Capital changes: local bonds and the new relationship with private finance

December 11, 2009

Chris Leslie, Director, NLGN and David Smith, Director Government & Advisory Team, Grant Thornton
Public Servant

Could we be on the brink of a major shift in the way the public sector engages with private finance? With the private finance initiative under seige from critics and a still reluctant market, many local authorities are hoping that the Treasury will refresh the PFI model and provide a more sophisticated framework able to cope with the new environment post credit crunch. Few commentators doubt the advantages that PFI brought for public sector investment over the past decade, helping construct over 800 schools, 70 hospitals 43 transport projects and 300 waste, leisure and housing projects in recent years – projects that might not otherwise have happened because of balance sheet orthodoxies. Yet the unfavourable lending conditions during the recession have required both the European Investment Bank and Treasury to ‘back-fill’ some of the larger schemes seeking capital, creating worries about the sustainability of the current PFI arrangements. While these circumstances may well pass and the markets calm, there is an opportunity to take stock of how much leeway we offer local councils in matching their needs to the capital vehicles available.

This autumn, Grant Thornton and New Local Government Network joined forces collaborating on the new report: Capital Contingencies: local capital finance in an era of high public debt, setting out the potential harm that could beset the nation’s infrastructure unless we see a renaissance of local activism in capital finance policy. The principle anxiety must surely be the Government’s projected reduction in capital grant from £44billion to £22billion by 2013/14. And should the state of the nation’s debt levels provoke even more extreme action by Ministers, it may be worth local councils preparing for the ready access they currently enjoy to cheaper capital loans via the Public Works Loans Board being constrained as the Treasury shores up its books. Councils may well need to use PFI more, rather than less, in the future – and perhaps even seek out new (or re-learned) techniques for dealing with capital markets directly.

We are one of the only developed countries not to see a thriving municipal bond market for public infrastructure debt, a practice that sustains local public works in the USA and Europe alike. In part the PWLB have removed the need for councils to go through the expense and hassle of such bond issuance arrangements – but things may be changing. The Conservatives have already floated the notion of local bonds as one means of supplementing capital grant for key local projects. While they do not elaborate on how these arrangements might work, lessons from abroad suggest that a ‘revenue bond’ approach – earmarking a revenue stream against which a joint venture company with minority public sector equity would borrow – might be finding favour. Institutional investors may welcome an emerging municipal bond market, especially if backed by consortia of local authorities for ease of administration.

Whatever the nuanced views of the political party successful after the next election, there can be no doubt that local authorities will need a wider range of tools at their disposal if they are to sustain some of the critical investment in public infrastructure – and even maintain their current stock of buildings and facilities as they gradually fall in need of repair. Councils may need new freedoms to raise finance independently, and any revenue streams that might become available could be key in delivering such innovation. It would also seem sensible for councils to club together and collaborate more successfully, encouraged perhaps by a Government and Audit Commission that rewards rather than punishes alternative approaches to capital finance. And he balance of Treasury’s and PUK’s roles should evolve from gatekeepers of standardisation to advocates of best practice in innovation. Sadly the recent Pre Budget Report appears to have missed an opportunity to deliver further clarity about Tax Incremental Financing. The fact that there have been insufficient signs of piloting with ‘Accelerated Development Zones’ or similar arrangements, may suggest that the Treasury is pulling up the drawbridge rather than offering a helping hand to councils as they prepare to cope in a colder capital climate.

While we hope that Ministers will provide some hope – even if only removing some of the strings attached to capital grants, reinforcing ‘single pot’ approaches or streamlining capital approvals processes – we must assume that councils will have to increasingly stand on their own two feet and fend for themselves. Many of the money market skills once available in-house have long since disappeared in many local authorities and so we hope that the LGA, Local Partnerships and other regional associations of councils will work closely with local government to take up a supportive role where the Treasury may well depart.


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