A View of Transparency & Financial Management

Paul Coughlin Global Head, Analytics & Operations Standard & Poors Ratings Services December 10, 2012

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How Standard & Poors Factors Transparency & Financial

Management in its Analysis

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2.

Framework for Sovereign Ratings

Political score Economic score External score Fiscal score Monetary score

Political and Economic Profile

Flexibility and Performance Profile

Sovereign Indicative Rating Level Exceptional Adjustment Factors

Sovereign Foreign Currency Rating

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3.

Assessing the Political Score

The political score is based on the qualitative analysis of the following factors:
The effectiveness, stability, and predictability of a sovereign's policymaking and political institutions
The transparency and accountability of institutions, data, and processes, as well as the coverage and reliability of statistical information The government's payment culture The potential impact of external organizations on policy making External security risks

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4.

Transparency & Accountability of Institutions, Data & Processes

The existence of checks and balances between institutions The perceived level of corruption in the country, which correlates strongly to the accountability of the institutions The unbiased enforcement of contracts and respect for the rule of law (especially in the area of property rights), which correlates closely to respect for creditors' and investors' interests The independence of statistical offices and the media, as well as the history of data revisions or data gaps, as measures of the transparency and reliability of the information

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5.

Consistency of Relevant Data

The previous point includes an assessment of the quality & consistency of the relevant data, which includes:
National Income Accounts
Fiscal Accounts Monetary Surveys

Public Enterprise Accounts

Balance of Payments International Investment Position

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6.

Impact on Sovereign Creditworthiness

Transparency and accountability of institutions bear directly on sovereign creditworthiness
They reinforce the stability and predictability both of political institutions and the political framework

They do this even though they may not reinforce the stability of a ruling political class or party

They enhance the reliability and accuracy of information, and help make known in a timely manner any significant shifts in a country's policymaking or the occurrence of risks relevant to sovereign credit risk

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7.

Analytical Framework for Rating International LRGs

Budgetary Debt burden and contingent liabilities

Institutional framework

Economy

performance

Liquidity

and flexibility

Financial Manage ment

Individual credit profile

Matrix Outcome

Local and Regional Government Rating

Overriding Factors: - Sovereign rating cap - Very weak liquidity or management - Performance below benchmark - Extraordinary support

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8.

Key Factors To Assess The Institutional Framework

Predictability

Revenue and expenditure balance

Transparency and accountability
Transparency and institutionalization of budgetary processes,

Disclosure and accounting standards for financial reporting in the LRG sector
Control levels and reliability of the information.

Systemic support

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9.

Institutional Framework: Transparency & Accountability

The strength of a public finance system depends on regulation of public sector accounting systems, accountability of managers and politicians, and system transparency We believe that strong and predictable systems usually impose high standards for transparency and accountability These standards are established by law or supported by the country's general management culture We believe that transparent and accountable systems promote the implementation of good practices, such as compulsory audits or external controls, accrual accounting, and consolidated reporting requirements Comprehensive reporting implies the requirement to report financial performance, balance-sheet, cash reserves, cash flow statements, real and financial assets, debt, and detailed information on the GRE sector on a timely basis. It also implies the need to report estimates of contingent liabilities

We also assess the reliability of the information through the existence of controls on financial statements by public institutions or recognized private auditing firms.
In our view, strong systems also ensure the general institutionalization of budgetary processes and the existence of a clear delineation of roles between the elected officials and the LRG's administration. We are of the view that such best practices also increase awareness of financial strengths and weaknesses On the other hand, we observe that in less transparent and sophisticated public finance systems, LRGs tend to focus on shortterm technical issues. They appear to operate with low-quality financial information standards and may have weak incentives for efficiency Weak and unpredictable systems tend not to set requirements or promote the implementation of best practices aiming to improve transparency of LRGs' financial operations and long-term planning, audits of financial statements, or better accountability of financial managers

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10.

Analytical Framework For Rating International LRGs

In addition to institutional framework, we assess for each individual Local or Regional Government 7 factors: Economy Financial management Budgetary flexibility Budgetary performance Liquidity Debt burden

Contingent liabilities

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11.

Assessing An LRGs Financial Management

Nine aspects define how an LRG financial management can affect its credit profile:

Transparency and disclosure

Budgeting Long-term capital and financial planning Revenue and expenditure management Debt management Reserve and liquidity management Management of government-related entities

Political and managerial strength

External risk management

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12.

Transparency and Disclosure

General level of financial disclosures (both to Standard & Poor's and the general public)

Clarity and comprehensiveness, together with the timeliness and frequency of their publication
The quality and level of detail of the financial reporting Scope and independence of the auditing Auditor's conclusions in recent years

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13.

