation PMD Hedging Cost : (j)= (a * b * 0.0001) TRS : (k) = (a * i * 0.0001* 4/52)
Original Tranche (£5,250,000) £0
New Tranche (£6,057,692) (£923,077)
Total (£11,307,692) (£923,077)
3.117% £218,171,719
PBT : (l) = (j+k)
(£5,250,000)
(£6,980,769)
(£12,230,769)
Tax at 30% : (m) = (l*h) S94 Adjustment (n) = (d*h) Provision : (o) = (n*g)
£1,575,000 £26,467,958 (£7,940,387)
£2,094,231 £38,983,558 (£11,695,067)
£3,669,231 £65,451,516 (£19,635,455)
Tax : (p) = (m+n+o)
£20,102,571
£29,382,721
£49,485,292
PAT : (q) = (l+p)
£14,852,571
£22,401,952
£37,254,523
£21,217,958
£32,002,788
£53,220,747
Pre Tax Equivalent (Barclays Benefit) :
( r) = (q/ (1-h))
PUG Calculations (Annual)
Stat Account
Man Acct
PUG
PBT
(£12,230,769)
£53,220,747
£65,451,516
Tax
£49,485,292
(£15,966,224)
PAT
£37,254,523
£37,254,523
The table below sets out the summary economics under five inflation scenarios. The first row sets out the minimum inflation rate under which the Transaction is profitable for the Barclays group. As per the Barclays Inflation Research desk, the annual UK RPI change for the year period January to December 2007 is estimated to be 3.2% whereas for the same period in 2006 it is estimated to be 4.1%. RPI Rate ! 0.62% 2.70% 3.70% 4.00% 5.00%
Post Prov PTE (£0) £43,642,308 £64,642,308 £70,942,308 £91,942,308
Prov (PTE) (£5,596,154) (£24,300,000) (£33,300,000) (£36,000,000) (£45,000,000)
Page 4 of 15
PUG £13,057,692 £56,700,000 £77,700,000 £84,000,000 £105,000,000
Tax Cap Utilised £56,583,332 £202,057,692 £272,057,692 £293,057,692 £363,057,692
ROTC 0.00% 21.60% 23.76% 24.21% 25.32%
4.
UK TAX ANALYSIS The U.K. tax analysis is supported by an opinion issued by Slaughter & May in February 2006 for the original transaction. Confirmation will be sought that the position remains unchanged from the original opinion issued.
4.1
BAIL
4.1.1
Following acquisition, the ILGs will represent creditor loan relationships of BAIL. For tax purposes, fair value accounting must be used to determine the amounts to be brought into account in respect of the ILGs under the loan relationships code (s.94 FA 1996).
4.1.2
During the term of the Transaction, BAIL will be taxed under the loan relationships code (s.94 FA 1996) on a fair value basis on both the coupon on the ILGs and any movement in the fair value of the ILGs over the period. An adjustment is made pursuant to s.94 FA 1996 to remove from taxable income amounts corresponding to the uplift attributable to inflation on the ILGs. Over any period for which the taxation of the ILGs is considered, any movement in the fair value of the ILGs over the period will be determined as if the carrying value of the ILGs at the beginning of the period was increased or reduced by the same percentage as the percentage increase or reduction in the retail prices index between the beginning and end of the period.
4.1.3
If the ILGs are transferred to Barclays under the Stock Loan, any interest expense on the Collateral will be deductible for BAIL under the loan relationships provisions (s.84 FA 1996) in accordance with the interest expense recognised in its accounts. As the Collateral will constitute a connected party debt, an amortised cost basis is required to be applied. This will be consistent with the accounting treatment.
4.2
Barclays
4.2.1
Any hedging of the Barclays group’s position will be performed by PMD in the course of its normal portfolio management activities.
4.2.2
If the ILGs are transferred to Barclays by BAIL under the Stock Loan, Barclays will not recognise anything in its balance sheet in respect of the Stock Loan. There will therefore be no debits and credits which can be attributed to a loan relationship in Barclays accounts in respect of the ILGs (other than the Shorts).
4.2.3
The Collateral provided to BAIL by Barclays will represent a connected party loan relationship of Barclays. Barclays will be taxed (under s.84 FA 1996) on any interest arising on the Collateral in accordance with the profits recognised in its accounts.
5.
TAX RISK
5.1
Deductibility of Manufactured Payments
5.1.1
The risk that para 7A Schedule 23A ICTA 1988 could operate to deny relief for manufactured payments made by Barclays in respect of coupons paid on the ILGs under the Stock Loan is considered low because the payments are made in the context of a transaction where a manufactured payment could not be seen to secure the advantage. In addition, the manufactured payments are on a market standard repo or stock loan transaction which is on normal commercial terms.
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6.
UK GAAP and IAS ACCOUNTING
6.1
BAIL
6.1.1
BAIL prepares it accounts under UK GAAP.
6.1.2
The Prefs will be classified as a financial liability under FRS 25 and would be carried at amortised cost.
6.1.3
On initial recognition, BAIL will measure the ILGs at fair value less attributable transaction costs. The discount or premium from the redemption value as at the date of acquisition will be amortised over time to the income statement.
6.1.4
The interest and indexation uplift (discount or premium) will be recognised in the income statement on an accruals basis.
6.1.5
At the first balance sheet date, the book value will be adjusted by the amortisation of the initial discount or premium but also by the movement in the RPI since acquisition (SORP on securities 37-28). Eg.
Acquisition value (A)
90
Expected redemption value on acquisition (B)
100
Maturity (C)
10 yrs
Initial amortisation (B-A)/C
1
Expected Redemption value on first balance sheet date (D)
110
Movement in RPI (E) = (D-B)
10
Amortisation adjustment at the end of year 1(E/C)
1
Total amortisation
2
6.1.6
At subsequent balance sheet dates, the same adjustment will be made.
6.1.7
On the transfer of the ILGs to Barclays under the Stock Loan, the Collateral posted to BAIL by Barclays will be treated as a loan made by Barclays to BAIL in the books of both entities. The loan will be carried at cost with interest recognised on an accruals basis.
6.2
Barclays Solus
6.2.1
Barclays prepares its solus accounts under IFRS.
6.2.2
The Prefs will be treated as a financial asset classified as a loan and receivable carried at amortised cost under IAS 39. Any dividends will be recognised in the income statement when declared.
6.2.3
Each TRS will meet the definition of a derivative under IAS 39 and will be fair valued through the P&L.
6.2.4
If the ILGs are transferred to Barclays by BAIL under the Stock Loan, the ILGs are not derecognised by BAIL as all the risks and rewards of ownership of the asset will remain with BAIL (IAS 39.20). Accordingly, Barclays will not recognise the ILGs on its balance sheet, but will recognise the fee payable in respect of the Stock Loan in its P&L.
6.2.5
The cash collateral posted to BAIL by Barclays will be treated as a loan made by Barclays to BAIL. The loan will be carried at amortised cost with interest accrued on an effective yield basis.
6.2.6
The stock loan or reverse repo executed by PMD will be treated as secured loans carried at amortised cost. The subsequent short sale will be treated as a financial liability at fair value through profit and loss.
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6.3
Barclays Consolidated
6.3.1
Barclays prepares its consolidated accounts under IFRS.
6.3.2
On initial recognition, Barclays will classify the ILGs as ‘at fair value through profit or loss’. Any directly attributable transaction costs would be included in the fair value on initial recognition.
6.3.3
The treatment of each TRS in Barclays consolidated accounts will be identical to its treatment in the Barclays’ solus accounts, i.e. marked to market through the income statement.
6.3.4
The Stock Loan and any payments under the Stock Loan (in respect of the Collateral and the manufactured payments representing the coupons on the ILGs) will be eliminated on consolidation as an intra-group transaction.
6.4
Barclays Consolidated US GAAP
6.4.1
BBPLC reports under US GAAP only on a consolidated basis.
6.4.2
On initial recognition, BBPLC will classify the ILGs as Trading Securities in accordance with FAS 115 and measure them at fair value with changes in fair value recorded in earnings.
6.4.3
Each TRS is a derivative and will be measured at fair value with changes in fair value recorded in earnings.
7.
CREDIT & MARKET RISK
7.1
During the period of the Transaction, Barclays will have a credit exposure to the UK Government on the ILGs.
7.2
The market risk exposure will be managed by PMD, who will mark appropriate limits to counterparties in respect of the management of this market risk, e.g. TRS, reverse repo or stock loan.
8
REGULATORY CAPITAL
8.1
WRAs
8.1.1
WRAs on the investment in ILGs are ordinarily weighted at 10%.
8.1.2
For the purposes of the Transaction it may be possible to weight the ILG positions at nil by netting the net the long position in BAIL against the short position in Barclays. This is the case since both the long and short positions are reported in the banking book.
8.1.3
PMD will report any WRAs associated with managing the market risk on the ILGs.
8.2
Large Exposures
8.2.1
The ILGs are exempt.
8.2.2
BAIL is a solo-consolidated subsidiary and hence the Prefs will not give rise to any internal large exposure.
8.3
Basel II analysis
8.3.1
As under Basel I (see 8.1.1) ordinarily an unhedged ILG position would attract WRAs but the weighting would be dependent on the applicable loss given default (“LGD”) and probability of counterparty default (“PD”) values applicable to the ILGs. Basel II, as under Basel I, permits the netting of the long position in BAIL and the short position in Barclays (see 8.1.2) and nil WRAs will be applicable.
Page 7 of 15
8.3.2
The large exposures on ILGs will remain exempt.
8.3.3
BAIL will continue to be solo consolidated subject the to confirmation to the FSA stating that it will satisfy the underlying conditions required under BIPRU 2.1 (refer to the analysis attached in Annex 3).
9.
PROVISION
9.1
SCM propose a provision equal to 30% of the tax deduction attributable to the RPI-linked adjustment made to the carrying value of the ILGs described in Section 4.1.2 above.
10.
CLIENT ENGAGEMENT
10.1
N/A
11.
MATERIALITY OF DEAL FOR COUNTERPARTY
11.1
N/A
12.
Other
12.1
NPSO approval is not required for Project Berry.
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Annex 1 1
1. The ILGs will be acquired to satisfy the ”sterling stock liquidity” requirements imposed upon the group by the FSA as well as to guarantee and collateralise various clearing and payment obligations of the 2 firm (“Liquidity Requirement”) . The responsibility for managing the Liquidity Requirement rests with the Barclays Treasury function, although the day-to-day management of this is delegated to the Portfolio Management Desk (the “PMD”). The ILGs would therefore be acquired and held in order to meet Barclays specific regulatory/legal and commercial requirements. 2. Liquidity management within the Barclays group involves maintaining a portfolio of highly marketable assets (“Eligible Securities”) that can easily be liquidated as protection against any unforeseen interruption to cash flow. Eligible Securities are defined by the Bank of England on its web site and include Gilts and ILGs. A summary as at 16 May 2006 is attached at Annex 2. It is noteworthy that this list does not include Japanese or US government securities which make up a large part of the market for government securities. There are other requirements that may limit the proportion of 3 particular securities that are held as part of the Liquidity Requirement . These include the fact that firms are not permitted to hold more than 25% of their eligible securities from any one issuer. 3. Barclays’ 2005 Accounts provide a breakdown of securities held as part of the Group’s treasury management portfolio for asset and liability liquidity and regulatory purposes as at 31st December 2005. PMD currently manages some £14.9bn of bonds issued by the UK and other governments. The fact that high quality liquid assets have to be retained as part of the Liquidity Requirement necessarily means that the return on these assets is generally sub-optimal in terms of returns on balance sheet and equity when compared to other activities in which the firm engages. 4. Typically, U.K. Gilts (including the ILGs) trade more expensively than other European government bonds in part because of the structural ‘demand side’ requirements of the U.K. pension and life insurance industry who buy gilts to match their long term liabilities. In addition, Gilts issued by the U.K. government have a higher credit rating than bonds issued by other European governments (for example Greece is A- and Italy is A+ by S&P) which also causes them to be higher yielding but with 4 more perceived risk of default than gilts and ILGs which are AAA rated . 5. In choosing to invest in ILGs in the Transaction (as opposed to (say) other government securities including non index linked gilts), a number of factors not least the credit rating and the yield will require consideration, and the decision will to some extent be influenced by the fact that holding ILGs provides an ancillary tax benefit. 6. The Bank of England while managing its official rate may through the open market operations (“OMOs”) enter into repo transactions (“Bank of England Repos”) over high quality bonds such as the ILGs. The ILGs may be used by Barclays to participate in the OMOs.
1
For UK incorporated retail banks where ‘sterling retail deposits at call or on short notice dominate their liabilities, not all of which in practice are withdrawn on their contractual maturity. This ‘stickiness’ leads to apparently large mismatches at shorter maturities. For these banks holding an appropriate stock of sterling liquidity against an unexpected loss of funding is…important’ LS Section 1 Page2 Section 3 FSA IPRU (Interim Prudential Source Book) January 2005. 2 (The liquidity tests refer to assets under consolidated accounting principles). 3 “In considering the adequacy of a UK incorporated bank’s stock of sterling liquid assets, the FSA also has regard to the degree of diversification of those holdings and the bank’s ability to mobilise them quickly and discretely when required (so as not to alert the market to a possible crisis). 4 th By way of illustration an article on Bloomberg on 9 November 2005 reported that S&P were considering a cut in Italy’s AA- credit rating. Jean Claude Trichet, the ECB President, stated that ECB policy was not to accept bonds as collateral with a rating of A-. This was expected to further increase yields on these bonds, relative to Gilts. PMD retains assets eligible for acceptance by the Bank of England (which generally has a slightly higher standard than the European Central Bank (“ECB”)).
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Annex 2 Eligible Securities
•
Gilts (including gilt strips)
•
Sterling Treasury bills
•
Bank of England euro bills and euro notes
•
HM Government non-sterling marketable debt
•
Sterling-denominated securities issued by European Economic Area (EEA) central governments and central banks and major international institutions which are described in the following lists:
•
List of eligible sterling-denominated international securities issued directly into CREST
•
List of eligible sterling-denominated international securities issued directly into Euroclear and Clearstream, Luxembourg
•
Euro-denominated securities (including strips) issued by EEA central governments and central banks and major international institutions where they are eligible for use in ESCB monetary policy operations and which are described in the following lists. These securities may either be those issued directly into Euroclear and Clearstream, Luxembourg or may be "CCBM securities" where the central bank in the country in which the relevant securities were issued has agreed to act as the Bank’s custodian under the Correspondent Central Banking Model (CCBM).
•
o
List of eligible euro-denominated international securities issued directly into Euroclear and Clearstream, Luxembourg
o
List of eligible euro-denominated CCBM securities
The above sovereign and supranational securities are subject to the requirement that they are issued by an issuer rated Aa3 (on Moody's scale) or higher by two or more of the ratings agencies (Moody's, Standard and Poor's, and Fitch).
Annex 3 Basel II analysis Basel II (BIPRU 2.1) requires certain underlying conditions, listed below, to be satisfied for solo consolidation to remain applicable. BAIL will satisfy all the requisite conditions for solo consolidation (detailed below). 1. The speed with which funds can be transferred or liabilities repaid to the firm and the simplicity of the method for the transfer or repayment; The preference share investment in BAIL will be redeemable at the option of the holder, BBPLC, on two days notice. 2. Whether there are any interests other than those of the firm in the subsidiary undertaking and what impact those other interests may have on the firm's control over the subsidiary undertaking and on the ability of the firm to require a transfer of funds or repayment of liabilities Not applicable as BAIL is 100% owned by Barclays Group Holding Limited (“BGHL”). 3. Whether the prompt transfer of funds or repayment of liabilities to the firm might harm the reputation of the firm or its subsidiary undertakings; Prompt repayment will not result in any reputational risk as the only asset held, namely the ILGs, will be disposed and all capital will be held internally within BBPLC group settled. The ILGs can be disposed of to PMD. PMD will then manage the sale of the ILGs to the market. 4. Whether there are any tax disadvantages for the firm or the subsidiary undertaking as a result of the transfer of funds or repayment of liabilities; The subsidiary would be required to dispose of its assets and incur a taxable trading profit or loss which it would have incurred irrespectively on disposal. No unfavourable tax disadvantages will be incurred in BGHL. 5. Whether there are any exchange controls that may have an impact on the transfer of funds or repayment of liabilities; Not applicable as all assets and funds are denominated in sterling and located within the UK. 6. Whether there are assets in the subsidiary undertaking available either to be transferred or liquidated for the purposes of the transfer of funds or repayment of liabilities; The ILGs which will be held by BAIL will be liquidated. The ILGs are sufficiently liquid to allow for disposal for purpose of repayment. As noted the above the ILGs can be disposed of on short notice to PMD who will then manage the sale of the ILGs to the market. 7. Whether any regulatory requirements impact on the ability of the subsidiary undertaking to transfer funds or repay liabilities promptly; None. 8. Whether the purpose of the subsidiary undertaking prejudices the prompt transfer of funds or repayment of liabilities; BAIL was formed with the principal objective of making investments. This will not prejudice the repayment of funds. 9. Whether the legal structure of the subsidiary undertaking prejudices the prompt transfer of funds or repayment of liabilities;
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Not applicable as all capital is currently and in future will be held directly by BGHL. 10. Whether the contractual relationships of the subsidiary undertaking with the firm and other third parties prejudices the prompt transfer of funds or repayment of liabilities; No existing contractual obligations with the BBPLC group prejudice the prompt repayment of funds. BAIL does not have any contractual commitments with external counterparties outside of the BBPLC group. 11. Whether past and proposed flows of funds between the subsidiary undertaking and the firm demonstrate the ability to make prompt transfer of funds or repayment of liabilities; and The provision and repayment of funds has in the past taken place over a single business day. 12. Whether the degree of solo consolidation by the firm undermines the FSA's ability to assess the soundness of the firm as a legal entity (taking into account any other subsidiary undertakings to which BIPRU 2.1 is being applied). 100% ownership by BBPLC and the exclusion of any third party apart from the investment in ILGs indicates a strong degree of solo consolidation.
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Annex 4 Transaction Diagrams
Closing (afterPrefsIssuance) Closing + 2 weeks (Ignoring Stock Loan) Step 1 £4bn
BAIL BAIL [SCM] [SCM]
ILG ILG Reverse Reverse Repo Repo C’ C’ party party
PMD Fee by SCM Step 4 ILG Portfolio Reverse Repo LIBOR -10bps
ILG Market
Purchase ofILGsfrom the market by Barclays as agent for BAIL
Step 3
Barclays Barclays
Step 5 Sale ofILGs to the market
[PMD] [PMD] Step 2
[Losses] + [LIBOR – 30bps]
External TRS [Gains] + [Coupon]
TRS TRS
On Closing + [2] weeks, TRS with TRS C’ party is unwound for cash
C’party C’party
Post- Closing Final Structure
BAIL BAIL [SCM] [SCM]
ILG Portfolio
PMD Fee
ILG ILG Reverse Reverse Repo Repo C’ C’ party party
ILG Portfolio Reverse Repo LIBOR -17bps
Barclays Barclays [PMD] [PMD]
ILG Portfolio
ILG Market
Memo
Barclays Capital
To
SCM Approvals Committee
From
Jonathan Zenios
Date
February 2005
Subject
Brazilian Investment Strategy
1.
SUMMARY Structured Capital Markets (“SCM”) is seeking approval to make an investment of £300m in a portfolio of Brazilian Real (“$R”) linked bonds together with associated hedging arrangements. The investments will be made through a specially formed UK tax resident company. The portfolio will be managed by Banco Barclays S.A. (“BBSA”). The benefit of the investment derives from the fact that the BBPLC group will generate pre-tax income at $R interest rates of c.19% but will not have any exposure to the $R:GBP exchange rate. The key financial data is set out below: Proposed product limit Estimated Revenue Tax capacity Return on Tax capacity WRAs Return on WRAs Balance Sheet Return on Balance Sheet PUG Tenor
£600m investment. c.£[26]m in 2005 – Part year c.£[8]m in 2006 – Part year Variable – depends on future $R:GBP FX rates. £60m Average c.55% £300m Average c.11% Nil 5-years
This Approvals paper contains a description of all significant tax, credit, market and operational risks associated with the transaction.
2.
TRANSACTION DESCRIPTION (all transactions assume £1 = R$5)
Set-Up Steps – Stage1 2.1.
Barclays Bank PLC (“BBPLC”) acquires the nominal ordinary share capital of an “off-the-shelf”, Cayman Islands incorporated company (“NewCo”) that was originally formed in 2004. BBPLC capitalises it with £[300]k of additional ordinary share capital. NewCo invests £[100]k in a portfolio of gilts.
2.2.
NewCo acquires the nominal ordinary share capital of an “off-the-shelf”, Cayman Islands incorporated company (“HoldCo”) that was originally formed in 2004. NewCo capitalises it with £[200]k of additional ordinary share capital. HoldCo invests £[100]k in a portfolio of gilts.
2.3.
HoldCo acquires the nominal ordinary share capital of an “off-the-shelf”, Cayman Islands incorporated company (“RealCo”) originally formed in 2004. HoldCo pays £[100]k for an additional R$[500]k ordinary share capital in RealCo. RealCo invests £[100]k in R$-linked assets.
2.4.
NewCo, HoldCo and RealCo are UK tax resident by virtue of management and control within the UK. The directors of NewCo, HoldCo and RealCo change their first accounting periods to a December 31, 2005 yearend.
2.5.
NewCo, HoldCo and RealCo prepare their statutory accounts under UK GAAP. NewCo and HoldCo have a GBP functional currency and RealCo has a BRL functional currency.
2.6.
RealCo enters into an agreement (the “Services Agreement”) with BBSA agrees to manage the investments of RealCo including being responsible for the selection of suitable issuers within agreed investment parameters, the application for credit approval and the post-close management of its portfolio. The Services Agreement can be terminated at 5 day’s notice by RealCo’s board of directors.
Set-Up Steps - Stage2 2.7.
BBPLC invests £300m in redeemable preference shares issued by NewCo (the “NewCo Prefs”). The NewCo Prefs are redeemable at both BBPLC’s and NewCo’s option.
2.8.
NewCo borrows an additional £700m (the “BB Sub Loan”) from an existing UK tax resident member of the Barclays group (“BB Sub”). The BB Sub Loan pays interest at 3-month GBP LIBOR. The BB Sub Loan can be terminated early at either BBSub’s or NewCo’s option.
2.9.
NewCo subscribes £1,000m for R$5,000m redeemable preference shares (the “HoldCo Prefs”). The HoldCo Prefs are mandatorily redeemable in 5 years and earlier at both HoldCo’s and NewCo’s option, either in cash or in-specie (permitting the redemption in a currency other than R$). The HoldCo Prefs entitle the holder to a cumulative priority dividend (payable in GBP) based on pre-UK tax quarterly Brazilian inter-bank average deposit rates (“BRLDI”).
2.10. NewCo and HoldCo hedge their BRL exposure by entering into a 5-year cross-currency swap (the “XCS”) with the following cashflows: Initial Exchange o
None
Regular Flows o
NewCo pays GBP amounts linked to BRLDI on a notional principal of R$5,000m; and
o
HoldCo pays 3-month GBP LIBOR on a notional principal of £1,000m;
Final Exchange o
NewCo pays the GBP equivalent of R$5,000m at the exchange rate in force at termination; and
o
HoldCo pays £1,000m.
Both HoldCo and NewCo can accelerate the XCS. 2.11. HoldCo lends £700m (the “HoldCo Loan”) to BB Sub on exactly the same terms as the BB Sub Loan.
2.12. HoldCo subscribes £300m for R$1,500m of irredeemable equity (the “RealCo Equity”). The RealCo Equity entitles HoldCo to a dividend (payable in GBP) equal to the profits of RealCo payable quarterly. 2.13. HoldCo hedges the expected $R-linked dividends on the RealCo Equity by entering into a series of nondeliverable currency forward sale agreements with the markets floor (the “Market Forwards”) under which HoldCo agrees to pay fixed $R-linked amounts in exchange for the GBP equivalents translated at the forward GBP:$R FX rates. 2.14. RealCo invests £300m in $R-linked bonds issued by third-party non-UK issuers (the “Bonds”). The Bonds will have a 1-year tenor and pay interest linked to the 1-year fixed Brazilian interest rate plus the applicable credit spread of the issuer. The Bonds will redeem for the GBP equivalent of R$1,500m at the exchange rate in force on the redemption date. The Bonds will be issued from MTN programmes. 2.15. BBPLC hedges the GBP interest rate risk by entering into a 1-year GBP fixed / floating interest rate swap on a notional of £300m. 2.16. BBPLC, NewCo, HoldCo and RealCo enter into a group relief agreement whereby BBPLC and NewCo agree to surrender group relief to HoldCo and RealCo for no payment.
