A municipal bond ( Muni Bond ) is a standard financial or debt instrument used to fund often development and bigger projects. With three (3) different types of municipal bonds, this financial instrument connects investors, otherwise known as buyers, with the bond issuer — borrower.
Municipal bonds are often issued by municipalities such as cities, counties, school districts, special taxing districts, local or state governments to fund large projects like road, school and facility construction as well as providing amenities. More importantly, several countries have been taking the bold approach towards leveraging the power of this funding source to finance development projects.
Usually, the bond issuer (e.g. local governments) turns to municipal bond because the nature of their request cannot be fulfilled by traditional sources (banking sector, domestic or foreign borrowings) of funds. This is because the amount needs to be raised (capital) are always higher than what the traditional sources can provide. Also, municipal bonds offer more flexible repayment terms.
To some extent, this financial instrument should help the issuer save some cost over other forms of debt. If done properly, the loan may be less expensive with other added advantages like longer maturity periods.
For example, in the United States, most municipal bonds are free from tax at the federal and state level. In most states, a muni bond can be tax-exempted from the state, local and federal taxes if the municipal development project is for the local community.
In its municipal bond market development analysis, the USAID examined more than 10 countries to see how developing countries are doing in muni bond arena. USAID discovered that introducing a new financial element in developing countries can be a complex undertaking, unlike developed countries where most of the municipal bond elements are already established.
However, many countries are waking up to the need of providing local governments with the resources they need to make use of muni markets in financing urban development. Below we’ll consider four (4) countries currently using municipal bond as a financial instrument.
Several cities in India are showing intents to appear in the stock market as they are planning to list their muni bonds. Going forward, civic bodies have shown support by raising funds. These civic bodies across the country have pledged their support to raise funds. It was reported that the Pune Municipal Corporation raised Rs 200, using municipal bonds, for the purpose of providing efficient water supply.
Some of the cities that are taking a reformed approach toward municipal bond markets are Bangalore, Nashik, Ahmedabad, Bhopal, Kishangarh, Panaji among others.
Balkans are one of the transition countries that aren’t doing well in the muni markets. Currently, the municipal bond instrument will work well due to the interest rate of existing financial instruments. Interest, credit and maturity period and risks can be tailored to suit project needs, hence, the market should be confident that muni bond will serve its intended purpose. However, in such developing countries, the appropriate type of municipal bond should be well thought-out. A municipal bond, as a financial instrument, must be tied to specific revenue generating projects so as to guarantee repayment of loans, and this will also help earn the trust of the investment community.
One of the problems transition countries may face in the implementation of this financial instrument is situations whereby the bond is not tied to a certain project. The investors’ community may be skeptical about risks factors like longer maturity period, higher credit risk as well as other performance factors of the bond.
The United States is one of the top countries with a surge increase in the sales of municipal bond. In 2015, issuance totaling $377.6 billion was made, and 2016 even recorded one of the highest sales years in the history of US muni market. Of recent, more than $111 billion were issued for critical needs which includes pension obligations and infrastructure development of cities across the United States.
Bond issuance is guided by regulatory laws and based on the terms of such bonds. With three types of bonds, the common and basic ones are a general obligation and revenue bonds . In general obligation, credits and full faith of the issuing city must be committed and loans are repaid through general tax revenue. This gives cities flexibility on what the money is used for and when maturity timeframe.
Revenue-tied bonds are repaid from designated sources of the fund or paid through dedicated project fees. It also limits the use of the funds by government or public officials.
The South African governments have demonstrated the use of the muni market to drive urban growth. The country passed an enabling law in 2004 which empowers municipalities (cities in this case) to issue bonds for long-term investments. However, according to the enabling legislation, The Municipal Finance Management Act, cities cannot borrow for operational expenditures but may do so only for long-term investments.
The new development has empowered cities to take bonds for infrastructures that need to be financed. This development in enabling law gives bond investors confidence to lend to municipalities because they understand the city or local governments bond issuer’s term is in compliance with government regulations which guarantee repayment.
However, this isn’t the case in many developing African countries. Some believe that deficiency in technicalities for municipal bond preparation or lack of financial readiness hinder the muni market development while others argue that municipal projects are not designed in a way that guarantees repayment of investors’ funds.
But the problem lies in the enabling law. In most of the African countries, the national or federal governments do not give local governments the responsibility roles and power, through national regulations, to acquire bonds for larger projects due to the limits on what they can borrow.
A good example of such a scenario happens in cities of Kampala and Dakar, Uganda and Senegal respectively. These markets also see the need of being independent or relying on commercial banks and development allocation to fund bigger projects but tapping into the resource of private investors. Despite proving their creditworthiness to bond issuance, their activities prove futile due to clashes in national and regulatory laws.
There are several risk conditions tied to the traditional bond markets. These common problems include single point failure and slower processing time and these are what digital blockchain-based bond sets to eliminate. Recently, the Worldbank launches bond-I, the world’s first public bond, which creates, allocates, transfers and manage bond using the blockchain technology.
BOSS-101 is TradeFinex’s Blockchain technology. BOSS-101 which stands for Bond Open Smart-Contracts Standard-101 allows bond issuance on the XinFin Mainnet. This initiative is part of TradeFinex global goals to make financial instruments liquid and interoperable.
With the BOSS-101, financial institutions, bond markets even municipal markets can create, manage and liquidate bonds through blockchain technology. With this innovative development, the flexibility can help the municipal bond market experienced a rapid surge especially in developing and transition countries.
Also, blockchain offers a more transparent, fast bond processing and efficient bond transfer or settlement. This will be a very desirable and welcomed development not only for developed countries but also in developing and transition countries.
Companies like Worldbank and Tradefinex BOSS 101 working on creating Digital bond.
I also have written a medium article comparing TradeFinex BOSS-101 with World Bank Bond-I, so you might want to check it out.