Resolution of 4 July 2017 defining the financial prudence principle applicable to borrowing and derivative operations of Autonomous Communities and Local Entities

OFFICIAL STATE BULLETIN No. 160 Thursday 6 July 2017 Sec. I. Page 57247 I. GENERAL PROVISIONS MINISTRY OF ECONOMY, INDUSTRY AND COMPETITIVENESS 7814 Resolution of 4 July 2017, of the Secretary General of the Treasury and Financial Policy, defining the principle of financial prudence applicable to borrowing and derivative operations of the Autonomous Communities and Local Entities.

The Organic Law 8/1980, of 22 September, on the financing of the Autonomous Communities, establishes in its article 13 bis that "all financial operations subscribed by the Autonomous Communities, in accordance with what is provided in article 2.1 of Organic Law 2/2012, of 27 April, are subject to the principle of financial prudence", with the definition of said principle regarding financial liabilities falling to the Secretary General of the Treasury and Financial Policy.

On the other hand, the consolidated text of the Law Regulating Local Treasuries, approved by Royal Legislative Decree 2/2004, of 5 March, states in its article 48 bis that "all financial operations subscribed by Local Corporations are subject to the principle of financial prudence", the definition of which, regarding financial liabilities, corresponds to the Secretary General of the Treasury and Financial Policy.

Furthermore, Royal Decree-Law 17/2014, of 26 December, on financial sustainability measures for the Autonomous Communities and Local Entities and others of an economic nature, creates the Financing Fund for Autonomous Communities and the Financing Fund for Local Entities. Adherence to the Financing Fund for Autonomous Communities, whether in its Financial Facility compartment or the Autonomous Liquidity Fund, entails subjecting to financial prudence conditions as determined by the Secretary General of the Treasury and Financial Policy. Additionally, in accordance with the aforementioned Royal Decree-Law 17/2014, operations implemented in securities and long-term credit operations will require express authorization from the Secretary General of the Treasury and Financial Policy.

This Resolution defines the principle of financial prudence applicable to the financial operations of the Autonomous Communities and Local Entities. For the definition of this principle, this Secretary General has taken into account the principle of sustainability of public finances established in article 4 of Organic Law 2/2012, of 27 April, on Budgetary Stability and Financial Sustainability, which safeguards the capacity of Public Administrations to finance their present and future expenditure commitments within the limits of deficit, public debt, and commercial debt arrears.

In annex 3 of this Resolution, the maximum differentials over the state's financing cost and other financial conditions applicable to borrowing operations of Autonomous Communities and Local Entities are established. Given current monetary conditions, and in particular the slope of the Treasury curve from one to two years, the maximum differentials for short-term and long-term borrowing operations have been equalized to avoid distortions in the maximum rate curve to which Autonomous Communities and Local Entities can be financed, which could distort financing decisions for certain terms.

The criterion in force until now, according to which any novation or restructuring of a borrowing operation had to be carried out at the maximum interest rate permitted by this Resolution, has allowed significant savings for territorial administrations. However, the current environment of historically low interest rates makes it difficult to continue with the restructuring and novation process. In this sense, and with the aim of continuing to generate financial savings, novations and restructurings are allowed at an interest rate above the maximum rate permitted by financial prudence, provided that the new operation generates a financial advantage, its residual life is greater than one year, the term of the existing operation is not modified, and all its clauses comply with the provisions of this Resolution. In the field of Local Entities, restructurings must also comply with the provisions of the regulations governing Local Treasuries.

Finally, certain minor modifications are introduced to improve the wording of some provisions based on mere normative technique criteria.

For all the above, this Secretary General has resolved:

First. Scope and principle of financial prudence. Autonomous Communities and Local Entities may only enter into borrowing and financial derivative operations under the terms established in the following sections, without prejudice to borrowing operations contracted with multilateral financing bodies, which will be exclusively subject to compliance with the maximum cost condition.