Ongoing Flows 2.17. RealCo receives the $R-linked coupon on the Bonds. 2.18. RealCo declares and pays a $R-linked dividend to HoldCo. Real Co is able to pay 100% of the $R-linked dividend (as opposed to 70%) since it obtains group relief at no cost from BBPLC or NewCo. 2.19. HoldCo uses the $R-linked receipt from RealCo to make payments under the Market Forwards. 2.20. HoldCo receives the GBP equivalent (fixed at outset at the forward FX rate) of the $R-linked fixed amounts under the Market Forwards. 2.21. HoldCo receives 3-month GBP LIBOR interest on the £700m HoldCo Loan and pays 3-month GBP LIBOR interest on the £1,000m XCS. 2.22. HoldCo receives the BRLDI linked amounts in GBP under the XCS. 2.23. HoldCo pays the dividends on the HoldCo Prefs. HoldCo is able to pay the pre-tax equivalent of the flows set out at 2.18 – 2.22 since it obtains group relief at no cost from BBPLC or NewCo. Therefore HoldCo has a)
a hedge of its $R-linked interest rate risk;
b) a hedge of its BRLDI interest rate risk; c)
an obligation to pay 3-month GBP Libor on £300m; and
d) a fixed stream of GBP cash flows (based on $R interest rates). 2.24. BB Sub receives 3-month GBP LIBOR interest on the BB Sub Loan and pays 3-month GBP LIBOR interest on the HoldCo Loan. Therefore BB Sub has a hedge of the interest rate risk on the BB Sub and HoldCo Loans. 2.25. NewCo receives 3-month GBP LIBOR interest on £1,000m under the XCS.
2.26. NewCo pays 3-month GBP LIBOR interest on the £700m BB Sub Loan. 2.27. NewCo pays the BRLDI linked amounts under the XCS. 2.28. NewCo receives a dividend on the HoldCo Prefs equal to the amounts set out at 2.25-2.27. Therefore NewCo has a)
a hedge of its BRLDI interest rate and exchange rate risk; and
b) a right to receive 3-month GBP Libor on £300m; 2.29. The amounts in 2.23c) and 2.28b) are equal and opposite. Therefore the net position for the NewCo, HoldCo, RealCo group is a fixed GBP receipt, based on $R interest rates on the Bonds. This amount will be taxed and ultimately paid as a dividend to BBPLC. 2.30. BBPLC therefore has a fixed rate asset (part profit, part cost of funds) and therefore BBPLC pays fixed under an interest rate swap in order to hedge the GBP Libor funding cost – leaving a fixed profit equal to the spread between (i) $R rates (translated in GBP at forward rates) on a notional of £300m and (ii) GBP fixed rates on a notional of £300m.
Unwind Steps - Early Termination or Maturity 2.31. Each of NewCo, HoldCo and RealCo will close off an accounting period. 2.32. The Bonds redeem at maturity, redeem early or are sold by RealCo. RealCo uses the proceeds to make further appropriate investments. 2.33. If appropriate RealCo terminates the Services Agreement with BBSA. 2.34. HoldCo terminates the XCS. HoldCo may or may not opt to redeem the HoldCo Prefs at the same time. 2.35. The BB Sub Loan, the HoldCo Loan, the Market Forwards and the IRS are terminated and repaid.
3.
ECONOMICS AND ECONOMIC DRIVERS
3.1.
This transaction allows BBPLC to earn $R-linked returns (c.19%) without taking the $R FX exposure normally associated with a $R investment.
3.2.
Each of BBPLC, NewCo, BB Sub and RealCo has an FX hedge on a pre-tax and post-tax basis. The benefit from the transaction manifests itself at HoldCo.
3.3.
From HoldCo perspective the RealCo Equity and the HoldCo Prefs do not give rise to FX gains or losses for tax purposes, whereas the XCS does give rise to FX gains or losses for tax purposes. If the $R depreciates against GBP the effect is shown below:
Instrument
Pre-Tax (£)
Tax (£)
Post-Tax (£)
RealCo Equity
(10.0)
0.0
(10.0)
HoldCo Prefs
33.3
0.0
33.3
XCS
(33.3)
10.0*
(23.3)
Total
(10.0)
10.0
0.0
* In order for this hedge to be effective BBPLC must value the tax deduction of 10, i.e. the transaction utilises tax capacity if the $R depreciates against GBP. The maximum amount of tax capacity that could be used is £1,000m if $R becomes worthless.
3.4.
If the $R appreciates the effect is shown below Instrument
Pre-Tax (£)
Tax (£)
Post-Tax (£)
RealCo Equity
10.0
0.0
10.0
HoldCo Prefs
(33.3)
0.0
(33.3)
XCS
33.3
(10.0)*
23.3
Total
10.0
10.0
0.0
* If $R appreciates against GBP more tax is paid in addition to the profit from the transaction.
3.5.
Therefore HoldCo has a post-tax hedged position (regardless of whether $R depreciates or appreciates against GBP) but is in receipt of $R-linked income. HoldCo sells the $R-linked income for GBP income. This is the equivalent of earning $R-linked income (c.19%) on a £300m investment.
3.6.
Attached as Appendix 2 is an analysis based on historical $R:GBP FX rates, the overall conclusion of which is that tax capacity usage is unpredictable and had similar transactions been executed over the past few years tax capacity would have been generated 48% of the time and utilised 52% of the time.
4.
TAX ANALYSIS
NewCo 4.1.
The HoldCo Prefs will be treated as capital gains tax assets and therefore any accounting entries in respect of exchange differences will be ignored. HoldCo will suffer capital gains tax on any exchange gains and losses only on disposal.
4.2.
The XCS should qualify as a hedge of the HoldCo Prefs for the purposes of Para 4 of the Disregard Regs. This is because: (a)
although the HoldCo Prefs are treated as debt in NewCo’s Solus Accounts the question of what is a “share” for the purpose of Para 4 is a legal and not an accounting test; and
(b)
Condition 3 of Para 4(3) should be satisfied as the XCS eliminates the exposure to exchange differences on the HoldCo Prefs.
The consequences are that any exchange differences arising on the termination of the XCS will be brought into account as capital as and when the HoldCo Prefs are sold or redeemed under SI 2002/1970. These gains and losses will offset the exchange gains and losses on the HoldCo Prefs.
HoldCo 4.3.
The HoldCo Prefs will not be taxed in HoldCo’s hands as they are shares issued by HoldCo and not loan relationships, notwithstanding their treatment as debt under FRS 25 (IAS 32).
4.4.
Para 4 of the Disregard Regs will not apply to the XCS in HoldCo and therefore the exchange differences will be brought into account in accordance with its solus accounts under the derivative contracts regime. The XCS is hedging the HoldCo Prefs therefore none of the 3 conditions in Para 4 of the Disregard Regs should be met.
4.5.
The RealCo Equity will be treated as a capital gains tax asset. HoldCo will suffer capital gains tax on any exchange gain or loss only upon disposal.
4.6.
The Market Forwards will be hedge accounted with the dividends received on the RealCo Equity under UK GAAP. Accordingly HoldCo will not be taxed on the net GBP amounts received.
RealCo 4.7.
RealCo is a BRL functional currency company. The Bonds are loan relationships and accordingly will be taxed under the FA 1996 regime. RealCo will therefore be taxed on its profits for the year (being the accrual of income on the Bonds) translated into GBP at the average exchange rate for the year.
4.8.
The overall benefit from the trade will be equal to the $R-linked income from the Bonds hedged into GBP at the forward FX rates under the Market Forwards. Consequently, if the average FX rate for the year is not equal to the average of the forward FX rates for the year the effective tax rate will not equal 30%. In this case the post-tax profit and hence the management accounts benefit will be different to the pre-tax profit and there will be a corresponding minor PUG impact.
Tax opinion 4.9. 5.
A tax opinion from Freshfields is attached as Appendix 3. TAX RISK
Unallowable purposes Para 13, Sch 9, FA 1996 5.1.
Debits will be recognised on the HoldCo Loan, the BB Sub Loan and BBPLC’s funding. However, given that the transaction will generate a pre-tax profit and that for this profit to be earned it is not necessary for the XCS to generate a deductible loss (indeed it may involve additional tax being paid depending on exchange rate movements) it will not be possible to show that the transaction as a whole was entered into with the objective of securing a tax advantage.
Para 23, Sch 26, FA 2002 5.2.
Debits will be recognised on the XCS and the IRS. For the same reason as set out at 5.1 above Para 23 will not apply.
Non-taxation of the XCS (Mandatory Matching post 1/1/05) 5.3.
HoldCo’s economic gain or loss on the RealCo Equity is hedged on a post-tax basis by the XCS. In circumstances where there is a loss on the XCS, there is a risk of Para 4 of the Disregard Regs applying to the XCS. However, Para 4 of the Disregard Regs should not apply to the XCS since it does not eliminate or substantially reduce the economic risk of holding the RealCo Equity. It is difficult to see how these provisions can be interpreted to apply otherwise than on a pre-tax basis. A pre-tax basis gain or loss on the XCS will, in fact, increase HoldCo’s economic exposure to $R rather than reduce it.
6. 6.1.
ACCOUNTING The accounting treatment set out below has been agreed with Financial Control.
RealCo Solus Accounts 6.2.
RealCo will prepare solus accounts under UK GAAP and will use a $R functional currency.
6.3.
RealCo will hold the Bonds on balance sheet at amortised cost and accruals account for interest income which will be taken to P&L.
6.4.
RealCo will account for the RealCo Equity as equity.
HoldCo Solus Accounts 6.5.
HoldCo will prepare solus Accounts under UK GAAP and will use a GBP functional currency.
6.6.
HoldCo will hold the RealCo Equity at cost and not retranslate it since it is a non-monetary item1.
6.7.
HoldCo will recognise the HoldCo Prefs as non-equity shares in its first accounting period and as a financial liability under FRS 25 (IAS 32) thereafter. It will contract rate account the XCS with the HoldCo Prefs and therefore recognise no exchange differences on either instrument on a current basis2.
6.8.
If the XCS is terminated at a point in time when the HoldCo Prefs are also redeemed then no amounts will be taken to the Profit and Loss Account. Any cash movements will simply be treated as Balance Sheet movements.
6.9.
If the XCS is terminated at a point in time when the HoldCo Prefs remain outstanding then the XCS will be retranslated and the exchange difference will be taken to the Profit and Loss Account and offset against the retranslation of the HoldCo Prefs to their current GBP value.
6.10. The Market Forwards will be hedge accounted against the dividends HoldCo receives on the RealCo Equity. NewCo Solus Accounts 6.11. NewCo will prepare solus Accounts under UK GAAP and will use a GBP functional currency. 6.12. NewCo will account for the HoldCo Prefs and XCS on a symmetrical basis to HoldCo. BBPLC Solus Accounts 6.13. BBPLC will account for the NewCo Prefs as a Loan and Receivable under IAS 39 and hold them at amortised cost. 6.14. The IRS will be cashflow hedged against the floating rate funding. The accrual of the fixed cashflows under the IRS will be recognised in the income statement with any fair-value differences recognised in equity. BBPLC Consolidated Accounts 6.15. The Bonds will be recognised as an AFS financial asset and translated into GBP at closing spot rate for inclusion in the Consolidated Accounts. Fair-value gains and losses will be recognised in the AFS portion of Equity by reference to $R at closing rates.
1 2
SSAP 20, para 5 SSAP 20, para 4
6.16. On consolidation exchange gains and losses on the RealCo Equity will be recognised in a separate component of Equity. This is because the RealCo Equity forms part of HoldCo’s net investment in RealCo (a foreign operation). 6.17. The Market Forwards will be cashflow hedge accounted against the income on the Bonds. Accordingly, the Market Forwards will be fair-valued through Equity. When the income on the Bonds impacts the Consolidated Income Statement an appropriate amount of the changes in the fair value of the Market Forwards will be recycled to the Income Statement. Accordingly, the net income on the Bonds after hedging will be equal to the GBP legs of the Market Forwards received in the particular year. 6.18. As a preliminary step in the consolidation of HoldCo and NewCo, it is first necessary to adjust their accounts to an IAS basis from UK GAAP. The HoldCo Prefs will be retranslated into GBP at closing spot rate and exchange differences recognised in each company’s IAS Income Statement. Similarly the XCS will be fair valued and the change in fair value recognised, by both companies, in their IAS Income Statements. As the XCS has floating interest rate payments on each leg the substantial majority of these fair value changes will be due to changes in FX rates 6.19. As set out above HoldCo will be subject to tax on exchange differences on the XCS but not on the HoldCo Prefs. For NewCo both the HoldCo Prefs and the XCS will be subject to tax as capital gains tax items. The XCS will only be tax effected by HoldCo at termination and accordingly there will be a difference between the tax base of the XCS and its carrying amount. This difference will be equal to the cumulative exchange differences that have arisen to date on the XCS. Accordingly, prior to consolidation a deferred tax asset or liability should be recognised by HoldCo in its pre-consolidation IAS accounts. Overall no net deferred tax asset or liability will be recognised by NewCo as the tax treatment on the HoldCo Prefs and the XCS are symmetrical. 6.20. On consolidation the HoldCo Prefs and the XCS will be eliminated from the Consolidated Income Statement and Balance Sheet on the basis that they are intra-group assets/liability and income expense. The deferred tax asset or liability, recognised by HoldCo will not be eliminated. The deferred tax asset or liability will be shown in equity as, in consolidated terms, it relates to the exchanges arising on retranslation of the Net Investment in RealCo. 6.21. The funding and the IRS will be accounted for in the Consolidated Accounts on the same basis as in BBPLC’s Solus Accounts. Recycling of FX reserve 6.22. At maturity of the $R investment the Consolidated Accounts will include an FX reserve on account of HoldCo’s net investment in RealCo (a foreign operation) and a tax reserve on account of the deferred tax asset or liability recognised by HoldCo on the XCS. Under IAS 21, para 48 these reserves will be recycled to the Income Statement upon disposal of RealCo. US GAAP analysis 6.23. The US GAAP analysis is expected to be broadly the same as the IAS treatment. 6.24. An opinion from PwC on the accounting treatment of the transaction will be obtained in advance of execution. 7.
CREDIT AND MARKET RISK
7.1.
RealCo has credit exposure to the issuers of the Bonds and BBPLC (markets) has a credit exposure on the Market Forwards.
7.2.
If $R depreciates against GBP, BBPLC is hedged on a post-tax basis by virtue of having taxable profits. If taxable profits are not available, then BBPLC does not have a post-tax hedge. The downside from this eventuality is best illustrated by viewing the table from 3.3 without the tax deduction for the pre-tax loss on
the XCS. In addition to this downside, the cost of creating the conventional pre and post-tax hedge would need to be considered. 7.3.
Assuming that Bonds are not sold outside of the BBPLC group, but the specifics of the transaction are terminated the exposure to $R is no longer hedged on a post-tax basis. The cost of creating the conventional pre and post-tax hedge is dependent upon the interest rates at the time of termination. Table A below shows the estimated costs (£’s m) of hedging the sterling principal value of the Bonds on early termination for the given shifts in BRL interest rates, relative to GBP. All necessary credit approvals for RealCo will be obtained by BBSA pursuant to Services Agreement through GFRM. All other credit risks will be obtained by the appropriate business unit via normal routes.
TABLE A Time since investment
8.
+1%
+2%
+3%
+4%
+5%
3-months
1.2
2.8
4.3
5.8
7.4
6-months
0.5
1.6
2.7
3.7
4.7
9-months
0.1
0.7
1.2
1.7
2.3
REGULATORY CAPITAL The regulatory analysis has been agreed with Finance.
8.1.
The investment in NewCo Prefs will constitute a £300m large exposure and therefore a utilisation of shortterm treasury concession limits.
8.2.
The NewCo Prefs will not constitute “lending of a capital nature” within the meaning of IPRU CA10.2(b) since the ultimate investment of the BBPLC group is in the Bonds which are likely to be issued by highlyrated financial institutions, have a high credit quality and are redeemable, i.e. it should not be hard to finance this activity from another source.
8.3.
The issuers of the Bonds are likely to be 20% weighted, hence WRAs of £60m will be consumed initially. The actual annual usage of WRAs will vary in sterling terms given that the Bonds are $R linked.
8.4.
In order to equate solus and consolidated WRAs, NewCo could be capitalised with £6m of equity.
8.5.
The Market Forwards will attract WRA’s equal to the CEE plus add-on.
8.6.
The return on WRA’s will average at around 55%.
9. 9.1.
OPERATIONAL ISSUES None.
10. PROVISION 10.1. Given that from inception it is not possible to predict whether more or less tax will be paid a zero provision is suggested. 11. OTHER 11.1. It is not considered that NPSO signoff is required for this transaction.
APPENDICES 1. 2. 3.
Structure Diagrams; Tax Capacity Analysis; and UK Tax Opinion.
Memo
To
Barclays Capital
SCM Approvals Committee
Copy From
Michael Keeley
Date
2 March 2007
Subject
Project Brontos
SUMMARY 1.
SCM seeks approval to present Project Brontos to the Milan Branch of Barclays Bank PLC (“Milan Branch”).
2.
Project Brontos involves Milan Branch entering into a Repo with an Italian Counterparty (the “Counterparty”) over a profit participating instrument (“PPI”) issued by a Barclays entity in Luxembourg.
3.
The counterparties identified for the transaction are Unicredito Italiano S.p.A group (“Unicredito”) and Intesa Sanpaolo S.p.A group (“Intesa”). It is envisaged that the transaction with Unicredito would be a TRY based transaction of up to €[2,500]m, and the transaction with Intesa would be a GBP based transaction of up to €[1,000]m. The transaction with Unicredito may comprise of separate Repos with up to three separate entities in the Unicredito group.
4.
Overall under Project Brontos, the Counterparty will make an investment with Milan Branch. The Counterparty achieves an enhanced pre tax return and will receive distributions which should be largely tax exempt while their funding costs and associated expenses should be fully tax deductible. Barclays’ benefit arises through sub-Libor funding from the Counterparty.
5.
Subject to approval of the transaction, it has been agreed that SCM will provide resource to the Milan Branch locally in order to facilitate the Milan Branch’s origination, management and execution of the trade for as long as is necessary.
6.
The version of the transaction outlined in this paper involves a TRY denominated PPI and an associated currency hedge (the Unicredito version). It is envisaged that Intesa will enter into a version ofthe transaction using a PPI denominated in another currency (GBP, EUR or USD). Intesa may or may not require currency hedging for such a transaction
7.
As part of the transaction, Barclays will represent that the payments under the PPI would benefit from the Italian tax exemption in the hands of Milan Branch were they to be received by the Milan Branch, i.e. had Milan Branch not transferred the PPI under the Repo. The Counterparties’ benefit is dependent on the repo seller (Milan Branch) being able to satisfy this condition. As such, Barclays would indemnify the Counterparties for any loss of benefit as consequence of the representation not being satisfied (see paragraph 121). The maximum loss that would arise if the representation was incorrect is €[52.8]m per annum per €[1,000]m investment for the Unicredito trade and €[14.2]m per annum per €[1,000]m investment for the Intesa trade. You will see from the Italian tax opinion in Appendix 2 that based on our facts the representation should be satisfied.
8.
Diagrams showing the transaction steps, including ongoing flows and unwind, are provided in the detailed description which begins on page 3.
Economic Benefit 9.
Key financial data is set out below.
Product Limit per annum
Estimated revenue per annum per trade (PTE, pre-provision): Tax capacity per annum Return on Tax capacity: WRAs Return on WRAs PUG Tenor
€150m of WHT across all jurisdictions, with the outstanding reimbursement due not to exceed €100m at any one time. The proposed transactions would 1 use up to €[65]m in 2007 . 2 €[22.6]m on a trade with a €[1,000]m investment (assuming a TRY based trade) 3 €[6.08]m on a trade with a €[1,000]m investment (assuming a GBP based trade) Nil n/a €[2]m per transaction Nil Less than 1 year.
10.
This paper assumes a transaction size of €[1,000]m for the purposes of illustration and a benefit split of 70:30 (prior to the cost of funding the tax reimbursement, which will be borne by Barclays) in favour of the Counterparty. It is assumed that the transaction terminates within 12 months. The assumed corporate tax rates in Italy and the UK are 33% and 30% respectively.
11.
This paper contains a description of all significant tax, credit, market and operational risks.
DETAILED DESCRIPTION This description assumes a TRY:EUR spot rate of TRY2:EUR1, Euribor = 5% and TRY Libor = 20%. Where the following description refers to TRY amounts, in practice these amounts will be settled in Euros for the euro equivalent of the given TRY amount, translated at the prevailing spot rate.
12.
An investment company subsidiary of BBPLC which is tax resident in the UK (“BarSub”) establishes a wholly owned subsidiary in Luxembourg, with €[25,000] ordinary shares (“LuxParent”). LuxParent will be a Sarl.
13.
LuxParent establishes a wholly owned subsidiary in Luxembourg, with €[20,000] ordinary shares (“LuxSub”). LuxSub will also be a Sarl. Additional LuxSub entities may need to be established for each transaction with a different Counterparty.
14.
LuxParent will use the €[5,000] of cash it retains to meet initial expenses, and places the remainder on deposit.
15.
LuxParent and LuxSub place the subscription proceeds on deposit.
16.
LuxSub will enter into an agreement with LuxParent whereby LuxSub must seek written consent from LuxParent before any issuance or transfer of any profit participating instruments (e.g., PPI).
1
[In 2007, other trades are expected to use approximately €22.5m of the WHT limit. Note that the 2007 revenue will be a proportion of this number dependent on the close date for the transaction. This number does not include cost of collateral, expected to be approx. €1.5m p.a. 3 Note that the 2007 revenue will be a proportion of this number dependent on the close date for the transaction. 2
Page 2 of 21
Figure 1: Principal Flows
9
Deposit €1000m
Head HeadOffice Office
Deposit 4 TRY 2000m
Deposit €1000m 8 €1000m
Milan Branch Milan Branch
BarSub BarSub
XCS Exchange of principals 6
7 Spot Purchase of PPI TRY 2000m Under Repo
Forward Sale and Coupon Swap over PPI
TRY 2000m
Counterparty Counterparty
5 Funding / Surplus Cash €1000m
(t=365)
€10m Loan and TRS
Deposit 3 TRY 2000m
LuxParent LuxParent 1
PPI TRY 2,000m
LuxSub LuxSub
2
Deposit TRY 2,000m
€10m
UK Bare Trust
Portfolio
17.
Barclays Bank PLC, London (“Head Office”) utilises a TRY[2,000]m overdraft facility to make a deposit with Milan Branch (the “Milan Branch TRY Deposit”).
18.
Milan Branch subscribes for a TRY[2,000]m PPI issued by LuxSub with a term of [20] years.
19.
Milan Branch is the legal and beneficial owner of the PPI. The key features of the PPI are provided in Appendix 1.
UK Bare Trust 20.
LuxSub will establish a UK Bare Trust (the “Trust”) and uses the proceeds of the subscription in the PPI to settle it with TRY[2,000]m.
21.
The Trust will have three assets (the “Portfolio”). The Portfolio will be funded by a €[10]m loan from BBPLC to LuxSub.
22.
The trust agreement will also provide for the Trustee to invest in a fourth asset in the form of a short term (i.e. less than 365 days) TRY[2,000]m deposit with Head Office (the “Barclays TRY Deposit”).
Page 3 of 21
23.
Further details of the Trust are provided in Appendix 1.
24.
Head Office uses the proceeds of the Barclays TRY Deposit to repay its TRY overdraft facility.
Counterparty Repo and Cross Currency Swap 25.
Counterparty raises €[1,000]m of new funding from the market or sources this from surplus cash.
26.
Milan Branch enters into a cross currency swap (the “CCS”) with the Counterparty with the following features:
4
26.1.
The maturity of the CCS is equal to the term of the Counterparty Repo.
26.2.
An initial exchange of principal under which the Counterparty pays €[1,000]m and Milan Branch pays TRY[2,000]m.
26.3.
Ongoing payments under which Milan Branch plays Euribor interest + Euro spread and 5 Counterparty pays TRY Libor interest + TRY spread .
26.4.
A final exchange of principal under which Counterparty pays TRY[2,000]m and Milan Branch pays €[1,000]m.
26.5.
All payments under the CCS will likely be settled in Euros.
27.
Milan Branch now has €[1,000]m of cash, and places this on deposit with Head Office in line with its normal business practice (the “Milan Branch EUR Deposit”) .
28.
