AUTHOR: DANIEL GODSON OLIKA
Student (LL.B) Faculty of Law, University of Lagos.
Governmental authorities usually require major financing for capital-intensive projects and one of the many ways of achieving this is through the issuance of bonds in the Capital Market. Bonds are commonly referred to as fixed-income securities and are one of the three main generic asset classes, along with stocks (equities) and cash equivalents. A bond is a debt security, similar to an IOU. Borrowers issue bonds to raise money from investors willing to lend them money for a certain amount of time. The Investment and Securities Act 2007 in Section 273 defines it as; an instrument of indebtedness issued by a body to secure the repayment of money borrowed by such body. These borrowers may be Corporations or Government entities and may issue bonds to finance a capital project or a debt. The bonds are purchased by investors and in return, the issuer promises to pay a specified rate of interest during the life of the bond and to repay the principal, also known as face value or par value of the bond, when it “matures,” or comes due after a set period of time.
Bonds generally help to preserve capital while investing and provides for a predictable source of income. There are different types of bonds. Corporate bonds are debt securities issued by private and public institutions. The investment-grade and high-yield bonds are classified based on the credit rating. The former has little credit risk and generates little interest whilst the latter is the exact opposite. Municipal bonds are debt securities which are issued by a Governmental authority. They can be further classified into; General obligation, Revenue and Conduit bonds. General obligation bonds are not secured by any assets; instead, they are backed by the “full faith and credit” of the issuer, which has the power to tax residents to pay bondholders. The Revenue bonds are backed by revenues from a specific project or source, such as highway tolls or lease fees. Some revenue bonds are “non-recourse,” meaning that if the revenue stream dries up, the bondholders do not have a claim on the underlying revenue source. The Conduit bonds are bonds issued by the Government on behalf of private entities such as non-profit colleges or hospitals. These “conduit” borrowers typically agree to repay the issuer, who pays the interest and principal on the bonds. If the conduit borrower fails to make a payment, the issuer usually is not required to pay the bondholders.
The issuance of bonds by a Governmental authority helps it finance projects it would not otherwise have been able to finance. In the past, the Federal and State Governments have funded projects through the issuance of bonds. Some of them include; Lagos (Series 1- N50bn; Series II- N57.5bn; Imo (N18.5bn); Kwara (N17bn); Niger (N6bn); Bayelsa (N50bn); Kaduna (N8.5bn); Ebonyi (N16.5bn), etc. Recently, the Federal Government of Nigeria issued a $1 billion Eurobond. The Federal Government of Nigeria also recently started issuing bonds to ordinary Nigerians through the Federal Government of Nigeria Savings Bond (FGNSB).This power to issue bonds by Governmental authority is subject to the legal requirements and preconditions stated in the existing legislation which governs the Capital Market and regulates its activities. This paper shall analyse the legal requirements for the issuance of bonds by the Federal and State Governments in Nigeria and discuss the implication of these requirements in light of contemporary events in the Nigerian Capital Market.
THE LEGAL FRAMEWORK
The Investment and Securities Act 2007 (ISA) generally regulates the issuance of bonds by the Federal and State Governments in the Nigerian Capital Market. In addition to the Act, Section 13 of the ISA provides that the Securities and Exchange Commission (SEC) is to regulate the Nigerian Capital Market. Pursuant to this, the SEC has enacted the Securities and Exchange Commission Rules (SEC Rules) 2013 to assist it in the performance of its regulatory functions. Thus, the ISA and SEC Rules jointly provide for the legal regulatory framework for the issuance of bonds in the Nigerian Capital Market. Jointly, both legislations provide for several pre-conditions and restrictions for the issuance of a bond by the Federal and State Governments in the Nigerian Capital Market.
