WORKSHOP ON CONTINGENT LIABILITIES

national treasuryDepartment:National Treasury

REPUBLIC OF SOUTH AFRICA

WORKSHOP ON CONTINGENT LIABILITIES

AMSTERDAMDECEMBER 2006

PHAKAMANI HADEBEDEPUTY DIRECTOR-GENERAL:

ASSETS AND LIABILITY MANAGEMENTNATIONAL TREASURY OF SOUTH AFRICA

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national treasuryDepartment:National TreasuryREPUBLIC OF SOUTH AFRICA

STRUCTURE OF PRESENTATIONSTRUCTURE OF PRESENTATION

1. Definition (slides 3 and 4)2. Legal Framework (slides 5 to 7)3. Policy Framework (slides 8 to 13)4. Management of CLs (slides 14 to 36)5. Reporting of CLs (slides 37 to 44)6. Future plans (slides 45 and 46)

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DEFINITION: DEFINITION: CONTINGENT LIABILITIESCONTINGENT LIABILITIES

A Contingent Liability is a loss which depends on the outcome of the contingency. A contingency is a condition or circumstance, the eventual outcome of which, whether beneficial or adverse, will only be confirmed by the course of uncertain future events.

from National Treasury Annual Financial Statements

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EXPLICIT AND IMPLICIT GUARANTEESEXPLICIT AND IMPLICIT GUARANTEES

A contingent credit risk is incurred when a party, in most cases a government-owned entity, is unable to meet its financial obligations to third parties that government has guaranteed.

It could also arise where there is market or public expectation for government to support a failed institution that is deemed to be of national interest.

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LEGAL FRAMEWORKLEGAL FRAMEWORK

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PUBLIC FINANCE MANAGEMENT ACT PUBLIC FINANCE MANAGEMENT ACT (PFMA) (PFMA)

Section 70 of the PFMA stipulates:The Minister of Finance must approve and concur with all guarantees, indemnities and securities requested by Cabinet Members.

Section 66 of the PFMA prescribesthe powers of Government and the Public Entities to borrow money, issue guarantees, indemnities and or securities that may bind the National Revenue Fund.

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CONSTITUTIONAL PROVISIONSCONSTITUTIONAL PROVISIONS

• The PFMA gives effect to sections of the Constitution of South Africa that requires national legislation:– To introduce generally recognised accounting

practices;– To introduce uniform treasury norms and

standards;– To prescribe measures to ensure transparency and

expenditure controls in all spheres of government;– To set the operational procedures for borrowing,

guarantees, procurement and oversight over the various national and provincial revenue funds.

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POLICY FRAMEWORKPOLICY FRAMEWORK

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UNDERLYING PRINCIPLESUNDERLYING PRINCIPLES

• NT to operate within an appropriate Credit Risk environment;

• Credit risk inherent in all new activities must be subject to adequate controls (procedures);

• NT must operate under a sound credit granting process;

• An appropriate credit administration, measurement and monitoring process must be maintained;

• Independence of the Guarantee Certification Committee (GCC).

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POLICY ON GUARANTEESPOLICY ON GUARANTEES(political support)(political support)

• To limit the issuance of guarantees;• Public entities to borrow on strength

of balance sheet;• Use guarantees to support

restructuring objectives;• Meeting international agreement

obligations;• Levying guarantee fees to equalise

the benefits on borrowing cost.

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MANDATE OF THE GUARANTEE MANDATE OF THE GUARANTEE CERTIFICATION COMMITTEECERTIFICATION COMMITTEE

“Optimum management of CLs through”• Risk assessment of the counterparties’ credit

quality;• Monitor concentration in portfolio;• Adopt a limit for total liabilities, set

conditions and monitor adherence;• Manage the CLs emanating from PPPs;• Have a holistic view of all CLs;• Satisfy itself of adequate systems in place;• Oversight on implementation of CL policy.

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MANDATE MANDATE -- continuecontinue

• Advise Minister on approaches/policies;• Consider applications and make

appropriate recommendations;• Determine appropriate fees and rules for

non-payment;• Consider legal implications;• Monitor utilisation of guarantees;• Consider the introduction of a funded

contingency reserve account.