Head Office makes a deposit of €[1,000]m with the market (the “Market EUR Deposit”).
29.
Shortly thereafter but on the same date that it enters into the CCS, Milan Branch enters into a sale and repurchase agreement with the Counterparty over the PPI (the “Counterparty Repo”), whereby 6 it sells the PPI and agrees to repurchase it on the next distribution payment date .
30.
The Counterparty repo will roll into a repeat repo transaction on the same terms via a Repo Confirmation (under the Master Repo arrangements) signed by both parties.
31.
The Counterparty may also provide notice that it intends to enter into a repeat repo transaction over instruments with a different total principal amount (see paragraph 45).
32.
The repurchase price under the Counterparty Repo will be calculated in accordance with the 7 following formula : Repurchase Price = P + I – GD Where: P = the purchase price I = TRY Libor + TRY spread. GD = the amount of distributions under the PPI gross of Luxembourg withholding tax levied at source.
33.
As the amount of the distributions paid on the PPI is subject to a cap (see Appendix 1, para 1.2), the difference between the initial purchase amount and the repurchase price will be either zero or a positive amount. Specifically, the repurchase price will be greater than the purchase price by the amount of the spread on the interest leg of the repurchase price calculation.
4
The version of the transaction outlined in this paper involves TRY denominated instruments and an associated hedge. Other versions of the transaction using instruments denominated in other currencies (including GBP, EUR and USD), which the Counterparty may or may not require hedging, are also envisaged. This is likely to be the case in the Intesa trade. 5 Since the spread under the repo is in TRY, the CCS also swaps the TRY spread into a EUR spread. 6 Other versions of the transaction using instruments denominated in other currencies (including GBP, EUR and USD) may have a Repo with a longer term. 7 As an alternative, the repo price could be equal to ‘P’ above and the flows ‘i – GD’ may be settled via a swap agreement which will constitute one contract together with the repurchase agreement. Furthermore, the formula may include amounts representative of interest on reinvestment amounts where appropriate.
Page 4 of 21
34.
Where required Milan Branch will make a representation to Counterparty under the Counterparty Repo that it would itself have been able to benefit from exempt income for Italian Tax Purposes on the return paid on the PPI had it not entered into the Counterparty Repo.
35.
Milan Branch and Counterparty may also enter into a foreign exchange hedging arrangement for a notional amount equal to the TRY amount of the withholding tax levied on the PPI distributions and which provides for a sum to paid (received) by Counterparty on any depreciation (appreciation) of TRY against EUR from inception to the next distribution payment date. Alternatively, Milan Branch may enter into a independent hedging arrangement with the market.
LuxParent Forward 36.
At the same time that the PPI is issued to the Milan Branch (an issuance which has been approved by LuxParent), LuxParent enters into an agreement to forward purchase the PPI (or PPI issued by LuxSub on similar terms) (the “LuxParent Forward”) from BarSub.
37.
The LuxParent Forward can be accelerated by either party. In any situation in which there is an early unwind, the LuxParent Forward will be accelerated and the PPI ultimately redeemed. Where there is an early unwind before a distribution payment date the Counterparty Repo and CCS will also be accelerated.
38.
The forward sale will be at the TRY par value of the PPI with ongoing flows under which LuxParent pays ‘i’ and BarSub pays ‘ND’; Where: i = TRY Libor – [adjustment]. ND = the amount of distributions under the PPI net of Luxembourg WHT.
39.
The adjustment to the payment of ‘i’ will be equal to Barclays benefit from the transaction.
BarSub Warrant 40.
BarSub will be granted an American style warrant (“BarSub Warrant”) by LuxSub giving it the right but not an obligation to subscribe at fair market value for PPI, identical in their terms to those issued by LuxSub to the Milan Branch. The BarSub Warrant will be exercisable at any time up to the maturity or shortly thereafter of the last repo transaction entered into with the Counterparty over the relevant PPI. The granting of the Warrant will require the consent of LuxParent.
41.
It is envisaged that BarSub will exercise the BarSub Warrant in order that it be able to satisfy its obligation to deliver the PPI under the LuxParent Forward.
Collateral 42.
Should collateral be required by the Counterparty for entering into the Counterparty Repo, Milan Branch will use the amounts otherwise invested in the Milan Branch EUR Deposit to enter into a reverse repo with Head Office over suitable securities (e.g., OECD Government securities) and charge these assets to the Counterparty. Head Office will use the amounts received from Milan Branch to make a back to back reverse repo with the market.
Transaction Timing and Structuring 43.
The Counterparty's usage of tax capacity is variable with movements in TRY Libor.
44.
This is because the Counterparty receives largely exempt distributions on the PPI and has a deductible expense on the CCS, both of which are linked to TRY Libor.
45.
In order to address the variability of capacity usage, it is intended that there should be flexibility in the notional size of the transaction over time. The actual arrangements will be subject to discussions with the counterparties as to their preferences, however potential arrangements include: 45.1.
Dividing the total principal amount of the PPI into a number of tranches, with a 3-month roll date. Therefore at any given roll date Counterparty would have the option to roll the Counterparty Repo over only some of the PPI issued at the inception of the transaction. Were this to happen, the PPI tranches which were not repoed on a given roll date would
Page 5 of 21
be sold to LuxParent under an acceleration of the relevant forward sale and ultimately redeemed. As such, were TRY Libor to increase, Counterparty would have the option to roll the Counterparty Repo over a smaller number of Genussschein tranches than that issued at inception. Likewise, should TRY Libor decrease, Counterparty would have the option to roll the Counterparty Repo over a great number of PPI tranches than that issued at inception. New tranches would be issued by LuxSub to enable this. 45.2.
Structuring the transaction on a 12 month basis, but adding early repurchase rights that can be effected by either party (subject to the CCY/EUR exchange rate being outside of a specified range) where any early repurchase may (at the election of the Holder under the terms of the PPI) trigger a distribution under the PPI (such that the transfer can be made on a ‘clean’ basis) at the option of the Counterparty.
46.
Depending on the selected approach, the other transaction arrangements will have to be amended accordingly. For instance, the Counterparty Repo may take the form of a 12 month master agreement and including provision for repeat repo transactions with a term equal to the period from one dividend payment date to the next (or in the case of the first roll from issuance to the first dividend payment date). The LuxParent Forward may be tranched, with the possibility to effect the forward sale on the individual PPI tranches issued by LuxSub.
47.
In any event, LuxSub will establish a programme under which it can issue tranches of PPI to enable new issues via a issue/pricing supplement and new subscription agreement.
Figure 2 :Interim Flows
5
EURIBOR €50m
Head HeadOffice Office
TRY Libor €200m
8
6
EURIBOR €50m TRY Libor €200m + Spread
EURIBOR €50m + Spread
XCS 7
TRY Libor €200m + Spread
Milan Branch Milan Branch
BarSub BarSub
TRY Libor - adjustment 10 €200m - €Xm
9
PPI (Gross) €200m
Counterparty Counterparty
4 EURIBOR €50m
PPI (Net) €170m
Embedded in repurchase price
LuxParent LuxParent
3
PPI (Net) €170m
11 Loan Interest €500,000
TRY Libor €200m 1
WHT €30m
LuxSub LuxSub
2
TRY Libor €200m
WHT €30m
Portfolio Return €500,000
UK Bare Trust
Portfolio
Page 6 of 21
Numbers are in euros and calculated on an annual basis: 48.
LuxSub receives €[200]m from Head Office as TRY Libor interest on the Barclays TRY Deposit via the Trust.
49.
LuxSub uses the €[200]m interest from the Barclays TRY Deposit to make a distribution on the PPI of €[200]m. This payment to the Counterparty is subject to Luxembourg withholding tax at a 15% rate, resulting in a net distribution of €[170]m. The withholding tax amount is paid to the Luxembourg tax authorities. A certificate setting out the amount of withholding tax paid will be stamped by the Luxembourg tax authorities and provided to Counterparty in accordance with the terms of the PPI. The certificate will identify the Holder as the recipient of the distribution made under the PPI.
50.
Milan Branch pays the Counterparty €[50]m representative of Euribor interest and receives €[200]m representative of TRY Libor under the CCS (excluding spreads).
51.
Milan Branch pays Head Office €[200]m interest due on the Milan Branch TRY Deposit and receives €[50]m interest on the Milan Branch EUR Deposit.
52.
Head Office receives €[50]m interest on the Market EUR Deposit.
53.
BarSub pays amounts representative of net PPI distributions to LuxParent and receives TRY Libor interest less adjustment under the LuxParent Forward.
54.
The return from the Portfolio will be swapped into 3 month Euribor and used to service the interest on the €[10]m loan made by Head Office.
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Figure 3 : Unwind
1
Deposit €1000m
Head HeadOffice Office
2 Repay Deposit 8 TRY2000m
BarSub BarSub
Repay Deposit €1000m
TRY2000m
Milan Branch Milan Branch
XCS Exchange of Principals 3
4 Repurchase of PPI TRY2011m
€1000m
Counterparty Counterparty
5 Funding / Surplus Cash €1000m
Purchase of PPI under Forward Sale 11 TRY 2,000m
Repay Loan €10m
Deposit 9 TRY 2,000m
LuxParent LuxParent
FMV Subscription 6 for identical PPI TRY 2,011m 7 FMV Redemption of PPI TRY 2,011m
Deposit TRY 2,000m 10
LuxSub LuxSub
€10m
UK Bare Trust
Portfolio
55.
Head Office will be repaid the Market EUR Deposit and will use the funds received to return the Milan Branch EUR Deposit to Milan Branch.
56.
Milan Branch will swap the €[1,000]m received from Head Office with Counterparty for TRY[2,000]m as a Final Exchange of principals under the CCS.
57.
Milan Branch will use the TRY[2,000]m received and an additional overdraft facility to repurchase 8 the PPI from the Counterparty for the repurchase price which is envisaged to be TRY[2,011] m under the Counterparty Repo.
58.
BarSub will exercise the BarSub Warrant and use an overdraft facility to subscribe at fair market value for PPI identical to those issued by LuxSub to the Milan Branch. This amount will include any applicable spread, with BBPLC Head Office acting as calculation agent.
59.
Using the proceeds of the subscription under the BarSub Warrant, LuxSub will redeem the PPI issued to the Milan Branch for fair market value which, for the purposes of this paper, is assumed to be TRY[2,011]m. In practice the fair market value will be determined by the calculation agent, acting in good faith, in order to identify acceptable bid-offer pricing levels for the PPI. The calculation agent will be BBPLC.
8
Calculated in accordance with the repurchase price formula: Repurchase price = P + i – GD = TRY[2,000]m + TRY[400]m + TRY[11]m (Spread) – TRY[400]m (GD)
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60.
Milan Branch uses the proceeds of the redemption of the PPI to repay the Milan Branch TRY Deposit (and settle the balance of any overdraft raised).
61.
Head Office returns the Barclays TRY Deposit to LuxSub, the funds being transferred directly to the Trust and makes an additional loan, should it be required, to LuxParent equal in amount to the shortfall (if any) between the fee received and the amount of withholding tax levied on the PPI distributions made by LuxSub.
62.
The Trust, acting on behalf of LuxSub, makes a deposit of TRY[2,000]m with LuxParent (the “LuxSub TRY Deposit”).
63.
LuxParent pays the forward sale price under the LuxParent Forward of TRY[2,000]m to BarSub.
64.
As a result of the LuxParent Forward, LuxParent is recognised as the owner of the PPI for Luxembourg domestic tax purposes. Any loan advanced by Head Office will be repaid once credit/reimbursement in respect of the prepaid corporation tax which LuxParent is treated as having borne (“Credit/Reimbursement”) is received from the Luxembourg Tax Authorities (see para 112).
65.
As a result of the steps above LuxParent has a TRY[2,000]m liability in the form of the LuxSub TRY Deposit and a TRY[2,000]m asset in the form of the PPI it now holds after settlement of the LuxParent Forward. LuxSub has an equal and opposite position.
66.
The remaining internal positions can be unwound by LuxParent returning the LuxSub TRY Deposit and LuxSub redeeming the PPI. It is expected that the redemption amounts payable under each of these arrangements will be equal, and can be netted off.
Page 9 of 21
ECONOMICS AND ECONOMIC DRIVERS Summary Economics Counterparty Genusscheine Receipt XCS TRY Libor Leg XCS Euribor Leg Funding Cost
Pre Tax Tax Post Tax !185,967,247 (!3,068,460) !182,898,787 (!185,967,247) !61,369,191 (!124,598,055) !50,000,000 (!16,500,000) !33,500,000 (!50,000,000)
!16,500,000
(!33,500,000)
!5,299,888
(!1,748,963)
!3,550,925
!5,299,888
(!26,500,333) !30,051,436
!35,351,324
Spread on Counterparty Repo Non-Recoverable WHT
Counterparty PTE Barclays
!52,763,171
Consolidated
TRY Libor Expense Euro Deposit Interest XCS TRY Libor Leg XCS Euribor Leg
Pre Tax Tax Post Tax (!185,967,247) !55,790,174 !130,177,073 !50,000,000 (!15,000,000) (!35,000,000) !185,967,247 (!55,790,174) (!130,177,073) (!50,000,000) !15,000,000 !35,000,000
Fee
!22,595,199 !22,595,199
Barclays PTE
!22,595,199
(!6,778,560) (!6,778,560)
!15,816,639 !15,816,639
For the example above we have made the following assumptions: •
The calculations above assume a 12 month transaction.
•
A TRY swap rate of 20% is used as a basis for the calculation of benefit.
•
The benefit is calculated using TRY:EUR forward exchange rates assuming quarterly payments under the Genussschein.
•
Note that the SCM benefit is in TRY and therefore subject to fluctuation in the absence of entering into a forward with the counterparty or other hedging arrangement, which could result in the benefit being a known amount of Euros.
•
There is no requirement for short-term funding (and thus no costs) associated with the credit/reimbursement of prepaid Luxembourg corporation tax, this is because on the basis of the numbers presented in the table, the fee received will be larger than the short-term shortfall.
TAX ANALYSIS UK Tax Analysis The UK treatment has been discussed with Slaughter and May and will be confirmed in an opinion which will follow. BBPLC (Milan Branch) 67.
The PPI, which is a debt agreement under civil law, should be a loan relationship within the meaning of s.81 FA 1996. This is on the basis that there is a creditor and debtor in relation to a money debt and there is a transaction for the lending of money.
Page 10 of 21
68.
The PPI will be a connected party loan relationship and thus taxed on an amortised cost basis. Exchange gains and losses will be brought into account under s.84A FA 1996.
69.
Since Milan Branch initially subscribed for the PPI, subsequently sells the instrument and ultimately repurchases it under the Counterparty Repo, the Counterparty Repo should qualify as a repo falling within section 730A ICTA 1988 and s.737A-C ICTA 1988. The repo – which is expected to have a repurchase price equal to par plus a small spread – factors in interest and manufactured overseas dividends (“MODs”), which will be deemed to be paid for UK tax purposes under s.737A ICTA 1988.The MODs are fully taxable and the interest and spread is relievable as an increase to the repurchase leg.
70.
As the spot sale and forward purchase are in TRY, s.730BB ICTA 1988 applies and brings into accounts exchange gains or losses under the loan relationships regime (s.730BB(6)).
71.
One technical point which arises on repo transactions involving loan relationships is the interaction of s.97 FA 1996 and paragraph 15 Schedule 9 FA 1996. The latter provision treats the repo spot seller as continuing to be party to the loan relationship (and hence presumably accruing income on that loan relationship), but s.97 also deems manufactured interest received by the spot seller to be interest on a loan relationship. In practice, this point obviously arises on all repos of debt instruments, and does not appear to give rise to any double taxation on the same income. The basis for this sensible approach seems to be that there is still only one item of income in the seller’s accounts.
72.
There is no reverse charge in respect of the MOD on the basis that the PPI are loan relationships, and therefore reg 2B of the SI 1993/2004 (MOD Regs) applies.
73.
Any profit or loss on redemption of the PPI will be brought into account in accordance with the loan relationship rules under FA 1996.
74.
The CCS is a derivative contract within the meaning of the Schedule 26 FA 2002, with debits and credits brought into account in line with the accounts.
BBPLC (Head Office) 75.
The LuxSub Deposit will be connected party loan relationship and taxed on an amortised cost basis. Exchange gains and losses will be brought into account under s.84A FA 1996.
76.
The Market Deposit will be taxed as a loan relationship under FA 1996 in line with the accounting treatment.
BarSub 77.
There are potentially different analyses of the Forward Sale over the PPI (which has an embedded Coupon Swap). On the one hand, the Forward Sale is a related transaction under s.84 FA 1996, such that profits and losses arising from the agreement should be brought into account under the loan relationship rules. Under this approach, the receipts and payments under the Coupon Swap would be viewed as income and expense incurred in the disposal of a loan relationship. If the TRY payments were dis-embedded from the purchase price and paid separately under the Forward by BarSub, they could alternatively be treated as manufactured interest payments under s.97 FA 1996.
78.
On the other hand, if and to the extent that the above payments are not brought into account under the FA 1996 regime, the Forward Sale could be analysed as a derivative contract governed by Schedule 26 FA 2002. Under this approach the tax treatment would again follow the accounting position.
Page 11 of 21
79.
Whether the receipts and payments under the Forward Sale are brought into account under the loan relationships regime, the derivative contracts regime or both (it seems possible for the loan relationships regime to apply to one leg of the Coupon Swap and for the derivative contracts regime to apply to the other leg), the overall result should be that the Forward and Coupon Swap should be taxed in accordance with BarSub’s accounting treatment.
LuxParent 80.
The discussion below is premised on the basis that LuxParent’s position must be analysed on the basis that it is UK tax resident (based on the CFC assumptions in Schedule 24 ICTA 1988)
81.
Depending on the analysis adopted for BarSub in respect of the Forward and Coupon Swap, LuxParent will have a symmetrical position (taxed under the loan relationship regime and/or the derivative contract regime).
82.
LuxParent will also obtain a Credit/Reimbursement for an amount equal to the Luxembourg WHT paid by LuxSub in respect payments on the PPI.
83.
The net position for LuxParent should be flat (before any spread) as a result of the expense under the Coupon Swap and the receipt together with tax Credit/Reimbursement (assuming the latter is taxable).
84.
It is envisaged that LuxParent would pursue an ADP.
85.
In any event, there is no motive to divert profits from the UK.
LuxSub 86.
Under the assumption that LuxSub is UK tax resident, LuxSub earns interest income on the Barclays Deposit (via the bare trust) and accrues an expense on the Genusschiene (a loan relationship). As such, LuxSub should be flat from a tax perspective having an equal and opposite income and expense item.
87.
It is envisaged that LuxSub would pursue an ADP.
88.
In any event, there is no motive to divert profits from the UK.
Treasury Consent/Notification 89.
As the General Consents do not apply to all the transactions which are contemplated, notification under s.765A ICTA 1988 will be required. Specifically: 89.1.
Issue of PPI. The General Consents should apply as the issue is to BBPLC for full consideration (para 3(b)(ii);
89.2.
Barclays TRY Deposit. No debenture is created/issued by a non-UK resident;
89.3.
Transfer of PPI by Milan Branch to BarSub. The General Consents should apply as the transfer is between members of the UK resident group; and
89.4.
Transfer of PPI to LuxParent by BarSub; the General Consents do not apply.
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Italian Tax Analysis The expected treatment has been discussed and agreed with Freshfields Milan and has been confirmed in an opinion which is attached herein (see Appendix [3]). Counterparty 90.
The Counterparty is subject to both IRES (the Corporate Income Tax) at 33% and IRAP (the Regional Tax on Productive Activities) at 4.25%.
91.
Subject to the next sentence, the Italian tax treatment of securities acquired under a repo (“riporto”) or a sale and repurchase agreement (“pronti contro termine”) is consistent with the accounting treatment: it does not represent the acquisition/disposal of the instrument and would not trigger capital gains/losses for the Counterparty. However, under Italian tax law the spot buyer is treated as the owner of any income received in respect of securities acquired under a Repo. This principle has been reaffirmed by a provision of law recently enacted (Art. 2(19) of Law Decree 3/10/06 n. 262, converted into law by Law 24/11/06 n. 286).
92.
The PPI qualify as instruments “comparable to shares” pursuant to art. 44(2) of Decree 917/86 and will therefore benefit from the 95% exemption accorded by Art 89(3) of Decree 917/86.
93.
Under Art 2(19) Law Decree 3/10/06 n. 262 an Italian resident tax payer which acquires foreign equity securities under a repo can rely on the 95% exemption from IRES if the spot seller could have claimed the 95% exemption had it not disposed of the equity instrument in the form of a repurchase agreement. In this case Counterparty should benefit from the 95% exemption because Milan Branch would have been able to claim the 95% exemption had it held the PPI.
94.
The deductibility of funding costs and any currency translation loss in relation to the repo (which may arise where the repo is denominated in a currency other than Euros) should not be impaired by the various provisions which have been recently enacted to limit the deductibility of costs and expenses.
95.
Should the Counterparty enter into a currency swap to hedge the currency exposure arising from the Counterparty Repo against Euro, any currency gains/losses realised thereon should be taxable/deductible for Italian tax purpose pursuant to the same rules which apply to the gains/losses realised on the hedged asset (repo).
96.
No Italian withholding tax should be levied on the flows exchanged by Milan Branch and the Counterparty under the currency swap. Should Milan Branch enter into a similar currency swap with head office, no Italian withholding tax should be imposed on the flows thereof.
97.
A foreign tax credit for the Counterparty should be available to the extent to which the distributions on the PPI are included in determining the taxable income of the Counterparty for IRES purposes (i.e. 5% of the gross distributions).
Milan Branch 98.
Milan Branch, being the Italian permanent establishment of a foreign company, is liable to both IRES (levied at the rate of 33%) and IRAP (levied at the basic rate of 4.25%, with possible regional surcharges of up to an additional 1%) as Italian resident corporations.
99.
For Italian corporate income tax purposes, the taxable profit of the branch must be determined on the basis of specific profit and loss accounts (IAS/IFRS).
100. The PPI will be shown as an asset and the Counterparty Repo will be reflected as a liability in the branch accounts. In the profit and loss of the branch, the distributions on the PPI are accounted as a positive item of income and the repo return (being the algebraic sum of repo price differential less the distributions on the PPI) among costs and expenses. In the Branches tax computation, an adjustment will be made to ensure that the dividends are not subject to tax in the hands of the Milan Branch corresponding to the principle in paragraph 91. Upon transfer or redemption of the PPI at maturity of the transaction, gains/losses will be taxable/relievable at the level of Milan Branch.