For the purposes of this Resolution, Autonomous Community and Local Entity refers to both the Administration of the Autonomous Community and the Local Entity as well as the rest of entities, bodies, and agencies dependent on them, included in the Public Administrations sector, Autonomous Communities subsector, and Local Corporations subsector, in accordance with the definition and delimitation of the European System of National and Regional Accounts of the European Union.

Borrowing operations contracted between two entities of the public sector dependent on the same Autonomous Community or Local Entity, or between an Autonomous Community or Local Entity and its public sector entities, in accordance with the definition and delimitation of the European System of National and Regional Accounts of the European Union, will not be subject to this Resolution.

Second. Instruments.

1. Autonomous Communities and Local Entities within the scope of application of this Resolution may carry out borrowing operations through, among others, the following instruments: a. Debt certificates under German law (Schuldschein). b. Negotiable or non-negotiable long-term securities, issued through public or private issuance, in wholesale markets or directed to the retail segment. c. Short-term financing instruments. d. Long-term loans. e. Financial leases. The use of instruments other than the aforementioned will be subject to the provisions of section eight of this Resolution.

2. In any case, Autonomous Communities adhered to the Financing Fund for Autonomous Communities will be subject to articles 19.1.a) and 24.b) of Royal Decree-Law 17/2014, according to which "they may not carry out operations implemented in securities nor long-term credit operations, except with prior express authorization from the Secretary General of the Treasury and Financial Policy, without prejudice to the mandatory authorization of the Council of Ministers, in accordance with article 14 of Organic Law 8/1980, of 22 September, on Financing of the Autonomous Communities".

Third. Financial conditions of borrowing operations. The maximum total cost of borrowing operations, including commissions and other expenses, except for those cited in annex 3, may not exceed the state's financing cost at the average term of the operation, increased by the corresponding differential as established in annex 3 of this Resolution.

Autonomous Communities and Local Entities that have their own valuation tools or independent external advice may determine the Treasury's financing cost at the time of the operation based on the methodology contained in annex 2 of this Resolution.

The rest of Administrations, to know the state's financing cost at each average term, will use the fixed rate tables or the maximum differentials applicable to each reference published monthly, by Resolution, by the Treasury Directorate General. The published maximum costs will remain in force until new costs are published.

In the case of securities issuances, the corresponding Administration must establish the price using annex 2 of the Resolution.

Compliance with the maximum cost condition will be considered at the time of opening the bidding process in the case of public tenders or at the time of submission of firm offers by financial entities in the case of financing through bilateral negotiation. The Autonomous Community must explicitly state the use of annex 1 or 2 prior to both the public tender and bilateral negotiations, and the offers presented by financial entities must reflect the methodology chosen by the Community. In the case of securities issuances, compliance with the maximum cost condition will be considered at the predetermined time for price fixing on the day the issuance is launched.

Operations eligible to be covered by the Financing Fund for Local Entities will have an amortization plan in which interest payments coincide with principal maturity dates.

Fourth. Coordination of issuances. Those Administrations that plan to carry out an operation described in point 1.b of section two must communicate to the Treasury the expected amount of the operation, the expected execution date, and the target term.

In the case of public issuances, the communication must be made with a minimum advance of 7 business days. In the case of private placements, the prior notice is only mandatory if the amount is equal to or greater than 500 million euros and must be made with a minimum advance of two business days.

If the Secretary General of the Treasury and Financial Policy does not pronounce itself on the business day following the receipt of the communication to issue negotiable securities, it will be understood that the operation may be announced and/or executed on the proposed dates, provided that the rest of the conditions established in this Resolution are respected.

Fifth. Financial derivative operations.

1. Interest rate and exchange rate swaps, options, and futures may be contracted according to standard market conditions.

2. In the event that a borrowing operation is carried out in a currency other than the euro, the exchange rate risk must be covered with a financial swap contract, unless there is a natural hedge. The cost of said financial swap will be incorporated into the calculation of the total cost of the operation, which may not exceed the limits established in section three.