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POLICY GUIDELINESPOLICY GUIDELINES• Guarantees are only issued where:

– Appropriate risk management procedures exist;

– Legislative requirements have been met;– Legal advice has been sought;– Time limit to the instrument;– Termination clause;– Maximum financial limits on claims;– There is a demonstrable need for

government to accept such risks.

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MANAGEMENT OF CONTINGENT MANAGEMENT OF CONTINGENT LIABILITIESLIABILITIES

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NATIONAL TREASURY STRUCTURENATIONAL TREASURY STRUCTURE

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ASSETS AND LIABILITY STRUCTREASSETS AND LIABILITY STRUCTRE

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RESPONSIBILITIES WITHIN THE NATIONAL RESPONSIBILITIES WITHIN THE NATIONAL TREASURYTREASURY

• Management and Policy oversight:– The ALM Division together with other relevant divisions

(budget office, public finance, OAG, intergovernmental relations, economic policy);

• Updating of Guarantee register:– Directorate: Accounting and Information

• The Guarantee Certification Committee was established for this purpose;– Chairperson: Head ALM– Members: Heads of various divisions, sector

experts, corporate governance, risk management;

– Secretariat: Asset Management Chief Directorate

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APPLICATION PROCESSAPPLICATION PROCESS

• The SOE makes a business case to the Executive Authority (line ministry);

• The EA submits proposal to the MOF;– Justify how request will enhance objectives

• Minister submits proposal to GCC for review and recommendation;

• GCC meeting convened (line ministry and SOE invited for a presentation);

• All deliberations on nature of recommendation to Minister without the presence of the applicant.

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APPLICATION PROCESS (continue)APPLICATION PROCESS (continue)

• GCC could request a further “special” meeting with the line ministries and/or SOEs;

• GCC (once satisfied and comfortable) makes a recommendation to the MOF;

• MOF sends letter of recommendation to EA and SOE;

• The EA concurs with the MOF and submits a memorandum (of all relevant details including the proposal document) to MOF;

• MOF approves with terms and conditions.

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MINIMUM INFORMATION REQUIREDMINIMUM INFORMATION REQUIRED• Business profile of the applicant;• Proposal with amount required and why;• Rationale for application (i.e. how

achieving the corporate plan will be enhanced);

• What the funds will be used for;• Repayment schedule and maturity of

underlying instrument;• Past three years balance sheets and

income statements and year to date figures;

• Cash flow projections.

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GUARANTEE AND ADMINISTRATION FEEGUARANTEE AND ADMINISTRATION FEE• The “old” administration fee (1996-2003):

– R25 000 per annum over the period of the exposure payable in full upon issuance;

• The “old” commercial levy (guarantee fee)– Aimed at levelling the playing field between public

sector borrowers and their competitors;– Has increased incrementally by 0.5% at a time to 3%

in 2003• The commercial fee may be reduced or waived

in full for:– Concessional loans where a guarantee is a non-

negotiable prerequisite;– Foreign rather than domestic loans;

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DESIGN OF THE NEW GUARANTEE FEEDESIGN OF THE NEW GUARANTEE FEE

• Objective: – More stable SOEs must find borrowing with a

guarantee expensive;– More unstable public entities must find

guarantees attractive (too expensive without);• Guarantee fee:

– 30bps per annum on the nominal value issued and on a pro rata basis;

– Payable on issue date and annually thereafter;– Should covenants be broken, fee can increase up

to 100bps;– Fees are reviewed annually.

