There is rather exciting news coming out of Europe: In October 2013, eleven local governments in France came together to establish a local and regional finance agency, which will borrow money and on-lend to the participating governments. In November, 2013, the Local Government Association in UK, which represents councils in the country, voted to establish a similar municipal bond agency. German municipalities are reported to be exploring the structure as well. (It is important to also highlight that the context of local governance varies across these countries: While France and UK are Unitary governments with lesser local autonomy; Germany is a Federal government with higher devolution of taxation).
So why are local governments in these countries looking to pool together to tap the market? Material pulled from the all-knowing web suggests that this is reflective of the effect of the global financial crises and recession on national finances. While the macroeconomic context in these European countries is completely different from that in Asian and African countries, the approach has potential for replication and is therefore worth discussing.
Specialized funds and financial intermediaries for local and regional governments are already operational in many countries and come in many avatars depending upon their objectives, ownership structures and functions. They may be:
bond banks that borrow from the debt capital market on behalf-of, or to re-lend to, participating local governments (such as U.S. state bond banks);
revolving funds (such as the U.S. state revolving funds, which started out as direct federal grants for water and wastewater treatment facilities to subsequently transition to a revolving loan fund program).
Credit pooling benefits issuers by spreading administrative costs across a large number of participating local governments (borrowers). The geographic diversification of the portfolio and the use of credit enhancements (debt service reserve fund, pledges, transfer intercepts, etc.) result in higher overall ratings. Which combined with the larger size of the issue, allow access to a broader investor base.
There are policy, legal, capitalization, ownership and management decisions that inform the design of such structures. Protection from government interference in credit decisions is critical. Unfair advantages that may stem from regulations, subsidies etc. should preferably be unbundled, so that other financial institutions are not pushed out of the municipal credit market. In terms of the pooling arrangement, agreeing upon liability is important, i.e. whether or not the municipalities are jointly and severally liable. The French agency was established only following years of negotiations. And it will be interesting to following developments in other European countries.