In the case of borrowing operations carried out in a currency other than the euro prior to the entry into force of the Financing Funds for Autonomous Communities and Local Entities, the exchange rate risk may be covered under standard market conditions.

3. In the case of Local Entities, the provisions of points 1 and 2 of this fifth section will apply without prejudice to what is established in the regulations governing Local Treasuries.

4. The Secretary General of the Treasury and Financial Policy may exceptionally authorize, in accordance with the "Exceptional Cases" section, the use of complex financial derivatives. A complex financial derivative is understood to be those that involve a high assumption of risk, such as leveraged risk options, derivatives referenced to the change in slope of interest rate curves, those linking interest rates of different currencies, those referenced to the evolution of stock market indices, those linked to variation between currencies, or combinations thereof.

5. In no case may the following be contracted: a. Financial derivatives defined in point 4 above without a maximum cost. b. Financial derivatives where the risk of any price index is assumed, except when the purpose of the derivative is the elimination of said risk. c. Financial derivatives that imply a deferral of the financial burden or an increase in financing. When, as a consequence of the restructuring of a financial derivative, a fixed-rate loan constructed from variable-rate financing and an implicit variable-fixed interest rate swap, or a loan with implicit derivatives formalized prior to the establishment of the prohibition in section 6.a), a breakage cost payable by the corresponding Administration is incurred, this may be passed on to the new fixed rate of the restructured derivative or to the new fixed rate of the fixed-rate loan, as applicable. This will not be considered a deferral of the financial burden or an increase in financing. The new rate may exceed the limits established in section three only by the portion corresponding to the breakage cost. d. Financial derivatives contracted outside reasonable market prices. To value this circumstance, the Autonomous Community or Local Entity must have its own valuation tools or have independent external financial advice. e. Financial derivatives containing early termination clauses as a consequence of a downgrade in credit rating.

6. The formalization of financial derivatives will require the signing of a standard master contract that includes the rights and obligations of these operations. Additionally, a standard collateralization contract in the market may be subscribed.

7. Derivatives contracted prior to the entry into force of this Resolution and that have not yet matured will remain subject to the ISDA, CMOF, or similar contracts that were in force at the time of contracting. Any migration of these derivatives to the new master contracts specified in point 6 above may in no case involve any disbursement by the Autonomous Community or Local Entity.

Sixth. Prohibitions. The following borrowing operations are prohibited: a. Those borrowing operations not implemented in securities that include implicit derivatives in the contracts, including early repayment options at the request of the financial creditor, except those derived from the breach of borrowing operation contracts. Financing operations at fixed interest rates constructed from variable-rate financing and an implicit variable-fixed interest rate swap will be permitted if they respect the rest of the conditions established in this Resolution.

b. Those whose financial structure entails a deferral of the financial burden. Zero-coupon issuances will only be permitted for terms equal to or less than 18 months.

c. Those containing trigger clauses linked to credit ratings or other economic-financial variables that imply early repayment of the debt or a change in its financial conditions. Only trigger clauses for the change of the applicable interest rate will be valid for the case where the maturities of the borrowing operations cease to be covered by the Financing Funds for Autonomous Communities and Local Entities. In no case may the new interest rate contravene the maximum cost fixed in section 1.b.i of annex 3.

d. Those borrowing operations not implemented in securities derived from the subrogation of the General Administration of the Autonomous Community or Local Entity or one of its entities in financial contracts of entities that form its public sector, which imply the assumption of debts previously guaranteed directly or indirectly by the Administration itself, in the event that such subrogation implies an increase in the cost of the preexisting operation. The establishment of assumption or subrogation commissions in these operations is also prohibited.

e. Those borrowing operations not implemented in securities derived from the subrogation of the General Administration of the Autonomous Community or Local Entity or one of its entities in other debts that do not have a financial nature or that lack direct or indirect guarantee by the corresponding Administration, and whose cost is above the borrowing cost at the equivalent average term that the Autonomous Community or Local Entity had on the date the original operation was closed. The establishment of assumption or subrogation commissions in these operations is also prohibited.