Section 223 of the ISA provides that Federal and State Governments may from time to time raise internal loans for any specific project authorized by the approving authority through the issue of securities in the form of registered bonds. Some of these legal requirements to be met before issuing a valid bond by the Federal and State Governments are;
Application to the Securities and Exchange Commission:
Before a Governmental authority can issue a valid bond in Nigeria, an application must have been made to the Securities and Exchange Commission. By virtue of Section 224(1) and (2) of the ISA, before bonds can be issued at the Capital Market by the Government of the Federation or the State, an application to do so must have been made to the Securities and Exchange Commission in a manner prescribed by the Commission. By virtue of Section 224(3) of the ISA, an application by the State Government shall be accompanied by; a copy of the law authorizing the issue of the bond specifying that a sinking fund to be fully funded from the Consolidated Revenue Fund Account of the issuer be established; a copy of an accredited rating report; an irrevocable letter of authority issued by the Accountant-General of the State or any person performing the function of that Office stating or authorizing the deduction at source from the statutory allocation due to the issuer in the event of default by or failure of the issuer to meet its payment obligations.
General Conditions under the SEC Rules:
The SEC Rules provide for a number of conditions to be satisfied by the issuing Governmental authority before the bond issued can be said to have been validly issued. Rule 566 of the Securities and Exchange Commission Rules (SEC Rules) provides for the conditions to be satisfied by the issuer (Federal or State Government) when issuing bonds in the Capital Market. They are; the internally generated revenue (IGR) of the issuer shall not be less than 60% of its total revenue of the state for the preceding year; investment in the bond issued not backed by an irrevocable letter of authority shall be restricted to Qualified Institutional Investors and High Net worth Individuals as defined under these rules and regulations; the guarantors rating shall not be below investment grade; in addition to the issuer’s internally generated revenue (IGR), the issuer shall provide a third party guarantee from a bank, insurance company, supranational institutions, international financial institutions or any other acceptable to the Commission, to cover payment of the principal and interest in the event of default; the guarantor shall be the primary banker of the issuer for the purposes of its IGR through the tenure of the debt issue; in the event of default by the issuer, the trustee shall within three months of such default request the guarantor to pay the principal sum and interest outstanding on the debt issue. Notice of the request by the trustee to the guarantor shall be filed with the Commission; the trustee shall within thirty (30) days of such default notify the Commission and outline further steps it intends to take in the matter.
The ISA provides for the requirement of publication of the details of the bond. Section 226 of the ISA provides that the particulars of each loan to be raised pursuant to this Act shall be published in the Gazette or any other official document by the body raising the loan and shall contain; the beneficiary of the loan; the sum of money to be raised by the loan; the mode or modes of raising the loan; the rate of interest payable on the loan; the dates in each year on which the half-yearly or quarterly interest on the loan shall be payable; the time at which a half-yearly or quarterly appropriation out of the general reserve and assets of the body or project of the body shall be made as a contribution; the date of redemption of the registered bond or securities to be issued for the purpose of raising the loan; and any other information relating to the loan considered necessary to effectively raise the loan; a duly executed copy of the third party guarantee shall be lodged with the trustee not later than five (5) days before the issue is open to the public; and the issuer shall disclose in the prospectus that the bond issue is not backed by an irrevocable letter of authority. This shall be boldly printed on the front cover of the Prospectus.
Appointment of a Registrar and Issuing House:
The Governmental Authority is generally required to keep a register of the details of the bond issued and appoint an issuing house. Section 227 of the ISA provides that the Federal or State Government shall keep a register in which all transactions in securities entered into by the body are recorded and into which shall be entered all information which by this Act are required to be entered in the register. The Federal or State Government may appoint a registrar for the purpose of keeping the register. The register may be kept in an approved place and may contain the following; the names and addresses of the holders for the time being of the securities concerned and the persons deriving title therefrom; the amount of securities held by every holder; and the date on which the name of every holder is entered in respect of the securities held in his name.
Establishment of a Sinking Fund:
In order to facilitate commerce and ensure that the Governmental authority is financially competent to redeem its debt, the Law requires that a sinking fund be established following the issuance of a bond. Section 250 of the ISA provides that subject to the approval of an appropriate authority, a sinking fund shall be established for the payment of sums at regular intervals (quarterly or every six months) for the redemption of the loan. By virtue of Section 251 of the ISA a separate sinking fund shall be established for each loan.
