esr-lease-finance-business

Economic Substance Regulations(ESR) – Lease-Finance Business

The definition of a Lease-Finance Business encompasses Licensees that offer credit or financing for any kind of consideration, and includes intra-group financing.

Offering credit or financing includes making loans to related or unrelated parties, entering into finance leases in relation to assets other than land, and providing credit in the form of hire purchase agreements, long term credit plans, and other types of financing arrangements.

Besides interest, consideration for the purpose of a Lease-Finance Business would also include origination and processing fees, gains upon conversion of a loan into the share capital of the debtor, and late payment penalties. However, granting of security in favour of the lender would not constitute consideration.

When there is no expectation of consideration from the credit at the time it is provided, the UAE business will not be considered as carrying on a Lease-Finance Business.

The investment in bonds or similar securities or debt instruments that are traded on a regulated exchange would also not be considered a Lease-Finance Business.

Licensees engaged in Banking, Insurance, and Investment Fund Management Business may also perform lease or financing activities as a normal part of their business operations. To prevent duplicate reporting, such Licensees are not also considered engaged in a Lease-Finance Business and will not need to separately demonstrate economic substance in respect of any ancillary Lease-Finance activities.

 

Core Income-Generating Activities of a Lease-Finance Business

 

The Regulations mention the following CIGAs for a Lease-Finance Business:

●  ‘Agreeing funding terms’ – This CIGA relates to the funding of the Licensee itself, and includes agreeing the type of funding (e.g. equity, preference shares, debt, etc.), the quantum of funding, the currency, the rates of interest payable, the security given (if any), and any covenants.

 

●  ‘Identifying and acquiring assets to be leased (in the case of leasing)’ – This CIGA refers to the activity of identifying and verifying suitable assets to purchase and then rent to a hirer or lessee for an agreed period, including negotiating the acquisition and the terms of the supply of the assets to be leased or hired.

 

●  ‘Setting the terms and duration of any financing or leasing’ – The Licensee is expected to have the authority (within certain parameters, where applicable) and undertake the negotiation of the amount of financing or leasing to be provided, the financial and other terms and conditions, and the relevant legal agreements to be entered into.

 

●  ‘Monitoring and revising any agreements’ – This CIGA could include obtaining data about a borrower or lessee (or the group to which they belong), testing compliance against covenants, extending the duration or the changing of other terms of the financing provided, and ensuring all relevant information is fed into the decision making process and any amended financing terms.

 

●  ‘Managing any risks’ – This CIGA refers to activities in relation to debt collection, monitoring and maintaining the conditions of the underlying leased assets (in the case of leasing), entering into swap and hedging arrangements, and developing and implementing strategies to reduce or spread risks.

 

Examples:

  • STU LLC (UAE) lends AED 1,000,000 to its subsidiary, VWX LLC, at a 10% interest rate per annum. In respect of the interest bearing shareholder loan made by STU LLC, it is considered engaged in a Lease-Finance Business (specifically, financing).

 

  • STU LLC subsequently assigns the AED 1,000,000 loan to YZ LLC (UAE), another group company. After the transfer, YZ LLC will be considered as carrying on a Lease-Finance Business. If the AED 1,000,000 loan was the only loan advanced by STU LLC, and STU LLC does not obtain an interest bearing loan receivable from YZ LLC in exchange for the transfer, STU LLC would cease to carry on a Lease-Finance Business once the transfer is effected.

 

  • TradeCo LLC (UAE) sells office supplies and allows its customers a 45-day payment term on invoices. If customers do not pay within 45 days, TradeCo charges late payment interest. This trade-credit arrangement is not a Lease-Finance Business, as the credit is not offered with the intention of generating interest, but rather to facilitate the trading business of TradeCo.

 

  • TreasuryCo LLC (UAE) is part of the JMR group and acts as the central treasury center for the group. TreasuryCo enters into external borrowing arrangements and on lends the borrowed funds to group companies at the same interest rate it is being charged by the external funders. Despite TreasuryCo not applying a mark-up on the interest it is being charged, it offers financing to group companies for consideration, and is thus considered to carryon a Lease-Finance Business.

 

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