Nigeria is a Federation which means that there are three levels of government in Nigeria: federal, state, and local, each of which is in charge of carrying out distinct duties. Under the Federal Republic of Nigeria’s Constitution, each of the 36 states is a semi-autonomous political entity that shares authority with the federal government. For instance, while the State Governments and the Federal Government jointly oversee health and education, the Federal Government (FG) is solely in charge of printing money and upholding the peace.
States are financed in two ways: either by Internally Generated Revenue (IGR) that accrues to them through personal income taxes and other levies, or through the monthly allocation of funds that they receive from the Federation Account Allocation Committee (FAAC). Although most of the states have potential to generate more from internal sources, they prefer going cup in hand to Abuja every month to share from the FAAC. It is however gladdening that many states have now realised the need to generate funds locally than wait to be ‘’fed’’ from the federation account.
Notwithstanding the improved revenue generation from internal sources, state governments continually have challenges in balancing the need for infrastructure development, social welfare programs, and efficient service delivery when compared to the limited financial resources at their disposal. The result is that states resort to the practice of borrowing funds, raising critical questions as to the sustainability of such practices, capacity to repay and the responsibilities of those entrusted with managing these debts.
State governments borrow money or raise capital through the issuance of bonds or loans. These loans are usually to enable the governments carry our developmental projects that their total revenue would ordinarily not have been able to carry. For our education, a bond is a debt instrument issued by governments, municipalities, corporations, or other entities to raise capital. When an entity issues a bond, it is essentially borrowing money from investors in exchange for a promise to repay the principal amount at a future date, known as the maturity date, along with periodic interest payments until maturity. There are two types of bonds: Amortising and bullet bond. An amortising bond is the bond that repays both principal and interest at the same time such that when the bonds matures, the balance in the account is nil. A bullet bond on the other hand pays only the periodic interest while the total principal is repaid at maturity enbloc. A state could, depending on several considerations, decide which type to go for.
In this article, I shall attempt a summation as to why governments raise capital either from private or public entities.
Infrastructure Development: Since the revenue accruing to the states are usually not enough, states often issue bonds to enable them finance large-scale infrastructure projects such as building highways, bridges, schools, and hospitals. Bonds provide a means for states to raise the necessary capital upfront to fund these projects, which contribute to economic development and improve the quality of life for residents. Moreover, they are of longer tenor thus giving the state a breathing space and making repayment easier.
Debt Refinancing: For several reasons, state governments may issue bonds to refinance existing debt obligations. This is usually common where such bonds are nearing maturity or carrying high-interest rates. Refinancing allows states to take advantage of lower interest rates or extend the maturity of their debt, resulting in potential cost savings over the long term.
Budgetary Needs: In times of budgetary shortfall or when faced with unexpected expenses, states may issue bonds to bridge funding gaps and maintain essential services. Bond proceeds can help cover operating expenses, fund public safety programs, or address other urgent priorities without relying solely on either the internal or FAAC allocation or even tax revenues.
Economic Stimulus: State governments may issue bonds to stimulate the economy and create jobs for its teeming populace. Since bond proceeds are invested in infrastructure projects, it also provides funding for small businesses and community development initiatives. Bond issuances can stimulate economic growth and support recovery efforts during recessions, crisis or downturns.
Capital Projects: States may issue bonds to finance capital projects for state-owned enterprises or public-private partnerships. These projects may include investments in transportation, utilities, energy, or other critical sectors that require substantial upfront capital investment but yield long-term benefits for the state and its citizens.
However, irrespective of the several benefits attributed to state borrowings, it is imperative to emphasise that borrowing is not without its risks. Borrowings therefore must be within acceptable threshold because if not managed responsibly, excessive debt can be a huge burden on future generations. Excessive debt can also restrict government’s ability to invest in essential services and expose them to vulnerabilities in case of economic downturns. Therefore, maintaining debt sustainability is crucial for responsible fiscal management. We have seen unfortunate incidences where bond proceeds are diverted to fund the lifestyles of government officials or used for objects not specified in the issue documents. This is largely responsible for why many of the projects highlighted in the issue documents are abandoned while the state continues to carry the burden of debt servicing for ages.