Budgeting
Comprehensiveness of the budgeting methods Consistency with the long-term financial strategy Continuity, reliability and effectiveness of budgeting procedures Scope of the government's budget and potential consolidation of companies owned by the LRG Useful metrics include the level of variations between budget and actual results, particularly in relation to operating revenues and expenditures, as well as the number of budget revisions during the year

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14.

Long-Term Capital and Financial Planning

Extent to which there is a credible and well-documented long-term financial plan that supports financial discipline and stability

Level and process of planning

Consistency around fiscal targets Plausibility of underlying assumptions concerning revenues and expenditures Actual performance against historic medium-term plans

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15.

Revenue and Expenditure Management

Planning and monitoring during the year to check consistency with fiscal targets

For revenues, our focus tends to be on the forecasting, administration, and collection of the main taxes, considering the reasons behind any variations from forecast
On the operating expenditures, we look at mechanisms in place to control and monitor costs For capital expenditure, we consider the level of planning, funding and prioritizing of the various projects, and the exposure to delays and cost overruns

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16.

Debt Management
Policies around the use of short- and long-term debt Exposure to debt-related risks such as those arising from interest rate and currency movements, refinancing, and concentration of lenders Appetite for and understanding of risk Relevant metrics may include the percentage of debt that is short term versus long term, fixed rate versus floating rate, and the mix of debt maturities

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17.

Reserve and Liquidity Management

Investment and liquidity policies, and the related appetite and understanding of risk

Ability to forecast cash flows, and identify pressure points during the year
Extent of the LRG's regular relationships with banks and investors Relevant metrics include the level of overdue payables, accounts receivable, and free cash or equivalents to cover short- and long-term financial obligations

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18.

Management of Government-Related Entities

Level of clarity around the purpose, financial performance, and operational effectiveness of government-related entities

Transparency around their financial reporting and medium-term business strategy

Their overall financial health

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19.

Political and Managerial Strength

Commitment to and ability to implement the fiscal discipline necessary to maintain creditworthiness

Governing party's ability to take unpopular decisions (often affected by the size and stability of its majority)
Expertise, continuity, and general capacity of the administration's managementinfluencing the governments ability to implement its will

Metrics for this assessment could include the size of a political majority, the track record of passing budgets without amendments, and the qualifications and experience of management

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20.

External Risk Management

Management's performance in identifying, measuring, and planning responses to key external risks

Potential willingness to use financial flexibilities or implement plans to maintain creditworthiness in a stress scenario
External risks could include economic recessions, natural catastrophes, a major reduction in government grants, or a change to the local or regional government system An LRG's management of external risks is important in enabling us to understand its capacity to withstand certain stress scenarios without defaulting

Comprehensiveness and credibility of risk management strategies

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21.

Overall Assessment Of An LRGs Financial Management

Score 1 Descriptor Very Positive Typical Characteristics The LRG has very prudent fiscal targets backed by widespread political support and implemented by sophisticated managements. It has transparent and well-defined financial policies reflected in reliable and public long-term planning and very good reporting. The management demonstrates a high degree of expertise, through very good planning and monitoring, prudent and well defined debt and liquidity management, and active external risk management. The LRG has prudent financial policies and practices that ensure a good degree of transparency and fiscal discipline through the electoral cycles. The management demonstrates relevant expertise, through good planning and monitoring, prudent debt and liquidity management, and some monitoring. The LRG has generally prudent financial policies, but they are frequently changed and may lack precision. The management is transparent and has adequate expertise, through good though not detailed planning and monitoring and generally prudent debt and liquidity management. But it may lack a comprehensive strategy to manage external risks. The LRG financial management is underdeveloped in some areas. In a stress scenario, the government may lack the political strength to impose fiscal discipline reporting meets the legal standard but is not very detailed and timely. Planning and monitoring are limited. The management of debt and liquidity maybe unpredictable to a degree, while any external risk migration is minimal. The LRG has a weak financial and credit culture, including poor monitoring and reported information that meets just the minimum requirements to maintain a rating. A lack of political stability makes it difficult to impose fiscal disciplines. The management lacks the relevant skills for planning and monitoring. The management of debt and liquidity is unpredictable and sometimes aggressive, while key external risks have not been identified.

Positive

Neutral

Negative

Very Negative

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22.

Transparency & Financial Management Contributes To:

Improved credit ratings Greater investor confidence Wider access to domestic and international capital markets Longer term funding Lower interest rates Greater public trust Improved fiscal performance/outcomes

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23.

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