enhancing the access of municipalities and municipal corporations

Enhancing the access of Enhancing the access of municipalities and municipal municipalities and municipal corporations to the domestic corporations to the domestic

finance marketfinance market

Conference Conference

Regional Development and Municipal Regional Development and Municipal FinanceFinance

Arabela Aprahamian, ECSPF, World BankArabela Aprahamian, ECSPF, World Bank

Michel Noel, ECSPF, World BankMichel Noel, ECSPF, World Bank

AgendaAgenda

The two sides of the marketThe two sides of the market Evolution of the municipal finance market since Evolution of the municipal finance market since

20022002 Reforming the legal and regulatory framework for Reforming the legal and regulatory framework for

the municipal finance marketthe municipal finance market Enhancing access of municipalities and Enhancing access of municipalities and

municipal corporations to domestic finance municipal corporations to domestic finance marketmarket

Mobilizing equity finance for municipal Mobilizing equity finance for municipal corporationscorporations

1. The two sides of the market1. The two sides of the market

1.1: Municipal finance: borrowing by municipalities on own account1.1: Municipal finance: borrowing by municipalities on own account

. possible explicit or implicit government guarantees. possible explicit or implicit government guarantees

. part of general government debt. part of general government debt

1.2: Municipal corporation finance:1.2: Municipal corporation finance:. Borrowing by municipal corporations . Borrowing by municipal corporations

- possible explicit or implicit municipal guarantees- possible explicit or implicit municipal guarantees - outside general government debt- outside general government debt. Equity mobilization by municipal corporations. Equity mobilization by municipal corporations

. various forms of PPPs . various forms of PPPs - PFI contract: equity in service corporation- PFI contract: equity in service corporation- concession: equity in operating company- concession: equity in operating company- divestiture: equity in underlying assets- divestiture: equity in underlying assets

2.1 Overall financial market conditions:2.1 Overall financial market conditions: Convergence and entry into EU single Convergence and entry into EU single

market-> reduction in sovereign spreadsmarket-> reduction in sovereign spreads 12-year Sovereign Eurobond vs. 3-Month Euribor

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2.2 Municipal finance market conditions: 2.2 Municipal finance market conditions: reduction in spreads, lengthening of reduction in spreads, lengthening of

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2.2 Municipal finance market 2.2 Municipal finance market conditionsconditions

-> increased geographical dispersion of municipal -> increased geographical dispersion of municipal loansloans

Loans >1 year maturity Loans >1 year maturity 2005 2005 2006 2007 2006 2007(in % of total) (in % of total)

BucharestBucharest 41.441.4 22.2 22.2Municipalities > 100KMunicipalities > 100K 41.841.8 53.0 69.5 53.0 69.5

Municipalities < 100KMunicipalities < 100K 11.3 15.5 21.211.3 15.5 21.2Small cities and communes 5.5Small cities and communes 5.5 9.3 9.3 9.3 9.3


-> higher geographical concentration of municipal -> higher geographical concentration of municipal bondsbonds

Domestic currency bonds 2005Domestic currency bonds 2005 2007 2007

(% of total)(% of total) Municipalities >100KMunicipalities >100K 52% 52% 94% 94% Municipalities <100K 37%Municipalities <100K 37% Cities and communesCities and communes 11% 6% 11% 6%


-> compression of municipal spreads due to:-> compression of municipal spreads due to:

– Excess liquidity in domestic banking system Excess liquidity in domestic banking system (until recently)(until recently)

– Pricing behavior of BCR (prior to privatization Pricing behavior of BCR (prior to privatization end-2006)end-2006)

– Moral hazard due to deficiencies in legal and Moral hazard due to deficiencies in legal and regulatory frameworkregulatory framework

3. Reforming the legal and 3. Reforming the legal and regulatory framework for regulatory framework for municipal finance marketmunicipal finance market

Key policy reforms to reduce moral hazard:

1.1. Move from ex-ante control of municipal borrowing to market-Move from ex-ante control of municipal borrowing to market-based discipline;based discipline;

2.2. Remove implicit central government guarantee of local Remove implicit central government guarantee of local government debt;government debt;

3.3. Phase-out short-term Treasury loans ;Phase-out short-term Treasury loans ;4.4. Clarify certain procedures of the local government bankruptcy Clarify certain procedures of the local government bankruptcy

framework;framework;5.5. Define the modalities of application of the Risk Fund;Define the modalities of application of the Risk Fund;6.6. Increase risk weight for unrated municipalities in calculation of Increase risk weight for unrated municipalities in calculation of

regulatory capital for banksregulatory capital for banks

3. 1 Move from ex-ante control of 3. 1 Move from ex-ante control of municipal borrowing to market-municipal borrowing to market-

based disciplinebased disciplineTwo types of control under Law 273/2006:Two types of control under Law 273/2006:

