Questions and Answers about Equity Investments
What are equity investments?
Equity investments occur when the government takes an ownership interest in a business. The business must be outside the General Government Sector, whether that it is a private sector business, or a government-owned business.
The government also has other equity investments such as in international development and aid bodies, but these are less common.
Why does the government undertake equity investments?
The government undertakes equity investments in order to support the achievement of policy objectives. For example, the purpose of such investments include:
as a means of putting money aside for future expenditure, such as the Future Fund;
to undertake an activity as a separate business, such as Australia Post; or
to participate in an international organisation as an equity subscriber, such as the International Development Association.
Are equity investments by government a recent development?
No. Equity investments have been used in public policy in Australia for many decades.
Are there non-government shareholders in government owned businesses?
There are no prohibitions on the government accepting outside shareholders in a business that it owns and controls. For example, prior to the sale of the government’s controlling interest in Telstra, that business had outside shareholders and the shares were listed on the Australian Stock Exchange.
What is the biggest equity investment program?
The biggest government program involving equity investments is the Future Fund. The Future Fund includes equities in the mix of investments that it makes to meet its objective to assist in funding future public sector superannuation payments.
How does the government approve a new equity investment in a government-owned business?
New equity investments in government-owned businesses are approved by government as part of its ongoing processes.
Are business assessments carried out on proposals to invest equity in a government-owned business?
Yes. When the government invests in a business it expects to receive its investment back through investment returns, and sometimes from the sale of a mature business. The government will usually consider a study of the relevant business prospects, which may be titled a business case. The government will often publicly release part of the business assessment. However, commercial-in-confidence or commercially sensitive information will not normally be released publicly.
What terms and conditions apply to equity investments in government-owned businesses?
There is a threshold requirement that an investment will only be recorded as an asset if there is an expectation that the government’s investment in the business will be returned. Many government-owned businesses are Government Business Enterprises (GBE), and are required to follow the GBE guidelines, which set a range of requirements. Other terms and conditions, including dividend policy, are determined on a case by case basis, as outlined in the GBE Guidelines.
There is more detail on the threshold issue, below.
Does the government monitor the performance of government-owned businesses?
Yes. While most government-owned businesses have boards that make their own business decisions, performance is monitored jointly by the responsible government department and the Department of Finance.
How does the government record equity investments in its accounts?
In the General Government Sector accounts, equity investments are recorded as financial assets, in the same way that commercial businesses record equity investments.
Does making an equity investment affect the underlying cash balance?
Making an equity investment, as long as it meets the threshold return test, does not affect the underlying cash balance. The underlying cash balance is measured as government revenue receipts, less government operating expense payments, less net payments to buy non-financial assets (and less net Future Fund receipts until 2020), and so does not include transactions in financial assets. Similarly, when a government redeems or sells its equity in a business, it does not affect the underlying cash balance.
How does the threshold return test work and what is its basis?
The government treats an investment in a government-owned business as equity if it meets a minimum level of financial return – the threshold return. This minimum level is that the investee expects to provide the government with a rate of return on its investment of at least the rate of inflation, known as a return in ‘real’ terms. The return is calculated by comparing the current values of equity injections provided by the government, with the current value of returns that the government will receive in the form of dividends, capital returns and proceeds of sale (if any). If the returns were not expected to meet this threshold, at the time the equity investment was made, some or all of the payment would be treated as a grant, and therefore as an expense, not as equity. The amount treated as a grant would depend on the expected level of return, relative to the investment.
This threshold return requirement results from putting into practice the requirements of the accounting and statistical standards.
Does any aspect of an equity investment affect the underlying cash balance?
Yes. Dividends received on the investment are classified as government revenue, and improve the underlying cash balance.
The interest on money the government borrows to finance an investment in a government-owned business is a government expense, and worsens the underlying cash balance. The government, however, borrows globally and not for individual programs, so the interest expense for equity investments is not separately itemised.
How does the government value equity investments?
Equity investments held by investment funds such as the Future Fund are valued at market value. The accounting term for this is “fair value”.
Equity investments in government-owned businesses are also recorded in the General Government Sector accounts at fair value, if this can be determined. If a fair value cannot be determined, accounting standards require the government to record its investment at its share of the net assets (assets less liabilities) of the business.
Examples of circumstances when it might not be possible to reliably determine a fair value include where it is a new business (a “start-up”), or a business that has significant fluctuations in profit because of the market in which it operates.
