The dream is for local authorities in Britain to tap the global bond markets to counter the deep cuts imposed on them by the government.
Number of bonds sold to date? Zero.
The problem, say investors, has its roots in the actions of one of the government’s own funding arms. About three-quarters of all money borrowed by councils comes from central funding via the Public Works Loan Board.
In 2010 the board decided to raise borrowing rates from about 20 basis points above gilts to 100bp “to suppress local authority borrowing and promote a market-facing approach by large borrowers”.
The move spurred councils, at the beginning of the cuts to their funding, to consider alternative sources of credit, such as muni bonds. In 2011 the Local Government Association, their representative body, estimated they would save 20bp-30bp if they borrowed via municipal bonds, beating the equivalent government rate.
But in 2013 the board slashed its own lending rates by up to 40bp, although the standard rate remains unchanged. It was this decision, at least in part, that has hindered the Local Capital Finance Co, say investors.
“If the government can raise money more cheaply then why would [local authorities] issue bonds separately?” said Louis Gargour, a fixed-income hedge fund manager at LNG Capital.
The Treasury denied the government had taken steps to undermine the creation of a municipal bond agency. “Local authorities can borrow from any willing lender, provided it is in sterling,” it said, “and they have longstanding powers to borrow from financial markets”.
The agency, which is backed by the LGA, says it is confident it can still raise funds and lend to councils at rates no higher than those available elsewhere.
Sir Merrick Cockell, who chairs the body, said it always knew it would have to be competitive. Furthermore, if its creation had spurred the board to bring borrowing costs down, that was no bad thing for councils.
“Maybe when we originally set the project up everyone was too optimistic on how much time it takes to do these things properly, but we took the decision to build the right board,” said Sir Merrick. “The framework is now ready and it is up to councils to decide on their borrowing needs. Then we can issue the first bond.”
The agency has appointed three banks to arrange its first bond sale and has obtained ratings from two agencies, though these are not yet public.
Government grants to local authorities in England and Wales have been cut by 40 per cent since 2010 and will be phased out altogether by 2020, replaced with the power to retain business rates, a tax on the value of local business premises. However, the LGA says it is sceptical of claims that these changes will not result in funding gaps.
Across the UK, public sector entities are expected to borrow substantial sums on markets this year as they come under increased pressure to fill holes left by austerity policies.
Housing associations have become the public sector’s most prolific borrowers, while universities in Cambridge, Manchester and Oxford have all tapped capital markets in recent years, borrowing £350m, £300m and £40m respectively.
If the UK develops a successful market in municipal bonds it will join established markets in China, Australia, Europe and the US, where the multi-trillion-dollar market is highly popular with investors thanks to generous tax breaks.
As councils in England and Wales are relatively small, the municipal bond agency plans to issue Scandinavian-style bonds backed by joint and several guarantees of the authorities involved. This approach has been adopted in France, where the Agence France Locale funding agency issued its first municipal bonds in 2015.
Yet it still took two years between the French agency’s inception and its first bond sales, said Mr Gargour. “New issues are difficult. The credit quality of councils has not been clearly established in investors’ minds. Once there are ratings things will be clearer. But they should get a move on before the UK raises interest rates.”
Investors say they have long been supporters of a new source of debt in the UK.
“We are very encouraging of a local authority debt market,” said Simon Bond, manager of Threadneedle UK Social Bond fund. “There has been a lot of uncertainty that has prevented it from coming to market — an election, change of government, new budget and so on. But it should pick up now.”
“Developments have been slow to materialise,” said David Rubinoff, managing director of Moody’s public sector Europe. “But we still think the [municipal bond] sector will grow in the UK over time. Long term, these local authorities will have to seek more bank financing or issue debt directly.”
Get alerts on UK local government finance when a new story is published