1. Purpose
The purpose of this study is to explore
A. the possibilities of issuing debt required for financing “Metro Project” for the Municipality of Ulaanbaatar and its legal environment;
B. the necessities to establish a Special Purpose Vehicle (SPV) to implement the project, its pros and cons, its organizational structure.
2. Legal framework for financing the Metro Project from the Municipality of Ulaanbaatar
2.1. Capital Expenditure Financing from the Municipality of Ulaanbaatar
According to the “Law on the Legal Status of the Capital City of Ulaanbaatar, Mongolia”, the Capital City will implement a total of 7 special functions and 18 other functions, and the Metro project falls under the other functions of “reducing traffic congestion, increasing the type, quality and accessibility of public transport services” specified in Article 8.3.11 of the law. Also, according to Article 11.2, other functions are legislated to be financed from the local budget.
In Article 4.1.27 of the Budget Law, "local budget" means the budget approved by the Citizens' Representative Khural of aimag, capital city, soum, district, or city or village council of national or local level, and prepared and allocated by the governor-general of the budget at that level; Article 4.1.24 of the same law defines “investment” means capital expenditures to be financed from the budget and to be transferred into the ownership of a legal body who is associated with the budget of the respective level. Therefore, the metro project is justified to be included in the capital's budget investment.
However, since the total budgeted cost of the EPC contract for the metro project is $2.4 billion, and an average of $600 million or 2 trillion tugriks per year until 2030, it is significantly higher than the capital's budget investment (1 trillion 564 billion tugriks in 2024). Therefore, it is advisable to allocate a certain part of the investment, as such 300 to 500 billion tugriks annually until 2030 from budget investment, and the remaining part, or 1.7 trillion tugriks, through other financing methods such as issuing debt securities by the capital city and public-private partnerships.
2.2. Legal Requirements of issuing debt securities from the capital
Except financing a certain portion of the Metro Project with local budget investment, it is possible 1) to issue debt securities in local market and 2) to issue bond in international market with sovereign guarantee in accordince with the Article 281 of the Debt Management Law.
Requirements for issuing securities
• Must have the support of the Khural of Citizens’ Representatives;
• Must have a conclusion under the supervision of the Ministry of Finance;
• Must have obtained approval from the Government;
• Must comply with the debt ceiling of the Government.
The Mayor of the city shall present the project to be implemented with borrowed funds to the Khural of Citizens of the Capital. The maximum amount of new government debt to be issued in a given fiscal year shall be approved together with the annual budget law, and the maximum amount of government debt guarantee shall be approved by the State Great Khural. When the Capital issuing securities, it shall be reviewed by the Ministry of Finance. Also it should be approved by the Government in accordance with the terms and requirements consistent with the Debt Management Law. Based on the approval of the Government, the Khural of Citizens' Representatives shall make a decision on the issuance of a loan.
The securities issued by the capital city shall comply with the government debt ceiling; shall be consistent with the Government's debt management strategy document, medium-term budget framework statement, and borrowing plan; and shall reflect the amount of obligations assumed through securities and the costs associated with the issuance of securities in the aimag and capital city budget drafts; and shall comply with the limits and the requirements and criteria specified in the Law on Fiscal Stability
It should be noted that the capital city cannot issue securities directly in the foreign market and is subject to mandatory conditions for obtaining a guarantee from the Government.
2.3. Recent experience of debt issuence from the Capital City
In June 2024, the capital city successfully issued bonds totaling 500 billion MNT in the domestic market, with maturities ranging from one to three years and interest rates between 12% and 14%. The city is now planning to issue USD 500 million in the international market.
3. [1] Legal possibilities of establishing a Special Purpose Vehicle (SPV) to implement projects
А. Special Purpose Vehicle (SPV)
SPV is a legal entity established solely for implementing a specific project. The SPV’s equity and liabilities are separate from the parent company and are usually established to isolate financial risks. SPVs are widely used in Project Finance and Public-Private Partnerships, and are the main legal entity responsible for all project-related contracts and activities.
Pros
Risk Isolation: One of the main reasons for using SPVs in project finance is to isolate risks. By separating the project into an independent entity, the SPV limits the financial risk of the assets within it and protects the parent company and other assets from the consequences of the project's failure.
Attracting investment: SPVs provide more flexible investment opportunities. Investors can invest directly in the project without being exposed to the financial risk of the parent company. This structure attracts professional investors to certain projects.