Page 13 of 21
101. Any gains/losses arising from the currency swaps entered into by the Milan Branch with the Counterparty and its head office will be taxable/deductible for Italian tax purposes. 102. Should there be any transfer or redemption of the PPI in the hands of Milan Branch in exchange for the payment of its market value, Milan Branch should be exempt from Italian transfer tax (since this would be a transaction between a non-resident subject and a subject formally authorised to carry out investment services in Italy). 103. The Counterparty Repo should not be subject to transfer tax, VAT, nor imposta di registro (stamp duty) provided that the agreement is executed outside the territory of Italy, or by way of exchange of letters. Anti Avoidance 104. It should not be possible to challenge the transaction under discussion under article 37-bis of Decree 600/73 since the transaction should be based upon valid economic reasons: the Counterparty obtains an economic return before considering any tax element associated to trade which is higher than return available for comparable transactions and in any case material compared to the tax benefit at stake. Luxembourg Tax Analysis Corporate Income Tax 105. LuxParent should be regarded for Luxembourg purposes as the beneficial owner of the PPI in LuxSub if certain conditions are met, the most important of which is that the LuxParent Hedge will attribute sufficient control, risk and rewards over the PPI to LuxParent. LuxParent should be treated as entitled to and taxable on the gross PPI distribution. 106. LuxSub should be treated as earning exempt income as a result of the income deriving from a permanent establishment for Luxembourg purposes (UK Bare Trust). 107. The withholding tax on the PPI is required under Luxembourg tax law as a withholding tax on the payment of a distribution on a securitised profit participation instrument Net Wealth Tax 108. From a Luxembourg tax perspective, neither LuxParent nor LuxSub should have any net assets subject to net wealth tax. 109. LuxSub has no net wealth tax base because the permanent establishment is respected for net wealth tax purposes (i.e., the exemption from corporate income tax is followed for net wealth tax purposes). Capital Duty 110. Capital duty will be due and paid on the creation of LuxParent and LuxSub 111. No capital duty should be due on the issue of the PPI. Credit/Reimbursement 112. Any Credit/Reimbursement due would be paid to LuxParent following the finalisation of LuxParent’s tax assessment in accordance with Luxembourg law. It is currently envisaged that a reimbursement would be available within two months of the end of LuxParent’s accounting period. We are currently also exploring the possibility of receiving reimbursements on the basis of anticipated filings, i.e. accelerated reimbursements within two months of each underlying periodic withholding tax payment in connection with payments under the Instrument . Tax Capacity 113. Project Brontos does not require the use of UK tax capacity. 114. The transaction does not require any Luxembourg capacity. The Luxembourg WHT paid by LuxSub should be treated as a prepayment of corporation tax at the level of LuxParent. This is on the basis that LuxParent should be beneficially entitled to the coupon paid by LuxSub from a Luxembourg tax
Page 14 of 21
perspective and hence is treated as having borne the WHT. On the basis that LuxParent has net taxable income equal to the spread paid to LuxParent, the prepayment (less an amount representing tax on the spread) is expected to be refunded shortly after the assessment period is closed. Consequently, this transaction does not require any Luxembourg tax capacity. 115. Overall the only tax capacity usage is by the Counterparty in Italy. TAX RISK Luxembourg Tax 116. The Luxembourg tax treatment will be confirmed in a ruling from the Tax Inspector. The ruling is a confirmation of the application and interpretation of the law as its stands. Rulings are binding on the basis of the principle of “good faith” in Luxembourg law and are not limited to tax law. The effect of this principle is that where a taxpayer has relied on a ruling, the tax treatment which the ruling confirmed is applied by the tax administration. The principle of good faith is specifically included in the Abgabenordnung (Tax Administration Law) and has been confirmed in several court decisions in other areas of law. 117. The rulings are binding where the taxpayer (i) submits a written request, (ii) discloses all relevant facts, (iii) transacts in accordance with the facts set out in the disclosure, and the (iv) law remains current. On the basis that these conditions are met, the ruling obtained in relation to the Brontos structure is binding. 118. The tax reimbursement itself would not be subject to a ruling from the Luxembourg Tax Inspector, but it is expected that the Inspector would confirm that all relevant tax and administrative provisions which are relevant to obtaining a timely reimbursement are applicable to the facts set out before the Inspector. This confirmation would have the aim of providing comfort that the reimbursement, and its timing, would be made in line with our expectations. 119. SCM will ensure that the reimbursement due from the Luxembourg Tax Authorities does not exceed €[150]m at any one time. UK Tax 120. The only UK tax risk is the risk that LuxParent and LuxSub could be treated as CFCs. This is considered to be a very small risk on the basis that both companies will pursue ADPs and in any event, there is no motive to divert profits from the UK. Italian Tax 121. As described in paragraph 34, Barclays will represent that the payments under the PPI would benefit from the Italian tax exemption in the hands of Milan Branch were they to be received by the Branch, i.e. had Milan Branch not transferred the PPI under the Repo. The Counterparties’ benefit is dependent on the repo seller (Milan Branch) being able to satisfy this condition. As such, Barclays would indemnify the Counterparties for any loss of benefit as consequence of the representation not being satisfied. The potential risk to Barclays of the representation is €[52.8]m per annum per €[1,000]m investment for the Unicredito trade and €[14.2]m per annum per €[1,000]m investment for the Intesa trade (i.e. assuming that the Counterparty is indemnified on a grossed-up basis for its expected level of profit from the trade). It is envisaged that the transaction with Unicredito would involve an investment of up to €[2,500]m, and the transaction with Intesa would involve an investment of up to €[1,000]m. ACCOUNTING 122. The analysis below in respect of the solus accounts of BarSub, BBPLC and the consolidated accounts of BBPLC has been confirmed with SCM Finance. LuxParent and LuxSub accounting has been confirmed with KPMG Luxembourg and will be agreed with PwC in Luxembourg. IFRS Milan Branch (branch books and records) 123. The PPI will be accounted for as a loan and receivable under the heading ‘Amounts owed from Group undertakings’ and accounted for at amortised cost.
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124. The Milan Branch TRY Deposit will be accounted for as a liability under the heading ‘Amounts owed to Group’ and accounted for at amortised cost. 125. The Counterparty Repo will be accounted for as a deposit from the counterparty under the heading ‘Deposits from banks’ and measured at amortised cost. 126. The Barclays EUR Deposit will be accounted for as an asset under the heading ‘Amounts due from Group undertakings’ and accounted for at amortised cost. 127. The CCS will be recorded as a derivative and fair valued through the profit and loss account. 128. Foreign exchange gains and losses on the assets and liabilities listed above, that are denominated in TRY, will be recorded in the profit and loss account. SCM (books and records) 129. The Milan Branch TRY Deposit will be accounted for as an asset under the heading ‘Amounts due from Group’ and accounted for at amortised cost. 130. The Barclays EUR Deposit will be accounted for as a liability under the heading ‘Amounts due to Group’ and accounted for at amortised cost. 131. The Barclays TRY Deposit will be recorded as a liability under the heading ‘Amounts owed to Group undertakings’ and accounted for at amortised cost. 132. The Market EUR Deposit will be accounted for as an asset under the heading ‘Loans and Receivables’ and accounted for at amortised cost. 133. The £10m loan to LuxSub, funding the Portfolio will be accounted for as a loan and receivable under the heading ‘Amounts owed from Group undertakings’ and accounted for at amortised cost. 134. The TRS will be accounted for a derivative and marked to market. Solus Accounts – BBPLC 135. The Barclays TRY Deposit will be recorded as a liability under the heading ‘Amounts owed to Group undertakings’ and accounted for at amortised cost. 136. The Market EUR Deposit will be accounted for as an asset under the heading ‘Loans and Receivables’ and accounted for at amortised cost. 137. The PPI will be accounted for as a loan and receivable under the heading ‘Amounts owed from Group undertakings’ and accounted for at amortised cost. 138. The £10m loan to LuxSub, funding the Portfolio will be accounted for as a loan and receivable under the heading ‘Amounts owed from Group undertakings’ and accounted for at amortised cost. 139. The TRS will be accounted for a derivative and marked to market. 140. The Milan Branch TRY Deposit and the Milan Branch EUR Deposit will eliminate on integration of the Milan Branch and Head Office. Solus Accounts – BarSub 141. The LuxParent Forward will be a derivative contract which is fair valued through the profit and loss account. Luxembourg GAAP 142. Under Luxembourg law, non-listed Luxembourg companies are permitted to prepare accounts only under Luxembourg GAAP. (It is only possible to depart from this by special agreement with all relevant Luxembourg authorities, e.g. regulators, tax authority). The following accounting summary has been provided by KPMG Luxembourg and has been prepared under Luxembourg GAAP and on the basis that LuxParent and LuxSub have Euro functional currencies. The KPMG accounting analysis will be reviewed by PwC prior to execution of the transaction. Solus Accounts – LuxParent
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143. LuxParent will show the LuxParent Forward as a derivative and will recognise the mark-to-market movements in the profit and loss account reflecting payments on the PPI and TRY Libor payments due to BarSub. Solus Accounts – LuxSub 144. Since the primary asset and liability of LuxSub are in TRY, it is likely that the functional currency of LuxSub for Luxembourg GAAP purposes will be TRY. 145. The Barclays TRY Deposit will be recorded as an asset and accounted for at amortised cost. 146. The Portfolio will be recorded a liability; either as ‘Loans and Receivables’ or if the assets are securities, ‘Treasury Bills’ or ‘Debt Securities’. Interest income under the Portfolio will be accrued in the profit and loss account. 147. The TRS will be accounted for a derivative and marked to market. 148. The PPI will be shown as debt liability with expenses reflected in the profit and loss account. 149. If, contrary to paragraph 144, LuxSub has a Euro functional currency, specific rules dealing with foreign exchange translations will apply. Luxembourg GAAP has specific rules dealing with value adjustments (e.g. foreign exchange translations etc) in respect of principal amounts. The general principle is that losses are recognised in the P&L when they are probable, but gains are only shown in the P&L when they are certain. As a result, LuxSub discloses any downward value adjustments linked to the TRY. The corresponding value adjustment on the PPI or TRY Deposit is an unrealised gain which has no P&L impact on the basis that the gain is not certain and could unwind during the life of the TRY Deposit.
BBPLC Consolidated Accounts 150. For consolidation purposes LuxParent and LuxSub will have EUR functional currencies being an extension of SCM’s European business. 151. BarSub, LuxParent and LuxSub will be consolidated by BBPLC as they are wholly owned and controlled by BBPLC, and BBPLC is exposed to the risk and rewards of the entities. They will be consolidated under IAS27. 152. On a consolidated basis the only external items to Barclays group are the: 152.1.
Counterparty Repo which will be accounted for at amortised cost as a liability under the heading ‘Deposits from banks’. The fee receivable from the counterparty will be included in the effective yield in repo (adjustment to repo rate), i.e. accrued over the term of the repo;
152.2.
Market EUR Deposit which will be accounted for as an asset under the heading ‘Loans and Receivables’ and accounted for at amortised cost; and
152.3.
CCS which will be fair valued through the profit and loss account.
152.4.
The Portfolio will be recorded a liability; either as ‘Loans and Receivables’ or if the assets are securities, ‘Treasury Bills’ or ‘Debt Securities’. Interest income under the Portfolio will be accrued in the profit and loss account.
153. Overall, Barclays obtains sub-libor funding from Counterparty shown as a sub libor spread on the Repo.
Counterparty Accounting 154. We understand that counterparties would show the transaction as a secured lending (i.e., deposit with Barclays) under IFRS. Standard interagency representations and warranties (including accounting treatment) will be agreed between the parties.
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REGULATORY CAPITAL Current Arrangements (Basel I) 155. On a solus and consolidated basis the transaction will use WRAs on the CCS which are equal to the counterparty risk weighting of 20% multiplied by of the sum of (i) [1]% of the Notional Amount plus (ii) any positive mark-to-market WRAs. 156. Any additional equity funding of BarSub from BBPLC, in order for BarSub to establish LuxParent will be a deduction from capital. The amount of any additional equity funding is expected to not exceed €[25,000]. 157. The subscription for the PPI by BBPLC (Milan Branch) will create an internal large exposure which will be mitigated by legal set off against the Barclays TRY Deposit. The set off will be by way of a side letter between BBPLC and LuxSub. Basel II 158. WRAs and exposure on CCS at the solus level will be subject to model in respect of risk weighting and exposure measurement (EPE). CREDIT 159. Barclays is not expected to take credit risk on the Counterparty under this transaction. However, it may have settlement risk to Counterparty for the return paid under the PPI.
CLIENT ENGAGEMENT Unicredito 160. The following staff of Unicredito have been engaged in the origination process to date: •
Ranieri De Marchis (CFO)
•
Luciano Tuzzi (Deputy CFO)
•
Stefano Porro (Head of SCM)
•
Nicola Gerundino (SCM)
•
Patrizio Braccioni (Head of Tax).
Intesa 161. The following staff of Intesa have been engaged in the origination process to date: •
Enea Saldarini (Head of SCM)
•
Federico Manna (SCM)
•
Giovanni Carpenzano (Head of Tax)
MATERIALITY OF PROPOSED TRANSACTION 162. The proposed transactions with Unicredito and Intesa, would involve investments by the Counterparty of up to €[2,500]m and €[1,000]m respectively. 163. The tables below summarise key financial data for each potential counterparty.
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Unicredito
Increase in Pre-Tax Income*
€ 14.25m
Total Tax Cashflow*
€ 152.0m
2005 PBT (UniCredito Group)
€ 5,603m
2005 taxes (UniCredito Group)
€ 1,719m
2005 Net Income (UniCredito Group)
€ 3,884m
Total assets as at 31 Dec 2005 (UniCredito Group)
€ 787,000m
Aggregate of share capital + reserves + net profit (UniCredito Group)
€ 39,300m
Intesa
Increase in Pre-Tax Income*
€ 1.4m
Total Tax Cashflow*
€ 15.2m
2005 PBT**
€ 6,751m
2005 taxes**
€ 1,843m
2005 Net Income**
€ 4,902m
Total assets as at 31 Dec 2005
€ 534,379m
Aggregate of share capital + reserves + net profit
€ 51,674m
* Based on a 12 month trade. ** 2005 numbers refer to the aggregated results of Banca Intesa S.p.A and Sanpaolo IMI S.p.A. (both having reported separately for the year ended 31 December 2005). PROVISION 164.
SCM proposes a nil provision on the basis that there is no material UK or Italian tax risk, and the Luxembourg tax analysis will be ruled in advance of any transaction.
Enclosures Appendix 1: Background Information Appendix 2: Draft Italian Tax Opinion (Freshfields Milan)
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Appendix 1: Background Information Profit Participating Instrument The PPI will have the following key features: 1.1.
The PPI will be issued in the form of a Genussschein. Genussschein are classified as debt instruments under civil law but can qualify as equity for tax purposes in both Italy and Luxembourg.
1.2.
The PPI holder will be entitled to a return that is equal to a proportion of the Issuer’s “profits” available, as defined in the PPI and subject to a cap which will be equal to a TRY Libor return on the principal amount of the PPI, for a maturity which corresponds to the frequency of the payment dates. The issuer is entitled to make advance payment on a quarterly or semi-annual basis. Should the amounts paid in this way exceed the profit determined in the issuer’s annual accounts the issuer will be entitled to a rebate.
1.3.
In the event of liquidation or early termination, the PPI holder participates in the good-will and hidden reserves of the issuer accumulated during the term of the instrument in the form of a redemption premium (or discount).
1.4.
The PPI will be documented as a freely transferable, registered instrument.
1.5.
In cases where the holder and issuer of the PPI are in the same accounting group the terms of the PPI will allow for the PPI to be redeemed by mutual agreement of the issuer and holder at fair market value.
1.6.
The issue amount of the PPI does not form part of the share capital of the issuer.
1.7.
The PPI holder has no shareholder rights, in particular the PPI holder has no management, control, information or voting rights.
1.8.
LuxSub will enter into a separate agreement with LuxParent under which LuxSub must seek written consent from LuxParent before any issuance or transfer of PPI.
1.9.
The issuer of the PPI is permitted to use the proceeds to make investments, either directly or indirectly by entering into agency, nominee or trust arrangements. The Issuer will obtain income from entities which (1) are resident in EU member states (as at the date of the issue of the Profit Participating Instrument), and (2) which benefit from the relevant double tax treaties (i.e., are not excluded entities) and (3) which have a credit rating of at least “AA” by S&P or “Aa2” by Moody’s.
1.10. Distributions made under the PPI will be non-deductible for Luxembourg Tax purposes (a point which will be covered in a ruling). Issuer will represent such fact to the holder of the PPI. 1.11. Any transfer of the PPI will, at the election of the Holder before such transfer, trigger a distribution of the accrued profit. 1.12. Issuer will also undertake to provide the holder of the PPI with a certificate setting forth the payment made under the PPI and the withholding taxes withheld from such payment.
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UK Bare Trust 2. Head Office makes a loan to LuxSub of €[10]m which pays Euribor on a quarterly basis. LuxSub directs Head Office to transfer the funds directly to the Trust which will invest them in accordance with the trust agreement. 2.1.
An existing UK tax resident investment company subsidiary of Barclays (likely to be Barafor Limited) will be appointed trustee of the Trust (“Trustee”).
2.2.
The trust agreement will provide for the Trustee to invest up to €[10]m in three or more separate assets (the “Portfolio”) consisting of: 2.2.1.
cash deposits with and securities issued by Barclays; and
2.2.2.
OECD government securities rated at least “AA” by S&P or “Aa2” by Moody’s; and
2.3.
Head Office and LuxSub via the Trust will enter into a Total Return Swap (“TRS”) under which the LuxSub will swap its return on the portfolio, including any credit events or fluctuations in the value of the portfolio assets, for a [3 month] Euribor return.
2.4.
Within the strict investment guidelines the Trustee is able to choose whatever assets, and new assets will be purchased on an approximately quarterly basis.
The Trustee will receive a fee from BBPLC (SCM) of c. €[10,000] per annum for its role as trustee to the Trust. The Trustee will prepare audited Trust accounts.
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Memo
Barclays Capital
To
SCM Approvals Committee
From
Michael Keeley
Date
5 February 2007
Subject
Approvals Paper – Project Knight: BB&T
1.
INTRODUCTION
Structured Capital Markets (“SCM”) are seeking approval to propose a financing transaction (“Project Knight”) between Branch Banking and Trust Company (“BB&T”) and Barclays Capital’s Luxembourg operations (“BarLux”). Subject to approval by BarLux, it is intended that three separate Project Knight transactions will be executed up to a total product limit of $[16,250]m. Separate approvals will be sought for the other two transactions in due course. Summary Project Knight involves BarLux establishing a new UK limited partnership (“UKLP1”), which subscribes $[4,000]m for a limited partnership interest (the “Subscriber Interest”) in a UK limited partnership (“UKLP2”) established by BB&T. UKLP2 will lend its funds to a company in the BB&T group (“BB&TSub3”). UKLP1 will agree to retire as a partner in return for payment from BB&T in 3 years’ time. Project Knight results in net funding of $[4,000]m to the BB&T group, which is fully collateralised with real estate and vehicle loans from BB&T and its subsidiaries. UKLP1 will receive an enhanced pre-tax return from its investment in the Subscriber Interest. This approvals paper contains a description of all significant accounting, regulatory, tax, credit, market and operational risks. Economic Benefit The economic benefit of the transaction is derived from the fact that UKLP1’s pre-tax return from the Subscriber Interest represents an above-LIBOR return on the investment made. Though the majority of the income received by UKLP1 will have been subject to US withholding tax at 30%, it is not expected to be subject to further taxation in Luxembourg. BB&T achieves an effective funding rate of 40 bps below LIBOR, which equates to a split between Barclays and BB&T on a pre-tax equivalent basis in the ratio of approximately 80:20 in Barclays’ favour. Key financial data for the transaction is set out below based on the proposed lending of $[4,000]m and assuming a 3-year USD swap rate of 5.1%: Product Limit
$[16,250]m* ($[4,000]m for BB&T transaction)
Estimated PTE revenue (Barclays consolidated)
$[65]m p.a. (Pre-Provision)
Tax capacity Return on Tax capacity PUG
$[205]m [31.7]% (Pre-Provision) 1 $[0] (Pre-Provision)
Tenor
[3] years
WRAs
$[813]m
* Product limit amount is the aggregate for all 3 contemplated Knight transactions. SCM propose a provision of 40% and based on this the post-provision annual economics are as follows:
Product Limit Estimated PTE revenue (Barclays consolidated)
$[16,250]m* ([4,000]m for BB&T transaction) $[32]m p.a. (Post-Provision)
Tax capacity Return on Tax capacity
$[205]m [15.6]% (Post-Provision)
PUG
Negative $[32]m p.a. (Post-Provision)
Tenor
[3] years
WRAs
$[813]m
Return on WRAs
[3.9]% (Post-Provision)
* Product limit amount is the aggregate for all 3 contemplated Knight transactions. 2.
TRANSACTION DESCRIPTION
2.1
Funding Structure Establishment and Funding of UKLP1
UK HoldCo : Prefs $4,008m, Ords $5m UK HoldCo UK
Lux HoldCo : Prefs $4,007m, Ords $5m Lux HoldCo $10m
Lux HoldCo Portfolio
UKLP1 GP Interest $1m
Lux
$2m
UKLP1 LP Interest $4,000m
Trust
UKLP1 UKLP1 UK
$1m UKLP1 Portfolio
2.1.1
Barclays will fund the structure by capitalising a newly incorporated Cayman Islands limited company which will be tax resident in the UK (“UK HoldCo”), which will in turn capitalise a Luxembourg S.a.r.l. (“Lux HoldCo”). Lux HoldCo will be set up and operated by Barclays Capital Luxembourg S.a.r.l. (“BCL”) and will have access to the necessary staff and premises to conduct its activities via a silent partnership agreement with BCL.
2.1.2
Barclays will subscribe $[4,008]m for the preference shares in UK HoldCo (the “UK HoldCo Prefs”) and $[5]m for the ordinary shares in UK HoldCo (the “UK HoldCo Ords”).
2
2.1.3
UK HoldCo will subscribe $[4,007]m for preference shares in Lux HoldCo (the “Lux HoldCo Prefs”) and $[5]m for the ordinary shares in Lux HoldCo (the “Lux HoldCo Ords”).
2.1.4
Lux HoldCo will subscribe $[4,000]m for the limited partnership interest in UKLP1 (the “UKLP1 LP Interest”) and UK HoldCo will subscribe $[1]m for the general partnership interest in UKLP1 (the “UKLP1 GP Interest”).
2.1.5
Lux HoldCo will invest $[10]m in a portfolio of high-grade US Dollar-denominated debt securities (the “Lux HoldCo Portfolio”) and $[2]m in a trust as detailed in Appendix 2.
2.1.6
UKLP1 will invest $[1]m in a portfolio of high-grade US Dollar-denominated debt securities (the “UKLP1 Portfolio”).
2.1.7
A detailed description of the funding and the steps required to mitigate the Luxembourg Capital Duty is provided in Appendix 1
2.2
Investment Structure Establishment and Funding of UKLP2
BB&TSub2
BB&TSub1 US
US
UKLP2 LP Interest $1,318m
UKLP2 GP Interest $1m
UKLP2 UKLP2 UK
UKLP2 Portfolio $1m
UKLP2 Portfolio
2.2.1
BB&T will form two Delaware limited liability companies (“BB&TSub1” and “BB&TSub2”). BB&TSub1 and BB&TSub2 will form an English law limited partnership (“UKLP2”). BB&TSub1 will subscribe $[1]m for a general partnership interest in UKLP2 (the “UKLP2 GP Interest”), and BB&TSub2 will subscribe $[1,318]m for a limited partnership interest in UKLP2 (the “UKLP2 LP Interest”).
2.2.2
BB&T will also form BB&TSub3, a Delaware corporation.
2.2.3
UKLP2 will invest $[1]m in a portfolio of high-grade US Dollar-denominated debt securities (the “UKLP2 Portfolio”).
3
Subscriber Interest and Retirement Agreement
IRS $4,000m notional
UK HoldCo : Prefs $4,008m, Ords $5m
UK HoldCo Forward over Subscriber Interest
BB&TSub 2
BB&TSub 1
US
UK
Lux HoldCo : Prefs 4,007m, Ords $5m
US
Lux HoldCo UKLP2 LP Interest $1,318m
CDS, Call Option and Charge
UKLP2 GP Interest $1m
Lux
UKLP1 LP Interest $4,000m Subscriber Interest $4,000m
UKLP2 UKLP2
UKLP1 GP Interest $1m UKLP1 UKLP1
UK
UK
Loan $5,318m
BB&TSub 3 US
2.2.4
BB&T will enter into an agreement with UKLP2 (the “Procurement Agreement”) to procure a third party to subscribe $[4,000]m for the Subscriber Interest, or failing that, to do so itself.
2.2.5
Pursuant to an invitation letter (the “UKLP1 Invitation Letter”), BB&T will invite UKLP1 to subscribe for the Subscriber Interest and thereby to become a partner in UKLP2.
2.2.6
As described above, UKLP1 will subscribe $[4,000]m for the Subscriber Interest.
2.2.7
The UKLP2 partnership agreement (the “Partnership Agreement”) will provide that: • • • •
The Subscriber Interest will entitle the holder to monthly distributions of [99]% of the first $[271]m of gross annual income of UKLP2; The UKLP2 GP and LP Interests will entitle the holder to monthly distributions of [0.00076]% and [0.99924]% respectively of the first $[271]m of gross annual income of UKLP2; All of the residual gross annual income of UKLP2 will be apportioned between the UKLP2 GP and LP Interests in accordance with their initial subscription amounts; Expenses of UKLP2 (excluding taxation) will be apportioned among the members firstly by reference to the allocation of the residual gross annual income of UKLP2 (up to the amount of such allocations); and secondly by reference to the allocations of the first $[271]m of gross annual income of UKLP2 (up to the amount of such allocations); 4
• 2.2.8
Taxation will be apportioned among the members of UKLP2 in accordance with the actual allocations of gross partnership profits of UKLP2 as given by the above methodology.
