Local government debt funding agency to be able to borrow in foreign currencies, be tax, prospectus and OIA exempt

The proposed local government bond bank, the Local Government Funding Agency (LGFA), will be tax exempt, won't have to issue prospectuses and will be able to borrow in foreign currencies.

In a brief counsel on the proposed LGFA, lawyers from Chapman Tripp also note it  won't be subject to the Official Information Act.

The legislation establishing the LGFA, the Local Government Borrowing Bill, has been referred to the Local Government Select Committee and is due to be reported back to the House by August 1. The Bill is co-sponsored by Finance Minister Bill English and Rodney Hide, the Minister of Local Government and recently deposed Act Party leader.

Buddle Findlay, another law firm, notes the proposals allow the Crown to lend money to the LGFA, but only if "necessary or expedient in the public interest to meet exceptional and temporary liquidity shortfalls," and on commercial terms.  It will have access to a standby facility through the New Zealand Debt Management Office, which will actually conduct the LGFA's borrowing. None of the LGFA's debt will be guaranteed by the taxpayer. The LGFA will also be exempt from the parts of the Reserve Bank of New Zealand Act that cover deposit-taker requirements.

Local government borrowing forecast to almost double within five years to NZ$10 billion

As Chapman Tripp says, the local authority debt market is fragmented with 80 issuers and several hundred mostly small debt issues. Treasury estimates this local government fragmentation adds about NZ$25 million a year to the sector’s collective interest bill.

"The burden this represents to the economy is already significant but will increase substantially if Treasury forecasts that local government borrowings will almost double within the next five years – from NZ$6 billion to around NZ$10 billion - are realised," Chapman Tripp says.

"The LGFA should also strengthen New Zealand’s capital markets by aiding the development of a deeper and more liquid market in standardised local authority bonds and by complementing the 'covered bond' market, which is being led by the main trading banks and facilitated by the Reserve Bank."

The plan is for the LGFA to issue bonds to both institutional (professional) and "ma and pa" retail investors and on-lend the money raised to participating councils to help fund their infrastructure and other capital investment costs. The idea is to achieve savings through scale and through a strong credit rating at or near AAA.

And, Chapman Tripp says, local authorities will be able to access lower interest rates to reflect their "very low credit risk" if the LGFA meets expectations. See a Local Government New Zealand statement on the LGFA here.

Tax exemption, council participation voluntary

The Bill sets out that the LGFA is to be a limited liability company but will be tax-exempt and has some statutory entitlements and exemptions enabling it to be treated as if it were a local authority, such as exemption from requirements to produce a prospectus.

"Participation by councils will be voluntary, but will need to be significant to generate the economies of scale needed to cover administration, marketing and other overhead costs. The Government kicked in NZ$5 million in seed funding in the 2010 Budget but has made it clear that no further financial commitment will be forthcoming," says Chapman Tripp.

Nine of the country's bigger local authorities, representing about 54% of combined rates income, have committed to support the LGFA. The Whangarei, Auckland, Tauranga, Western Bay of Plenty, Hamilton, Greater Wellington and Tasman councils have decided to participate in the LGFA subject to public consultation. Wellington City Council is considering the proposal and Christchurch City Council is "supportive", according to Local Government New Zealand.

The broader local government sector is said to be "broadly although not universally supportive," adds Chapman Tripp.

"The thinking behind this policy is that, because the new entity will act as a kind of ‘conduit’ to allow local authorities to achieve collectively what they can already do individually, it should be able to take advantage of the same regulatory environment (a sort of inversion of the general legal rule that subsidiaries cannot do things that their parent bodies cannot do)."

Able to borrow in foreign currencies

However, the major exception is that the LGFA will be able to borrow in foreign currencies, which is something local authorities acting on their own aren't allowed to do and will continue to be barred from. The proposed exception to this, however, is that the new Auckland City Council, due to "its size, assumed sophistication and funding needs" will be allowed to borrow in currencies other than the New Zealand dollar.

The new  "Super City" wants to be able to borrow money in foreign currencies as it seeks longer-term funding in a move it estimates will ultimately save about NZ$10 million a year. Auckland City Council is expected to borrow an extra NZ$600 million in the next six years, making it the second biggest borrower in New Zealand after the central government.

Meanwhile, Chapman Tripp points out the LGFA won't be subject to the Official Information Act, but says nor will local authorities be able to use the LGFA to shield themselves from the OIA.

"If a local authority is entitled to access particular information as a result of a contract with the LGFA, that information will be treated as being held by that local authority (even if this is not physically/factually accurate) and will, therefore, be subject to the OIA."

Will LGFA be set up as a council controlled organisation?

The Bill leaves the ownership structure and governance arrangements of the LGFA to be developed by the local government sector. Chapman Tripp suggests this leaves some "curious" drafting issues on whether the LGFA will be set up as a council controlled organisation (CCO). The law firm notes CCO status can't be legislated for because it depends on a factual assessment of control over the entity.

"This conundrum is rather awkwardly resolved through clause five in the Bill, which essentially provides that the Bill will lapse if the LGFA does not become a CCO or at any time in the future ceases to be a CCO – as would happen, for example, if a more than 50% share was privatised."

"This does not mean that the agency would cease to exist. And, indeed, the door seems to be open for it to re-jig its shareholding and slip back under the Bill’s regulatory framework through a novel on/off switch in the legislation, for which it is difficult to think of a precedent," Chapman Tripp says.

Privatisation?

"Conversely, were a majority share to be sold into private ownership and the special provisions in the Bill lost, some lenders could potentially find themselves in possession of some arguably invalid and unenforceable local authority guarantees concerning the LGFA’s foreign currency indebtedness. No doubt, the constitutional documents establishing the new entity will contain sufficient checks and balances to prevent such an outcome – or at least prevent a single authority with a large shareholding forcing such an outcome on its fellow participants."

Chapman Tripp suggests submitters on the Bill might question whether safeguards should be inserted to prevent this scenario.