B. Variants of SPV ownership
1. Establishing a SPV fully or partially owned by the capital city.
Several laws have granted the capital a right to establish local legal entities. For example, the Article 77.4 of the “Law on State and Local Property” adopted by the Parliament in 1996 grants the full authority to the Khural of Citizens' Representatives to make decisions on the establishment, reorganization, and liquidation of local legal entities and to monitor their implementation. Also, the Article 18.3 of the “Law on Administration, Territorial Units and Their Management of Mongolia” states that “Aimags, soums, capital cities, and districts may establish local-owned legal entities for the purpose of implementing their functions assigned by law.” Article 15.1 of the “Law on the Legal Status of the Capital City of Ulaanbaatar, Mongolia” approved in 2021 states that “The capital city may have legal entities with local ownership or with local partial ownership.”
Form of legal entity
A SPV established by the capital city may have the following forms of legal entity. These include:
• Locally owned self-financing enterprise: It is defined according to the Article 15.2 of the “Law on State and Local Property,” as “A self-financing enterprise is a legal entity independently engaging in civil transactions, based on self-financing principle on given state property items”. The procedure for exercising local ownership representation in a locally owned self-financing enterprise is regulated by the “Law on State and Local Ownership”, and the election of an independent member of the board of directors, appointment of executive management, committees under the board of directors, the secretary of the board of directors and relations related to their activities are regulated by the “Law on Companies”.
· Company (non-public, public JSC, LLC): In the case of establishing a project implementation SPV by the Capital city in the form of a company, the “Law on Companies” will be followed. The “Law on Companies” defines “a company as a legal entity in which the capital invested by the shareholders is divided into a certain number of shares, has its own special property, and its main purpose is to make a profit.”
Private Investment in the SPV
Article 18.1 of the “Law on the Legal Status of the Capital City of Ulaanbaatar, Mongolia” approved by the Parliament in 2021 states that “An entity specified in Article 3.1.2 of the Law on Investment may invest in tangible and intangible assets of a capital city-owned legal entity operating for profit.” Therefore, it seems that the legal framework for attracting foreign and domestic investors has been established. The investment proposals of foreign and domestic investors are legally approved by the Citizens’ Representative Khural of the capital city, and by its authorization, the Governor of the capital city and the Mayor of Ulaanbaatar. If the government does not provide a guarantee, attracting investment in the SPV has the advantage of not affecting the government debt ceiling.
SPV borrowing and issuing securities
Article 16 of the “Law on State and Local Property” states that “A legal entity owned by the state or with a majority of state property shall borrow and issue securities upon obtaining permission from the central state administrative body in charge of finance and budget matters.” and Article 20 of the same law states that “A legal entity owned by the state and local and with a majority of state and local shall not borrow or issue securities without the permission specified in Article 16 of this Law.” The process of issuing securities and borrowing securities by a SPV is the same as issuing securities by the capital city, and the requirements specified in the Law on Debt Management are the same, except that the borrower is not the capital city, but the SPV.
2. SPV established by the Ministry of Finance
The Metro project falls under the special function specified in Article 8.3.11 of the “Law on the Legal Status of the Capital City of Ulaanbaatar, the Capital of Mongolia”, which is “projects and measures aimed at reducing road congestion, increasing the type, quality and accessibility of public transport services, and solving other problems facing the capital city”. Therefore, since the special functions of the capital city are legislated to be financed from the local budget, it is not possible to finance the project from the state budget. Therefore, the implementation of the Metro project through the establishment of a SPV by the Ministry of Finance may pose legal problems. This needs to be reviewed in more detail.
3. Establishment of a SPV with private sector participation
Article 15.2 of the “Law on the Legal Status of the Capital City of Ulaanbaatar, the Capital of Mongolia” states that “Works and services related to the implementation of the functions of the capital city and the capital city that cannot be performed by private legal entities may be executed by legal entities specified in Article 15.1 of this law on the basis of a contract.” It is understood from the above that some functions of the capital and the capital city can be done by private legal entities. This relationship is regulated by the Law on Public-Private Partnership. In accordance with the “Law on Public-Private Partnership”, it is possible to establish a joint venture with the private sector.
