Developing the municipal bond market

Municipal bonds, more popularly known as “munis” abroad, are debt obligations issued by states, cities, municipalities, state enterprises and other government entities below the national level.

The proceeds of these bonds are used to build roads, bridges, schools, highways, railway systems, hospitals, sewer systems, and other projects for the public good.

Municipal bonds have historically been proven to encourage development at the community/local level. They have been used for infrastructure development.

In the United States, for example, projects like the Golden Gate Bridge, Hoover Dam and the New York City subway system were funded by municipal bonds.

A fairly recent example is the $2.6-billion municipal bond float approved by the California State legislature in July 2012 to build an initial 130-mile stretch high-speed rail line connecting Los Angeles and San Francisco.

Indeed, the US municipal bond market raised $367 billion in 2012, according to data provider Thomson Reuters.

A study also indicates that the size of the municipal bond market in the United States is at least $3.7 trillion.

In Japan, where the use of municipal bonds is very popular, changes have been made over the years to make them more attractive to investors. These include increasing the minimum size of publicly offered bonds, establishment of a settlement network (JBNet), decreasing the underwriting commission and making them redeemable only at maturity.

This fund-raising scheme is not a new concept in the Philippines.

Our local government units are expressly authorized to issue bonds, debentures, securities, collateral notes and other obligations to finance self-liquidating, income-producing development and livelihood projects.

As early as 1998, the Bankers Association of the Philippines and the Development Bank of the Philippines created the Local Government Unit Guarantee Corporation (LGUGC) to facilitate LGU bond floatation. Even before the creation of the LGUGC, there were municipal bond flotation—although very few—in the market.

The LGUGC was the first privately managed local government guarantee corporation set up in a developing country in Asia. Among the LGUGC-guaranteed LGU bonds were those issued by the cities of Caloocan and Tagaytay; Puerto Princesa and the Municipality of Infanta.

But while we were the first in Asia to come up with this initiative, our municipal bond market has not been fully developed and utilized as a tool of economic development at the local level. As a matter of fact, the records of the LGUGC would readily indicate that there have only been a handful of LGU bond issuances. The LGUGC guarantees more bank loans than bond floatation by our LGUs.

Among the factors are: lack of reliable information about LGUs, unfamiliarity on the part of domestic investors, the possibility of political interference in project management or in debt servicing, uncertainty about management capacity at the LGU level, uncertainty about the quality of feasibility studies, lack of an independent rating agency, lack of a market for secondary trading and lack of access to IRA as security for LGU obligations.

It’s about time for our government to revisit the issue.

The government must take the initiative to promote domestic economic growth through the use of devises that would generate employment at the community level and pump-prime the local economies.

The need for infrastructure at the local level alone, which may be too small to attract funding under the national government’s PPP program, should be enough reason to develop the municipal bond market.

Bond markets are an important element of a developed financing framework.  They are efficient mechanisms for mobilizing the resources of financial institutions, mutual funds, pension funds, insurance companies and wealthy individuals.

LGU bonds reduce the reliance of LGUs on the government for their development initiatives.  They, in fact, give meaning to local autonomy envisioned by the Constitution for our local government units.

Equally important is that the system encourages good governance among local government executives. It puts a premium on good governance. Inevitably, investors will buy be bonds issued by local government units that implement transparent good governance.

Municipal bonds also provide the investing public with an alternative investment instrument. In mature markets like the US, Japan and Europe, municipal government bond markets are an integral part of the financial markets. They are given incentives—even tax-exempt status—because of their historically proven role in the improvement of local economies and development of capital markets.

Some of the structural changes needed for the development of the municipal bond market in the Philippines are already happening.  For example, the Credit Information System Act (CISA), which establishes data bank for borrowers, has been enacted into law. The PDEx, which is the exchange for debt instruments trading, is now operational.  The GOCC Law has been enacted.  Transparency in the financial markets is the order of the day.  Good public governance, which is the centerpiece of the Aquino Administration, is taking roots.

Of course, there are still issues that need to be addressed. We need a forward-looking and clearer enabling environment to ensure the development of this proven financial instrument. Our policy makers may want to consider improving the legal framework governing municipal bonds. For example, in 2007, Japan’s legislature enacted Act 64 of 2007 to establish the Japan Finance Organization for Municipalities (JFM) to help develop the municipal bond market in Japan.

It would be a tragedy for the Philippines, which is badly in need of infrastructure projects, not to develop the municipal bond market while it is being nurtured and utilized for developmental purposes in the rest of the world.

(The author, formerly the president of the Philippine Stock Exchange, is now a senior partner of the Angara Abello Concepcion Regala & Cruz Law Offices,or Accralaw. The views expressed in this column are solely his and should in no way e attributed to Accralaw. He may be contacted at francis.ed.lim @gmail.com.)