The Autumn Statement identified raising productivity as the central long term economic challenge facing the UK with a new £23bn National Productivity Investment Fund (NPIF) to be targeted at, housing, transport, digital communication and research and development. It is likely that a significant part of the NPIF infrastructure investment (particularly that for housing and transport) will be secured directly or indirectly by Local Government and Local Government for its part needs to consider the “municipal financing instruments” available to it to work alongside the NPIF to increase infrastructure investment further.
Local authorities in England and Wales have traditionally raised funds for infrastructure investment from the Public Works Loan Board (PWLB), a statutory body operating within the UK Debt Management Office. However, the 2010 Autumn Statement increased PWLB rates from 0.15% over gilts to 1% over gilts greatly increasing the cost of new borrowing and re-financing (although there are concession rates of 80bps which most local authorities will be able to take advantage of and 60bps for an infrastructure project nominated by a Local Enterprise Partnership).
Borrowing from commercial banks has been more limited due to bank capital maintenance requirements making it difficult for them to compete with the PWLB. Commercial bank loans have almost entirely been Lender Option Borrower Option (LOBO) loans (a long term loan with a lender option to increase the rate with a linked borrower option to repay the loan). Local authorities are generally looking to refinance their LOBO loans where a fixed rate cannot be negotiated.
Little local authority capital markets activity has occurred since 1994 when Leicester and Salford Councils turned to the bond markets. However, the increase in PWLB rates has raised the inherent political risk and authorities are turning to other independent sources of funding in the London capital markets. The UK Municipal Bonds Agency is seeking shortly to make its first capital markets issue, the funds from which will be on loan to local authorities. In addition, Warrington BC has recently issued £150m of CPI Bonds and Aberdeen Council £370m of RPI bonds and before this the Greater London Authority issued £600m of bonds for Crossrail and £200m of CPI bonds for the Northern Line Extension. Transport for London also has its own £5bn Medium Term Note and £2bn Commercial Paper programmes.
Institutional investor opportunity
Capital markets issues by local authorities can achieve pricing to challenge PWLB rates. The UK Municipal Bonds Agency is also using the credit enhancing technique of making each local authority jointly and severally liable for each loan. Institutional investors providing bi-lateral loans could also, potentially, become a niche source of finance providing competitive pricing in return for an indexed long term secure income stream. From a lender’s or investor’s perspective lending to local authorities should not be complex due to their financial standing although there are intricacies (primarily arising from statute) which will need to be considered. There will be little or no need for financial covenants as statutory safeguards which underpin local authorities, should give sufficient comfort to investors.
- Under the Local Government Finance Act 1992 local authorities are prevented from borrowing to fund day to day services and their revenue budgets must balance without borrowing. The Local Government Act 2003 empowers local authorities to borrow for any purpose relevant to their functions or for the prudent management of their financial affairs. Authorities have a duty to determine annually and keep under review how much money they can afford to borrow. Authorities must also have regard to the Prudential Code for Capital Finance in Local Authorities published by CIPFA which requires borrowing to be prudent, affordable and sustainable.
- Local Authorities must appoint a statutory Chief Finance Officer under Section 151 of the Local Government Act 1972. CFOs in England and Wales have various statutory responsibilities in relation to financial management including a requirement to submit a report to the Council of the local authority if the CFO determines the authority cannot pay its bills as they fall due (Section 114 Local Government Finance Act 1988).
- Section 13 of the Local Government Act 2003 addresses security for borrowings. A local authority cannot mortgage or charge any of its assets as security for its borrowings and any such security given is unenforceable. However, all local authority borrowings are, by statute, charged indifferently on all of the revenues of the authority. All such security ranks equally without priority. Whilst technically, it could face a situation where it is unable to pay its debts when they fall due, a local authority is not subject to the Insolvency Act 1986.
However, a local authority can be subject to the appointment of a receiver under Section 13(5) of the Local government Act 2003. Such a receiver may be appointed by the High Court on the application of any person entitled to principal or interest in respect of local authority borrowing where the amount outstanding is at least £10,000 and remains unpaid for two months following a written demand. The High Court may appoint such a receiver on such terms and confer such powers as it thinks fit. These powers may include any powers which the local authority has, in relation to collecting, receiving or recovering the revenues of the local authority, issuing levies or precepts or setting, collecting or recovering council tax.
- A “safe harbour” provision contained in Section 6 of the Local Government Act 2003 states that a lender is not bound to enquire whether the local authority has power to borrow and is not prejudiced by the absence of such a power. A lender therefore need not concern itself as to the purpose, prudence of affordability of the borrowing nor that procedural requirements have been complied with.
- There are also statutory requirements on local authorities in England and Wales to set aside revenue to repay debt through the Minimum Revenue Provision (“MRP”) regime contained in the Local Authorities (Capital Finance and Accounting) (England) Regulations 2003.
- Finally, local authorities have access to Government grant funding in addition to council tax, business rates and business rate supplement (the latter financed Greater London Authority borrowing for Crossrail). Although the dynamics are changing the inherent safety nets in current business rate regime mean there is less dependency (and risk) on the local economy. However, this may change with the proposed 100% business rate retention. There are other potential policy revenue drivers such as Enterprise Zones where 100% business rates can be retained for 25 years (this is being used by the GLA amongst other sources of revenue to fund GLA borrowing for the Northern Line extension). Other evidence of Government support is the availability of the PWLB as lender of last resort.
Whilst these safeguards should give comfort to institutional investors, there will remain events which could trigger a mandatory prepayment and/or local authority default. Mandatory prepayment is likely to be triggered by:
- it becoming unlawful for the local authority to perform any obligations under the bonds or loan agreement; or
- a change in status occurring of the local authority. A change in status whilst falling short of illegality will be a change in the nature of the local authority as borrower such as the local authority ceasing to be treated as a local authority within the Local Government Act 2003. In addition to failure by the local authority to meet a payment and a breach which has not been remedied, other events of default are likely to include:
- the appointment of a receiver by the High Court in respect of the authority under section 13(5) of the Local Government Act 2003;
- the dissolution of the local authority other than where there is a statutory successor;
- cross default in respect of other loans of the local authority. Institutional investors should also include information requirements which would be triggered by specific statutory actions or reports by or on behalf of the authority and which could give an early warning of a deterioration in the local authority’s financial position.