Simultaneously, UKLP1 will enter into an agreement under which it will agree to retire from UKLP2 and permit BB&T to be admitted to UKLP2 on the same terms (the “Retirement Agreement”). Under the Retirement Agreement, UKLP1 will agree to retire in [3] years’ time (or earlier on (i) [1] business day’s notice by Barclays if BB&T were to become insolvent or the security interest in the Collateral (defined below) is determined to be invalidly perfected, (ii) [5] business days’ notice by Barclays (iii) or [5] – [20] business days’ notice by BB&T) for a formula price (the “Retirement Amount”) equal to the aggregate of: (i)
UKLP1’s initial capital contribution to UKLP2 (i.e. $[4,000]m);
(ii)
interest linked to the 3-year USD swap rate (accruing on a monthly basis); and
(iii)
any interest on any shortfall in expected distributions on the Subscriber Interest
minus the aggregate of:
2.2.9
(i)
partnership distributions made in respect of the Subscriber Interest;
(ii)
a breakage amount should the transaction be unwound by Barclays within [90] days of closing); and
(iii)
any interest on any excess in expected distributions on the Subscriber Interest.
If Barclays retires from UKLP2 on 5 business days’ notice, then BB&T will have the option to borrow an amount equal to the Retirement Amount from UKLP1 for a term of 55 calendar days at a pre-agreed rate (the “Retirement Loan”). After the first 25 calendar days, the rate on the Retirement Loan will increase by a spread which will economically incentivise BB&T to redeem the Retirement Loan. UKLP1 will retain the collateral package set out in 2.2.10 during this period.
2.2.10 BB&T will collateralise the Retirement Agreement by pledging $[4,000]m of collateral (the “Collateral”) to UKLP1 in support of its obligation to pay the Retirement Amount. The Collateral is expected to comprise of real estate and vehicle loans. 2.2.11 UKLP1 will pledge the Subscriber Interest in favour of BB&T in support of its delivery obligations under the Retirement Agreement. 2.2.12 UKLP2 will lend $[5,318]m (the “BB&TSub3 Loan”) to BB&TSub3. The BB&TSub3 Loan will have a [3]-year term and will carry fixed monthly interest equal to the [3]-year USD swap rate at issue. 2.2.13 BB&T will enter into a 3-year par break interest rate swap with a notional of $[4,000]m (the “IRS”) with Barclays under which BB&T will pay 1-month USD LIBOR and receive 3-year USD swap rate on a monthly basis.
2.3
Key Periodic Flows
2.3.1
UKLP2 will receive monthly payments of USD interest on the BB&TSub3 Loan net of 30% US withholding tax.
2.3.2
UKLP2 will pay out the majority of its income to UKLP1 as monthly partnership distributions on the Subscriber Interest. UKLP2’s remaining profits will be distributed to BB&TSub1 and BB&TSub2 as holders of the UKLP2 GP Interest and the UKLP2 LP Interest, respectively.
5
2.3.3
UKLP1 will pay out the majority of its income to Lux HoldCo as monthly partnership distributions on the UKLP1 LP Interest.
2.3.4
Lux HoldCo will use all cash received to subscribe for further Trust Units and the Trust will lend the money interest-free back to Lux HoldCo (the “Trust Loans”).
2.3.5
Lux HoldCo will place the cash received from the Trust Loans on deposit with external financial institutions (the “External USD Deposits”).
2.3.6
Barclays will borrow enough US dollars to satisfy its monthly obligations under the IRS (the “Barclays External Borrowing”) from external sources.
2.3.7
Barclays will receive 1-month USD LIBOR and will pay BB&T 3-year USD swap rate under the IRS.
2.3.8
Barclays will pay 1-month USD LIBOR on its funding.
2.4
Hedging Arrangements
2.4.1
Barclays will designate the USD Deposits (defined in Appendix 1) and Barclays External Borrowing as a functional currency hedge of the investment in the US dollar functional currency branch comprised of UK HoldCo and its subsidiaries. At the solus level, they will similarly be designated as a foreign exchange hedge of Barclays’ investment in UK HoldCo.
2.5
Maturity/Early Termination
2.5.1
On maturity (expected to be after a term of 3 years and assuming the Retirement Loan is not advanced): •
The Retirement Agreement will complete.
•
UKLP1 will receive the Retirement Amount from BB&T.
•
UKLP1 will retire from UKLP2.
•
BB&T will be admitted to UKLP2.
•
The Collateral will be returned to BB&T.
•
The UKLP1 Portfolio will be liquidated.
•
UKLP1 will be dissolved. Lux HoldCo and UK HoldCo will retain the funds in the form of USD assets. Lux HoldCo is expected to use the funds to seek alternative investment opportunities.
•
The IRS will be terminated.
6
3.
ECONOMICS AND ECONOMIC DRIVERS
3.1
Project Knight will result in an enhanced return on Lux HoldCo’s indirect investment in UKLP2. This is due to the fact that the pre-tax return on the Subscriber Interest is an above-LIBOR return on the investment made.
3.2
Though the majority of the income earned by Lux HoldCo will have been subject to US withholding tax at a rate of 30%, it is not expected to be subject to further taxation in Luxembourg.
3.3
A summary of the annual economics of the transaction is given in the tables below: Inputs Barclays investment in the Transaction ($m) Barclays USD funding cost Barclays investment in USD securities ($m) Barclays investment in UKLP2 ($m) BB&T investment in UKLP2 ($m) Luxembourg tax rate
4,013 5.10% 13 4,000 1,319 29.63%
US federal tax rate Tax provision level
35.00% 40.00%
BBPLC Consolidated Position Gross income Funding costs Pre-tax income
269.22 (204.66) 64.56
US WHT paid Luxembourg income tax paid UK tax Post tax benefit
(80.55) (0.18) 61.38 45.20
Provision (40%)
(22.56)
Post Tax benefit (post-provision)
22.64
PTE benefit (post-provision)
32.34
Benefit split (in favour of BBPLC)
80.1%
Figures in these tables are expressed in USD millions. 3.4
BB&T’s benefit from the transaction arises from the fact that it obtains a sub-LIBOR funding on its borrowing. This equates to a benefit of 40 bps on $[4,000]m (i.e., $[16]m).
4.
TAX ANALYSIS
4.1
Luxembourg Tax Analysis
4.1.1
It is intended that the Luxembourg tax treatment will be formally confirmed in rulings prior to the commencement of the transaction and this will be a condition of approval.
4.1.2
We have received an opinion from KPMG Luxembourg confirming the proposed analysis for the transaction which is included as Appendix 3. The key points of the analysis are as follows:
7
Corporate Income Tax 4.1.3
Any income realised by UKLP1 whether or not distributed to Lux HoldCo or UK HoldCo should be tax exempt in Luxembourg under Luxembourg domestic principles.
4.1.4
Lux HoldCo should be fully taxable on the interest generated from the Lux HoldCo Portfolio and any interest earned on profits placed on deposit (after deduction of management expenses). Capital Duty
4.1.5
Capital Duty is currently payable on the creation of share capital at a rate of 1% of the capital created.
4.1.6
However, Capital Duty should be limited to relatively immaterial amounts and in particular the asset contributions made by UK HoldCo for the Lux HoldCo Prefs should not be subject to Capital Duty due to the application of a whole business contribution exemption. (See Appendix 1) Net Wealth Tax
4.1.7
Net wealth tax is payable each year at a rate equal to 0.5% of net assets.
4.1.8
The UKLP1 LP Interest should be an exempt asset for net wealth tax purposes.
4.1.9
Net wealth tax on Lux HoldCo’s profits placed on deposit will be mitigated by means of the structure detailed in Appendix 2.
4.2
UK Tax Analysis Corporation Tax
4.2.1
The key points of the intended UK tax analysis are set out below, and a draft opinion from Slaughter & May confirming the analysis is attached at Appendix 4.
4.2.2
Project Knight will not require Treasury Consent or Treasury Notification.
4.2.3
No apportionment of the “chargeable profits” of any entity involved in the transaction should be required under UK CFC legislation.
4.2.4
Barclays should be able to deduct interest paid on the USD Deposits and any net payments made under the IRS for UK tax purposes.
4.2.5
No stamp duty should be payable in respect of the transaction.
4.2.6
Barclays will indemnify BB&T for any UK tax liabilities arising to it from the arrangements but no such liabilities are envisaged.
8
5.
TAX RISKS
5.1
US Tax Risks
5.1.1
Project Knight does not involve Barclays undertaking any direct US tax risks. All US tax risks will be borne by the BB&T group.
5.1.2
Sullivan & Cromwell’s US tax opinion confirming BB&TSub3’s requirement to withhold US tax on the interest paid in respect of the BB&TSub3 Loan is attached as Appendix 5. Sullivan & Cromwell have also confirmed that no US withholding tax should be imposed on any amount due under the Retirement Agreement to the extent UKLP1 provides a properly completed IRS Form W8BEN and/or W-8IMY to BB&T.
5.2
Luxembourg Tax Risks
5.2.1
As the transaction will be subject to rulings in Luxembourg and this will be a condition of approval, it is not considered that any material Luxembourg tax risks will exist.
5.3
UK Tax Risks The following issues have been considered by Slaughter and May in their opinion. CFC
5.3.1
No apportionment of the chargeable profits of any entity involved in the transaction should be required under UK CFC legislation.
5.3.2
The ECJ has confirmed in the case of Cadbury Schweppes that the UK’s CFC rules contravene EU law by constituting a restriction on the freedom of establishment within the EU. The ECJ stated that such a restriction would be justified only to the extent that it affects “wholly artificial” arrangements. Lux HoldCo will be validly established with genuine economic presence in Luxembourg.
5.3.3
In addition, Lux HoldCo is not expected to be subject to a “lower level of taxation” in Luxembourg, as the local tax paid in Luxembourg will be greater than 75% of the corresponding UK tax. Therefore Lux HoldCo would not be expected to be a CFC even in the absence of the Cadbury Schweppes decision.
5.3.4
The Government has recently proposed to amend the CFC rules following the ECJ decision. However it is not considered that the proposed changes go far enough to deal with the issues raised by Cadbury Schweppes. We accordingly expect that there will be further changes required once the UK Courts have considered the ECJ decision which is due to take place later this year. Repatriation of Profits
5.3.5
On an ultimate repatriation of the profits of Lux HoldCo to the UK, HMRC might seek to challenge the availability of a credit for any underlying US withholding tax paid by the application of s804ZA ICTA 1988. Accordingly, it is intended that Lux HoldCo will not repatriate profits to the UK in the form of dividends.
9
Para 13 FA 1996/ Para 23 Sch 26 FA 2002 5.3.6
HMRC may contend that the USD Deposits have an “unallowable purpose” and seek to deny deductions for debits arising in respect of interest paid on the USD Deposits under Para 13 Sch 9 FA 1996.
5.3.7
As Barclays would have accepted the USD Deposits regardless of whether or not the transaction were to be entered into, we believe that Barclays cannot be said to accept the USD Deposits with a main purpose of securing a tax advantage and that Para 13 cannot operate to deny relief in the above manner.
5.3.8
Similar arguments could be raised in respect of the IRS under Para 23. However, based on current interest rates there are expected to be net-taxable credits on the IRS in 2007 and we accordingly consider this risk to be very low.
6.
DISCLOSURE
6.1
Project Knight is not disclosable in the UK.
6.2
Sullivan & Cromwell’s opinion confirming that the transaction is not reportable in the US is attached as Appendix 5.
7.
ACCOUNTING The accounting analysis is in the process of being agreed with Finance. An accounting opinion will be obtained from PwC before closing.
7.1
IFRS ANALYSIS Barclays Consolidated Accounting
7.1.1
A full accounting analysis is given in Appendix 6. A summary of Barclays’ consolidated position is given below.
7.1.2
The USD Deposits and Barclays External Borrowings will be accounted for in the usual way. However, sufficient borrowings to match the investment in the capital and reserves of UK HoldCo will be designated from time to time as a fair value foreign currency hedge of the investment in UK HoldCo and its subsidiaries.
7.1.3
The IRS will be a derivative for IAS 39 purposes and will be carried at fair value through profit and loss.
7.1.4
The combination of the acquisition of the Subscriber Interest and the Retirement Agreement will be accounted for as a secured loan to BB&T on the basis that the instruments were entered into at the same time and in contemplation of each other. Barclays will recognise its share of the gross income of UKLP2 and its share of the withholding tax thereon as part of the tax charge in its consolidated profit and loss account.
7.1.5
The UKLP1 and Lux HoldCo Portfolios will be recognised as available for sale assets and income will be recognised using the effective interest method whilst changes in fair value will be taken through equity.
10
7.1.6
For consolidation purposes it will be necessary to retranslate the dollar profit earned by Lux HoldCo into sterling. In order to achieve this, the dollar result for each month will be converted to sterling at the month end rate. This calculation will be performed by multiplying the dollar result for the month by the USD:GBP exchange rate (i.e. as opposed to dividing by the GBP:USD exchange rate).
7.1.7
In accordance with IAS21.45 the foreign exchange gains and losses recognised on the UK HoldCo Prefs will not be taken to equity but will remain in profit and loss (noting that the UK HoldCo Prefs will not constitute part of the net investment in the US functional currency foreign operation because the 20 year redemption clause means that it cannot be said that “settlement is neither planned nor likely to occur in the foreseeable future”).
7.2
US GAAP Barclays Consolidated Accounting Analysis
7.2.1
The Retirement Agreement will not be a derivative because it is not capable of net settlement (Para 6 SFAS 133).
7.2.2
The acquisition of the Subscriber Interest plus the Retirement Agreement will not be equivalent to a sale of the Subscriber Interest by the BB&T Group within the meaning of Para 6 SFAS 140. In particular UKLP1 will not be permitted to sell or pledge the Subscriber Interest without permission from BB&T and BB&T will be both entitled and required to purchase the Subscriber Interest under the terms of the Retirement Agreement. Accordingly, the transaction will be accounted for as a secured lending in the Barclays Group accounts (Para 12 SFAS 140).
7.2.3
Barclays will recognise the net distributions from UKLP2 as interest on this secured lending (i.e. it will not gross up for withholding tax).
7.2.4
The IRS will be a derivative for SFAS 133 purposes and will be carried at fair value. BB&T Consolidated Accounting Analysis
7.2.5
BB&T will consolidate BB&TSub1, BB&TSub2, BB&TSub3 and UKPL2 for US GAAP purposes.
7.2.6
The combination of the issuance of the Subscriber Interest and the Retirement Agreement will be accounted for as a borrowing by BB&T secured by the Subscriber Interest.
8.
REGULATORY CAPITAL WEIGHTED RISK ASSETS Consolidation
8.1.1
UK HoldCo, Lux HoldCo and UKLP1 will form part of Barclays’ consolidated regulatory group because Barclays will own 20% of the votes in these entities.
8.1.2
UKLP2 will not form part of Barclays’s consolidated regulatory group due to the transfer of risks to BB&T under the Retirement Agreement. Instead, Barclays will have an exposure to BB&T which is weighted at [20]%, giving WRAs of $[800]m.
11
8.1.3
The UKLP1, Lux HoldCo and Trust Portfolios are expected to be high grade US Dollar denominated debt securities, which attract a risk weighting of [100]%. Barclays will therefore have WRAs of $[13]m in respect of these holdings.
8.1.4
The total WRAs marked in respect of the above exposures will be $[813]m. It is expected that this number will be reduced significantly under Basel 2 due to the Collateral. Solus Level
8.1.5
Pursuant to the LE structure set out in Appendix 1, Barclays will have an exposure to BB&T which is weighted at [20]%, giving WRAs of $[800]m.
8.1.6
The $[5]m UK HoldCo Ords will be deducted from the solus capital ratio (i.e., $5m/10% = $50m).
8.1.7
The above treatments have been agreed with SCM Finance. LARGE EXPOSURES Internal
8.1.8
Absent the arrangement set out in Appendix 1, Barclays would have an internal large exposure of $[4,008]m to UK HoldCo by virtue of the UK HoldCo Prefs. As described in Appendix 1, Barclays will mitigate $[4,000]m of the internal large exposure in respect of the UK HoldCo Prefs by having UKLP1 in effect guarantee UK HoldCo’s obligations to Barclays with regards to the UK HoldCo Prefs pursuant to CDS 1. There will be a right of set off between payments due under CDS 1 and the Call Option. External
8.1.9
The Barclays Group will mark an exposure to the BB&T Group equal to the maximum exposure of UKLP1 to BB&T under the Retirement Agreement (i.e., $[4,000]m).
8.1.10 Finance have confirmed that, based upon the 31 December 2006 numbers, Barclays will not need to seek approval from the FSA for an increase in the consolidated pre-notification limit against BB&T. 8.1.11 The Barclays Group will mark an exposure to the third party counterparties in respect of the Lux HoldCo, UKLP1 and Trust Portfolios equal to $[13]m in the aggregate. Basel II 8.1.12 On introduction of Basel II, it is understood that exposures to the UK Integrated Group will be treated as exempt. 8.1.13 As such, Barclays’ exposure to the $[4,008]m UK HoldCo Prefs will fall away being replaced by UK HoldCo’s exposure to the $[4,007]m Lux HoldCo Prefs. 8.1.14 CDS 1 will fall away. 8.1.15 UKLP1 will effectively guarantee Lux HoldCo’s obligations to UK HoldCo with regards to principal amount of the Lux HoldCo Prefs by entering into a credit default swap (“CDS 2”). 12
8.1.16 Barclays will assign the Call Option and the Charge to UK HoldCo. 8.1.17 UK HoldCo will be entitled to offset any amounts due by UK HoldCo under the Call Option against any amounts due to UK HoldCo under CDS 2 in respect of the Lux HoldCo Prefs. 8.1.18 Upon introduction of Basel II, the LE mitigation operates in the same way in that the substantive effect of the arrangements is that UK HoldCo never has an economic exposure to the performance of Lux HoldCo. This is because, in all circumstances in which an amount becomes due under CDS 2, the Call Option is accelerated and there is an offset between the amounts due to UK HoldCo under the CDS 2 and the Call Option strike price payable by UK HoldCo. Therefore, notwithstanding that UKLP1 is not considered an eligible guarantor under Basel II in respect of the unfunded credit derivative constituted by CDS 2, UK HoldCo's only exposure is to the performance of BB&T under the Retirement Agreement. 9.
CREDIT & MARKET RISK
9.1
Credit analysis of the underlying assets and security arrangements will be conducted in the normal way and approved by GFRM prior to closing.
9.2
Consistent with the accounting treatment set out in Appendix 6, Barclays will treat the Subscriber Interest together with the Retirement Agreement as a secured loan to the BB&T Group. The loan will therefore give rise to a credit exposure equal to the Retirement Amount. BB&T is expected to pledge the Collateral in support of its obligations under the Retirement Agreement (i.e., satisfaction of the Retirement Amount).
10.
PROVISION
10.1
It is proposed that a pre-tax provision of [40]% of the tax on the CFC apportionment be applied to the transaction.
11.
CLIENT ENGAGEMENT
11.1
Morris Marley (Treasurer), Ken Daniels (Executive Vice President), Hal Johnson (Executive Vice President), Margaret Fletcher (Senior Vice President), John Foreman (Senior Vice President), Howard Hudson (Associate General Counsel), John Watson (Executive Vice President), Mark Livingston (Senior Vice President), Ken Fitchett (Senior Vice President), Kathy Coffield (Assistance Vice President), and Melodye Tomlin (Senior Vice President) of BB&T have been engaged in the origination process. In addition, the CEO, John Allison has approved in principle Project Knight.
11.2
The deal will be submitted for approval to the Board of Directors of BB&T and is expected to take place on 20 February 2007.
11.3
SCM will obtain further confirmation from appropriate senior personnel within the BB&T organisation (but outside of the deal team) that the transaction has been approved by senior management within the BB&T organisation.
12.
MATERIALITY OF DEAL WITH COUNTERPARTY
12.1
As a result of the transaction, the BB&T group is expected to raise net funding of $[4,000]m and receive pre-tax enhancements of approximately $[16]m per annum. 13
12.2
Overall the BB&T group will be taxed on its economic return from the transaction and as such the tax charge in its consolidated accounts will increase. Project Knight should not however materially impact the effective federal tax rate of BB&T as BB&T will be subject to US federal income tax equal to 35% on the benefit generated from the transaction.
12.3
Based on the BB&T financial statements for the year ended 31 December 2005, Barclays’ investment in the Subscriber Interest and Retirement Agreement will increase the gross assets of BB&T by approximately [3.66]% (i.e., $[4,000]m/$[109,170]m) and gross liabilities by [4.08]% (i.e., $[4,000]m/$[98,041]m). The pre-tax return generated from the transaction would increase the total profit before tax of BB&T by approximately [0.65]% ($[16]m/$[2,467]m) and increase their current federal income taxes payable by approximately [8.77]% (i.e., $[5.6]m/$[638]m) in a full year.
12.4
In 2002, Barclays entered into a STARS transaction with BB&T which is due to mature in August 2007. Pursuant to the STARS transaction, BB&T raised net funding of $1,500m and receives a pre-tax enhancement of approximately $53.5m per year. Based on the BB&T financial statements for the year ended 31 December 2005, the gross assets in respect of the STARS transaction represented approximately 1.37% (i.e., $1,500m/$109,170m) of BB&T’s total gross assets and the liabilities in respect of the STARS transaction represented approximately 1.53% (i.e., $1,500m/$98,041m) of BB&T’s total liabilities. The additional foreign taxes paid pursuant to the STARS transaction increased BB&T’s foreign income taxes payable by approximately 97% (i.e., $106m/$109m). The ratio of federal to foreign taxes paid was 6.84:1 for the year ended 31 December 2005.
13.
OTHER
13.1
Following the NPSO process recently undertaken for the set up of BCL it is not considered that a further NPSO is required for this transaction.
13.2
SCM Finance and Luxembourg Finance have agreed the respective responsibilities for reporting this transaction.
13.3
Based on the proposed product limit, SCM will need to agree an exception to the general tax risk framework for these transactions. This will be taken forward separately and will be a condition for approval.
APPENDICES 1. – Barclays Funding Structure 2. – Luxembourg Net Wealth Tax Mitigation 3. – Luxembourg Tax Opinion 4. – U.K. Tax Opinion 5. – U.S. Tax Opinion 6. – Accounting Analysis
14
Memo
To
SCM Approvals Committee
From
Gourang Agrawal
Date
13 July 2006
Subject
Establishment of a Luxembourg Office for SCM– Minutes of SCM Approvals Committee Meeting
This memo sets out the minutes from the SCM Approvals Committee meeting on 13 July 2006 for the Establishment of a Luxembourg Office for SCM. Present Patrick Clackson (Chair) (PC) Roger Jenkins (RAJ) Iain Abrahams (IHA) Paul Emney (PE) Francis Dickinson (FD) Roger Versluys (RV) Brett Flowers (BF) Stephen Barrett (SB) Brad Hurrell (BH) Andrew Monkhouse (AM) Jos Corswarem (JC) Graham Wade (GW) Gourang Agrawal (GA) Introduction GW explained the proposed establishment of the Luxembourg operations for SCM. It was noted that other areas of the firm (such as HR and FMCS) have already been involved in the proposal. It was also noted that the new Luxembourg entities were not being set up as regulated entities. Discussion The expected operational cost of the Luxembourg operations was discussed and it was noted that the revenue potential justified the expected expenditure. It was also noted that NPSO and SCM Approvals would be sought prior to the commencement of any significant activity by the Luxembourg entities. Finance: confirmed approval. SCM will co-ordinate finance arrangements for new operations with Alfred Lang in Frankfurt. Legal: confirmed approval. Regulatory: confirmed approval. Group Tax: confirmed approval.
GFRM, Market Risk and Compliance confirmed their approval by email. Operations: were still reviewing the transaction at the time of the Approvals meeting. Operations have subsequently confirmed their approval for the transaction. Approval was granted to proceed with the proposal.
Memo
Barclays Capital
To
SCM Approvals Committee
From
Iain Abrahams
Date
12 October 2007
Subject
Approvals paper – Project Valiha
1
SUMMARY Structured Capital Markets (“SCM”) is seeking approval for Project Valiha (the “Transaction”) with Credit Suisse in the UK (the “Counterparty”). Barclays Bank PLC (“Barclays”) is currently party to a number of sterling denominated, fixed floating interest rate swaps with two of its affiliates (“CayCo1”, a Cayman incorporated, UK tax resident subsidiary and “UKSub2”, a UK incorporated and tax resident subsidiary). Since these interest rate swaps were entered into, sterling interest rates have moved such that they are now standing at a material gain for Barclays of £[381.4]m. The terms of the interest rate swaps are such that when considered together, Barclays has an economic exposure akin to a fixed rate amortising loan. The proposed Transaction will involve transferring the value in these swaps from Barclays to the Counterparty without triggering a taxable gain. Although it is proposed that the Transaction will involve all of the interest rate swaps between Barclays and CayCo1 (“Tranche 1”) and between Barclays and UKSub2 (“Tranche 2”), for simplicity the transaction description and detailed analyses in this paper will refer only to the entities and instruments relating to Tranche 1 (unless specifically stated otherwise). Economic Benefit The interest rate swaps between Barclays and its affiliates are £[381.4]m in the money for Barclays across Tranche 1 and Tranche 2. The economic benefit of the Transaction is derived from the Barclays group’s ability to transfer the fair value gain on these interest rate swaps (which is currently unrealised for UK tax purposes) to the Counterparty without triggering a taxable gain. Barclays is entitled to [62.5]% of such benefit. It should be noted that the benefit arises to Barclays on a post-tax basis and to the Counterparty on a pre-tax basis, which results in a PTE benefit split of approximately [70 : 30]. 100% of the Barclays benefit will arise in 2007.
