Monday, July 05, 2004

The majority of the provisions of the Local Government:  Municipal Finance Management Act 2003 (“the Act”) came into effect on 1 July 2004.  The object of the Act is to secure sound management of the financial affairs of municipalities by establishing requirements for transparency and accountability in the financial affairs of municipalities.
Municipalities occupy an important position as they are responsible for providing us with many of the services and infrastructure that we rely on.  In return, we pay rates to the municipalities.  Municipalities also look to domestic and international financial institutions for funding.  From a ratepayer’s perspective, the ideal scenario is for the relevant municipality to balance its books and ensure that its financial position is not subject to any adverse movements which may result in it being necessary for the municipality to increase rates, such as the municipality ending up out-of-the-money on a derivative trade.  From a financial institution’s perspective, the concern is to ensure that any municipality with which such financial institution trades or in respect of which such financial institution holds a debt obligation has the capacity so to trade or to issue such debt.  Chapters 6 (Debt) and 14 (General Treasury Matters) of the Act should be of particular importance to financial institutions when dealing with municipalities.
Chapter 6 provides that a municipality may only incur short-term debt or long-term debt in accordance with the provisions of the Act.  For these purposes, “short-term debt” means debt repayable over a period of not exceeding one year, “long-term debt” means debt repayable over a period exceeding one year and “debt” means a monetary obligation created by a financing agreement, note, debenture bond or overdraft, or by the issuance of a municipal debt instrument, or a contingent liability (which needs to be carefully considered).
A municipality may only incur short-term debt when necessary to bridge shortfalls within a financial year during which the debt is incurred, in expectation of specific and realistic anticipated income to be received within such financial year.  Additionally, a municipality may only incur short-term debt if the relevant debt agreement has been approved by a resolution of the municipal council signed by the mayor and the municipality’s accounting officer has signed the relevant debt agreement.
Insofar as long-term debt is concerned, a municipality may only incur such long-term debt for capital expenditure on property, plant or equipment to be used for the purposes of achieving the objects of local government as set out in the Constitution or re-financing existing long-term debt.  Further, for a municipality to incur long-term debt, the accounting officer of the municipality must, at least 21 days before the meeting of the council at which approval for the debt is considered, make public an information statement setting out particulars of the proposed debt (including the amount of the proposed debt, the purposes for which the debt is to be incurred and particulars of any security to be provided) and inviting the public, the National Treasury and the relevant provincial treasury to submit written comments to the council in respect of the proposed debt.  The accounting officer must submit a copy of the information statement to the municipal council at least 21 days prior to the meeting of the council together with particulars of the essential repayment terms and the anticipated total cost in connection with such debt over the repayment period.  There are also certain requirements that must be met in relation to re-financing existing long-term debt, the most important of which seems to be that the existing long term debt must have been lawfully incurred.
A further restriction on the capacity of municipalities to incur debt is that the relevant debt must be denominated in Rand and may not be indexed to or affected by fluctuations in the value of the Rand against any foreign currency. 
A municipality may, by resolution of its council, provide security for any of its debt obligations or its contractual obligations undertaken in connection with capital expenditure on property, plant or equipment to be used by the municipality for the purposes of achieving the objects of local government in terms of the Constitution.  The permitted types of security and the permitted ways of granting such security by the municipality are very broad and include specific payment mechanisms to ensure exclusive payments to lenders or investors.
The Act imposes a duty upon any person interacting with a prospective lender in the context of a municipality borrowing money to disclose to the prospective lender all information that such person has that may be material to the decision of the prospective lender to lend to the municipality and to take reasonable care to ensure the accuracy of any information disclosed.Finally, chapter 14 of the Act provides that no municipality may incur a liability or risk payable in foreign currency (subject to certain exceptions), nor conduct any commercial activities otherwise than in the exercise of powers assigned to it in terms of the Constitution.  It is not clear whether the latter would include entering into derivative trades. 
A number of issues which are important to financial institutions flow from these provisions of the Act, and I would like to mention two of them briefly.  First, the question of capacity.  Do the provisions of the Act operate to limit the capacity of municipalities to enter into certain types of transactions unless certain formalities have been complied with?  This would seem to be the case, although the Act does not expressly say so.  Second, it follows that financial institutions will need to ensure, when dealing with municipalities, that they have carried out adequate due diligence in relation to the transaction in question and that they have taken appropriate representations and warranties from the accounting officer as to the municipality’s compliance with the provisions of the Act.   The Act provides that a lender may rely on written representations signed by the accounting officer of a municipality.
Ratepayers, for their part, should be satisfied that the Act provides a framework for borrowing by the municipalities. 
David Anderson