(Bloomberg Opinion) -- It took six years for the U.K. Municipal Bonds Authority to make its capital markets debut, with its first bond sale arriving in March. The pace, though, could be about to accelerate. As the pandemic squeezes local governments already strapped for cash, there’s a renewed impetus to establish a fully-fledged U.K. muni market to provide a quasi-sovereign alternative to government gilts.
Many other countries already have thriving regional debt markets, including Germany, Italy and Spain. In the U.S., the muni market is worth more than $4 trillion. Thus far, efforts to establish a similar borrowing venue in the U.K. have faltered.
That failure stems partly from a 30-year-old legal case. When the courts ruled that the London Borough of Hammersmith and Fulham had exceeded its statutory authority by dabbling in interest-rate swaps, banks had to unwind billions of pounds worth of derivatives contracts with more than 130 similar counterparties. The capital markets instantly became off-limits to local councils — and lawyers tend to have very, very long memories.
The U.K.’s centralized fiscal powers have also made it difficult for local governments to develop bond-issuing skills, given the paucity of taxes they’re allowed to levy. Devolving fiscal authority away from Westminster has been a slow process, spurred in part by Scotland and Wales demanding more control over tax-and-spend policies as they threatened to become independent nations.
In 2014, things started to look promising. A parliamentary committee said it supported transferring some tax-raising and spending powers to local authorities, allowing them to borrow to invest in infrastructure projects. And the Local Government Association set up the U.K. Municipal Bonds Association, or MBA, with 56 local authorities becoming shareholders. Then politics got in the way, including three general elections, a Scottish independence referendum and then the Brexit vote.
That’s why it took until March for the MBA to sell its first bond. That first issue comprised 350 million pounds ($438 million) of five-year floating-rate notes on behalf of Lancashire County Council. The agency’s next step is to offer pooled bond issues whereby several local authorities team up to borrow; Westminster City Council and Barnsley Borough Council have already signed up to the plan.
There’s the potential for the U.K. muni market to exceed 100 billion pounds, depending on the yields investors demand for taking on quasi-government credit risk, says Christian Wall of PFM Financial Advisers LLC, a Philadelphia-based public finance consultant that’s advising MBA. It’s an enticing proposition, he says, given that no local authority has defaulted on a debt since the establishment of the first one, the Corporation of London, in 1067.
Even before the pandemic closed down most of the economy, local councils faced a funding pinch, hamstrung by years of austerity in the wake of the global financial crisis. In the past decade, central government funding of local authorities has declined by almost 60%, according to a 2019 report by the LGA. It predicted a funding gap that would climb to 8 billion pounds by the end of the 2025 fiscal year. And that was before the coronavirus increased the need to expand care for the elderly, the homeless and the disabled.
The renewed enthusiasm among U.K. local authorities to tap the capital markets comes after the government raised the cost of money supplied by their traditional financing source, an agency called the Public Works Loan Board. In October, the Treasury raised the premium over gilts on those loans by 100 basis points, to 1.8 percentage points, in an effort to deter councils from borrowing cash to invest in income-generating properties often located outside of their regional boundaries.
The surprise increase shows how local government remains at “the whim of Whitehall” when it comes to borrowing, so the MBA provides a welcome alternative, says Jonathan Carr-West, chief executive of the Local Government Information Unit.
The debut MBA bond’s initial quarterly interest rate was 81 basis points below the variable rate charged by the state agency PWLB at the time of issue. Even at current ultra-low yields, that represents a handy potential cost saving for councils that choose to allow the muni agency to issue bonds on their behalf.
A U.K. muni market should be a win-win evolution. On the supply side, there’s no question local authorities will need to borrow more. Their income from amenities such as public sports grounds, swimming pools and car parks is melting just when they need to provide more assistance to the vulnerable. On the demand side, pension funds and other asset managers would welcome a bond-market alternative to the flood of gilt supply that’s coming as the government funds its various business-support projects. What’s not to like?
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Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."
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