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  • Forget the accounting, it's time to redfine leasing Posted on 06 December 2018

    Volume 12, Number 129, of Leasing World was the one. Where Leasing World, the ‘Economist’ of the leasing trade press, famed for its authoritative insight into the industry, declared the time may have come to: ‘Drop the word Leasing from the lexicon’.

    LW reported senior industry figures had suggested that leasing was sometimes seen as the poor relation to investment banking, having poor career prospects, a tax fiddle, or even ‘not very sexy’. 

    The problem isn’t the word, but its definition. Dropping it in favour of, say, ‘asset finance’ won’t fix it. The crux of the matter is that the definition of leasing was hijacked in the 1980’s. The time has come to rescue it.  

    John Adams, author of Commercial Hiring and Leasing (Butterworths, 1989), nailed it. The essential characteristic of any lease contract, Adams wrote, is that it enables capital equipment to be secured by revenue expenditure. (For anyone not close to the accounting, that means the firm doesn’t have to tie up its own cash).

    On that basis, any contract that enables capital equipment to be secured by revenue expenditure, regardless of any other trivial details (such as who owns the equipment or what happens at the end of the contract) should be seen as part of the leasing industry.

    Don’t reject that idea too quickly, it’s what works very successfully in the United States.

    According to the Equipment Leasing and Finance Association (ELFA), in 2018, a projected $1.676 trillion will be invested by U.S. businesses, non-profits and government agencies in plant, equipment and software. Approximately 63%, or $1.059 trillion of that investment, will be financed through loans, leases and lines of credit.

    The majority of these contracts are not accounting leases, but all form part of the joined-up equipment leasing and finance industry. Most finance companies provide a range of solutions, they are all represented by ELFA, and the industry attracts and retains top young people.

    That doesn’t happen here, because of the hijack of leasing.  It can be traced back to 1984 with the first lease accounting standard, SSAP 21. That’s when leases first became defined in an exclusionist way.

    The accounting regulators define a lease as a contract where the equipment is owned by the lessor and made available to the lessee. That might seem logical to accountants, but it meant that other loans secured on assets were ‘officially’ declared not to be leases. After the 1984 hijack, the UK leasing industry became defined by how contracts are accounted for, not by what actually matters for businesses needing equipment.

    No-one really noticed this at the time, as the tax benefits of accounting leases were such that other types of asset loans were rare.

    That has changed and is likely to change further. Many big-ticket equipment finance contracts are already set up as loans rather than accounting leases. Who is doing this? Leasing firms and leasing experts within them, because that’s where the right skills sit.

    We should expect a shift over the next decade towards loans that aren’t accounting leases, in some cases from accounting leases to loans, but often from general business loans to secured equipment loans.

    This reflects:

    1) The long-term erosion of the tax benefits of accounting leases compared to loans.

    2) The new lease accounting standard, IFRS 16, that for its users removes any remaining perceived benefits of off-balance sheet accounting for operating leases.

    3) Tighter prudential regulation of banks, meaning that whereas in the past banks might have been content to lend with floating charges over business assets as security, in the future having fixed charges over equipment could help lower the required level of regulatory capital (and, in turn, result in lower interest rates).

    4) The slow but steady move towards a more diverse range of funding sources for UK business lending, with more use of asset-backed securities and the need for those to contain loans backed by security over specific assets.

    To prepare for this future, we have to rescue the definition of leasing.  It should include all financial contracts that enable capital equipment to be secured by revenue expenditure. Perhaps we will call the industry ‘equipment leasing and finance’ where there’s space, like the Americans. But, for short, leasing will do just fine.  

    With this wider definition, we will show that leasing is no poor relation, no tax fiddle, it will offer great career prospects, and yes, it will be rather sexy after all.

    Forget the 30% or so lease penetration levels we have lived with for decades. Once the definition of leasing is rescued, the sky will be the limit.

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