Councils ‘need bond guarantees’

14 Dec 11

Local authorities have been warned that they will need to guarantee each others’ debts if a new local authority bond agency is to get the top credit rating needed to make the plans viable.

By Richard Johnstone | 15 December 2011

Local authorities have been warned that they will need to guarantee each others’ debts if a new local authority bond agency is to get the top credit rating needed to make the plans viable.

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The Local Government Association is set to announce its proposals for the collective agency in January. This could act as a focal point for council plans to raise new funds from the markets for the first time in nearly two decades.

Such a scheme would be similar to those already operating in Europe.

A senior figure in one European scheme told Public Finance that UK authorities would need to provide an explicit cross-guarantee of the agency’s debts.

Esa Kallio, the executive vice president of the Finnish credit institution for municipal authorities, MuniFin, said that councils ‘would have a much better story to tell’ investors with such an agreement. It should be a ‘must’ to get the top triple-A rating, he said.

LGA programme director for finance Mark Luntley has said such a rating would be a necessity for the scheme.

Kallio added: ‘The guarantee is the only way that you could transfer the triple-A rating of the sector to investors. Without it this would be very difficult nowadays.’

However, concerns have been raised about the legality of such arrangements, which have never been put in place in the UK before, and which may not be legal under current legislation. The government has been called on to clarify whether councils would be allowed to enter into a cross-guarantee agency.

MuniFin is majority owned by its members, which include 328 of the 336 Finnish municipalities.

The company has €12.6bn of loans outstanding and can make as many as 250 bond transactions a year. Money raised can then be loaned to local authorities for investments such as infrastructure. This is a structure that the UK agency would look to mirror.

Kallio said advantages for councils include loan rates offered ‘much lower than what the banks are able to offer’.

The member municipalities are jointly liable for MuniFin’s commitments to investors – if one member fails to meet its obligations, then all other members must make up the shortfall. Kallio said that although this has never been used, without a cross-guarantee of funding obtaining backing for bond issues ‘would be a difficult job’.

‘This guarantee is for payments to the investors. The municipalities are not responsible for agreements between MuniFin and the municipalities, but we have to cover funding to the investors.’

Councils in England began to examine the potential for borrowing using bonds as part of reforms to the housing revenue account system announced in October 2010. Local authorities will take on a proportion of housing debt in exchange for keeping their locally raised rents, and 138 of them will have to ‘buy out’ of the current system from government.

The government subsequently announced that the rates for loans from the Public Works Loan Board to make these payments would be cut. But all other PWLB loans remain at the higher rate, of 1% over government gilts. This was put in place in the 2010 Comprehensive Spending review and has led to the LGA examining whether bond issues may be cheaper than the PWLB.

Speaking at CIPFA’s Treasury Management conference in November, Luntley said that the ‘collective agency needs to be a triple-A rated organisation’, and he added that ‘most of these collective models rely to some degree on cross-guarantees’ to do this.

He added: ‘There are two issues [with cross-guarantees]: whether councils would be prepared to do that, and whether we have the powers to do that, and I don’t think we do. That’s a pretty big hurdle.’

Plans for bonds to fill a shortfall in local authorities’ capital spending plans were backed by a report published by the New Local Government Network in December.

It found a ‘strong rationale’ for the creation of a new local government funding agency and called for central government to clarify the legal issues.

Alison Scott, CIPFA’s assistant director, local government, who was part of the Capital Futures taskforce for the NLGN report, told PF that cross-guarantees were a tricky issue. ‘We need to ask, can a local authority actually default? It’s almost a theoretical cross-guarantee.’

She added that the General Power of Competence ‘would seem to give the flexibility that this would need’.

Responding to the calls for clarity, the Department of Communities and Local Government said: ‘We consider that councils already have the power to borrow by issuing bonds, and recommend that authorities seek legal advice before undertaking any innovative transactions.’

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