Failure to disclose full sovereign debt portfolio goes against law

The recent media reports indicating that the National Treasury has not disclosed Kenya’s entire sovereign debt portfolio to the International Monetary Fund raise significant concerns regarding adherence to public finance principles outlined in the Constitution.

It is now public knowledge that the Government of Kenya has successfully raised significant funds through structured finance transactions aimed at addressing pending bills in the road sector and financing major projects, including the Talanta Stadium and a modern conference centre at Bomas of Kenya.

While these transactions are secure in nature, they still represent a debt to the Exchequer and must be publicly disclosed. Not disclosing such debts constitutes a clear breach of the Constitution. The principles of public finance outlined in the Constitution mandate the transparent, equitable, and accountable management of public funds, which is essential for fostering sustainable economic development and economic justice.

These principles are not merely decorative or optional provisions for institutions and state officers to selectively implement. Courts have determined that they are binding and form the core fabric of the Constitution, obligating all individuals to adhere to them when making decisions that impact the rights of others.

Structured finance is not unique; it encompasses various transaction types, such as securitisation (or asset-backed finance), leveraged buyouts, and project finance. In a typical securitisation transaction, a company looking to raise capital may transfer certain assets to a special purpose vehicle (SPV) or trust under a “true sale” legal arrangement. The transferred assets, known as receivables or financial assets, are handled by the originator, while the obligors are the entities responsible for paying these receivables. The SPV or trust can issue securities or debt-like instruments in the capital markets, with holders of these securities receiving payments from the proceeds of the receivables.

Traditionally, securitised assets include mortgage loans, corporate loans, credit card receivables, and other self-liquidating assets. In the Eurodollar markets, complex securitisation structures have emerged, allowing risks in project lending to be securitized.

On the other hand, a Leveraged Buyout Transaction (LBO), involves a group of investors, sometimes associated with the management of the company, taking control of that firm (referred to as the target firm) by indirectly causing it to borrow and then using its proceeds to purchase its stock. In a typical LBO transaction, the acquisition minded investors create a shell company and after obtaining commitment from lenders to borrow sufficient funds to purchase the stock of the target firm, the shell company makes a tender offer for those shares.

The shell company then pays for the purchased shares by drawing down on its loan commitment. After purchasing those shares and, thereby, acquiring the target firm as a subsidiary, the shell company causes the target firm to merge with itself. The merged firm is then given the name of the target firm and pledges its assets to the LBO lenders to secure payment of the loan.

Project finance plays a crucial role in the development, construction, and operation of capital-intensive facilities such as power plants, oil pipelines, transportation systems, and other significant assets. The essence of project financing lies in the expectation that these projects will generate sufficient revenues to repay the financing.

 Project finance is typically executed in two phases; construction phase, where financing is primarily raised through secured borrowings, with equity contributions from general or limited partnerships. Post-completion phase, on the other hand, is done after the project is completed. Permanent financing can be secured through various methods, including secured borrowing or leveraged leasing.

It’s important to highlight that, unlike traditional financing, where companies raise funds by issuing securities representing equity or debt with claims on payment secured by liens on company properties, structured finance transactions offer a more efficient framework. This allows companies to raise funds from capital markets at lower costs, while minimising exposure to liquidity, credit, and market risks.

In various jurisdictions, particularly in the United States, structured finance transactions have significantly contributed to corporate growth, supported by a predictable and systematic legal framework. This has allowed both institutional and retail investors to access a diverse portfolio of investments, enhancing risk diversification and fostering the growth of capital markets and the economy.

While these regions have transitioned from traditional financing methods to structured financing, reaping substantial benefits, Kenyan companies are only beginning to explore balance-sheet financing due to an outdated legal regime and inadequate regulatory framework. Interestingly, it is the government, rather than the private sector, that is engaging in these transactions. However, the lack of transparency and meaningful public participation in these dealings raises concerns.

Although these transactions help alleviate the government’s reliance on conventional sovereign borrowing, questions remain regarding their execution. Key inquiries include: Which banks or private players are providing the financing and liquidity for these transactions?

To ensure transparency and public engagement, it is crucial for the National Treasury to disclose details about the securitisation of receivables from the Fuel Development Levy, Railway Development Levy, Sports Levy, and Tourism Levy. Kenyans deserve clarity on the amounts received for each transaction and the identities of the financiers involved. Additionally, it is vital to confirm whether these transactions have received Parliamentary approval and if the relevant documents are available for public review.

The government’s increasing focus on structured finance transactions highlights the urgent need for Parliament to establish a legal framework that will guide the implementation of these transactions and monitor risks to taxpayers.

Enacting a dedicated legal framework for securitisation and similar transactions is essential for: transforming illiquid assets into tradeable securities, enabling the government to raise capital for infrastructure, managing public debt, boosting liquidity without immediately increasing the national debt burden, and unlocking capital by monetising future revenue streams across the economy.

Peter Wanyama, Legal Counsel Team Leader, Manyonge Wanyama & Associates LLP