Many project and lease arrangers are unaware that an Asian synthetic lease business exists at all. Deals in the region go unreported.

But a market does exist and can be divided into two distinct sections: deals for US companies with foreign subsidiaries or multinational companies with US GAAP reporting requirements; and deals for indigenous Asian companies that adhere to international accounting standards.

The first category provides the biggest volume of potential business in the region, particularly for US financial institutions with their sizeable US-based clients.

Several deals have been structured this year, including a synthetic lease for US chemicals giant Dupont. This $100 million Citibank-arranged transaction to help finance a Lycra plant production line facility in Singapore.

Citibank is also working on a second $100 million synthetic lease mandate for an undisclosed multinational company to finance its Australian information technology investments, and on a third deal for another multinational company operating in Malaysia. All three financings are driven by the corporates' desire for improved balance sheet ratios.

The second Asian synthetic lease category, the market for local firms, is, according to Ian McBain, head of Citibank's leasing team in Sydney, ?a different kettle of fish entirely?.

Most Asian companies are not so concerned about balance sheet ratios as their US counterparts, although this is gradually changing. So far, the greatest demand for synthetic financings from regional companies has been concentrated in Australia and surprisingly, Japan, given the dearth of cross-border leases into the country over the last three years.

Several Australian corporates entered into small-scale synthetic leases last year, without revealing whether the deals have been arranged for Australian companies with US reporting requirements. According to several Australian bankers contacted, the recent $130 million long-term operating lease arranged for Broken Hill Proprietary locomotives and iron ore wagons is best described as a synthetic lease. This deal was arranged by Babcock & Brown, with WestPac acting as sole underwriter.

?Generally speaking, there has been increasing convergence between Australian GAAP and US GAAP,? says Michael Frazer, tax partner in Arthur Andersen's Australian financial transactions division, indicating, in theory at least, domestic synthetic leases are possible in Australia.

Frazer says synthetic leases can be booked either as a pure accounting play, whereby the original lessee's entitlement to depreciation is maintained, or as a sale for tax purposes and resale back.

Transactions in which Australian companies are the lessee are becoming more popular for the same reason that the US synthetic lease business grew ? corporates wanted to concentrate on core business and divest themselves of peripheral assets, says Jim Rowe, senior manager of ANZ global structured finance in Melbourne.

?In the last two years we've seen Australian companies become much more responsive to balance sheet management concepts,? adds Rowe.

Tony Stolarek, tax partner at Arthur Andersen in Melbourne, says that the domestic synthetic lease market could become more important because it is tax-driven leases that are the primary target of the current Australian tax revisions.

In late September of last year, the Australian government made a number of revisions to the tax code, guided by recommendations from the Ralph Report.

With respect to the leasing industry, the report suggests the removal of accelerated depreciation allowances and balancing charge roll-over relief.

But Stolarek also points out that the high level of uncertainty during what he terms a hiatus period, has dampened down the volume of all types of leases in Australia.

Ralph Report recommendations making a distinction between routine and non-routine leases are largely to blame. In broad terms, a lease will be considered non-routine and treated as a sale and loan transaction if it exceeds a certain dollar value and term.

According to Arthur Andersen's current analysis, all big-ticket, infrastructure, plant or equipment leases should be interpreted as non-routine if the Ralph Report recommendations are upheld in their existing form.

All big-ticket leases, including synthetic leases would be very challenging as a result. ?This in part is reflected in the lack of activity in the leasing market in Australia,? says Stolarek.

Frazer reminds the leasing industry that the recent changes to the tax environment have produced another, significant disincentive to do synthetic leases through a sale-leaseback approach.

?Existing assets purchased before the announcement on depreciation changes are entitled to accelerated depreciation. But if the asset is sold and leased back, the new tax regime applies and accelerated depreciation is lost,? he says.

The demand for synthetic lease products in Australia is likely to be a function of the lobbying currently taking place in the market, to preserve as much of the old tax regime for leasing as possible, as well as a function of changing corporate attitudes to balance sheet management.

Outside of Australia, a select number of Asian companies are responding to marketing by would-be arrangers. Singapore's Neptune Orient Lines (NOL) is interested in a synthetic lease deal.

NOL has a track record of opting for off-balance sheet financing ? it has entered into a number of operating lease agreements, and is said to have assets on its books that it wants refinanced, possibly by way of a synthetic lease.

One Singapore banking source says that NOL is likely to use its US-based subsidiary as the vehicle for any synthetic deal.

This news surprises other financiers. According to another Singapore-based banker, NOL is only paying a marginal amount of tax since a good portion of income from shipping activities is tax-exempt in Singapore.

?NOL did a number of sale-leasebacks in the US following the purchase of American President Lines to rejig its balance sheet, but these leases were not synthetic leases,? says another.