To ensure that due process is followed in all borrowings particularly by states, the parties particularly the states must align such borrowings with legal frameworks, regulations, and oversight mechanisms for transparency, accountability, and prudent financial management. It is to ensure this that the Trustees are appointed and entrusted with the responsibilities of safeguarding the interests of bondholders and upholding the integrity of borrowing agreements. Trustees are Individuals or entities appointed to oversee the borrowing process, ensuring compliance with legal and regulatory requirements and protecting the interests of bondholders.
Responsibilities of Trustees:
Trustees play a crucial role in the borrowing process because they act and protect the interest of bondholders and also ensuring that parties adhere to the terms and conditions of borrowing agreements. Some of the few key responsibilities of the Trustees in state bond transactions could be summarised as follows:
Safeguarding Bondholders’ Interests: Trustees are charged with the duty of protecting the rights and interests of bondholders by ensuring that they periodically receive their coupon as well as the principal. It is also the duty of the Trustees to ensure that proceeds from bond issuances are used for the intended purposes outlined in the borrowing documents. They monitor the use of funds and verify that projects funded by the borrowings are executed efficiently and effectively.
Ensuring Compliance: Trustees ensure compliance with legal and regulatory requirements governing the issuance of bonds, including the accuracy and completeness of offering documents, adherence to covenants and conditions, and timely disclosure of material information to bondholders, the state and the Regulators.
Facilitating Communication: Trustees serve as intermediaries between state governments and bondholders, facilitating communication and providing information to both parties. They disseminate bond reports, notices, and other communications to bondholders, fostering transparency and accountability.
Monitoring Financial Performance: Trustees monitor the financial performance of state governments, assessing their ability to meet debt service obligations. They analyse key financial indicators to evaluate the creditworthiness and financial health of the borrowing entities. Thus the Trustees must ensure that the state periodically publish its accounts so that the Trustees can make informed decisions regarding the state’s obligation to bondholders.
Exercising Remedial Actions: In cases of default or non-compliance with borrowing agreements, trustees have the authority to take remedial actions to protect the interests of bondholders. This may include initiating legal proceedings, enforcing contractual remedies, or negotiating with the borrowing entity to address underlying issues.
While trustees play a critical role in safeguarding bondholders’ interests, they face various challenges and considerations in fulfilling their responsibilities. These include:
Complex Legal and Regulatory Environment: Trustees must navigate a complex landscape of legal and regulatory requirements governing bond issuances, which may vary across jurisdictions and evolve over time.
Financial Risk Management: Trustees must assess and manage financial risks associated with bond issuances, including credit risk, interest rate risk, and market risk, to protect the interests of bondholders.
Conflict of Interest: Trustees must avoid conflicts of interest and ensure impartiality in their dealings with state governments and bondholders to maintain trust and integrity in the borrowing process.
Changing Market Conditions: Trustees must stay abreast of changing market conditions, economic trends, and geopolitical developments that may impact the performance of bonds and the ability of state governments to meet their debt obligations.
Conclusion:
Borrowing by state governments is an essential aspect of fiscal management, enabling governments to raise capital for critical initiatives and stimulate economic growth. Trustees play a pivotal role in the borrowing process, ensuring transparency, accountability, and protection of bondholders’ interests. By fulfilling their responsibilities diligently, trustees contribute to the integrity and stability of financial markets and support sustainable economic development. As state governments continue to navigate fiscal challenges and pursue growth opportunities, the role of trustees in overseeing borrowing activities remains paramount in safeguarding the interests of all stakeholders involved.
Bunkaya Gana Esq is the Managing Director, Greenwich Trustees Limited. He can be reached on 08033335436 or Greenwichtrustees.com