– case by case ex-ante authorization by MOFcase by case ex-ante authorization by MOF– prudential limit on local government debt service (30% of own prudential limit on local government debt service (30% of own

revenues);revenues);+case by case derogations issued by MOF (ex Bucharest in June +case by case derogations issued by MOF (ex Bucharest in June

2005)2005)

GD 9/2007: major source of moral hazard on municipal GD 9/2007: major source of moral hazard on municipal finance marketfinance market

– MOF assumes the role of assessing municipal creditworthiness of MOF assumes the role of assessing municipal creditworthiness of local government for each new borrowinglocal government for each new borrowing

– Political pressure on MOF to bail-out local government in case of Political pressure on MOF to bail-out local government in case of default on debt obligation it has itself approveddefault on debt obligation it has itself approved


based disciplinebased discipline1.1. Phase one: Phase one: automatic authorization by MOF unless otherwise automatic authorization by MOF unless otherwise

notified within 15 working daysnotified within 15 working days simplified dossier of application (local government simplified dossier of application (local government

decision to borrow, loan agreement or bond decision to borrow, loan agreement or bond prospectus, past and current budget execution)prospectus, past and current budget execution)

decision to deny based solely on documentation decision to deny based solely on documentation submitted or breach of prudential limitsubmitted or breach of prudential limit

decision communicated on websitedecision communicated on website right to appeal decision -> separate regulationright to appeal decision -> separate regulation prohibition of case-by-case derogation of debt service prohibition of case-by-case derogation of debt service

ceilingsceilings


based disciplinebased disciplinePhase TwoPhase Two automatic authorizationautomatic authorization ex-post control of local government ex-post control of local government

borrowing through quarterly budget borrowing through quarterly budget execution review processexecution review process

if breach of debt service limit, prohibition if breach of debt service limit, prohibition of new net borrowing until budget of new net borrowing until budget brought back into compliance with brought back into compliance with prudential ratioprudential ratio


based disciplinebased discipline

Phase ThreePhase Three ex-post control through regular yearly ex-post control through regular yearly

budget execution review processbudget execution review process prohibition of new net borrowing if prohibition of new net borrowing if

breach of prudential limitbreach of prudential limit


based disciplinebased discipline

Following entry into Euro-zone:Following entry into Euro-zone: local governments obtaining two global scale, local local governments obtaining two global scale, local

currencycurrency credit rating by established credit rating agencies can have credit rating by established credit rating agencies can have

more relaxed debt service limitmore relaxed debt service limit-> give room to market participants for making credit -> give room to market participants for making credit

decisions based on credit qualitydecisions based on credit quality Ex post control exercised by MEFEx post control exercised by MEF Ex-ante approval maintained in case of borrowing in Ex-ante approval maintained in case of borrowing in

foreign currency ( outside Euro-zone following Euro entry) foreign currency ( outside Euro-zone following Euro entry)

3.2 Remove implicit central government 3.2 Remove implicit central government guarantee of local government debtguarantee of local government debt

Article 63 of LPF allows local government Article 63 of LPF allows local government debt to be guaranteed by own revenue (incl debt to be guaranteed by own revenue (incl government transfers)government transfers)

Gives precedence to such debt over all Gives precedence to such debt over all other claims against local governmentother claims against local government

-> some financial institutions consider that own--> some financial institutions consider that own-revenue guarantee is exercisable with Treasuryrevenue guarantee is exercisable with Treasury

-> local government own-revenue guarantee -> local government own-revenue guarantee considered as good as government guaranteeconsidered as good as government guarantee

-> mentioned in bond prospectus to investors-> mentioned in bond prospectus to investors

3.2 Remove implicit central government 3.2 Remove implicit central government guarantee of local government debtguarantee of local government debt

Law 288/2002 stipulates that State Treasury can only execute payments when Law 288/2002 stipulates that State Treasury can only execute payments when ordered by budget manager of public institutionsordered by budget manager of public institutions

This appears to give local government discretion in honoring their guarantee or This appears to give local government discretion in honoring their guarantee or notnot

Law 110/2007 addresses this ambiguity: if a public institution fails to fulfill its Law 110/2007 addresses this ambiguity: if a public institution fails to fulfill its payment obligation within 6 months from enforcement order, creditor may payment obligation within 6 months from enforcement order, creditor may request enforcement based on Civil Procedure Code and/or other applicable request enforcement based on Civil Procedure Code and/or other applicable legal provisionlegal provision