How are changes in the fair value of equity investments treated?
A change in the value of an equity investment does not change the amount of government’s holdings of these investments; similarly, it does not change the nature of the investment nor the classification of the entity that has received it. Only the value of the investment changes. Because nothing else changes, valuation changes are included in a separate category called “other economic flows” on the operating statement, together with other changes in asset or liability valuations caused by factors such as changes in exchange rates or interest rates.
Valuation changes do not impact the underlying cash balance.
Can the government write-down the value of its equity investments?
Under accounting standards, the government cannot unilaterally write-down any assets, including equity investments. The government only writes down equity investments if accounting standards provide for this.
In the General Government Sector accounts, write-downs can occur in one of two ways:
Where the equity investment is valued at fair value – accounting standards require write-down to the fair value, but not further. This is frequently based on lower expectations of future profits; or
Where the equity investment is valued using the investee’s net assets – the value of the investment will change if the assets, less liabilities, of the investee changes. There are several accounting standards relevant to write-down of assets in different circumstances. In essence, these standards require evidence that a write-down is required, and prescribe the methods of calculating the write-down.
In private business, a new owner may write-down the value of a newly-acquired business if, for example they have different expectations of future profits than the previous owner held. This process is, though, subject to accounting standards. Such circumstances very rarely occur in government businesses, because ownership usually stays within government.
How do equity investments affect the government’s debt position?
One measure of the government’s debt position is “net debt”, which is borrowings, less cash holdings, less loans the government has made. Gross debt is the total amount of borrowings.
Equity investments affect the government “net debt” position in several ways:
When the government borrows money to invest in equity in government-owned businesses, this increases net debt;
Similarly when the government redeems or sells equity in government-owned businesses, this reduces net debt; and
When an investment fund such as the Future Fund changes its investment mix to increase (or reduce) its holdings of equities, net debt may increase (or decrease). This is because equities are not counted in calculating net debt, but most other types of financial investment are counted.
What assurance is there that the government correctly accounts for equity investments?
The government’s accounts, including equity investments, are required to comply with accounting standards, which are set independently.
The Auditor-General audits the government’s accounts every year, including equity investments. The audit examination includes both equity values and the dividends received from them.
The Auditor-General also has the power to undertake audits of the performance of government programs.
The Australian Bureau of Statistics may review classification of items when compiling Government Finance Statistics.
Where do equity investments appear in the Budget Papers?
Amounts expected to be provided as an equity injection in government-owned businesses, or equity redeemed – that is, the new amounts invested or repaid each year – are included in a table in Statement 3 of Budget Paper No 1.
Australian Government budget financial statements also appear in Statement 9 of Budget Paper No 1. Financial statements of the actual outcomes appear in the monthly financial statements, Final Budget Outcome and Consolidated Financial Statements. Since the government has many millions of transactions each year, the financial statements provide a high-level summary of those financial transactions to present a concise overall picture of government finances. As a consequence, equity investments are not separately itemised. The following is a quick guide to the lines in government financial statements in which the most common transactions and balances in equity investments are included:
The amount of equity investments held - “Equity investments” section in the Balance Sheet;
The amount of equity invested/repaid during a year for government-owned businesses – “Net cash flows from investments in financial assets for policy purposes” in the Cash Flow Statement;
The amount of equity invested/repaid during a year for the Future Fund and other investment funds – “Net cash flows from investments in financial assets for liquidity purposes” in the Cash Flow Statement;
Dividend revenue received – “Dividends and income tax equivalents” in the Cash Flow Statement;
Dividend revenue due each year (accrual accounting) – “Dividend income” in the Operating Statement, with some additional detail in Note 5;
Valuation changes each year on government-owned businesses – “Revaluation of equity investments” in the Operating Statement; and
Valuation changes each year on other equity investments – “Other gains/(losses)” in the Operating Statement.
The list of government-owned businesses that currently satisfy the technical definition of a “public corporation” appears at the end of Statement 9 in Budget Paper No 1. Further information about the accounting and valuation of individual equity investments is usually located within the financial statements of the administering government department, rather than the Budget Papers. An exception to this is where an equity injection will be made or redeemed during the forthcoming budget year which, as noted above, is reported in Statement 3 of Budget Paper 1.
The Future Fund publishes quarterly portfolio updates, which are available on its web site. The Fund website also includes information about its investment policy and practices.