Table 1. SPV ownership and its comparisons
Options | Pros | Cons |
Wholly owned by the Capital City | More control, policy independency | Legal requirements and limitations, approval of loans by the Government |
Collaboration between the Ministry of Finance and Capital city | Centralized oversight, proven experience engaging international lenders, and streamlined Ministry of Finance approval processes for borrowing | Capital city’s Limited involvement, slower decision making, legal limitations to establish SPV with Ministry of Finance |
Joint venturebetween the private entity and the Capital City (PPP) | Risk sharing, attracting private investments | Loss of control, risk of losing public control and interest |
Privately owned (PPP) | No debt burden in a case of without sovereign guarantee | Violation of public interest |
4. Conclusion
• Given the scale of the project and the debt burden on the capital city budget, the Metro project should be funded by blending the capital city budget, raising bonds in the domestic and foreign markets, and public-private partnerships.
• In the case of issuing securities by the capital city itself or by a SPV with ownership of the capital city, there will be strict legal requirements such as compliance with the state debt ceiling and budget stability criteria, and obtaining permission from the Ministry of Finance and the Government.
• When implementing the metro project, it is advisable to isolate financial risks by establishing a SPV.
• The current legislation in force provides a complete legal o for establishing a SPV by the capital city, and the SPV has the right to attract investments and borrow, and when borrowing, it is necessary to obtain relevant permits from relevant state agencies. However, the approval of the Government is not mentioned for attracting investments. The financial structure of a SPV with private ownership may not directly affect the government debt ceiling.
Next steps:
• To study the economic viability, budgetary pressure, and debt repayment potentials from the Capital City or a SPV owned by the Capital City
Research Conducted by
Chuluunbaatar Shinebaatar (Professional in Contracts)
5. Legal frameworks regulating the Capital City’s debt issuance
Law | Relevant Article |
LAW ON THE LEGAL STATUS OF THE CAPITAL OF MONGOLIA, ULAANBAATAR CITY /REVISED/ JULY 7, 2021 | 8.3. The capital city shall implement the following other functions: 8.3.11. projects and measures aimed at reducing road congestion, increasing the type, quality and accessibility of public transport services, and resolving other issues facing the capital city; 11.1. The capital city shall have an independent budget in accordance with Article 16.1 of the Law on Administrative, Territorial Units and Their Management of Mongolia. 11.2. The funds necessary for the implementation of the special functions specified in Article 8.2 of this Law shall be financed from the state and local budgets, and other functions specified in Article 8.3 shall be financed from the local budget. 13.1. The capital city may issue securities in accordance with the conditions and procedures specified in the law. 13.2. The issuance of capital securities shall be regulated by the Law on Debt Management and other relevant laws. |
LAW ON DEBT MANAGEMENT FEBRUARY 18, 2015 | 3.1. This law shall regulate relations related to the creation and management of debts with the condition of repayment from the state and local budgets. 4.1.15. "loan" means creating debt through debt instruments other than Government debt guarantees; 6.2.3. Government loans and Government debt guarantees shall be approved by the State Great Khural, and municipal loans shall be approved by the Citizen's Representative Khural of Provinces and the Capital city; 10.1. The Citizen's Representative Khural of Province and the Capital city shall exercise the following full powers regarding debt management: 10.1.1. to ensure and monitor the implementation of debt management laws and regulations; 10.1.2. to discuss and approve proposals for projects and/or activities submitted by the Governor to be implemented with the loan capital at the local level; 10.1.3. to discuss the results of projects and/or activities in municipalities financed with the loan capital along with the budget execution report, and to give instructions regarding their implementations; 10.1.4. to discuss the proposal of the Governor to create local debt, make a decision to create local loans based on the Government's approval; 10.2. Governors of provinces and the capital city shall exercise the following full powers regarding the debt management: 10.2.1. to prepare proposals for projects and/or activities to be implemented with the loan capital at the local level and submit them to the Citizen's Representatives' Meeting in accordance with section 19.1 of this law; 10.2.2. to organize the work of ensuring the implementation of projects and/or activities implemented with the loan capital in municipalities, and monitor their operations; 17.1. The maximum amount of newly created debt of the Government in the fiscal year shall be approved together with the annual budget law, and the maximum amount of the Government debt guarantees shall be approved by the State Great Khural. 