Credit release authorities (ie mayors and president of city councils) must order Credit release authorities (ie mayors and president of city councils) must order all steps to ensure payment of amounts dueall steps to ensure payment of amounts due

In case of failure to comply, State Treasury, acting on instruction of court, may In case of failure to comply, State Treasury, acting on instruction of court, may transfer the funds directly from municipality account to creditortransfer the funds directly from municipality account to creditor

-> Unclear if market participants make distinction between these -> Unclear if market participants make distinction between these procedures and central government guarantee, resulting in moral hazard on procedures and central government guarantee, resulting in moral hazard on municipal finance marketmunicipal finance market

-> -> Policy reformPolicy reform– Ensure that future legislation and regulations in the field of public debt Ensure that future legislation and regulations in the field of public debt

makes it clear that local government debt carries no implicit Government guaranteemakes it clear that local government debt carries no implicit Government guarantee

3.3 Phase-out short-term Treasury 3.3 Phase-out short-term Treasury loansloans

Three problems with the ST Treasury loans to local governmentsThree problems with the ST Treasury loans to local governments MOF assumes role of credit allocation and pricing for local MOF assumes role of credit allocation and pricing for local

governmentsgovernments International experience shows that Treasury loans or other International experience shows that Treasury loans or other

government-run credit facilities are open to political pressure government-run credit facilities are open to political pressure Treasury loans are ready-made instrument to bail out local Treasury loans are ready-made instrument to bail out local

government in case of defaultgovernment in case of default

->Treasury loans soften budget constraint for local governments and ->Treasury loans soften budget constraint for local governments and generate moral hazard on municipal finance marketgenerate moral hazard on municipal finance market

-> Policy reform -> Policy reform – Progressively phase-out Treasury loans, starting with largest citiesProgressively phase-out Treasury loans, starting with largest cities– Use provisions of LLPF allowing local governments to open bank Use provisions of LLPF allowing local governments to open bank

account linked with a loan from commercial bank and open overdraft account linked with a loan from commercial bank and open overdraft facility with private banksfacility with private banks

3.4 Clarify certain procedures of 3.4 Clarify certain procedures of the local government bankruptcythe local government bankruptcy

Articles 74 and 75 of LLPF provide sound legal framework Articles 74 and 75 of LLPF provide sound legal framework for local government bankruptcyfor local government bankruptcy

2007 version of Draft Law implementing Art. 74 and 75 of 2007 version of Draft Law implementing Art. 74 and 75 of LLPF specify criteria for declaring state of financial crisis LLPF specify criteria for declaring state of financial crisis and termination, content of financial recovery plans, and termination, content of financial recovery plans, participants in process, and sanctionsparticipants in process, and sanctions

-> -> Policy reformPolicy reform– Clarify definition of essential municipal servicesClarify definition of essential municipal services

– Define highly restrictive conditions for Treasury loans and for Define highly restrictive conditions for Treasury loans and for support from Government reserve fund to local governments support from Government reserve fund to local governments undergoing plan of insolvency recoveryundergoing plan of insolvency recovery

3.5 Define the modalities of 3.5 Define the modalities of application of the Risk Fundapplication of the Risk Fund

LLPF provides establishment of Risk Fund to LLPF provides establishment of Risk Fund to cover financial risks deriving from guarantees by cover financial risks deriving from guarantees by local government units for loans contracted by local government units for loans contracted by municipal corporationsmunicipal corporations

Risk Fund accumulates commissions and other Risk Fund accumulates commissions and other

fees paid by beneficiaries of loan guarantees and fees paid by beneficiaries of loan guarantees and is used in case of guarantee callsis used in case of guarantee calls

-> -> Policy reformPolicy reform– Define methodology for valuation of guarantee fees in Define methodology for valuation of guarantee fees in

parallel with methodology used for National Risk Fundparallel with methodology used for National Risk Fund

3.6. Increase risk weight for unrated municipalities in calculation of regulatory

capital for banks

NBR regulations require:NBR regulations require: 50% risk weight for loans to jurisdictions 50% risk weight for loans to jurisdictions

with no credit ratingwith no credit rating variable risk-weight for rated jurisdictionsvariable risk-weight for rated jurisdictions

