Meeting the Funding Gap: UK Municipal Bonds Agency & Public Works Loan Board

United Kingdom

According to the Local Government Association (LGA), by 2020 local authorities will have lost 60p in every £1 they were allocated by central government a decade ago. Notwithstanding this reduction in funding, the demands to provide social care and infrastructure investment has never been greater and have caused local authorities to turn to the property market in search of income to bridge the funding gap.

Many local authorities have used record low interest rates to borrow money to invest in property, including commercial assets ranging from office blocks and industrial buildings to shopping centres and retail parks, not necessarily in their own areas. The latest data shows that borrowing by councils shot up to £10bn in 2017-18 from £4.4bn four years earlier.

The most common source of funding has been low-rate borrowing from the Public Works Loan Board (PWLB), part of central government’s UK Debt Management Office (DMO). The LGA set up the UK Municipal Bonds Agency Plc (UKMBA) in 2014 to help provide its local authority members an alternative to PWLB funding. Its aim was to allow authorities to raise finance through 'muni bonds' issued by the UKMBA, replicating the approach of similar agencies across the world. It was hoped that such bonds would have a number of advantages over PWLB finance, including even lower costs than the DMO. The Chair of the UKMBA had said that muni bonds would allow local authorities to 'buy shares in shopping centres, invest in improved housing or transport, all in a more commercial way'.

An essential characteristic of the UKMBA bond was a joint and several guarantee provided by participating local authorities. This guarantee was thought to be unattractive to local authorities and this is seen as one of the reasons the UKMBA had failed to launch a single bond since it was set up. On 28 March 2019, UKMBA announced that it was dropping the requirement for the bonds to be underpinned by such a guarantee. The rating agencies will need to review the ratings previously given to UKMBA as a result and the outcome of this review may, in turn, affect the pricing and therefore the potential attractiveness of the UKMBA as a funding source.

Demand for funding will remain as local authorities seek to bridge the funding gap. Whether the UKMBA will be able to restructure its offering so that it can offer an attractive alternative to the PWLB (or local authorities accessing the capital markets directly) remains to be seen. Together with the likely unavailability of European Investment Bank funding following Brexit, this means it is likely in the short-term that local authorities will continue to borrow from the PWLB or raise funding privately from banks, although the restriction on local authorities providing security for borrowings (section 13 of the Local Government Act 2003) potentially places a limit on how much private finance will be provided.

Local authorities’ investment in a diverse range of property assets including shopping centres is likely to continue, with the systemic risks that this brings given the decline in the 'bricks and mortar' retail business. In the short-term, the PWLB is likely to remain a major source of the funds for such investment. The fear of many observers is that the risk of reductions in lettings and rental income will fall firmly on the local authorities. This could exacerbate, not eradicate, the funding gap challenges they face.