Think tank calls for greater legal clarity so councils can use municipal bonds

A leading think tank has called on the government to provide greater legal clarity on a range of issues so that local authorities can make use of municipal bonds and save key infrastructure projects threatened by capital funding shortfalls.

In its report, Capital Futures, the New Local Government Network said bond issuances could in certain circumstances prove to be the cheapest financing option for councils.

This was potentially the case because of an increase in the rate offered at the Public Works Loan Board. The report also highlighted how other sources of finance such as PFI, asset sales and developer contributions had slowed “with a fall from political favour and a flat-lining property market respectively”.

The think tank suggested that the PWLB increase made it a priority for councils to find more cost-competitive sources of borrowing for capital purposes.

It said a bond issue by the Greater London Authority showed how this financing option could potentially save councils up to 20 basis points on their borrowing costs. This in turn could translate into savings worth millions of pounds on a large bond issue.

The report said that for smaller borrowing needs, private placements or pooled issuances could present an alternative route which was still likely to offer a saving on the PWLB. “There is also the potential that a collective agency, borrowing on behalf of multiple member authorities and then on-lending, could offer another source of finance that is cheaper than the PWLB."

The think tank said that there was nothing in legislation to prevent local authorities exploring these various funding options. It said there were, however, ways of structuring them that would either make it easier or would help to mitigate some of the underlying risks involved, and as a result would be likely to bring down borrowing costs.

“Currently legislation relating to withholding tax prevents councils paying out on bond coupons gross of tax, meaning a SPV must be used for the issuance,” the report said, recommending that an amendment to the legislation be included in the Finance Bill to rectify this.

The NLGN added that councils were currently prohibited from using derivative products, which when issuing a bond would help to mitigate for volatilities in underlying interest rates.

“Financial institutions require greater legal clarity that councils will be able to use derivatives in the future than the new General Power of Competence (GPC) can offer,” the think tank warned.

“Similarly cross guarantees are needed for the most effective operation of a Local Government Funding Agency, yet, again the GPC is not seen as a strong enough legal clarification about councils’ ability to use these.”

The report urged central government to support councils by finding a way to offer greater legal clarity on these issues. “Without this, councils may be ill-quipped to manage risk or to secure the best rates from market finance,” it argued.

Research carried out by the NLGN found that – in the aftermath of a 22% cut in central government funding for local infrastructure – some 84% of councils surveyed faced a capital funding shortfall.

“This translates into crumbling schools, potholed roads and slower economic growth for many parts of the country,” the NLGN warned.

Nearly two thirds of respondent councils (62%) predicted that a rise in the PWLB rate would change the way they borrowed.

Report author Tom Symons said “a much more ambitious approach” from the sector was needed if the infrastructure deficit was to be addressed.

He said: “Councils must explore a completely new landscape of financing options to survive this Spending Review. Issuing bonds on the capital markets could enable vital investments to be saved, assuming the right market conditions.”

According to the report, total capital spending for local authorities is set to decrease from £11bn in 2010/11 to £6bn in 2014/15 in real terms – equating to a 45% real terms decrease in capital grant.

The Capital Futures report was compiled by the think tank with support from a taskforce comprising experts from across the local government finance sector.

Paul Woods, finance director at Newcastle City Council and chairman of the taskforce, said: “The responsibility for driving economic growth and responding to the demands of communities in an uncertain and difficult climate has fallen largely on councils. Councils have a vital role to play, and it is important that as a sector we optimistically grasp this time as a moment of opportunity.”

The key recommendations in the Capital Futures report were:

• The government should introduce a short piece of legislation, similar to the TfL Act, detailing the legal use of derivatives by local authorities
• The government should use the passage of the Finance Bill 2011 to insert a clause stipulating local authorities’ ability to pay gross bond coupons
• Councils should make risk management a public activity and communicate downside and upside risks to citizens
• If the Government implements regulation of tax increment financing use this must be light-touch and localised as a system, with no arbitrary limits on the number of schemes allowed
• The government should inject new impetus into the use of land auctions by permitting the use of privately owned land in a series of pilots in early 2012
• To make the needed advances, the work that takes forward Total Place and Total Capital concepts, such as Community Budgeting, must build the use of capital resources into its scope.

A copy of the NLGN report, which will be launched tomorrow, is to be made available on the think tank’s website.

Philip Hoult