1
The key financial data is set out below (please see Section 9 for a summary of the Transaction economics and the impact of varying provision levels, if any): Pre provision (if any)
Post provision (if any) Assumes a provision level of 50%, however the final provision level has yet to be determined (see Section 9).
Proposed size of transaction
£[381.4]m
N/A
Estimated revenue
£[99.6]m
£[21.9]m
Tax capacity Return on Tax capacity
£[362.3] m [27.5]%
£[362.3]m [6.0]%
WRAs Return on WRAs
£[12]m (up to a max of £[74.7]m) [133]% (based on max WRAs)
£[12]m (up to a max of £[74.7]m) [29]% (based on max WRAs)
PUG
N/A
£[(48.1)]m
Tenor
Approximately 1 month
N/A
1
The above numbers are subject to movements in interest rates and do not include accruals or breakage amounts, therefore they are subject to change. However it is not anticipated that such movements will be material. Therefore we are seeking approval for a Transaction size of up to £[400]m. This Approvals paper contains a description of all significant tax, credit, market and operational risks.
1
See Section 3.4 for an explanation of the way use of capacity is determined.
2
2 2.1
DETAILED TRANSACTION DESCRIPTION Present Position 2.1.1 For Tranche 1, the current structure is as follows:
Parent Prefs £100k
Ords £Nom
Class A Prefs £2,000m
InvestCo InvestCo
Parent Parent
IRSs Barclays Loan £120m
Ords £Nom
CayCo1 CayCo1
Sub2 Prefs £5k
Sub1 Prefs £95k
Sub1 Sub1
Sub2 Sub2
LP1 Interest £95k
GP Interest £5k
ELP £120.1m
Assets
2.1.2 The following paragraphs provide an overview of the Transaction; however please refer to Appendix 1 for a detailed transaction description (including additional diagrams). Numbers in the transaction description which are in square brackets are subject to movements in interest rates and do not include accruals or breakage amounts, therefore they are subject to change. However it is not anticipated that such movements will be material. 2.1.3 A wholly owned, Cayman incorporated, UK tax resident investment company affiliate of Barclays (“InvestCo”) owns all of the ordinary share capital in a Cayman incorporated, UK tax resident subsidiary (“CayCo1”). Both InvestCo and CayCo1 have a sterling functional currency and prepare accounts under UK GAAP and IFRS respectively. 2.1.4 Barclays owns £2,000m of redeemable preference shares in CayCo1 (the “Class A Prefs”).
3
2.1.5 Barclays also owns all of the ordinary share capital in an existing UK incorporated and UK tax resident subsidiary (“Parent”). Parent has a sterling functional currency and prepares its accounts under UK GAAP. Parent owns all of the ordinary share capital in two existing Cayman incorporated and UK tax resident subsidiaries (“Sub1” and “Sub2”). Sub1 and Sub2 both have sterling functional currencies and prepare their accounts under UK GAAP. 2.1.6 In March 2007, CayCo1 received £48m (the then market value) to acquire ten out of the money sterling denominated interest rate swaps (the “IRSAs”) from its wholly owned, UK incorporated and UK resident subsidiary (“UKSub1”) (not shown). Subsequently sterling interest rates moved such that in aggregate, the IRSAs were standing at a loss of £186m in CayCo1. At that time, CayCo1 entered into a set of ten swaps with Barclays (the “IRSBs”, and together with the IRSAs, the “IRSs”) such that Barclays had an economic exposure akin to that of a fixed rate amortising loan of £186m. 2.1.7 Barclays designated the IRSs as post-tax fair value hedges of its investment in the Class A Prefs. CayCo1 has made a Reg 6(5B) election. 2.1.8 Since March 2007, interest rates have moved further such that Barclays’ in the money position under the IRSs is £[190.7]m. 2.1.9 In October 2007, Barclays capitalised Parent with £100k of redeemable preference shares (the “Parent Prefs”). Parent then capitalised Sub1 and Sub2 with £95k and £5k of redeemable preference shares respectively (the “Sub1 Prefs” and the “Sub2 Prefs”). 2.1.10 Sub1 and Sub2 used the capitalisation proceeds of the Sub1 Prefs and the Sub2 Prefs to form an English limited partnership (“ELP”). Under the limited partnership agreement (the “LP Agreement”), Sub1 holds the “LP1 Interest” and Sub2 holds the “GP Interest” in ELP. The LP1 Interest and the GP Interest are entitled to 95% and 5% respectively of ELP’s profits and losses and ELP’s assets on a winding up/upon leaving the partnership. Sub2 as general partner holds 100% of the voting rights in ELP. 2.1.11 Barclays then made a £120m loan to ELP (the “Barclays Loan”) which ELP used to acquire £120m of gilts. 2.2
Proposed Transaction 2.2.1. On the first day of closing (“Day 1”), Barclays will enter into a novation agreement with CayCo1 and Sub1 whereby it will novate its in the money legs of the IRSs to Sub1 in exchange for £[190.7]m, being the market value of the IRSs. Sub1 will use the proceeds from issuing an additional £[190.7]m of Sub1 Prefs to Parent to fund its payment to Barclays for acquisition of the IRSs (the “Novation Payment”). 2.2.2. The [following] day (“Day 2”), Sub1 and CayCo1 will agree to novate the IRSs to ELP and Sub2 will make a cash contribution to ELP of £[1.5]m in exchange for which, ELP will credit the capital account of Sub1 with £[190.7]m reflecting the fair value of the IRSs contributed and will credit the capital account of Sub2 with £[1.5]m. The terms of the LP Agreement will be amended to entitle the LP1 Interest holder to a preferred entitlement on liquidation (the “LP1 Preferred”) of £[162.3]m with the rest of ELP’s residual assets being distributed in proportion to the profit sharing ratio of [95 : 5]. 2.2.3. ELP will draw up management accounts for the accounting period ended on Day 2. 2.2.4. On the final day of closing (“Day 3”), Counterparty will subscribe for a £[182.7]m limited partnership interest in ELP (the “LP2 Interest”) which will entitle Counterparty to [95]% of ELP’s profits and losses and ELP’s assets on a winding up (after taking into account the LP1 Preferred). The LP2 Interest holder will have no voting rights but will have the right to retire from the partnership on [5] business days’ notice in exchange for 4
cash proceeds equal to its share of the fair value of ELP’s net assets (the “Termination Entitlement”). 2.2.5. The LP2 Interest will also be redeemable at fair value at the option of Sub2 (on behalf of ELP) on [5] business days’ notice. 2.2.6. Sub2 will continue to hold 100% of the voting rights in ELP. However, the proportion of profits and losses, and assets on a winding up/retirement from the partnership to which the LP1 Interest and the GP Interest are entitled will be reduced to [4.75]% and [0.25]% respectively. 2.2.7. Sub2 will enter into an agreement with Barclays (the “Management Agreement”) to delegate the day to day running of ELP to Barclays, subject to the provisions of the LP Agreement which will be amended to specify that ELP may only invest in specified classes of assets. 2.2.8. ELP will use the £[182.7]m proceeds from issuing the LP2 Interest to repay the £120m Barclays Loan with the balance being kept on deposit with Barclays or invested in additional sterling denominated treasury bills or gilts. 2.2.9. Barclays and Counterparty will each guarantee the performance and/or obligations of their relevant affiliates under the Transaction. 2.2.10. At some time after Day 3, the IRSs will either mature or may be terminated prior to their scheduled maturity at the option of either CayCo1 or Sub2 (as general partner of ELP). If the IRSs are terminated prior to their scheduled maturity, CayCo1 will borrow £[190.7]m from Barclays (the “CayCo1 Loan”) to pay ELP the termination value of the IRSs (the “Termination Payment”). 2.2.11. It is anticipated that sometime after the IRSs have matured or been terminated, the Transaction will be unwound. Counterparty may choose to retire from the partnership in exchange for cash proceeds in accordance with the LP Agreement. Alternatively Sub2 may give notice and redeem the LP2 Interest or liquidate ELP, disposing of the Assets and distributing the proceeds in the ratios provided for in the LP Agreement. 2.3
Tranche 2
2.3.1. The IRSs relating to Tranche 2 are currently (and have always been) between Barclays and UKSub2 rather than between Barclays and CayCo1. UKSub2 is a UK incorporated and UK tax resident company which prepares its accounts in sterling under UK GAAP. UKSub2 is a wholly owned subsidiary of “CayCo2”, a Cayman incorporated UK tax resident affiliate of Barclays. Therefore in applying the Transaction steps described above, the role of CayCo1 will be carried out by UKSub2. 2.3.2. UKSub2 currently holds the IRSs as a hedge of floating rate certificates of deposit (the “FRCDs”) that it previously acquired from Barclays. Barclays will redeem the FRCDs before the year end.
5
3.
4
ECONOMICS AND ECONOMIC DRIVERS 3.1
The Tranche 1 and Tranche 2 IRSs each currently have a market value of £[190.7]m respectively i.e. a total in the money position for Barclays of £[381.4]m.
3.2
Currently, Barclays is taxed on the IRSs on an accruals basis. The economic benefit of the Transaction is derived from the fact that the Barclays group is able to transfer the gain on the Barclays legs of the IRSs to the Counterparty without triggering a taxable gain on the increase in fair value of the IRSs since their inception.
3.3
100% of the Transaction benefit is realised in 2007 and Barclays is entitled to [62.5]% of the benefit.
3.4
The total tax capacity relating to the Transaction of £[362.3]m is determined as follows: 3.4.1
£[190.7]m of tax capacity relating to the IRSs has been used in CayCo1 in 2007 irrespective of whether the Transaction takes place or not;
3.4.2
£[190.7]m of tax capacity relating to the IRSs will be used in UKSub2 when the FRCDs that UKSub2 holds (and which are currently being hedged in UKSub2 by the IRSs) are disposed of (anticipated to be on [7 December 2007]); and
3.4.3
£[19.1]m of tax capacity will be created by the Transaction in Sub1 and Sub2. This capacity will be created in 2007.
3.4.4
Thus viewed over the full term of the original swaps, this Transaction uses £[362.3]m of capacity.
3.5
Refer to Section 9 for a summary of the impact of different provision levels (if any) on the Transaction economics.
3.6
Assuming ELP’s gilt portfolio is disposed of by 31 December 2007 at the latest, the expected cost associated with holding the gilts should not exceed £300k.
INTENDED TAX TREATMENT 4.1 Barclays Tax Analysis The Transaction has been discussed with Slaughter & May and the following summary is supported by a draft UK tax opinion attached at Appendix 2. Barclays 4.1.1
The IRSs are designated as a fair value hedge of the Class A Prefs therefore fair value movements on both the IRSs and the Class A Prefs are recognised in the income statement. The Reg 6(5B) election made by Barclays is disregarded by virtue of Reg 6(5A)(a), therefore Reg 9 should apply to bring the debits and credits arising on the IRSs into account on an accruals basis.
4.1.2
Paragraph 28, Sch 26 FA2002 should apply to the transfer of the IRSs to Sub1 such that Barclays is treated as disposing of the IRSs for a consideration equal to their notional carrying value as determined for tax purposes under an appropriate accruals basis. Therefore for tax purposes, Barclays should not recognise any gains or losses on the transfer of the IRSs to Sub1.
InvestCo 4.1.3
The Transaction should have no material UK tax implications for 6
InvestCo. CayCo1 4.1.4
The IRSs are recognised as derivatives with fair value movements recognised in the income statement. CayCo1 made a Reg 6(5B) election and the IRSs are not designated as a hedge of any instruments in CayCo1, therefore Reg 9 does not apply so that debits and credits are brought into account on a fair value basis.
Parent 4.1.5
The Transaction should have no material UK tax implications for Parent.
Sub1 4.1.6
Once Sub1 becomes party to the IRSs following the novation, relevant credits and debits would be brought into account on an accruals basis. Paragraph 28, Sch 26, FA2002 applies to the novation. Therefore for the purposes of determining such credits and debits Sub1 should be deemed to have acquired the IRSs for their notional carrying value as determined by Barclays under Reg 9 on the date immediately before the novation (i.e. approximately nil).
4.1.7
No debits or credits should be brought into account as a result of novation of the IRSs to ELP. Following the novation of the IRSs to ELP, Sub1 should be deemed under paragraph 49, Sch 26, FA2002 as owning the IRSs and will continue calculating credits and debits on the IRSs on an accruals basis, bringing [95]% of those credits and debits into account.
4.1.8
Following the admission of the Counterparty as a partner in ELP the share of credits and debits brought into account as discussed in 4.1.7 above will be reduced to [4.75]%. In particular, on termination of the IRSs Sub1 will be taxable on [4.75]% of the gain determined against a notional carrying value of approximately nil.
Sub2 4.1.9
No debits or credits should be brought into account as a result of the novation by Sub1 of the IRSs to ELP. As a partner in ELP, Sub2 should be deemed under paragraph 49, Sch 26, FA2002 as owning the IRSs and will calculate credits and debits on the IRSs on an accruals basis and bring [5]% of those credits and debits into account.
4.1.10 Following the admission of the Counterparty as a partner in ELP the share of credits and debits brought into account as discussed in 4.1.9 above will be reduced to [0.25]%. Similarly to paragraph 4.1.8, on termination of the IRSs Sub2 will be taxable on [0.25]% of the gain determined against a notional carrying value of approximately nil (on the basis that Sub 2 acquired its interest in the IRSs under paragraph 28, Sch 26, FA2002). ELP 4.1.11 ELP is not a taxable entity in the UK. UKSub2 4.1.12 UKSub2 accounts for the IRSs as a hedge of an investment the FRCDs and recognises income on an accruals basis. Accordingly any credits and debits on the IRSs are brought into account on an accruals basis. 4.1.13 After termination of the IRSs fair value losses will be amortised (and 7
brought into account) over the remaining 19 year term of the FRCDs or if the FRCDs are disposed of or redeemed (it is anticipated that the FRCDs will be redeemed before the year end), the full fair value debits would be brought into account at such earlier time. CayCo2 4.1.14 The Transaction should have no material UK tax implications for CayCo2. 4.2 Counterparty Tax Analysis 4.2.1
Counterparty is a UK resident financial trader. Therefore after becoming a partner in ELP it should be taxable in respect of its interest in the IRSs on a fair value basis under paragraph 50, Sch 26, FA2002.
4.3 Disclosure Regulations 4.3.1 5
The disclosure position is to be determined.
TAX RISK Having had discussions with Slaughter and May, the following is SCM’s assessment of the key tax risks: Gain on Novation to ELP 5.1 The analysis of the Transaction concludes that there should be no credits or debits arising to Sub1 as a result of the novation of the IRSs to ELP. This analysis is based on the application of paragraph 49, Sch 26, FA2002 which deems Sub1 as being party to the IRSs held by ELP. The expected effect of this deeming is that either: 5.1.1
Sub1 is treated as a party to the IRSs prior to and after the novation and therefore there is no disposal of the IRSs by Sub1 and therefore no related transaction, or
5.1.2
Even if the novation were a related transaction, the UK GAAP accounts prepared by Sub1 on the basis of such statutory fiction would show no credits or debits since Sub1 would have to determine the effects of the disposal of the IRSs to itself.
5.2 If the above analysis were not correct, Sub1 would have to determine credits arising on the novation of the IRSs to ELP and for these purposes the carrying value of the IRSs would be based on the notional carrying value of the IRSs as determined for tax purposes by Barclays under Reg 9 on a date immediately before the novation to Sub1 (i.e. approximately nil). Para 23 5.3 The nature of the Transaction means that there are a number of debits and credits arising on a mark to market basis in CayCo1, or on an accruals basis in UKSub2. It is necessary to consider the risk that paragraph 23, Sch 26 FA2002 (“Para 23”) may apply to the Transaction such that debits on the IRSs are disallowed. 5.4 The IRSs were entered into as part of a previously approved UK accretive transaction. Debits arising to CayCo1 on the IRSs to date and to UKSub2 on the eventual disposal of the FRCDs which the IRSs are hedging would be claimed regardless of whether the Transaction is implemented or not.
8
Para 13 5.5 There are debits and credits arising to Barclays and its UK tax resident affiliates on internal loans, in particular on the Barclays Loan to ELP. It is necessary to consider the risk that paragraph 13, Sch 9 FA1996 (“Para 13”) may apply to the Transaction such that debits on the internal loans are disallowed. 5.6 The Barclays Loan was made in order to enable ELP to purchase the Assets and the relevant debits will arise regardless of whether the Transaction takes place. Furthermore, for any debts arising to Barclays and its affiliates in respect of the internal loans (including the Barclays Loan) there will be equal and opposite credits arising to Barclays or its affiliates taxable in the UK. 6.
ACCOUNTING 6.1 The below accounting treatments have been discussed with SCM Finance and will be confirmed with PwC prior to closing. 6.2 It is intended that ELP, Sub1, Sub2, Parent and UKSub2 will prepare or continue to prepare accounts under UK GAAP. Subject to approval by the BarCap CFO, confirmation that the relevant entities can prepare or continue to prepare accounts under UK GAAP will be obtained from Chris Lucas, Group CFO, prior to closing. Barclays Solus 6.3 Barclays prepares its solus accounts under IFRS. 6.4 The IRSs have been designated as a fair value hedge of the Class A Prefs. Barclays treats the IRSs as derivatives and accounts for them on a fair value basis with any fair value gains or losses recognised in the income statement under IAS39. Barclays is taxed in respect of the IRSs on an accruals basis. Accordingly Barclays recognises a deferred tax liability under IAS12 on the difference between the carrying value of the IRSs and their tax base, taking the tax expense to the income statement (IAS12.58). 6.5 On Day 1, novation of the IRSs to Sub1 will result in Barclays derecognising them in its accounts. At that time Barclays will cease to be liable to tax in respect of the difference between the carrying and fair market values of the IRSs. Therefore the deferred tax liability will be reversed through the income statement. CayCo1 Solus 6.6 CayCo1 prepares accounts under IFRS. 6.7 CayCo1 treats the IRSs as derivatives under IAS39 and accounts for them on a fair value basis with any fair value gains or losses recognised in the income statement. CayCo1 is taxed on the IRSs on a fair value basis with the relevant current tax impact recognised in the accounts on a current basis. 6.8 CayCo1 will continue recognising the IRSs on the same basis after novation of the Barclays’ legs to Sub1. UKSub2 Solus 6.9 UKSub2 prepares accounts under UK GAAP and does not adopt FRS26. 6.10 UKSub2 treats the IRSs as derivatives and accounts for them as a hedge of a 19 year loan asset (i.e. the FRCDs) on an accruals basis. On disposing of the FRCDs any 9
unrealised loss on the IRSs is taken immediately to the profit and loss account. 6.11 UKSub2 is taxed on the IRSs on an accruals basis, with the relevant current tax impact recognised in the accounts on a current basis. ELP Solus 6.12 ELP prepares accounts under UK GAAP and does not adopt FRS26. 6.13 ELP recognises the GP Interest as equity under FRS25 since it is not redeemable at the option of the holder or at a fixed future date. Upon the receipt of a further contribution from Sub2 on Day2, the equity would be increased accordingly. 6.14 ELP recognises the LP1 Interest as equity under FRS25 since it is not redeemable at the option of the holder or at a fixed future date. On novation of the IRSs to ELP and the corresponding increase in ELP’s capital, the equity would be increased accordingly. 6.15 ELP will recognise the LP2 Interest as a liability (FRS25.18(a), AG25) as it is redeemable at any time on [5] business days’ notice at the option of the holder. 6.16 ELP treats the Assets as debt investments with the relevant interest income recognised in the profit and loss account on an accruals basis. 6.17 ELP will recognise the IRSs as an investment in a synthetic amortising fixed rate loan under FRS5, with the respective interest income recognised on an accruals basis. 6.18 Taxes arising on the IRSs held by ELP will be imposed on its partners (Sub1 and Sub2) but will be born by ELP under the terms of the Tax Payment Agreement. Any payments made by ELP under the Tax Payment Agreement will be recognised as tax in its profit and loss account. There will be no timing differences arising to ELP in respect of the IRSs and therefore no deferred tax liability would be provided in this respect. Sub1 Solus 6.19 Sub1 prepares accounts under UK GAAP and does not adopt FRS26. 6.20 Sub1 recognises the Sub1 Prefs as a liability under FRS25 as they are redeemable at any time at the option of the holder on 1 business day’s notice. 6.21 Sub1 will treat the investment in the IRSs as an investment in a synthetic amortising fixed rate loan under FRS5, with the respective interest income recognised on an accruals basis. 6.22 Taxes imposed on Sub1 in respect of its interest in ELP as well as the payments received from ELP under the Tax Payment Agreement will be recognised as tax items in the profit and loss account. There will be no timing differences arising to Sub1 in respect of the IRSs and therefore no deferred tax liability would be provided in this respect. 6.23 On Day 2 Sub1 will derecognise the IRSs and will instead recognise an investment in an affiliate at the carrying amount of the IRSs. Accordingly no profits will be recognised on contribution of the IRSs to ELP. 6.24 On Day 3 when Counterparty subscribes for the LP2 Interest, Sub1 will recognise an impairment loss in respect of its investment in ELP. Sub2 Solus 6.25 Sub2 prepares accounts under UK GAAP and does not adopt FRS26. 6.26 Sub2 recognises the Sub2 Prefs as a liability under FRS25 as they are 10
redeemable at any time at the option of the holder on 1 business day’s notice. 6.27 Sub2 recognises the investment in ELP at cost. 6.28 On Day 3 when Counterparty subscribes for the LP2 Interest, Sub2 will recognise an impairment loss in respect of its investment in ELP. Parent Solus 6.29 Parent prepares accounts under UK GAAP and does not adopt FRS26. 6.30 Parent recognises the Parent Prefs as a liability under FRS25 as they are redeemable at any time at the option of the holder on 1 business day’s notice. 6.31 Parent recognises its investments in Sub1 and Sub2 at cost. Barclays Consolidated 6.32 Barclays prepares consolidated accounts under IFRS. 6.33 Barclays has sole control of Parent, Sub1, Sub2, ELP, UKSub2 and CayCo1 and therefore consolidates them as its subsidiaries under IAS27. 6.34 Barclays treats the Assets as financial assets available for sale under IAS39, and therefore recognises them at fair value (IAS39.46) with interest recognised in the income statement using an effective interest method (AS39.55(b)), and changes in fair value being recognised directly in equity. 6.35 The current tax asset arising in CayCo1 on the IRSs is currently recognised in the consolidated accounts. As the current tax asset cannot be eliminated on consolidation, the corresponding deferred tax liability in respect of Barclays’ solus position in the IRSs is also currently recognised in the consolidated accounts. 6.36 UKSub2’s IFRS equivalent accounts (for consolidated purposes) would show a current tax asset in respect of the IRSs. This current tax asset relates to the fair value loss in the IRSs which Barclays will crystallise before the end of the year by redeeming the FRCDs that the IRSs are used to hedge. As the current tax asset cannot be eliminated on consolidation, the corresponding deferred tax liability in respect of Barclays’ solus position in the IRSs is also recognised in the consolidated accounts. 6.37 On Day 1, once the IRSs are novated to Sub1, Barclays will reverse the deferred tax liability in respect of the IRSs and will provide for the deferred tax liability in respect of Sub1’s position in the IRSs for similar reasons to those set out in 6.35and 6.36above. On Day 2, Barclays will reverse the deferred tax liability in respect of Sub1’s position under the IRSs and will instead provide for the deferred tax liability in respect of ELP’s position in the IRSs. 6.38 On Day 3, following the admission of the Counterparty as a partner, the terms and the scope of ELP’s activities will be amended in accordance with the agreed deal terms and as a result will become narrowly defined. Therefore ELP will become a SIC-12 entity. From that point, Counterparty will become entitled to the majority of the benefits and exposed to the majority of the risks incident in the assets and the activities of ELP. Accordingly Barclays will cease consolidating ELP in accordance with SIC-12. At that point Barclays will be treated as having disposed of its subsidiary and will recognise a profit on disposal of ELP in the consolidated income statement equal to the excess of the disposal proceeds over the carrying value (as calculated under IFRS) of ELP’s net assets (IAS27.30). The carrying value of the consolidated net assets will include the deferred tax liability
11
recognised by Barclays in respect of the IRSs held by ELP. 6.39 Following the admission of the Counterparty as a partner, Barclays will recognise the investment in the LP1 Interest and the GP Interest as well as the liability under the IRSs at their respective fair values (IAS39.43). 6.40 There should be no material differences between Barclays consolidated IFRS analysis and its consolidated US GAAP analysis. 7.