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GUARANTEE FEE DESIGNGUARANTEE FEE DESIGN

COMMERCIAL PAPER (current spreads for selected entities)

ENTITY JIBAR Entity1 -10 to +5 Entity2 +0 to +10 Entity3 +10 to +15 Entity41 -5 to 0 Entity5 +18 Entity6 +20 Entity7 +20 ESTIMATED Entity8 +80 to 100 Entity9 +20 to 30

1 With a Government guarantee

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GUARANTEE FEE DESIGNGUARANTEE FEE DESIGN

5 AND 10 YEAR BONDS ENTITY R153 (5YEAR) R157 (10YEAR) Entity1 35 30 to 35 Entity2 40 35 to 40 Entity3 74 n/a Entity41 21 24 Entity5 75 n/a Entity6 74 95 Entity7 84 43 ESTIMATED Entity7 150 >200 Entity82 30 to 35 30 to 35

1 With a Government guarantee 2 With a Government guarantee

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ADMINISTRATION FEEADMINISTRATION FEE

• For short-term loans (less than 5 years)– R75000 per annum;

• For long-term loans (more than 5 years)– R50000 per annum;

• Payable once off at the outset of the guarantee;

• Increased admin work required to monitor fees payable on money market instruments.

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LEGAL ISSUESLEGAL ISSUES

• Legal advisors of borrower to provide an opinion setting out at least the following:– Borrower has power and authority to borrow;– Borrower ensures that its obligations rank at

least pari passu to other unsecured obligations;– Borrower will execute obligations without

contravention of applicable laws;– Borrower not involved in any court action that

may materially adverse consequences;– Consequent to signature, organisational setup

and financial status of borrower will not change.

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RISK ASSESSMENT OF CLRISK ASSESSMENT OF CL

• Qualitative Analysis

– Industry Risk– Operating

Environment– Market Position– Management

• Quantitative Analysis

– Cash Flow position– Capital structure– Credit rating– Profitability Ratios

• Return on Equity• Efficiency Ratio

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RATING METHODOLOGY (continue)RATING METHODOLOGY (continue) Risk Rating Description Risk class 1 Known loss Very high risk 2 Doubtful Very high risk 3 Substandard Very high risk 4 Special attention Very high risk 5 Marginal High risk 6 Acceptable High risk 7 Fair Moderate risk 8 Good Moderate risk 9 Strong Low risk 10 Excellent Very low risk

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RATING METHODOLOGYRATING METHODOLOGY

CRITERIA WEIGHT (%) RATING WEIGHTED RISK RATING

Adherence to the PFMA

8 7 0.56

Debt to equity (gearing)

10 5 0.5

etc. --- --- --- etc. --- --- --- Total 100 Weighted risk rating

5.5

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CONTINGENT LIABILITY REGISTERCONTINGENT LIABILITY REGISTER

• Directorate: Accounting and Information maintains a register of all guarantees. It contains the following information:– Date;– When guarantee was issued;– Guaranteed Capital amount;– Guaranteed Capital amount outstanding;– Accrued interest;– Guaranteed institution;– Guarantee in respect of (e.g. loan to Eskom);– Original currency.

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TO CAPTURE A CONTINGENT LIABILITYTO CAPTURE A CONTINGENT LIABILITY(Guarantee Register)(Guarantee Register)

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LIST OF CONTINGENT LIABILITIESLIST OF CONTINGENT LIABILITIES(Guarantee Register)(Guarantee Register)

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TO VIEW CAPTURED CONTINGENT TO VIEW CAPTURED CONTINGENT LIABILITIES (Guarantee Register)LIABILITIES (Guarantee Register)

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GUARANTEED LOAN DETAILSGUARANTEED LOAN DETAILS(Guarantee Register)(Guarantee Register)

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LOAN PAYMENT SCHEDULELOAN PAYMENT SCHEDULE(Based on loan terms and conditions)(Based on loan terms and conditions)

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MAINTENANCE OF GUARANTEE REGISTERMAINTENANCE OF GUARANTEE REGISTER

• SOEs and Departments must submit guarantee information to the ALM division (quarterly and annually);

• New figures are compared to previously reported figures (to ensure completeness and accuracy);

• Deviations are followed-up;• Guarantee register is subjected to an

annual internal audit.

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REPORTING OF CONTINGENT LIABILITIESREPORTING OF CONTINGENT LIABILITIES

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• Monthly, Quarterly and Annual reports are prepared for:– Central Bank (SARB);– IMF;– Office of the Accountant-General (OAG);– Head of Department (National Treasury).