19.1. In accordance with Article 281, Clauses 6.2.2, 7.1.2, and 8.1.4 of this law, Governors of provinces and the capital city shall get a loan after it revised by the state central administrative organization in charge of finance and budgetary matters and based on the Government's approval. The loan decision shall be approved by the Citizen's Representatives Meeting of the province and the capital city. 19.2. The matter of debt creation from the state budget by the Governor of provinces and the capital city with the condition of repayment within the given fiscal year shall be regulated in accordance with the Law on Budget. Article 281 . Issuance securities by province and the capital city /This article was added according to the law as of July 7, 2021./ 281.1. Provinces and the capital city may issue securities in the internal market in national currency for the purpose of refinancing certain projects and/or activities and previously issued securities. 281.2. The governor of a province or the capital city shall perform functions of security issuer on behalf of the province or the capital city. 281.3. Projects and/or activities specified in section 281.1 of this Law shall meet the requirements specified in clauses 18.5.1, 18.5.2, 18.5.3, and 18.5.4 of this law. 281.4. Governors of provinces and the capital city shall present their proposals for issuance of securities to the Citizens' Representatives' Meeting, and in case a favorable decision was made, it shall be submitted to the state central administrative organization in charge of financial and budgetary matters for a conclusion at least four months before the beginning of the fiscal year. 281.5. If the state central administrative organization in charge of financial and budgetary matters determines that the draft decision of the Governor of the province or capital city to issue securities complies with the limits specified in clause 6.1.4 of the Law on Fiscal Stability, conditions, requirements, and criteria specified in the law, the draft decision shall be submitted to the Government before submitting the annual draft budget to the Government. 281.6. When issuing securities of the province or the capital city, the section 19.1 of this law shall apply, and the following requirements shall be fully met: 281.6.1. obtained a permission to issue securities from the Government; 281.6.2. compliance with the Government's new debt limit; 281.6.3. the budget draft of the province or the capital city which complies with the Government's debt management strategy document, medium-term budget framework statement and loan plan shall include the amount of debt obligations to be covered by securities, and expenses related to issuance of securities; 281.6.4. it has been determined that the conclusion made by the state central administrative organization in charge of financial and budgetary matters in accordance with section 16.2 of this law complies with the limits specified in clause 6.1.4 of the Law on Fiscal Stability and the requirements and criteria specified in the law; 281.6.5. the Citizens' Representatives Meeting supported the Governor's proposal to issue securities of the province or capital city; 281.6.6. others stated in the legislation. 281.7. The state central administrative organization in charge of financial and budgetary matters shall develop the procedures related to issuing, trading, and reporting securities to be issued by the Governor of the province and the capital city, and the procedures shall be approved and implemented by the Government. 281.8. It is prohibited to pay payment of securities of the province or the capital city by the state budget transfer and/or aid. 281.9. It is prohibited to issue securities of the province or the capital city in violation of the terms and conditions stipulated in this law. 33.4. The following entity may request the Government member in charge of the relevant sector to issue a government debt guarantee when borrowing to implement projects or measures:: 33.4.1. state or local owned enterprises, or state or local controlled enterprises; |
BUDGET LAW DECEMBER 23, 2011 | 4.1.24. “investment” means capital expenditures to be financed from the budget and to be transferred into the ownership of a legal body who is associated with the budget of the respective level; 4.1.27. “local budget ” means a budget approved by aimag, capital city, soum and district Citizens’ Representative Khurals and money collected, allocated and expended by general budget governors subordinated to the budget of the respective level; 4.1.30."Local budget base expenditure" means the sum of current and capital expenditure related to the management of administrative and territorial units and the implementation of local functions and delegated state functions. 4.1.34." budgetary entity” means state or locally owned, not-for-profit legal body who provides work and services to execute the functions of the state in accordance with the approved budget and registered by the State Central Administrative Body Responsible for Finance and Budget Matters, as stipulated in provision 7.1.3 of the Law on State Registration of Legal Bodies |
LAW ON FISCAL STABILITY June 24, 2010 | 4.1.8."Government debt" shall mean: 4.1.8.a/payment obligations of Mongolian government, aimags and capital city to others created by debt instrument; 4.1.8.b/amount of Government debt guarantee issued in accordance with the law and contract; 6.1.4.the balance expressed in the current value of Government debt shall not exceed 60 percent of GDP calculated in the annual price of the particular year. |