8.
CREDIT AND MARKET RISK
7.1
Due to the nature of the Assets (sterling denominated UK gilts with a remaining maturity of 5 months) the credit risk and market risk associated with the Assets should not be material. This was discussed and agreed with Credit and Market risk prior to acquisition of the Assets by ELP.
7.2
Sub2 (a wholly owned Barclays subsidiary) as GP will always have 100% voting control of ELP. In addition, ELP will repay the Barclays Loan using the proceeds from issuing the LP2 Interest therefore there should be no material credit risk on the Barclays Loan.
7.3
In the event any Credit approval is required (for example in respect of the acquisition of additional gilts by ELP), this will be obtained by SCM through GFRM via the normal process.
7.4
The economic profile of the IRSs taken together will be equivalent to a fixed rate amortising loan. Across both tranches of the Transaction, the total fair value of this loan is currently £[381.4]m. Although there will be ongoing movements in the fair market value of the IRSs/loan, this is not expected to be material during the closing period. Whilst the volatility will affect the overall size of the transaction, the variation will impact both Barclays and the Counterparty in accordance with the agreed benefit split.
REGULATORY CAPITAL 8.1
Basel I Barclays solus:
8.1.1
The additional Parent Prefs are treated as debt for regulatory purposes and therefore generate internal LE of £[381.4]m on Day 1 across the two tranches. However, also on Day 1, the IRSs are novated from Barclays to Sub1. Currently Barclays is marking internal LE of £492m (including add-ons) in respect of the IRSs which will no longer be necessary once they are novated to Sub1. Since the existing Parent Prefs generate internal LE of £100k, on Day 1 upon novation of the IRSs, the overall internal position will be reduced by £[110.5]m.
8.1.2
On Day 2, an additional £[3.0]m of internal LE across the two tranches will arise on the further capitalisation of Parent (i.e. the issue of £[3.0]m of additional Parent Prefs).
8.1.3
Upon Counterparty subscribing for the LP2 Interest, Barclays will guarantee the obligations of CayCo1 (and of UKSub2) under the IRSs. Therefore on Day 3 internal LE of £[381.4]m will arise across Tranche 1 and Tranche 2 in respect of this exposure. In the event the IRSs are terminated early, the guarantee by Barclays will no longer be required. However internal LE will arise on the CayCo1 Loan (and also on any loan from Barclays to UKSub2) – anticipated to be a total of £[381.4]m across the two tranches.
8.1.4
The £120m internal LE arising on the Barclays Loan has been mitigated by 12
virtue of ELP pledging the Assets (eligible collateral for regulatory purposes) in support of its obligations under the Barclays Loan. 8.1.5
In aggregate, an additional £[273.9]m of additional internal LE will arise as a result of the proposed transaction steps such that the total internal LE position is £[765.9]m. Treasury Concession will be required for this internal large exposure, subject to approval from BarCap and Group Treasury. To the extent that cash received by ELP upon early termination of the IRSs is repatriated to Parent, Parent may use these proceeds to partially redeem the Parent Prefs and hence reduce the amount of internal LE.
8.1.6
The Sub1 and Sub2 capital accounts of £[381.5]m and £[3.0]m respectively (across both tranches) will be treated as equity in their respective solus accounts for accounting and regulatory purposes. Barclays could unwind the structure and cause the LP1 Interest and the GP interest to be redeemed on short notice (within 10 business days). Therefore there should not be any issues in respect of "connected lending of a capital nature" and hence no deduction from solus capital. ELP should not be a taxable entity for UK tax purposes therefore HMRC should not be a creditor and ELP should not have any other external senior creditors. Barclays consolidated:
8.1.7
Barclays currently consolidates CayCo1 and UKSub2 for regulatory purposes. Barclays will also consolidate Parent, Sub1, Sub2 and ELP for regulatory purposes. ELP will continue to be consolidated after Counterparty has subscribed for the LP2 Interest since the Barclays Group will retain control of ELP, even though Barclays will cease consolidating ELP for accounting purposes.
8.1.8
10% WRAs should continue to be marked on the Assets since they comprise fixed rate Zone A central government paper with a remaining maturity of less than one year. In the event that ELP uses the proceeds from issuing the LP2 Interest and terminating the IRSs to acquire further gilts or UK Treasury bills (after repaying the £120m Barclays Loan), since it is anticipated that these assets will also be 10% weighted, up to £[62.7]m additional WRAs may arise (10% of (2 x £[182.7]m - £120m + £[381.4]m).
8.1.9
To the extent the proceeds from issuing the LP2 Interest and terminating the IRSs are simply put on deposit with Barclays, no additional WRAs would arise.
8.2
Basel II Barclays solus:
8.2.1
Parent, Sub1, Sub2 and ELP will have their centre of management and interests in the UK and should fall within the UKIG. Therefore there should be no internal LE or WRAs on the Parent Prefs, the Sub1/Sub2 Prefs, Sub1’s capital account or Sub2’s capital account. Barclays consolidated:
8.2.2
Barclays will consolidate CayCo1, UKSub2, Parent, Sub1, Sub2 and ELP for regulatory purposes. ELP will continue to be consolidated after Counterparty has subscribed for the LP2 Interest since the Barclays Group will retain control of ELP, even though Barclays will cease consolidating ELP for accounting purposes.
8.2.3
The WRAs on the Assets (including any additional gilts or UK Treasury bills acquired) will be modelled using standard Probability of Default, Loss Given Default, Maturity and Exposure at Default inputs and is not expected to be significant given the nature of the assets. 13
8.3 9.
The regulatory capital reporting has been agreed with Finance.
PROVISION
9.1
The provision level for the Transaction has yet to be determined.
9.2
The economic benefit of the Transaction at varying provision levels, based on the current estimated deal size of £[381.4]m is summarised below: 0%
20%
30%
40%
50%
£m
£m
£m
£m
£m
69,977,834 (291,664) 69,686,169
69,977,834 (291,664) 69,686,169
69,977,834 (291,664) 69,686,169
69,977,834 (291,664) 69,686,169
69,977,834 (291,664) 69,686,169
0 108,703,431 (108,703,431) 0
(21,740,686) 108,703,431 (108,703,431) (21,740,686)
(32,611,029) 108,703,431 (108,703,431) (32,611,029)
(43,481,372) 108,703,431 (108,703,431) (43,481,372)
(54,351,715) 108,703,431 (108,703,431) (54,351,715)
PAT
69,686,169
47,945,483
37,075,140
26,204,797
15,334,454
PTE
99,551,670
68,493,547
52,964,486
37,435,424
21,906,362
PUG
29,573,837
(1,484,287)
(17,013,348)
(32,542,410)
(48,071,471)
Tax Capacity
362,344,770
362,344,770
362,344,770
362,344,770
362,344,770
27.5%
18.9%
14.6%
10.3%
6.0%
Profit on disposal of LP Cost of Gilt Portfolio PBT Tax Provision Current Tax Deferred Tax
RoTC
10. CLIENT ENGAGEMENT 10.1 Lawrence Fletcher (Global Head), Mike Humphreys (Managing Director) and Ian Drewe (Director) from the Counterparty’s Global Structuring Group were involved in originating the deal. 10.2 SCM will confirm that the deal has been approved by the relevant individuals at the Counterparty prior to close. 11. MATERIALITY OF DEAL WITH COUNTERPARTY 11.1 Key figures from the Counterparty group’s (Credit Suisse Group) consolidated financial statements for the year ended 31 December 2006 are summarised in the table below using a CHF:GBP FX rate of 2.39 and have been used to estimate the impact of the Transaction on the Counterparty financial statements for the year ended 31 December 2007:
14
CHFm
£m
Income Statement Revenue Profit before Tax Tax
38,603 14,300 2,389
16,152 5,983 1,000
Balance Sheet Gross Assets Net Assets
1,255,956 43,586
525,505 18,237
11.2 The pre-tax benefit for the Counterparty group will be £[38.7]m based on the current valuations of the IRSs. This will increase the revenue, profit before tax and tax numbers by [0.2]% (£[38.7]m / £16,152m), [0.65]% (£[38.7]m / £5,983m) and [1.2]% (30% * £[38.7]m / £1,000m) respectively. 11.3 Gross and net assets will increase by less than [0.1]% (£[38.7]m / £525,505m) and [0.2]% (£[38.7]m / £18,237m) respectively. 12. OTHER 12.1 It is not considered that NPSO signoff is required 12.2 Barclays will not provide directors for any external entities neither will an external person be a director of any Barclays entities. 12.3 Upon subscription by the Counterparty for the LP2 Interest, ELP will be a collective investment vehicle (“CIS”) (prior to this, a group exemption applies). However Sub2 will delegate day to day management of ELP to Barclays (an “authorised person” for these purposes) under the Management Agreement, therefore the legal requirements in respect of managing a CIS should be satisfied. 13. APPENDICES Appendix 1 – Detailed Transaction Description Appendix 2 – Tax Opinion from Slaughter and May
15
Memo
Barclays Capital
To
SCM Approvals Committee
From
Adam Moses
Date
[ ] October 2007
Subject
Pre-approvals paper – Project Faber
1.
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SUMMARY
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Structured Capital Markets (“SCM”) is seeking approval for Project Faber (the “Transaction”) with the Luxembourg branch (“LuxBank) of HSH Nordbank AG (“HSH”). LuxBank will be a Luxembourg resident financial institution. The Transaction involves Barclays Investment Bonds (Isle of Man) Limited (“BIB (IoM)”) investing through a Luxembourg resident company (“LuxCo”) in a portfolio of high grade investments. BIB (IoM) will forward sell preference shares issued by LuxCo (the “B Prefs”) to LuxBank. Economic Benefit
The key financial data is set out below:
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... [2]
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Post provision (if any) N/A
£[9.6]m in 2007, £[11.9]m in 2008, £[7.8]m in 2009.
£[2.9]m in 2007, £[(0.7)]m in 2008, nil in 2009.
WRAs Return on WRAs PUG
£[24.1]m in 2007, £[73.4]m in 2008, £[27.1]m in 2009. [23.5]% for transaction £[10.5]m [278.5]% for transaction N/A
Tenor
[364] days
£[24.1]m in 2007, £[73.4]m in 2008, £[27.1]m in 2009. [1.8]% for transaction £[10.5]m [21.5]% for transaction £[(51.1)]m in 2007, £[8.2]m in 2008, nil in 2009. N/A
Tax capacity Return on Tax capacity
Deleted: .
Deleted: 23.6…67.3…, £[25.4]m in 2009 ... [4]
Pre provision (if any) £[1,496.1]m, stepping down to £[1,123.8]m after approx. 30 days.
Estimated revenue
... [1]
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Due to the availability of certain Luxembourg tax benefits, LuxBank is able to provide a gross up under the Forward for any Luxembourg withholding tax suffered on the B Prefs. To the extent that withholding tax arises, BIB (IoM) will be able to take this into account in computing its chargeable profits for CFC purposes with the effect that no apportionment will be required for the relevant accounting periods covering the transaction. LuxBank will derive a benefit of £[2.1]m from the Transaction.
Proposed size of transaction
Deleted: The … (“LuxBank”)
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... [6]
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... [7]
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... [8]
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1
... [11]
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This Approvals paper contains a description of all significant tax, credit, market and operational risks. 2.
DETAILED TRANSACTION DESCRIPTION The paragraphs below provide a summary of the Transactions steps. A detailed transaction description is attached at Appendix 1. Transaction Steps 2.1 BIB (IoM), a wholly owned, Isle of Man resident subsidiary of Barclays currently has a deposit with Barclays of £[915.6]m. 2.2 [5] days before the closing date, via BIB (IoM)’s immediate parent Murray House Investment Management Limited (“MHIML”), Barclays will capitalise BIB (IoM) with £[207.9]m of ordinary shares. 2.3 BIB (IoM) will then use the £[207.9]m proceeds and £[914.6]m of its existing deposit to set up a UK limited partnership (“LP”) with another wholly owned subsidiary of Barclays (“UKSub”) and acquire the “LP Interest”. UKSub will acquire the “GP Interest” for £[1]m. 2.4 LP will invest the £[1,123.5]m cash in a portfolio of short term reverse repos over OECD sovereign securities. 2.5 Prior to closing, BIB (IoM) will change its current accounting period end date to [15 May 2007] and adopt IFRS in respect of the new accounting period.
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2.6 On the closing date, BIB (IoM) and LuxBank will set up a Luxembourg incorporated and resident S.a.r.l. (“LuxCo”). 2.7 LuxBank will acquire the “A Shares” for £[100]k which will carry 99% of the votes in LuxCo. 2.8 BIB (IoM) will transfer the LP Interest to LuxCo in exchange for the £[1,122.5]m “B Prefs” in LuxCo. The terms of the B Prefs are such that they are mandatorily redeemable after [364] days and redeemable at the option of LuxCo. In addition, the redemption price of the B Prefs is as follows: Par + LIBID – gross dividends declared. 2.9 BIB (IoM) will also enter into a forward (the “Forward”) over the B Prefs with LuxBank for delivery in [364] days time. The Forward may be accelerated by either party on notice. The price payable under the Forward (the “Forward Price”) will be Par + LIBID – net dividends declared. The difference between the redemption price of the B Prefs and the Forward Price is equal to any Luxembourg withholding tax levied on the B Prefs dividends. 2.10 HSH will enter into a credit derivative contract (the “CDS”) with Barclays under which Barclays will compensate HSH to the extent that the redemption value of the B Prefs is less than their initial par value less any gross dividends declared. 2.11 HSH and BIB (IOM) will enter into an Assignment Agreement (the “Assignment Agreement”) under which HSH will transfer any amounts falling due under the CDS to BIB (IOM) as part settlement of HSH’s obligations to pay the Forward Price under the Forward. 2.12 BIB (IoM) will use the remaining £[1]m of its existing deposit with Barclays to subscribe for the “C Shares”. The C Shares are redeemable at the option of either LuxCo or BIB (IoM).
Deleted: Prior to
verdil 17/10/07 16:06 Deleted: via BIB (IoM)’s immediate parent Murray House Investment Management Limited (“MHIML”), Barclays will capitalise BIB (IoM) with £[130]m of additional ordinary shares. <#>BIB (IoM) will change its current accounting period end date to [17 May 2007] and adopt IFRS in respect of the new accounting period. <#>BIB (IoM) will then use the combination of its capitalisation proceeds, its existing deposit and a drawdown facility from Barclays to set up a UK limited partnership (“LP”) with another wholly owned subsidiary of Barclays (“UKSub”) and acquire the “LP Interest”. UKSub will acquire the “GP Interest”. <#>LP will invest its cash in a portfolio of short term reverse repos over OECD sovereign... [12] securities. verdil 16/10/07 19:12 On the closing date, Deleted: 1,053.7
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2.13 LuxCo will invest the proceeds of issuing the A Shares and the C Shares in a portfolio of reverse repos over OECD sovereign securities.
Deleted: also
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2
2.14 Also on closing, via MHIML, Barclays will capitalise BIB (IoM) with an additional £[48.2]m of ordinary shares. 2.15 BIB (IoM) will then make use of a drawdown facility provided by Barclays to borrow £[297.5]m, which it will combine with the £[48.2]m capitalisation proceeds to make a capital contribution of £[345.7]m to LP. 2.16 [15] days after the capitalisation of LuxCo, LP will declare a dividend to LuxCo and LuxCo will correspondingly declare a dividend on the B Prefs. In both cases the dividends will be declared for payment [14] days later. 2.17 [29] days after the capitalisation of LuxCo, LP will liquidate part of the LP Portfolio in order to pay LuxCo the dividend declared. LuxCo will use the proceeds to pay a net dividend on the B Prefs, after deduction of 15% Luxembourg WHT. 2.18 It is anticipated that the dividend on the B Prefs will be declared prior to 31 December 2007 and but will be paid after the year end during the first week of January 2008. However, it is possible that both declaration and payment of the dividend will occur in January 2008.
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Early unwind/Maturity
Deleted: 7
2.19 It is anticipated that LuxBank will initiate the liquidation of LuxCo using its rights under the A Shares. 2.20 LP and the LP Portfolio will be liquidated, each of UKSub and LuxCo receiving their original capital contributions plus any remaining pro rata share of LP’s profits.
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2.21 The Forward will be automatically accelerated and cash settled.
Deleted: and
2.22 The B Prefs will be redeemed for their redemption value and the proceeds used to settle the Forward. 2.23 The A Shares and the C Shares will receive their relevant liquidation entitlements. 2.24 In the event that LuxBank does not initiate the liquidation of LuxCo, BIB (IoM) will exercise its rights to redeem the C Shares and accelerate the Forward.
3
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3.
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ECONOMICS AND ECONOMIC DRIVERS 3.1 The economic benefit of the transaction is computed as follows: 3.1.1 BIB (IoM) solus
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Transaction Total £m
Deposit interest MTM profit on financing (B Prefs) Interest on Barclays Loan Dividend on C Shares Return on C Shares
52.5 52.5 (1.5) 14.7
PBT
118.2
Tax
-
PAT
118.2
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Deposit interest MTM profit on financing (B Prefs) Interest on Barclays Loan Dividend on C Shares Return on C Shares
3.1.2
PBT BBPLC Solus
Assumed funding cost of transaction Assumed funding cost of deposit Interest on Barclays Loan Dividend from UKSub PBT
3.1.3
3.1.4
4.
Transaction Total £m
Tax
Deleted: PAT
(74.0) (52.5) 1.5 0.3 (124.7)
Tax
35.7
PAT
(89.0)
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Profit after tax for the Barclays Group (i.e. BIB (IoM)’s economic profit of £[118.2]m which is not taxable in the Isle of Man and Barclays post tax position (including assumed funding costs) of £[(89.0)]m) is £[29.2]m pre-provision. This is equivalent to Barclays pre-provision revenue from the transaction of £[40.9]m on a pre-tax equivalent basis. The reverse repos over OECD soveriegn securities in the LP and LuxCo Portfolios are expected to pay a return of LIBOR less [40] bps. The collateral costs will be borne by Barclays and are £[4.6]m. This cost is already included in the benefit calculation above.
Tax
Deleted: PAT
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TAX ANALYSIS/CONSEQUENCES
Deleted:
.
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4.1
UK Tax Consequences
4.2
The key points of the following UK tax summary have been discussed with Freshfields and are supported by the tax note attached at Appendix [2]. Prior to submission of this paper to the Approvals Committee, an opinion will be obtained which fully covers the points outlined in the note.
4.3
Assumed funding cost of transaction Assumed funding cost of deposit Interest on Barclays Loan Dividend from UKSub PBT
Deleted: 8
Barclays and UKSub are UK tax resident. BIB (IoM) is tax resident in the Isle of Man and LuxCo should be Luxembourg tax resident.
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4
4.4
Barclays 4.4.1
Interest receivable on the Barclays A Facility should be taxable.
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4.4.2
Interest payable on the Barclays Deposit will be deductible.
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4.5
BIB (IoM) 4.5.1
In computing the chargeable profits of BIB (IoM) for CFC purposes, the following tax consequences should arise from the Transaction:
4.5.1.1 The B Prefs, but not the C Shares, should fall within the provisions of s.91B FA 1996, therefore BIB (IoM) chargeable profits should include its LIBID return under the B Prefs. 4.5.1.2 £[52.5]m of the £[52.5]m Luxembourg WHT suffered on the B Prefs should be deductible under s.811 ICTA 1988. 4.5.1.3 It has been assumed that interest payable on the Barclays A Facility will not be deductible. 4.5.1.4 The proportion of Luxembourg WHT applicable to the accounting period in which the B Prefs dividend is paid should be “creditable tax” as defined by s.751(6)(a) and should reduce BIB (IoM)’s chargeable profits accordingly. 4.5.1.5 Any return on the C Shares should be treated as capital therefore excluded from the chargeable profits calculation. 4.5.1.6 BIB (IoM)’s pro rata share of the profits of LP for the pre closing period during which it holds the LP Interest should be taxable. Transaction Total £m
4.5.2
4.6
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BIB (IoM) CFC comp (total) Deposit interest 91D income Section 811 deduction for WHT Capital gain on C Shares Interest on Barclays Loan C shares dividend Gross chargeable profits
52.5 52.5 (52.5) 14.7 (1.5) 52.5
Creditable tax Net chargeable profits
(52.5) (0.0)
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BIB (IoM) CFC comp (total) Deposit interest 91D income Section 811 deduction for WHT Capital gain on C Shares Interest on Barclays Loan C shares dividend Gross chargeable profits
BIB (IoM) should not be a CFC for the 12 month accounting periods ended [15 May 2008] and [9 May 2009]. [The BIB (IoM) accounting period for 2008-2009 is changed to end 9 May 2009.]
LuxCo should not be UK controlled for the purposes of s.765 ICTA 1988 or the Controlled Foreign Company rules as LuxBank has [99]% of the votes.
UKSub 4.7.1
4.8
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LuxCo 4.6.1
4.7
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Creditable tax Deleted: Net chargeable profits
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UKSub should be taxable on its pro rata share of the profits of LP based on its allocation under the partnership agreement.
LP
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4.8.1
LP should be a disregarded entity for the purposes of UK tax. Its profits should be taxable on its partners in accordance with the profit sharing
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5
arrangements, 4.9
UK Disclosure Rules 4.9.1
The Transaction will be disclosed to HMRC.
4.10 Luxembourg Tax Consequences 4.10.1 The key points of the following Luxembourg tax summary have been discussed with Bonn Schmitt Steichen (“BSS”) and are supported by the tax opinions attached at Appendix [3]. The tax analysis will be confirmed in advance with the Luxembourg authorities by way of a ruling. 4.11 LuxCo 4.11.1 LuxCo should not be taxable on the distributions received from LP because this will be considered income derived from an exempt participation. 4.11.2 LuxCo will be subject to tax on the interest income from the LuxCo Portfolio. 4.11.3 Capital duty should not be payable on the issuance of the B Prefs in exchange for the LP Interest nor on the capital contribution made by BIB (IoM) to LP. The former is an exempt share-for-share exchange whilst the latter is a non-taxable indirect capital contribution. However, capital duty at 1% will be chargeable on the issuance of the £[100]k A Shares and the £[1]m C Shares. 4.11.4 LuxCo will be obliged to withhold tax at a rate of 15% on dividends paid under the A Shares to LuxBank and under the B Prefs to BIB (IoM) (anticipated to be £[315]k and £[52.5]m respectively).
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4.11.5 An immaterial amount of net wealth tax will be payable as LuxCo’s holding in LP is an exempt asset.
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4.12 LuxBank Tax Analysis 4.12.1 LuxBank should be treated as beneficial owner of the B Prefs [and is taxable on [50]% of any dividends paid on the B Prefs.] 4.12.2 LuxBank should receive a deduction equal to [50]% of the fall in value of the B Prefs which occurs when the B Prefs dividend is paid. This should offset the taxable dividend income in [4.12.1]] 4.12.3 LuxBank should also be entitled to claim a credit against its corporate income tax liability for the 15% WHT applied to the B Prefs dividend. 4.12.4 Dividends receivable under the A Shares should be [50]% taxable. However a credit should be available for the 15% Luxembourg WHT suffered. 5.
