Local authorities will be able to access lower interest rates to reflect their very low credit risk if the proposed Local Government Funding Agency (LGFA) performs to expectations.

The idea has been in development since at least 2009 and the establishment legislation – the Local Government Borrowing Bill – has been referred to Select Committee for report back by 1 August 2011.

This Brief Counsel looks at the design of the LGFA as expressed in the Bill.

What the LGFA will do

The LGFA will issue bonds to wholesale and retail investors and on-lend the funds raised to participating councils to meet their infrastructure and other capital investment needs. The aim is to achieve savings through scale and (hopefully) through a respectably high credit rating – at or near AAA is considered necessary to underpin the economics.

The new agency's access to a standby facility with Treasury's Debt Management Office (which will actually conduct the borrowing function) and a provision enabling guarantees by participant authorities are intended to convince the international ratings agencies on this score.

The problem the LGFA seeks to address

The market for local authority debt is fragmented with 80 issuers and several hundred mainly small issues of debt. Treasury estimates that this fragmentation adds around $25 million a year to the local government 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 $6 billion to around $10 billion - are realised.

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.

How the scheme will work

The Bill provides that the LGFA will be a limited liability company but will be tax-exempt and gives it certain statutory entitlements and exemptions to enable it to be "treated as if it were a local authority", including exemption from the requirement 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 $5 million in seed funding in the 2010 Budget but has made it clear that no further financial commitment will be forthcoming.

In 2009, when the concept was being investigated in some depth, nine of the larger local authorities, representing 54% of rates income, committed to support the creation of a single local government debt vehicle and have since signed letters of intent to this effect. The wider sector is also said to be broadly (although not universally) supportive.

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).

The one significant exception is that the LGFA will be able to borrow in foreign currencies; something a local authority acting on its own behalf is, and will continue to be, statutorily barred from doing under the Local Government Act 2002. Due to its size, assumed sophistication and funding needs, Auckland City will also be exempt from this prohibition in its own right following passage of the Bill.

The LGFA will not be subject to the Official Information Act 1982 (OIA), but nor will local authorities be able to use it to shield themselves from the operation of 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.

Chapman Tripp commentary

The Bill sets the high level design for the LGFA only, leaving the ownership structure and governance arrangements to be developed by the sector. This decision creates some curious drafting issues regarding whether the LGFA will be constituted as a council controlled organisation (CCO) as CCO status cannot be legislated for since 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.

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. It may also be an issue for submissions whether safeguards should be inserted in the Bill to prevent such a scenario.

Next steps

The Bill is co-sponsored by Bill English as Minister of Finance and Rodney Hide as Minister of Local Government. Normally this would ensure its passage before Christmas. But this is an election year and the legislative timetable is particularly tight – especially given signals from the Government that it will be using urgency less often.

However, the elections should not pose a risk to the Bill as it is unlikely to be controversial between Labour and National.

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.