• All reports to the Central Bank are in terms of the SDDS of the IMF;

• All departments record guarantees in their various Annual Financial Statements.

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• OAG consolidates guarantee figures in the consolidated financial statements of the National Government;

• Audited Annual Financial Statements of Departments presented to Parliament Annually;

• Audited Consolidated Financial Statements of the National Government is presented to Parliament Annually.

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REPORTING IN THE ANNUAL FINANCIAL REPORTING IN THE ANNUAL FINANCIAL STATEMENTS OF THE NATIONAL STATEMENTS OF THE NATIONAL

TREASURY (2005/6)TREASURY (2005/6)R'000

Contingent Liabilities 168,732,322 as % of GDP 45.5

Underwritten by Government 95,407,674 Guaranteed Liabilities 65,813,111 Road Accident Fund 21,351,450 SASRIA reinsurance cover 1,000,000 ECIC 7,243,113

Other 73,324,648 Post retirement medical assistance 37,000,000 Government Pension funds 9,847,300 South African Reserve Bank 115,172 Unemployment Insurance Fund 2,299,827

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ANNUAL FINANCIAL STATEMENTSANNUAL FINANCIAL STATEMENTSReporting (2005/6)Reporting (2005/6)

R' 000Guaranteed liabilities 65,813,111

Transnet 19,067,865 Development Bank of South Africa 11,700,954 Trans-Caledon Tunnel Authority 15,028,786 Telkom S.A. 4,315,000 South African Roads Board 6,199,080 KOBWA 1,603,060 Industrial Development Corporation of SA 1,172,035 Eskom 132,287 Lesotho Highlands Development Authority 1,666,202 SA Reserve Bank 4,355,941 Central Energy Fund 477,110 Land Bank 94,791

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TOTAL GUARANTEES ISSUED AND TOTAL GUARANTEES ISSUED AND AMOUNTS UTILISEDAMOUNTS UTILISED

0

20000

40000

60000

80000

100000

120000

2001/02 2002/03 2003/04 2004/05 2005/06

Total guarantees issuedAmounts utilised

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SA RATING UPGRADES SINCE 1994SA RATING UPGRADES SINCE 1994Moodys S&P Fitch R&IAaa AAA AAA AAAAa1 AA+ AA+ AA+Aa2 AA AA AAAa3 AA- AA- AA-A1 A+ A+ A+A2 A A AA3 A- A- A-Baa1 BBB+ BBB+ BBB+Baa2 BBB BBB BBBBaa3 BBB- BBB- BBB-Ba1 BB+ BB+ BB+Ba2 BB BB BBBa3 BB- BB- BB-B1 B+ B+ B+B2 B B BB3 B- B- B-Caa1 CCC+ CCC+ CCC+Caa2 CCC+ CCC+ CCC+Caa3 CCC- CCC- CCC-Ca CC CC CC

1st rating assigned in 1994 C C C CCurrent rating D D D

Lower risk

Investmen

t grad e

Higher risk

Speculative grad

e

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OTHER “IMPLICIT” CONTINGENT OTHER “IMPLICIT” CONTINGENT LIABILITIESLIABILITIES

• Under-funding of commitments based on actuarial valuations (Pension funds, RAF);

• Post-Retirement medical assistance – expected present value of future commitments;

• Export credit cover to SA exporters – net of total underwriting exposure and total assets of the entity;

• Reinsurance cover (max R1billion);• Unemployment insurance claims (based on

actuarially calculated provisions).

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FUTURE PLANSFUTURE PLANS

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CURRENT AND FUTURE INITIATIVESCURRENT AND FUTURE INITIATIVES

• Integrated electronic filing of all guarantees (line ministries and National Treasury);

• Measure and manage the contingent liabilities of PPPs;

• Forensic examination of all line ministries and spheres of government;

• Review the mandate of the “GCC”;• Review the appropriate level of contingent

liabilities.

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THANK YOU!!THANK YOU!!

WORKSHOP ON CONTINGENT LIABILITIES

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