Registration of the Bond:
Like all instruments recognized by the Law, the Law requires that the Bond be registered. Rule 564 of the SEC Rules provides that a bond issued by the Federal or State Government shall be registered in accordance with the provisions of the Rules. Asides its provisions on the registration of the Bond as a debt instrument, the Law provides for certain requirements before the Bond can be registered. The requirements for the registration are contained Rule 565 of the SEC Rules.
CONTEMPORARY ISSUANCE OF BONDS BY GOVERNMENTAL AUTHORITIES
Governmental authorities have been particularly active in the Nigerian Capital Market in recent times, particularly the Federal Government of Nigeria. Their activities in the Capital Market in relation to the issuance of bonds generally underscores the importance of a comprehensive legal framework for the issuance of bonds by Governmental authority. The importance of this has substantial bearings in a wide array of disciplines, covering; Law, Economics, Commerce and Government. In February of this year (2017), the Federal Government of Nigeria issued its 3rd Eurobond for $1 Billion. This fact has serious implications worth considering. Perhaps, the most important implication of this bond issued by the Federal Government of Nigeria is that Nigeria is still deemed to be credit-worthy by investors despite its economic crisis. The Federal Government intends to use proceeds from the bond to fund capital expenditures in the 2017 budget. Abraham Nwankwo, the Director-General of the Debt Management Office (DMO) has announced that; the Eurobond is the latest step in a broader debt strategy designed to significantly re-balance our debt profile towards longer term financing and reduce the burden of interest on our annual budget. The Eurobond further underscores the importance of the preservation of the legal framework for the issuance of bonds by Governmental authority in Nigeria. This is due to the fact that unless a comprehensive legal framework exists, trading in bonds of such high amounts with a Governmental authority in the Nigerian Capital Market will be difficult. This affects investments generally, the Nigerian Capital Market, Ease-of-Doing Business in Nigeria and lastly development; as the bonds are used for capital projects which mostly help to facilitate development.
Interestingly, in March of this year (2017), the Federal Government of Nigeria; through its Debt Management Office (DMO) announced the establishment of the Federal Government of Nigeria Savings Bond (FGNSB). The FGNSB was established to help ordinary Nigerians to invest in the Capital Market by purchasing bonds issued by the Federal Government. The ripple effect of the establishment of the savings bond is that it helps Nigerians develop a savings habit and it helps them to meet long-term financial obligations in this dire economic dispensation through the payment of interests as they become due. Nigerians can purchase these bonds for as little as N5,000 (the minimum price), any amount after that must be paid in multiples of N1,000. The bond is a General Obligation bond as investors rely on the full faith and credit of the Government to meet its obligations as they become due. The interest rates are also favourable as they are generally higher than what obtains in the Banks. This stresses the importance of a sound legal regime for the issuance of bonds by Governmental authorities in order to ensure the credibility of the Government and the financial security of the Citizens.
The contemporary investment activities of the Governmental authorities in Nigeria (particularly the Federal Government) have made an examination of the legal framework for the issuance of bonds by Governmental authority in Nigeria necessary. This is due to the fact that a robust legal framework regulating these activities helps to spin the wheels of commerce, ensure certainty, proper legal regulation and credibility in the Nigerian Capital Market; features which help to determine its efficiency in the long-run. The legal framework examined above reveals that the Nigerian Capital Market currently enjoys a robust and comprehensive legal regulation and that investing through the purchase of bonds issued by Governmental authorities is commercially viable. The ripple effect of this is that the Nigerian Government is better empowered to tackle developmental challenges and the economic crisis through initiatives like the FGNSB and the debt strategy that facilitated the $1 billion Eurobond. Undoubtedly, the consequence of the robust legal framework in place is that it helps to present the Nigerian Capital Market as a goldmine, which if tapped, can help to achieve important developmental, economic, legal and trade objectives.
Cyber Law, Intellectual Property Law and International Tax Law form the core of my legal research interest. When I am not busy with these; African Literature, Biographies of Greats and World Politics keep my mind alive. I currently serve as Editor-in-Chief of both the Unilag Law and the Journal of the Mooting Society, University of Lagos.