Debt and Related Operations 307
swaps (CDS) (protection buyer) from the securi-
tization unit (protection seller) for a premium to
obtain protection against possible default losses
on the pool of assets.^27 Th e protection seller is-
sues a debt instrument. Th e proceeds from the
issue of debt securities by the securitization unit
are invested in low-risk, low-return fi nancial as-
sets (such as deposits), and the income accrued
on this investment, together with the premium
from the CDS, fi nances coupon payments on
the debt securities due by the securitization unit
to the investors. On maturity, the holders of the
debt securities are reimbursed, provided there
has been no default on the pool of assets. If there
is a default, the protection buyer is compensated
by the protection seller for the default losses re-
lated to the pool of assets, while the holders of
the debt securities (investors) suff er losses for the
same value, a realized holding gain for the pro-
tection seller.
Th e debt securities issued by the securitization
unit are part of public sector debt if the securiti-
zation unit is part of the public sector.- Synthetic securitization without a securitization
unit: Th e owner of the asset issues credit-linked
notes (CLN). CLN are debt securities that are
backed by reference assets (such as loans and
bonds), with an embedded CDS allowing credit
risk to be transferred from the issuer to investors.
Th ere is usually a higher interest rate to com-
pensate the investors for taking on higher risks.
Credit protection for the pool of assets is sold by
the investors to the protection buyer (or issuer
of the CLN) by buying the CLN. Repayment of
principal and interest on the notes is conditional
on performance of the pool of assets. If no de-
fault occurs during the life of the note, the full
redemption value of the note is paid to investors
at maturity. If a default occurs, investors receive
the redemption value of the note minus the value
of the default losses.
With synthetic securitization without a securiti-
zation unit, the debt securities (CLN) issued by a
public sector unit are part of that unit’s debt.
A3.66 On-balance sheet securitization involves
debt securities backed by a future revenue stream
(^27) A credit default swap is a fi nancial derivative whose primary
purpose is to trade credit default risk.
generated by the assets. Th e assets remain on the bal-
ance sheet of the debt securities issuer (the original
asset owner), typically as a separate portfolio. Th ere is
no securitization unit involved. Th e issue of debt se-
curities provides the original asset owner with funds
and the debt securities form part of the original asset
owner’s debt.
Debt Arising from Off -Market Swaps
A3.67 In macroeconomic statistics, swaps give rise
to fi nancial derivatives, which are nondebt instru-
ments (see paragraph 7.215). However, off -market
swaps have a debt component.
A3.68 An off -market swap is a swap contract that
has a nonzero value at inception as a result of having
reference rates priced diff erently from current market
values—that is, “off -the-market.” Such a swap results
in a lump sum being paid, usually at inception, by
one party to the other. Th e economic nature of an off -
market swap is a combination of borrowing (i.e., the
lump sum), in the form of a loan, and an on-market
swap (fi nancial derivative). Th e loan component of
an off -market swap is debt and, if a public sector unit
receives the lump-sum payment, this will be part of
public sector debt. Examples of swaps contracts that
may involve off -market reference rates include inter-
est rate and currency swaps.
A3.69 Because the economic nature of an off -market
swap is equivalent to a combination of a loan and a fi -
nancial derivative, two stock positions are recorded in
the balance sheet:- A loan—a debt instrument—which is equal to
the nonzero value of the swap at inception and
with a maturity date equivalent to the expiration
date of the swap - A financial derivative (swap) component—a
nondebt instrument—that has a market value of
zero at inception.
A3.70 Th e loan position is a liability of the party
that receives the lump sum, while the derivative posi-
tion may appear either on the fi nancial asset or liabil-
ity side, depending on market prices on the balance
sheet date.
A3.71 Future streams of fl ows relating to these
stock positions are also partitioned between those re-
lating to the loan and fi nancial derivative component,
respectively.