LAW ON THE 2025 BUDGET OF MONGOLIA DECEMBER 12, 2024 | Article 11. The maximum amount of new debt to be issued by the Government in the 2025 fiscal year is hereby approved as follows: 11.1. The maximum amount of internal borrowing for the purposes specified in Articles 12.1.2 and 12.1.3 of the Law on Debt Management is up to 300,000.0 million tugriks; 11.2. The maximum amount of external project loans to be used by the Government for the purposes specified in Article 12.1.5 of the Law on Debt Management is up to 1,542,428.3 million tugriks. Article 13. The maximum amount of debt guarantees to be issued by the Government in the 2025 fiscal year is 3,500,000.0 million tugriks. |
6. Legal framework of establishing a SPV by the Capital City
Law | Relevant Article |
LAW ON STATE AND LOCAL PROPERTY MAY 27, 1996 | Article 15. Classification of state owned enterprises 1. A state owned enterprise is an enterprise based only on state property and receiving funds from state budget, and it shall be divided, in accordance with its legal status: to self-financing enterprise and budget-funded enterprise. 2. A self-financing enterprise is a legal entity independently entering into civil transaction, based on self-financing principle on given state property items. 3. A budget-funded enterprise is a legal entity, on the basis of given state property items financed from state budget and who's activity is limited to producing and service only for state demand. 16. State-owned and state-dominated legal entities shall obtain loans and issue securities upon obtaining permission from the central state administrative body in charge of finance and budget matters. 20. Without the permission specified in paragraph 16 of this law, legal entities owned by the state or local government, or with a majority state or local government, are prohibited from obtaining loans or issuing securities. Article 77. Citizens’ Representative Khural’s authority regarding local property: 4/ To make decisions on establishing, restructuring, and dissolving legal entities of local government property, and to oversee their implementation. |
LAW ON THE LEGAL STATUS OF THE CAPITAL OF MONGOLIA, ULAANBAATAR CITY /REVISED/ JULY 7, 2021 | Article 15. Legal entities owned by the capital city 15.1. The capital city may have legal entities with local ownership or with local partial ownership. 15.2. Services that cannot be performed by private legal entities related to the implementation of the functions of the capital and the capital city may be performed by legal entities specified in Article 15.1 of this Law on the basis of a contract. Article 18. Investment in the capital 18.1. Law on Investment may invest in tangible and intangible assets of a capital city-owned legal entity operating for profit. 18.2. The investment proposal submitted in accordance with Article 18.1 of this Law shall be approved by the Khural of Citizens' Representatives of the capital city or, upon its authorization, by the Governor of the capital city and the Mayor of Ulaanbaatar. Article 19. Support for investment in the capital city 19.1. In order to protect the rights and legitimate interests of investors operating in the capital city and to work with them to develop the capital city, the Investors Council shall be established under the Governor of the capital city and the Mayor of Ulaanbaatar city. 19.2. The council specified in Article 19.1 of this law shall be non-permanent, and the composition and working procedures of the council shall be approved by the Governor of the capital city and the Mayor of Ulaanbaatar city. 19.3. The administration of the capital city shall provide the following guarantees to investors who have invested in accordance with Article 18.2 of this law: 19.3.1. to follow the procedures and grounds specified in the General Administrative Law when resolving issues of changing, annulling, or terminating the decisions specified in Article 18.2 of this law; 19.3.2. to provide information related to investments; 19.3.3. not to change the decision to acquire and use land, unless otherwise provided by law; 19.3.4. to issue special licenses specified by law for investment-related activities; 19.3.5. other specified by law. 19.4. Unless otherwise provided by law, the capital city administration shall provide the following guarantees to legal entities that have received investments specified in Article 18.1 of this law in order to ensure the effectiveness of investments in the capital city: 19.4.1. to flexibly resolve working hours; 19.4.2. to provide financing for expenses specified in the relevant regulations, depending on the type, form and purpose of the investment, in the interests of the public; 19.4.3. other specified by law. 19.5. The capital city administration shall use the option specified in Article 42 of the General Administrative Law when resolving issues of providing guarantees specified in Articles 19.3 and 19.4 of this law. 19.6. When deciding whether to provide investors in the capital city with the guarantees specified in Articles 19.3 and 19.4 of this law, the priority areas of development of the capital city shall be the criterion, and the Citizens' Representative Khural of the capital city shall decide based on its proposals. |
LAW ON ADMINISTRATION, TERRITORIAL UNITS AND THEIR MANAGEMENT OF MONGOLIA 24 DECEMBER, 2020 | 18.3. Aimags, soums, capital cities, and districts may establish locally owned legal entities to carry out their functions as provided by law. |
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