Guarantees

This Toolkit item relates to Part 2 - Investment Governance, Funding and Financing of the Commonwealth Investments Resource Management Guide.

What is a guarantee?

A guarantee is a contractual undertaking where one party assumes responsibility for the debt, or performance obligations, of another party should that other party default in some way.

For example - where the Commonwealth guarantees repayment of borrowings by a Commonwealth or other entity in favour of a third party.

The 3 key conceptual guarantees are contractual, legislative and non-contractual guarantees, with their accounting treatment outlined below, demonstrating their key distinctions.

When should I use a guarantee?

There are a number of considerations to be balanced in determining the most appropriate non-grant financing options (or blend of options).

There may be different policy reasons for providing a guarantee. In the investment context, one reason is guaranteeing financial obligations of a party to strengthen the recipient’s credit profile to enable private financing instead of providing direct Government financing.

By underwriting the risks that the private sector is unsuited or unwilling to bear, Government can “crowd-in” financing to projects earlier or to projects that would otherwise have difficulty in obtaining private financing (whether at all or on reasonable terms) by enhancing the credit profile of a third party or project.

Letters of comfort, which are similar instruments to guarantees, are issued to the other party in a contract to indicate a level of assurance that an obligation will be met. Although letters of comfort are morally binding, they are not legally binding. The issuer of the letter may be unlikely to take responsibility for any losses caused by reliance on the letter and very little assurance is actually provided to entities. Therefore, letters of comfort generally don't have impacts on financial statements. Please contact PGPA for further guidance on letters of comfort.

The Finance Minister has the power under section 60 of the Public Governance, Performance and Accountability Act 2013 to grant indemnities, guarantees or warranties. This power has been delegated to the accountable authorities of non-corporate Commonwealth entities in the Finance Minister’s delegation, subject to the directions in the delegation which limit the use of the power. For example, the Commonwealth can provide guarantees in relation to the obligations of the private sector. Further guidance on Guarantees is available in Indemnities, guarantees and warranties by the Commonwealth (RMG 414) in the right hand menu.

Characteristics of guarantees

Characteristic	Details
Ability to influence financed objective Low	Strategic influence limited to guarantee conditions.
Level of market intervention Low-Medium	The level of intervention depends on the value of the risk guaranteed. By reducing riskiness Government can attract financing to projects earlier or to projects that would otherwise have difficulty in obtaining private financing (whether at all or on reasonable terms).
Commercial discipline incentive Low	Low incentive
Certainty of financial return Nil or High	Nil or high certainty (if fee charged)
Opportunity to realise upside gain Nil	Nil capacity
Level of financial risk Medium	Depending on the guarantee terms and scope, there is the opportunity to share risk with the private sector party. If called, the Commonwealth will need to pay the amount of its liability as per the terms of the guarantee.
Security of asset Nil	Nil security
Administration costs Low-Medium	Generally, low administration. However, if called, the Commonwealth will incur additional administration costs.

Accounting and budget classification and reporting of guarantees

Typically, guarantees are classified as contingent liabilities for balance sheet purposes (with some minor differences between the types of guarantees) with legislative requirements for reporting contingent liabilities contained in the Charter of Budget Honesty Act 1998.

Contractual guarantees are recognised as financial guarantees with an impact on Fiscal Balance (FB) as well as Underlying Cash Balance (UCB) if paid. If a payment is probable for a contractual guarantee it has an impact on UCB in the year the payment is expected.

Legislative and other non-contractual guarantees are recognised as liabilities if they are reliably measurable and it is probable a payment will be made. Non-contractual guarantees recognised as liabilities have an impact on FB. As with contractual liabilities, if a payment is probable for a non-contractual guarantee it has an impact on UCB in the year the payment is expected. Where legislative and other non-contractual guarantees are not reliably measurable or probable to result in a payment are classified as contingent liabilities and disclosed in the relevant entity’s financial statements.

In the instance Government charges a fee to the recipient for providing the guarantee (known as a guarantee fee), those fees improve the UCB and FB.

Contingent liabilities with a possible impact on the forward estimates greater than $20 million in any one year, or $50 million over the forward estimates period are disclosed in the Statement of Risks in Budget Paper 1 – Budget Strategy and Outlook.

Commonwealth entities other than companies are required to report contingent liabilities in their annual financial statements in accordance with the PGPA Financial Reporting Rule 2015. Commonwealth companies are also required to report in accordance with the Corporations Act.

More information on recognition in Budget aggregates is available here .

Examples of Commonwealth guarantees

The Accommodation Payment Guarantee Scheme was introduced in the 2006-07 Budget and guarantees the repayment of aged care residents’ refundable accommodation payments (including deposits and accommodation bonds) if the approved provider becomes insolvent or bankrupt and defaults on its refund obligations.

The Guarantee Scheme is covered under the Aged Care (Bond Security) Act 2006 and the Aged Care (Bond Security) Levy Act 2006. There is no current expiry on this guarantee scheme.

As at 30 June 2018, the figure for lump sum accommodation payments held by the residential aged care sector sits at $27.5 billion. This means that the Commonwealth’s total possible liability for this guarantee as at 30 June 2018 was $27.5 billion.