Debt and Related Operations 297
A3.21 A common example of debt conversion is
debt-for-equity swaps.^6 Determining the value of
the equity may be diffi cult if the equity is not ac-
tively traded on a market, as is likely to be the case if
the unit that issued the equity is a controlled public
corporation. If the equity is not traded, its valuation
should be based on one of the methods set out in
paragraph 7.173.
A3.22 Further examples of debt conversions are
other types of debt swaps (such as external debt ob-
ligations for exports or “debt-for-exports”) or debt
obligations for counterpart assets that are provided
by the debtor to the creditor for the creditor to use
for a specifi ed purpose, such as wildlife protection,
health, education, and environmental conservation
(debt-for-sustainable-development).
A3.23 Direct and indirect debt conversions should
be distinguished. A direct swap leads directly to the
acquisition of a nondebt claim on the debtor (such as
a debt-for-equity swap). An indirect debt conversion
involves another claim on the economy, such as a de-
posit, that is subsequently used to purchase equity.
Debt prepayment.
A3.24 Debt prepayment consists of a repurchase,
or early payment, of debt at conditions that are agreed
between the debtor and the creditor. Th e debt is extin-
guished in return for a cash payment agreed between
the debtor and the creditor. Th e transaction is re-
corded at the value of the debt prepaid. Debt prepay-
ment could be driven by the debtor’s need to reduce
the cost of its debt portfolio by taking advantage of fa-
vorable economic performance or market conditions
to repurchase debt.
A3.25 If the debt is owed to offi cial creditors and
is nonmarketable (e.g., a loan), an element of debt
forgiveness could be involved (i.e., if the prepayment
occurs within an agreement between the parties with
an intention to convey a benefi t). As explained in the
section on debt forgiveness (see paragraph A3.8), a
capital transfer or capital grant from the creditor to
the debtor is recorded for debt forgiveness, which re-
duces the value of the outstanding liability/claim.
(^6) Oft en, a third party is involved in a debt-for-equity swap, buy-
ing the claims from the creditor and receiving equity in a public
corporation (the debtor).
Debt Assumption and Debt Payments on Behalf of Others
Debt assumption
A3.26 Debt assumption is a trilateral agreement
between a creditor, a former debtor, and a new debtor
(typically a government unit), under which the new
debtor assumes the former debtor’s outstanding liabil-
ity to the creditor, and is liable for repayment of debt.
Calling a guarantee is an example of debt assump-
tion. If the original debtor defaults on its debt obliga-
tions, the creditor may invoke the contract conditions
permitting the guarantee from the guarantor to be
called. Th e guarantor unit must either repay the debt
or assume responsibility for the debt as the primary
debtor (i.e., the liability of the original debtor is extin-
guished). A public sector unit can be the debtor that
is defaulting or the guarantor. A government can also,
through agreement, off er to provide funds to pay off
the debt obligation of another government unit owed
to a third party.^7
A3.27 Th e statistical treatment of debt assumption
depends on (i) whether the new debtor acquires an
eff ective fi nancial claim on the original debtor, and
(ii) if there is no eff ective fi nancial claim, the relation-
ship between the new debtor and the original debtor
and whether the original debtor is bankrupt or no
longer a going concern.^8 Th is implies three possibili-
ties (see Figure A3.1):- Th e debt assumer (new debtor) acquires an ef-
fective fi nancial claim on the original debtor.
Th e debt assumer records an increase in debt li-
abilities to the original creditor, and an increase
in fi nancial assets, such as in the form of loans,
with the original debtor as the counterparty. Th e
original debtor records a decrease in the original
debt liability to the creditor and an increase in
liabilities, such as in the form of a loan, to the
debt assumer. Th e value of the debt assumer’s
claim on the original debtor is the present value
(^7) For example, a central government unit off ering to provide funds
to pay off the debt of a local government unit owed to a bank.
(^8) An “eff ective fi nancial claim” is understood to be a claim that is
supported by a contract between the new debtor and the original
debtor, or (especially in the case of governments) an agreement,
with a reasonable expectation to be honored, that the original
debtor will reimburse the new debtor. A “going concern” is under-
stood to be an entity in business, or operating for the foreseeable
future.