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Securitisation of future VAT income

Securitisation

Introduction

Real-time reporting is on the rise around the world. While it’s main goal is to tackle VAT fraud, there are many other applications of this tool. However, these applications depend on choices made during the design phase of real-time reporting. One of the major design choices to look at is whether the registered VAT data is made publicly verifiable. Previously we have shown that this can help businesses to e.g. automate audits, but in this blog post we will explain how governments can use it to lower their costs and increase their budget.

So before you keep on reading, consider this: at the moment real-time reporting is very much hyped (at least, as far as the VAT world is concerned, you won’t see it appear on TikTok just yet). When one looks at real-time reporting we always talk about fraudulent companies. Now let’s turn that concept on its head, instead of a fraudulent company you might also have governments where the international financial establishment is looking at with sceptical eyes. For financiers, not all governments carry the same risk, nor do the financiers always believe the data they are provided by governments. So how about we use real-time reporting to reduce the trust necessary for parties to finance governmental expenses? As governments can now cryptographically prove their income, trust in the government’s capacity to repay its liabilities will increase and that reduces the interest rate attached to governmental bonds.

Before we dive deeper into this topic, let’s first try to understand what it means to make the registered VAT data publicly available.

Some background: securely sharing government information

To start with: the more data you have about something, the better you can estimate its value. When you’re looking to buy a house, you can make the best offer by understanding how nice the neighborhood is, how well the building is maintained, and so forth. When you’re getting a loan, it is in the bank’s best interest to gather as much data about you as possible in order to assess the likelihood of default and to set the interest rate at a competitive level.

But there’s a catch: creating and gathering data costs resources. There is only so much investigation which anyone can do before it’s time to make the purchasing decision. Although it is important to both trust and verify, sometimes verification is just too expensive.

In the digital age, more and more data is being created than ever before, allowing for people to more accurately assess the value and risks involved in any particular transaction. However, that data creation and collection comes with a major downside: privacy and confidentiality are at risk, and subsequently some notions of fairness as well. In various blog posts we have explained why data should be treated with care (e.g. here and here). A government would never publish the entire financial history of all of their citizens and companies to the world, even though it would allow companies to more accurately set prices and could lead to massive economic growth.

The privacy and confidentiality concerns can be overcome by using cryptography, the science of secure communication. By using modern cryptography, very specific proofs and attestations can be made about data without revealing everything. In other words, by making the data publicly verifiable, the data becomes more trustworthy, and thereby more useful.

In the far future, every incoming (tax) or outgoing (subsidy) financial flow of governments could potentially be made partially publicly verifiable. We explained one example of the use of this in one of our previous blog posts. By using a confidential real-time reporting system for VAT collections, companies can prove to auditors what information is noted at the tax authority, thereby allowing a large part of the auditors job to be automated, and allowing the auditor to focus on the most important and fraudulent cases.

Lowering government financing costs using real-time reporting

Most governments in the world take on debt. However the amount of debt differs enormously between countries. Even within the EU it ranges from 199% of GDP (Greece) to 18.5% of GDP (Estonia). The total amount of debt taken on by EU Member States is €12,036,166,000 000 with an average debt to GDP ratio of 97.3% (figures are from January 2021).[1]

The debt is raised by giving out government bonds. Despite the large amounts at play, this is the most normal order of the day. Interest rates and credit ratings indicate the level of perceived risk for lenders.[2] The risk can be decreased when more data is available about the likelihood of repayment of debts or about the revenue generated in a country by its taxpayers. For example, this type of data can be useful if a government wants to use future government income as collateral, but it is also useful if a government wants to generally build trust with credit institutions.

What kind of collateral can governments actually put up? Well, typically they don’t. The only collateral which governments have historically put up include proceeds generated by state-owned enterprises from natural resources such as oil.[3] However, governments do not just earn income from natural resources. Actually their largest source of income is often taxes, and that income has the potential to be used as collateral as well (this is also known as securitisation). Future expected incoming cash flows from VAT revenue can be used as collateral in order to raise debt with a favorable interest rate or assess better the economic power of a country and revenue generated. This is the case because once a real-time reporting system is introduced in a country, the government can prove more accurately how much VAT will be collected. In order to leverage this data and actually securitise the future VAT income, it needs to be made publicly available. However, as discussed in the previous paragraph this might create concerns regarding privacy and confidentiality.

Summitto’s invoice reporting system is the only solution that solves this problem by making use of modern cryptography. This is because the data in our system is public by default, shared not just with a single creditor but anyone who wants to access it. This in turn is only possible because we ensure no valuable pricing information is exposed. Third parties will be able to validate tax revenue information in a 100% confidential manner. Let’s now have a look at what this could mean for a country that is looking for additional financing.

Case study: Securitisation of oil revenue - Pemex

In order to understand the potential impact of the securitisation of future tax revenue, we can use the case of Mexico where future revenue of state-owned oil company Pemex was securitised. Pemex:

“saved via securitization anywhere from 50 basis points to 337.5 basis points from what it would have had to pay on senior Pemex debt. The savings relative to UMS [United Mexican States] spread was even more substantial."[4]

The World Bank compared the 7 year and 18 year future oil receivable backed Pemex securities against the United Mexican States unsecured bench-mark euro bonds maturing in 2026 for the period January 29, 1999 - April 21, 2000 and found that in general the securities backed by future oil receivables is cheaper. It’s important to note that even a decrease of 50 basis points can make an enormous difference on the costs for a government:

“For example, raising $200 million through asset backed securitization can lead to a saving of more than $5 million in interest costs over a four year period—and more than $11 million over a seven year period—if the spread is 50 basis points lower than a comparable unsecuritized transaction”[5]

So, the securitisation of future state revenue can offer enormous benefits for governments. The implementation of a confidential real-time reporting system will make it possible to apply this use case to VAT revenue.

It’s important to emphasise that although it can be a very useful tool, there are also a couple of risks attached to this way of financing. These risks include that it is a (almost) entirely new type of lending tool which can come with high costs because standardisation is often not feasible due to country-specific needs. Costs include obtaining investment banking expertise, legal services and credit rating.

Conclusion

This has been a brief introduction to a very complex topic. Through analysing the use case of Pemex, a Mexican state-owned oil company, we showed that securitising future government revenue can help governments that struggle to take on affordable debt. The implementation of summitto’s confidential real-time reporting system will make it possible to do the same thing, but then for future VAT income. This is the case because our system allows the government to publish VAT reporting data in a secure way which in turn enables them to accurately prove how much VAT will be and is collected. In short, summitto’s real-time reporting system will not only lower a country’s VAT gap, it can also help countries to take on loans against a better price.

In case you want to learn more about how summitto’s real-time reporting system exactly works and how it benefits both the public and private sector click here. For questions, shoot us a message at info@summitto.com

[1] https://ec.europa.eu/eurostat/documents/portlet_file_entry/2995521/2-21012021-AP-EN.pdf/a3748b22-e96e-7f62-ba05-11c7192e32f3

[2] https://www.investopedia.com/terms/s/sovereign-credit-rating.asp

[3] https://documents1.worldbank.org/curated/en/323541468780624671/pdf/wps2582.pdf

[4] https://documents1.worldbank.org/curated/en/323541468780624671/pdf/wps2582.pdf

You can also find more information about the topic here: https://www.imf.org/external/pubs/ft/wp/2002/wp02106.pdf

[5] https://documents1.worldbank.org/curated/en/323541468780624671/pdf/wps2582.pdf