BBL sponsored by the Municipal Finance Thematic Group

1. BBL sponsored by the Municipal Finance Thematic Group Municipal Insolvency Principles and Practice -- Comparing the Cases of Hungary and South Africa Wednesday, April 7 Presenters: Matt Glasser, AFTU1, and Mihaly Kopanyi, TUDUR, World Bank

2. Introduction Does municipal insolvency matter? Local governments often face financial troubles: overdue debt, unpaid suppliers’ bills, tax arrears Three basic scenarios • No-rule scenario: often entails moral hazard and bail-out by the sovereign government • Insolvency legislation: rule-based treatment of troubled cases • Use corporate bankruptcy law: works well in the US but may lead to no-rule scenario in developing countries

3. Dealing with Municipal Insolvency Hungary’s Experiences in Policy, Legislation, and Practice Mihaly Kopanyi Sr. Municipal Finance specialist TUDUR Urban Development Unit

4. Municipal Borrowing and Insolvency Pre-transition • State guarantee on deposits and on municipal debt 1990 – 1995 • Principle: No state guarantee on municipal debt (LG Act) • Practice: Implicit guarantee and discretionary bail out 1996 – 2003 • Act on Municipal Debt Resolution 1996 • CG statement on No Bail out unless Parliament approval • 19 M Bankruptcy Procedure Commenced, + about 100 out-of court agreements between 1996 and 2003

5. Act on Municipal Debt Adjustment 1996 Objectives • Prevent and preempt M defaults • Maintain public services in defaulted M • Clear admin and legal procedure for those affected • Rule-based reorganization and workout procedure • Allow market expansion of M debt as revenues increase • Sovereign guarantee need Parliament authorization in the national budget

6. Debt Resolution Process Petition to court Justified Process halted, appeal possible NO Enterprise Registry Trustee appointed Debt Committee Notice to creditors Emergency Budget Reorganization Plan NO Agreement Court order for inventory of assets for liquidation Trustee prepares a liquidation report for Court approval Agreement Compromised workout Debt w-o plan signed Submission of Plan to Court Publication of Plan closure of w-o process no appeal possible Court approves liquidation plan appeal possible Assets liquidated, creditors paid Trustee paid Publication of outcome Closure of DR

7. An Out-of-court Resolution - Tokaj • External audit on M institutions and management end-1995 • Consolidate/merge institutions and reduce staff by 15 % • Set up a municipal treasury, improved cash management and liquidity • Zero based Budgeting and new financial information system • Renegotiate debt with the lead bank and suppliers Results: • Solvency restored and deficit reduced (HUF34 mo by 1997), balanced budget since 1998, • Increased liquidity and cost efficiency • Solid city development since 1998.

8. Insolvency Procedures 1996-2003

9. Lesson learned #1 Key Factors in Avoiding Bankruptcy Petition • Early debt restructuring with all lenders and vendors • Rationalization of M budgetary institutions • Municipal treasury (soft or hard) • Internal audit and reduction of staff • Decrease voluntary M services • Enhance internal control and asset liability management • LAST RESORT: Application for a deficit grant (grant for bridging gaps in the operational budget)

10. Lessons Learned #2 • Cautious, market driven borrowing • Strong incentives for timely out-of-court resolution • Poor financial and project mgmt. skills at local level • MBr Act does not constrain lending • Banks view the MBr Act overly protects borrowers • Councilors and M executives can not be held personally liable for default • MBr Act does not constrain M borrowing (the M sector is 70% below borrowing ceiling)