NOL deal or not, Singapore is a target market for the finance community. ?Synthetic leases will depend on corporate credits, and Singapore is one of the places where credits are dependable,? says Harm Prop, head of the transport finance group at ABN Amro in Singapore.

A significant percentage of Singapore companies, like their Australian equivalents, have moved closer to US GAAP style reporting procedures, says Prop.

Even more encouraging, Japanese companies are doing synthetic leases. ?Many Japanese corporations now report their financials under US GAAP, are publicly-listed, and more appreciative of products that improve earnings related ratios,? says John Duffy, senior vice-president at Sumitomo Bank Leasing and Finance in London.

Duffy adds that these companies also have numerous overseas subsidiaries. Some of these subsidiaries have ?thin? capitalization rules in their jurisdictions of operation, such that adding new assets onto the balance sheet requires more regulatory capital in the business.

Synthetic leases can be structured, says the financier, to allow fixed asset investments without the need to meet onerous capitalization rules. Last year, Japanese subsidiary NEC Europe, closed a synthetic lease on assets in the UK. A deal that Sumitomo Bank was rumoured to have arranged. The underlying operating lease in the deal is rumoured to have been booked under both US and UK GAAP standards.

The fact that US GAAP is now more common in Japan is partly the result of a new financial regulation that requires Japanese companies to give details of which accounting approach is used when they disclose their financial statements to foreign investors.

?Japanese corporates think that having to mention that financial results are put together under local accounting guidelines discourages some overseas investment,? says the leasing source.

In the last two months, Japanese tyre manufacturer, Bridgestone, made public that it was shifting to US GAAP accounting, precisely because of the foreign investment issue.

Nevertheless, the number of Japanese companies reporting consolidated accounts under US GAAP guidelines is relatively small.

One Tokyo lease arranger estimates that only 30 to 40 large Japanese corporates use US GAAP standards.

That translates into a market where between five and 10 synthetic leases are being booked each year with deals in the $10 million to $100 million range.

Some transactions have been for semiconductor manufacturers, tacked on to manufacturing equipment. ?On a number of occasions, Japanese lessees have entered into synthetic leases before an overseas bond issue,? says the Tokyo source.

Since synthetic leasing is designed to allow a lessee to retain depreciation rights while keeping the asset in question off balance sheet, it depends on a detailed analysis of tax and accounting procedures of the country in question if US GAAP or IAS 17 standards are not being used.

Generally, deals are not possible in either Japan or Korea, where tax tends to follow accounting procedure.

Banking sources who have carried out the necessary due diligence explain that in the Philippines, Malaysia and Singapore, where the accounting system follows US-style form over substance, there is a good chance of a synthetic lease market with local companies as the lessees.

In Hong Kong, which for historical reasons follows UK-style substance over form, a synthetic lease is more difficult. ?In Hong Kong it is only really possible to do these deals if the investor takes real residual value risk, in which case the deal is more of a true sale-leaseback rather than a synthetic,? says McBain.

One difficulty in expanding the product's reach in Asian is that there is no tax benefit in synthetic leases to balance the initial cost of doing due diligence in countries where the structure has not been employed before.

Luckily, say bankers, synthetic deals are not particularly complex in terms of their legal structure.

Most of the legal hours in these deals tend to centre around low-key but essential issues, like stamp duty and local transfer of assets regulations.

A process of education is also needed for what will be an unfamiliar product to many companies.

Some corporates have the impression that synthetic leasing implies borrowing costs that are substantially higher than vanilla debt.

On this Duffy says, ?the costs might normally be slightly higher than the company's marginal cost of debt, but the overall economic benefits should be compared against their weighted average cost of capital, (WACC) which would typically be higher than this cost?.

The synthetic lease market's potential in Asia is attracting more banks into the game.

Sumitomo Bank itself, which has been a regular participant in the aircraft finance market over the last decade, is shifting its attentions away from debt financing and further into the synthetic business.

Sumitomo's aerospace and lease finance division is reorganizing to reflect this new focus. The synthetic lease business will be directed out of London.

The bank's move is based partly on the experience of synthetic leasing the institution has built up in North America, Europe and Japan.

In the light of Japan's banks' increased ROE concerns, there's an obvious rationale for the Sumitomo move ? better margins.

Interestingly, Macquarie Bank, a prolific player in the cross-border leveraged lease market over the last decade is sceptical of synthetic leasing's potential.

A Macquarie source says, ?we spent some time looking at market, but will not invest a lot of time in developing the product.? Even in its own backyard, Australia, the bank doesn't think many corporates will ever be that interested in the structure. Intriguingly the source says, ?as the traditional cross-border lease markets contract we are developing other products, but not synthetic leasing.? And there is always the danger that tax and accounting authorities could clamp down on synthetic leasing, if it becomes a widespread practice.

?It is worth remembering that the Australian Tax Office moves much quicker on accounting revisions than tax revisions,? says a Sydney-based banker.