TAX RISK 5.1
5.2
Based on discussions with Freshfields, the key tax risks in the Transaction are summarised below. A full discussion of the risks is included in the tax note from Freshfields in Appendix [2]. UK Tax Risk Section 91B Risk on B Prefs 6
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5.2.1 The B Prefs should fall within section 91B FA 1996 (“Section 91B”) since for these purposes BIB (IoM) should be treated as holding the B Prefs (irrespective of the Forward) and the B Prefs should satisfy the conditions in s.91D FA 1996: 5.2.1.1 The B Prefs are redeemable within the meaning of section 91D(2); 5.2.1.2 Given the formula for the B Prefs redemption price, the B Prefs are designed to give a LIBID return (which equates to the return one would expect on an investment at a commercial rate of interest); and 5.2.1.3 There are strong arguments that BIB (IoM)’s purpose in holding the B Prefs is to secure a “tax advantage”. 5.2.2 There is a risk that the B Prefs do not in fact satisfy condition 2 of s.91D and hence do not fall within s.91B. The B Prefs redemption formula is by reference to gross dividends whereas BIB (IoM) suffers 15% WHT on any dividend received under the B Prefs. Although this is adjusted for by the pricing under the Forward (and indeed, the solus accounts of BIB (IoM) will show a net LIBID return on BIB (IoM)’s investment), looking at the B Prefs in isolation, it could be argued that they do not give a LIBID return. However, if the B Prefs did fail to satisfy condition 2, then they should satisfy the conditions in s.91E by virtue of the Forward and hence still fall within the provisions of s.91B. 5.2.3 The effect of failing to fall within s.91B would be that, instead of being taxed on a fair value basis (i.e. on the net LIBID interest earned on the “in substance” loan to LuxBank), the B Prefs would generate £[350.0]m taxable income in respect of the B Prefs dividend plus a £[300.5]m loss on redemption which could be disallowed. However the risk that neither s.91D nor s.91E applies is considered remote. Section 91B Risk on C Shares 5.2.4 There a risk that the C Shares fall within s.91B such that any return on the C Shares is taxed as income. The C Shares are entitled to the residual net assets of LuxCo after return of capital and dividends on the A Shares and the B Prefs. However, given the costs which are borne by LuxCo (including LuxBank’s fee under the A Shares), the return on the C Shares will be significantly lower than LIBID and so the conditions in s.91A-s.91E should not be met. 5.2.5 With regard to case law in respect of whether the return is income or capital, and on the basis that BIB (IoM) should neither be held to be trading nor, as discussed above, fall within the loan relationship provisions, the £[14.7]m return on the C Shares should be treated as capital and therefore excluded for the purposes of BIB (IoM)’s chargeable profits calculation. 5.2.6 In the event the C Shares are in fact treated as income for the purposes of CFC tax, s.42 FA 1998 provides that income should be computed in accordance with generally accepted accounting practice. Since the accounts of BIB (IoM) will show only the profit over and above the C Share subscription and the capital contribution, income for these purposes would be £[14.7]m.
sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: First line: 1.23 cm, Outline numbered + Level: 4 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: 1.27 cm sheikha 17/10/07 10:02 Formatted: Indent: Left: 2.5 cm, Hanging: 1.25 cm, Outline numbered + Level: 4 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: 1.27 cm, Tabs:Not at 1.27 cm sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: verdil 15/10/07 10:23 Deleted: 43
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Para 13 Risk
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5.2.7 The risk that paragraph 13, Sch 9 FA 1996 (“Para 13”) applies to interest payable on the Barclays deposit is not considered to be material on the basis that such interest would be payable irrespective of whether the Transaction took place or not.
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5.2.8 Since Barclays will use non-interest bearing current accounts (“NIBCAs”) to fund repayment of BIB (IoM)’s deposit, it will not be possible to identify any interest debits in respect of this funding. Therefore it should not be possible to apply Para 13 to such funding. 7
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... [15]
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5.2.9 The Barclays A Facility will only be in place for [29] days. Under Para 13, interest payable of £[1.5]m may be disallowed in BIB (IoM)’s chargeable profits calculation and has been assumed non deductible for the purpose of calculating the benefit of the Transaction. Section 811 Risk 5.2.10 In cash terms, BIB (IoM) will suffer WHT and receive a net dividend on the B Prefs. Therefore BIB (IoM) will claim a s.811 ICTA 1988 (“Section 811”) deduction in respect of this Luxembourg WHT. There is a risk that the deduction is disallowed on the basis that when the Forward is taken into account, BIB (IoM) has no net exposure to the WHT. However, the receipt of a payment under the Forward should arguably not impact on an analysis of the amount of tax “paid” for s.811 purposes. 5.2.11 It is also helpful that LuxBank is anticipated to be in a net tax paying position and will therefore claim a credit in respect of the WHT rather than a refund. This reduces the risk of an adjustment under s.811(4). 5.2.12 In the event that the s.811 deduction is disallowed, BIB (IoM)’s chargeable profits for the relevant accounting period will be increased. BIB (IoM) is likely to be classified as a CFC for the period and will be required to pursue an acceptable distribution policy (“ADP”) and pay 90% of it chargeable profits to MHIML as a dividend which will be taxable in the hands of MHIML (assuming the time limit for an ADP has not expired) or suffer an apportionment of its chargeable profits to MHIML, the apportionment also being taxable on MHIML. Section 751(6) Risk 5.2.13 There is a risk that for the purpose of calculating its chargeable profits, BIB (IoM) cannot include a proportion of the Luxembourg WHT suffered on the B Prefs as “creditable tax” under s.751(6) ICTA 1988 (“Section 751(6)”). 5.2.14 Assuming that s.804ZA ICTA 1988 applies, BIB (IoM) should be assumed or deemed to have made a s.805 ICTA 1988 election and therefore eligible to claim a deduction for the Luxembourg WHT suffered on the B Prefs as described above. 5.2.15 In addition, s.751(6) provides that “creditable tax” for CFC purposes includes the amount of any relief from corporation tax which would be given to BIB (IoM) in respect of any foreign tax which is brought into account in determining those chargeable profits. Therefore BIB (IoM) will also claim a capped amount of Luxembourg WHT as creditable tax (i.e. the amount of the WHT which is attributable to the B Prefs income included in BIB (IoM)’s chargeable profits calculation for the period in which the B Prefs dividend is paid). Unlike the s.811 deduction, creditable tax for CFC tax purposes can be set off against existing income in BIB (IoM), further reducing its chargeable profits. 5.2.16 [Potentially expand tax risk section subject to risks identified in revised Freshfields Note.]
6.
ACCOUNTING 6.1
Barclays, BIB (IoM), UKSub and LP will prepare their solus financial statements under IFRS in sterling. LuxCo will prepare its accounts under Lux GAAP in sterling. Barclays and LuxBank both prepare consolidated financial statements under IFRS in sterling and Euros respectively.
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sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 1.27 cm + Indent at: sheikha 17/10/07 10:02 Formatted: Indent: Left: 0 cm, Hanging: 1.25 cm, Outline numbered + Level: 1 + Numbering Style: 1, 2, 3, ... + Start at: 3 + Alignment: Left + Aligned at: 0 cm + Tab after: 0.63 cm + Indent at: 0.63 cm, Tabs:Not at 0.63 cm sheikha 17/10/07 10:02 Formatted
8
... [17]
6.2
The consolidated accounting analysis is summarised below. A detailed accounting analysis, including the solus accounting in respect of each entity, is attached at Appendix [4].
6.3
The accounting treatment has been agreed with SCM Finance and with PwC.
6.4
Barclays consolidation analysis 6.4.1
Deleted: ]
6.4.2
As GP, UKSub (and therefore Barclays) will control LP and will make all the management decisions in respect of LP and the LP Portfolio. Therefore Barclays will consolidate LP under IAS 27.
Deleted: [A PwC opinion in respect of the accounting analysis is attached at Appendix [5].]
6.4.3
LuxCo is an SPE under SIC-12 since, although LuxBank will own [99]% of the voting rights, LuxCo, which will have restricted articles of association, will be created for a specific, well defined purpose and its activities will be restricted. Barclays will receive the majority of the reward from LuxCo’s activities and is exposed to the majority of risks by virtue of the C Shares which are entitled to the net assets of LuxCo after payment of dividends and return of capital on the B Prefs and the A Shares. Therefore Barclays will consolidate LuxCo.
6.4.5
6.4.6
6.4.7
6.6
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Barclays owns 100% of the share capital and voting rights in BIB (IoM) and UKSub and will therefore continue to consolidate both BIB (IoM) and UKSub under IAS 27.
6.4.4
6.5
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sheikha 17/10/07 10:02 Formatted: Indent: Left: 0.75 cm, Hanging: 1 cm, Outline numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 0.63 cm + Indent at: 0.63 cm, Tabs:Not at 0.63 cm ... [18]
The LP and LuxCo Portfolios should be accounted for as “loans and receivables” at amortised cost.
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The Forward should be accounted for as a derivative under IAS 39 and fair valued through the consolidated income statement. On the date of declaration of the B Prefs dividend, Barclays should show a pre-tax profit on the Forward equal to the effective gross up under the Forward.
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... [20]
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The Luxembourg WHT suffered on the B Prefs dividend should be reflected in the tax line of the consolidated income statement on the date that the dividend is declared as an expense. The Luxembourg WHT relates to the gain on the Forward due to declaration of the dividend and should be recognised as deferred tax which becomes current tax when the WHT is paid. The A Shares should be treated as debt in the consolidated accounts.
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sheikha 11/10/07 9:19 Deleted: here should be no material differences between t
Anticipated consolidated LuxBank position
6.6.2
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The Barclays consolidated IFRS position and the Barclays consolidated US GAAP position are expected to be materially the same.
6.6.1
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Under IFRS LuxBank should recognise the Forward as a derivative under IAS 39 and recognise fair value movements on the Forward in its income statement. Until day [t + 15] prior to declaration of the B Prefs dividend, the B Prefs redemption price will be equal to the Forward Price (noting that both can be accelerated at short notice such that any time value of money impact is negligible). Upon declaration of a dividend on the B Prefs, both the Forward Price payable by LuxBank under the Forward and the B Prefs redemption price will be reduced by the amount of the dividend. The Forward Price will also increase by £[52.5]m in respect of the WHT which becomes payable by LuxBank as a result of the gross up within the Forward Price calculation. However, LuxBank will simultaneously become entitled to a credit of £[52.5]m therefore there will be no net movement in LuxBank’s assets and liabilities. LuxBank should recognise a liability in its balance sheet in respect of the WHT gross up payable under the Forward and a receivable in respect of the WHT credit due from the Luxembourg authorities.
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sheikha 11/10/07 9:18 from Deleted: ] [Awaiting finalised analysis ... [28] Chris Weidler]
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7.
6.6.3
The A Shares should be carried at historic cost with dividends recognised in the income statement when declared.
6.6.4
LuxBank will have voting control of LuxCo and will consolidate LuxCo based on German GAAP. [LuxBank are currently not expecting to consolidate LuxCo under IAS 27].. LuxCo will also be classified as an SPE under SIC-12 and consolidated by Barclays.
CREDIT AND MARKET RISK 7.1
8.
Barclays will have full management discretion over the LP Portfolio by virtue of an investment management agreement (“IMA”) with UKSub which is the general partner of LP.
7.2
The LP and LuxCo Portfolios will consist of reverse repos over OECD sovereign securities.
7.3
Since these assets are highly rated, any credit risk associated with the transaction is expected to be immaterial.
7.4
A credit limit will be marked against the various third party European financial institutions in respect of the reverse repos entered into to source the OECD sovereign securities.
7.5
All necessary credit approvals will be obtained by SCM through GFRM via the normal process.
7.6
Barclays will be exposed to market risk in respect of the interest rate risk on the LP and LuxCo Portfolios. With respect to the LuxCo Portfolio, this risk is not considered to be material given its size and in any case, the reverse repos are anticipated to be short dated. In respect of the LP Portfolio given that the reverse repos are anticipated to be short dated and the loans to LuxBank are anticipated to carry a LIBOR i.e. floating rate of interest, again the risk is not anticipated to be material.
sheikha 17/10/07 10:02 Formatted: Indent: Hanging: 1.27 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 2.77 cm + Indent at: 2.77 cm sheikha 15/10/07 14:19 Deleted: Although
sheikha 17/10/07 10:02 Formatted: Indent: Hanging: 1.27 cm, Outline numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 2.77 cm + Indent at: 2.77 cm sheikha 15/10/07 14:21 Deleted: , as described in paragraph [6.8.3],
sheikha 17/10/07 10:02 Formatted: Indent: Left: 0.5 cm, Hanging: 1.5 cm, Outline numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 0.63 cm + Indent at: 0.63 cm, Tabs:Not at 0.63 cm sheikha 17/10/07 10:02 Formatted: Indent: Left: 0.5 cm, Hanging: 1.5 cm, Outline numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 0.63 cm + Indent at: 0.63 cm, Tabs:Not at 0.63 cm sheikha 17/10/07 10:02 Formatted: Indent: Left: 0.5 cm, Hanging: 1.5 cm, Outline numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0 cm + Tab after: 0.63 cm + Indent at: 0.63 cm, Tabs:Not at 0.63 cm sheikha 17/10/07 10:02 Formatted
... [33]
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8.3 WRAs
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8.3.1
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REGULATORY CAPITAL 8.1 The regulatory capital reporting has been agreed with Finance. Basel I 8.2 Barclays solo-consolidated position 8.2.1
8.3.2
8.3.3
MHIML and BIB (IoM) are solo-consolidated. Subsequent to entering into the transaction, both companies should continue to meet the requirements for solo consolidation therefore approval from the FSA should not be required.
There should be no WRAs on either the B Prefs or the C Shares since these are intra-group items. The Forward with LuxBank can be viewed as a credit derivative which provides BIB (IoM) with credit protection on the B Prefs. In accordance with CD 5.8 (22), it should therefore be ignored for WRA purposes. However, upon declaration of a dividend on the B Prefs, BIB (IoM) will become entitled to a receivable under the Forward in respect of the 10
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corresponding gross up therefore counterparty risk should be recognised on this receivable i.e. WRAs of £[10.5]m (20% x £[52.5]m). 8.4 Large exposures 8.4.1
6.1.1
From the time that BIB (IoM) acquires the LP Interest until it is transferred to LuxCo (anticipated to be approximately 5 days), an internal exposure of £[1,122.5]m will arise in respect of the LP Interest. Since this exposure will only last a short period of time, subject to approval from Treasury it is not intended that this will be mitigated. On day t, internal exposures of £[345.7]m and £[1,122.5]m arise on the C Shares and the B Prefs respectively. LP will guarantee the obligations of LuxCo to redeem the C Shares and the B Prefs and will pledge the £[1,469.1]m LP Portfolio to BIB (IoM) in support of this obligation. Since the LP Portfolio will consist of reverse repos over OECD sovereign securities (which qualify as eligible collateral), the internal exposure on the C Shares and the B Prefs will be mitigated to zero.
Deleted: 3
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8.4.2
8.4.3
8.4.4
8.4.5
In line with CD 10.1 (1), the credit protection on the B Prefs provided by the Forward can also be ignored for WRA purposes. Upon declaration of a dividend on the B Prefs, BIB (IoM) will become entitled to a receivable of £[52.5m] under the Forward. Since the exposure will be for less than one year, this exposure is exempt for the purpose of calculating Barclays’ 25% limit. In order to pay any B Prefs dividend, the LP Portfolio will be partially liquidated, however on the basis that the price at which LuxCo is obliged to redeem the B Prefs will also reduced, it is anticipated that there should still be sufficient eligible collateral within the LP Portfolio to mitigate a significant proportion of the internal exposure on the C Shares and the B Prefs. To the extent Barclays is required to provide a guarantee (in respect of the obligations of LuxCo and LP) to the counterparties of the repos entered into to source the OECD collateral, such guarantees will give rise to an internal large exposure of Barclays to LuxCo and LP approximately equal to £[51.9]m (£[1,469.1]m x 1.02 x 1.015 - £[1,469.1]m), assuming a 2% haircut. No large exposure will arise in respect of the CDS given the exposure to the B Shares, under the CDS, will be mitigated by the pledge of eligible collateral under 8.4.2 above.
8.5 Barclays consolidated position 8.5.1
Barclays should consolidate UKSub, LuxCo and LP therefore transactions between these entities should be eliminated for regulatory purposes.
8.6 WRAs 8.6.1 8.6.2
The £[1,469.1]m LP Portfolio will consist of reverse repos over OECD sovereign securities and therefore will attract a 0% risk weighting. The Forward with LuxBank provides the Barclays Group with second loss credit protection on the LP Portfolio. This protection has not been recognised in calculating the capital required in respect of the LP Portfolio therefore, as at the solus level, the Forward should be ignored for capital adequacy purposes. Similarly to the analysis at the solus level, upon declaration of a dividend on the B Prefs, WRAs of £[10.5]m should be marked in respect of the corresponding receivable under the Forward.
8.7 Large exposures
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8.7.1
The same analysis applies as at the solus level, such that upon declaration of a dividend, an exposure of £[52.5]m to LuxBank arises.
Basel II 8.8 Barclays solo-consolidated position 8.8.1
Barclays has confirmed to the FSA that the Basel II requirements for solo consolidation will continue to be met by both MHIML and BIB (IoM) and therefore they will continue to be solo consolidated under Basel II.
8.9 WRAs 8.9.1
8.9.2
WRAs declaration of a B Prefs dividend, WRAs should be marked on the resulting receivable under the Forward with LuxBank and will be modelled using standard Probability of Default, Loss Given Default, Maturity and Exposure at Default inputs. LuxCo is not part of the UKIG, therefore prima facie solus WRAs will be required to be marked on the C Shares and the B Prefs. However, since LP will pledge OECD securities as collateral in respect of LuxCo’s obligations under the C Shares and the B Prefs, this collateral should be taken into account when modelling the applicable risk weighting and should reduce it accordingly. Any unhedged exposure would be risk weighted at 100%.
8.10 Large Exposures 8.10.1 The internal exposure on the C Shares and the B Prefs should continue to be mitigated since the LP Portfolio pledged by LP should continue to qualify as eligible collateral. 8.10.2 Any external exposure to LuxBank in respect of the receivable under the Forward should be calculated using the same EAD as for WRA purposes. 8.10.3 The large exposure discussed at 8.4.5 above in respect of any guarantee provided by Barclays to the third party repo counterparties may be as high as £[89.3]m (£[1,469.1]m x 1.02 x 1.04 - £[1,469.1]m) depending on the results of the modelling approach adopted. 8.11 Barclays consolidated position 8.11.1 Under Basel II, Barclays should continue to consolidate UKSub, LuxCo and LP. UKSub and LP will be part of the UKIG, however LuxCo will not. Since BIB (IoM) invests debt in LuxCo (which is outside the UKIG) and LuxCo invests in the equity of LP (which is inside the UKIG), the UKIG capital base should be increased.
sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1.25 cm, Numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0.87 cm + Tab after: 2.14 cm + Indent at: 2.14 cm, Tabs: 2.75 cm, List tab + Not at 2.14 cm verdil 15/10/07 9:11 Deleted: 1
sheikha 17/10/07 10:02 Formatted: Indent: Left: 0.5 cm, Hanging: 0.75 cm, Numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0.75 cm + Tab after: 1.76 cm + Indent at: 1.76 cm, sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1.25 cm, Numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0.87 cm + Tab after: 2.14 cm + Indent at: 2.14 cm, Tabs: 2.75 cm, List tab + Not at 2.14 cm sheikha 17/10/07 10:02 Formatted: Indent: Left: 0.5 cm, Hanging: 0.75 cm, Numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0.75 cm + Tab after: 1.76 cm + Indent at: 1.76 cm, sheikha 17/10/07 10:02 Formatted
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verdil 16/10/07 19:50 Deleted: 81.3
verdil 16/10/07 19:50 Deleted: 1,338.1
verdil 16/10/07 19:50 Deleted: 1,338.1
8.12 WRAs 8.12.1 The risk weighting of the LP Portfolio will be modelled using standard inputs. Under Basel II, the definition of collateral still includes OECD sovereign securities. However, for longer dated OECD sovereign securities the applicable haircut may increase by up to 4%. Therefore, the relevant haircut should be taken into account in calculating the Loss Given Default input to the LP Portfolio risk weighting calculation. 8.12.2 The risk weighting of the £[1.1]m LuxCo Portfolio and in respect of the receivable under the Forward, once a dividend has been declared on the B Prefs will also be modelled using standard inputs.
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8.13 Large exposures 8.13.1 Any external exposure to LuxBank under the Forward or in respect of the collateralised loans to LuxBank within the LP Portfolio should be calculated using the appropriate inputs and methodology. 9.
PROVISION 9.1
It is anticipated that the s.811 deduction and the creditable tax adjustment in the chargeable profits calculation of BIB (IoM) will be subject to an [80]% provision and a [100]% provision respectively.
9.2
The table below demonstrates the impact of provisioning on the economic benefit of the Transaction: S.811 Deduction 50%
Statutory PBT Tax
Creditable Tax Adj. 70% 46.1
Provision Level S.811 Deduction Creditable Tax Adj. 65% 85% 46.1
(16.8)
Provision
(7.5)
Management Accounts PTE PUG
S.811 Deduction 80%
(16.8) (10.5)
(9.7)
Creditable Tax Adj. 100% 46.1 (16.8)
(12.7)
(12.0)
15.8
9.5
3.2
(36.6)
(42.9)
10. CLIENT ENGAGEMENT 10.1
10.2
Ralf Schneider (Global Head of Equity Sourcing & Structured Products), Estelle Charron (Deputy Head Strategic Solutions) and Hans-Peter Hoffmann (Head of Tax) have been engaged in the origination process of Project Faber and previous transactions with HSH (such as Project Guitar, Project Chronos and Project Athena).
sheikha 17/10/07 10:02 Formatted: Indent: Hanging: 1.38 cm, Numbered + Level: 1 + Numbering Style: 1, 2, 3, ... + Start at: 8 + Alignment: Left + Aligned at: 0.63 cm + Tab after: 1.38 cm + Indent at: 1.38 cm, Tabs:Not at 1.38
sheikha 17/10/07 10:02 Formatted: Indent: Hanging: 1.26 cm, Numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0.75 cm + Tab after: 1.76 cm + Indent at: 1.76 cm verdil 15/10/07 18:12 Deleted: S.811 Deduction 50%
SCM will confirm that the deal has been approved within HSH prior to closing.
Statutory PBT
11. MATERIALITY OF DEAL WITH COUNTERPARTY 11.1
sheikha 17/10/07 10:02 Formatted: Indent: Left: 1.5 cm, Hanging: 1.25 cm, Numbered + Level: 3 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0.87 cm + Tab after: 2.14 cm + Indent at: 2.14 cm, Tabs: 2.75 cm, List tab + Not at 2.14 cm
sheikha 17/10/07 10:02 Formatted: Indent: Hanging: 1.26 cm, Numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0.75 cm + Tab after: 1.76 cm + Indent at: 1.76 cm
(15.0)
(30.3)
sheikha 17/10/07 10:02 Formatted: Indent: Left: 0.5 cm, Hanging: 0.75 cm, Numbered + Level: 2 + Numbering Style: 1, 2, 3, ... + Start at: 1 + Alignment: Left + Aligned at: 0.75 cm + Tab after: 1.76 cm + Indent at: 1.76 cm,
Tax
The Transaction will generate income of £[2.1]m for LuxBank and tax payable of £[0.4]m. On a consolidated basis, the summary accounts of HSH for 2006 were as follows:
Provision Management Accounts PTE PUG
(€m) Net profit Equity Tax (credit) / charge Gross balance sheet assets
2006
2005
2004
460 7,173 222 189,400
400 6,800 (123) 185,056
127 6,536 252 164,090
Creditable Tax Adj. 70% 47.3 (18.2)
(7.1)
(10.0) 16.8 (30.5)
sheikha 17/10/07 10:02 Formatted: Indent: Hanging: 1.38 cm, Numbered + Level: 1 + Numbering Style: 1, 2, 3, ... + Start at: 8 + Alignment: Left + Aligned at: 0.63 cm + Tab after: 1.38 cm + Indent at: 1.38 cm, Tabs:Not at 1.38
11.2 Based on 2006 numbers, the Transaction will have a [0.37]% impact on Net Profit, and a [.18]% impact on Tax. There should not be a material impact on HSH’s balance sheet. 11.3 Overall, the Transaction should not have a material impact on the financial statements of HSH.
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sheikha 15/10/07 14:22 Deleted: Timm Hoeynck (Head of Strategic Solutions and Head of Equity Sourcing),
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12.1 It is not considered that NPSO signoff will be required.
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12.2 It is anticipated that Barclay’s personnel will be appointed as directors of
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12. OTHER
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LuxCo [along with a director from HSH]. Although LuxCo is consolidated by Barclays for accounting purposes, it will also be an external LuxBank entity. Confirmation from BCS that the relevant Barclays personnel are covered by the Directors’ & Officers’ Liability Insurance will be obtained prior to closing [along with the relevant approvals for the HSH director]. APPENDICES Appendix 1 – Detailed Transaction Description Appendix 2 – Tax Note from Freshfields Appendix 3 – Tax Opinion from Bonn Schmitt Steichen sheikha 10/10/07 19:33
Appendix 4 – Detailed Accounting Analysis
Deleted: [
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sheikha 11/10/07 9:20 Deleted: Appendix 5 – [PwC Accounting Opinion]
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