f. Those derived from the transformation of unpaid debts of a non-financial nature of the Autonomous Community or Local Entity that have an explicit or implicit cost, into others of a financial nature whose cost is above the borrowing cost at the equivalent average term that the Autonomous Community or Local Entity had on the date the original operation was closed.

g. Those borrowing operations not implemented in securities that do not provide for the possibility of early repayment at the request of the debtor. The formalization of debt certificates under German law (Schuldschein) that do not provide for the possibility of early repayment at the request of the debtor will be permitted, provided that the rest of the conditions respect what is established in this Resolution. Variable-rate operations may not contain breakage costs for early repayment on interest payment dates. In the event that early repayment occurs on dates other than interest payment dates, the inclusion of a breakage cost is allowed provided that said cost is calculated according to market practice. Fixed-rate financing operations may include breakage costs in favor of one or any of the parties, regardless of whether early repayment is made on interest payment dates. In any case, such breakage costs may only reflect the economic damage of the cancellation of the operation due to the change in the conditions of interest rate swaps from the formalization or disbursement of the loan until the moment of its amortization (or in other words, the cancellation of the implicit variable-fixed interest rate financial swap). The risk premium of the operation, equivalent to the risk premium that would correspond to the loan if it were variable, for the average term remaining from the date of early repayment to the date of amortization provided in the initial contract, may not be incorporated.

h. Those variable-rate operations that contain floor clauses on the applicable reference, except if the Autonomous Community or Local Entity is compensated in the differential applicable to the operation for the sale of that floor option at market prices.

i. Those variable-rate borrowing operations not implemented in securities in which the reference Euribor used does not coincide with the interest settlement period, except if the contract includes the market adjustment of the margin between the reference used and the one appropriate for the interest settlement period.

Seventh. Modification of financial conditions of long-term loans. The novation, restructuring, or refinancing of borrowing operations not implemented in securities derived from a prior contract of the Autonomous Community or Local Entity or its public entities must be formalized according to what is provided in this Resolution, and the maximum financial cost must be that established in section three of this Resolution. In any case, operations in which the resulting cost of the operation financially exceeds the cost of the preexisting operation are prohibited.

Modification of a prior contract of the Autonomous Community or Local Entity or its public entities, in which the resulting cost of the operation financially exceeds the maximum cost permitted according to section three of this Resolution, will only be permitted when a financial saving is generated and the following conditions are met simultaneously: i. the operation has a residual average life greater than one year, ii. the term of the operation is not modified, iii. the modification of the contract implies a reduction in the interest rate of the operation, iv. the clauses of the new contract respect what is established in this Resolution.

Any financial entity other than the original creditor may formalize an operation under these criteria in order for the Autonomous Community or Local Entity or its public entities to amortize the previous operation early.

In the field of Local Entities, the operations referred to in this section must also comply with what is provided in the regulations governing Local Treasuries and the norms that develop or complement them.

Eighth. Exceptional cases. Exceptionally, the Secretary General of the Treasury and Financial Policy may authorize borrowing and derivative operations that do not comply with the conditions of this Resolution. For this, the Autonomous Community or Local Entity or its public entities must present a report detailing the financial convenience of the operation, the causes that justify such special conditions, and how it affects their solvency.

Additionally, in the case of financial derivatives, the report will explain the functioning of the derivative and the purpose pursued with it. Derivatives for which the knowledge of their functioning or their adequacy to the purpose pursued is not sufficiently justified will not be authorized.

Ninth. Information obligations.

1. Autonomous Communities and Local Entities are obliged to communicate the final conditions of all borrowing and derivative operations carried out and of the global portfolio of debt and derivatives to the Ministry of Finance and Public Function in accordance with the information supply obligations established in legislation.

cve: BOE-A-2017-7814 Verifiable at http://www.boe.es

OFFICIAL STATE BULLETIN No. 160 Thursday 6 July 2017 Sec. I. Page 57248

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cve: BOE-A-2017-7814 Verifiable at http://www.boe.es

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