-> -> Policy reformPolicy reform– Raise risk-weight to 100% for jurisdictions with Raise risk-weight to 100% for jurisdictions with

no credit ratingno credit rating

4. Enhancing access of to 4. Enhancing access of to domestic finance marketdomestic finance market

-> Design and implement coherent strategy to -> Design and implement coherent strategy to enhance access of municipalities and enhance access of municipalities and municipal corporations to domestic finance municipal corporations to domestic finance market in the context of EU single marketmarket in the context of EU single market

-> Consists of range of technical assistance -> Consists of range of technical assistance and financial support instruments modulated and financial support instruments modulated in function of the risk profile of particular in function of the risk profile of particular sub-national entitiessub-national entities

4. Enhancing access of to 4. Enhancing access of to domestic finance marketdomestic finance market

Tier 1: Low-risk sub-national Tier 1: Low-risk sub-national entitiesentities

-> small group of 10-15 municipalities at one to two notches -> small group of 10-15 municipalities at one to two notches below sovereign rating (based on international credit rating below sovereign rating (based on international credit rating or internal risk assessment by banks)or internal risk assessment by banks)

-> can access domestic market at maturities exceeding 15 -> can access domestic market at maturities exceeding 15 years and at spreads below 50 basis points without years and at spreads below 50 basis points without sovereign guaranteesovereign guarantee

-> have graduated from support from IFIs because the cost of -> have graduated from support from IFIs because the cost of credit enhancement that could be provided by IFIs to them credit enhancement that could be provided by IFIs to them would be higher than benefit of enhancement in terms of would be higher than benefit of enhancement in terms of spread reduction and maturity extensionspread reduction and maturity extension

-> in practice some of these municipalities still draw IFI -> in practice some of these municipalities still draw IFI resources but this is expected to change over timeresources but this is expected to change over time

Tier 2: Medium-risk sub-national Tier 2: Medium-risk sub-national entitiesentities

-> Market access at higher spreads and shorter maturities-> Market access at higher spreads and shorter maturities

-> Dual package of technical assistance and financial support-> Dual package of technical assistance and financial support

-> Technical assistance-> Technical assistance– Develop capacity to prepare investment programs and projectsDevelop capacity to prepare investment programs and projects– Develop conditions for private participation in local infrastructure Develop conditions for private participation in local infrastructure

(tariffication of utilities)(tariffication of utilities)– Structure PPPsStructure PPPs– Administer social protection programs for low-income householdsAdminister social protection programs for low-income households– Obtain credit ratingObtain credit rating

Tier 2: Medium-risk sub-national Tier 2: Medium-risk sub-national entitiesentities

-> Financial support-> Financial support– Provide credit enhancement for local Provide credit enhancement for local

government debtgovernment debt– Partial credit guarantee facility (PCGF) for sub-Partial credit guarantee facility (PCGF) for sub-

national debt obligationsnational debt obligations

4.3 High risk municipalities/4.3 High risk municipalities/municipal corporationsmunicipal corporations

-> no access to domestic financial market, even with credit -> no access to domestic financial market, even with credit enhancementenhancement

-> uncreditworthy entities should not borrow from any source -> uncreditworthy entities should not borrow from any source (including on-lending from central Government)(including on-lending from central Government)

-> Support to focus essentially on technical assistance to -> Support to focus essentially on technical assistance to strengthen fiscal and financial management and corporate strengthen fiscal and financial management and corporate governance up to point where entities can produce audited governance up to point where entities can produce audited financial statementsfinancial statements

-> For small cities, promote inter-municipal undertakings with -> For small cities, promote inter-municipal undertakings with medium cities to achieve economies of scalemedium cities to achieve economies of scale

-> Establish competitive capital grant program-> Establish competitive capital grant program– Subject grants to transparent requirements (score)Subject grants to transparent requirements (score)– Subject repeat grants to specific improvement in scoreSubject repeat grants to specific improvement in score– Graduate to Tier 2Graduate to Tier 2

5. Mobilizing equity finance for municipal 5. Mobilizing equity finance for municipal corporationscorporations

Local Infrastructure Equity Fund (LIEF):Local Infrastructure Equity Fund (LIEF):

5.1 LIEF characteristics5.1 LIEF characteristics

5.2 Selection of Fund Manager5.2 Selection of Fund Manager

5.3 Establishment of Fund 5.3 Establishment of Fund

5.4 Establishment of JVs5.4 Establishment of JVs

5.5 Procurement of investment 5.5 Procurement of investment programmeprogramme

enhancing the access of municipalities and municipal corporations

Documents

municipal finance market

municipal corporation

local government debt

treasury local government

market participants

market evolution

case of borrowing

implicit municipal guarantees