CIPFA Scottish Treasury Management Forum Workshop Local authority

CIPFA Scottish Treasury Management Forum Workshop Local authority borrowing – an HMT perspective 23 February 2012 Andy Ralph Local Authority Capital Expenditure, Statistics and CLG Core Programmes, HM Treasury UNCLASSIFIED

The historic picture Historic capital outturn expenditure and receipts from asset sales have been: Capital expenditure/£m 199900 200001 200102 200203 200304 200405 200506 200607 200708 200809 200910 201011 Scotland 816 803 930 972 1, 033 1, 264 1, 572 1, 952 2, 184 2, 554 3, 293 N/A England 6, 998 8, 288 10, 028 11, 672 12, 326 14, 404 16, 797 16, 472 20, 395 20, 233 21, 362 23, 385 Asset sales/£m 199900 200001 200102 200203 200304 200405 200506 200607 200708 200809 200910 201011 Scotland 304 150 165 207 217 355 366 451 514 230 229 N/A England 3, 651 3, 512 3, 579 5, 040 5, 322 4, 661 3, 777 3, 671 3, 992 1, 353 1, 427 1, 498 Source: respective local government finance statistics for each year Huge growth in capital expenditure in Scotland (404%) and in England (334%) over the period 1999 -2011. But the impact of fiscal tightening is clear in 2011 -12 forecasts in England which suggest a reduction of over 10% in spend. 2

Spending Review 2010: Overview The Government had to make tough choices in the Spending Review about how taxpayers’ money is allocated and prioritised spending which supports long term economic growth, such as capital funding for key infrastructure projects. Overall reduction in local capital spending consistent with CDEL cuts. English LA capital expenditure forecast to fall by c 30% over the period 2011 -12 to 2014 -15, including reductions in capital funding from Depts of c 45% and forecast reduction of self-financed capital (LASFE) of c 17%. Despite difficult decisions, no cap on local prudential borrowing. Recognised as a priority flexibility and maintained to ensure high value local capital investment is prioritised. 3

The Public Works Loan Board and the Spending Review The Public Works Loan Board (PWLB) lends to GB LAs for capital investment purposes. The PWLB accounts for c 80% of all GB LA debt. Scottish LAs account for £ 7. 95 bn of total PWLB outstanding debt of £ 53. 1 bn (2010 -11 Annual Report). Operationally, the PWLB is part of the Debt Management Office (DMO) an HMT agency. The decision to increase the rates on PWLB loans to local authorities to an average 1% above UK Gilts was effective from 20 October 2010. The rationale for increasing PWLB rates was based on the following considerations: • PWLB loans represent on-lending of central government borrowing. In tackling the fiscal deficit, local authorities need to recognise their impact on the wider debt picture; • Placing downward pressure on LA borrowing for capital investment is consistent with the path of public sector capital spending over the Spending Review period; and • Very cheap PWLB loans allow local authorities to make sub-optimal capital investment choices and an increase in rates should make them more market facing and require greater consideration of relative value for money and return on investment. 4

01 4. 20. 0 10 5 01. 20. 0 10 01 6. 20. 0 10 7 01. 20. 0 10 8 01. 20. 0 10 01 9. 20. 1 10 0 01. 20. 1 10 01 1. 20. 1 10 2 01. 20. 0 10 1 01. 20. 0 11 01 2. 2. 0 01 3 1 01. 20. 0 11 01 4. 20. 0 11 5 01. 20. 0 11 01 6. 20. 0 11 7 01. 20. 0 11 8 01. 20. 0 11 01 9. 20. 1 11 0 01. 20. 1 11 01 1. 20. 1 11 2 01. 20. 0 11 1 01. 20. 0 12 01 2. 20. 0 12 3. 20 12 . 0 PWLB Maturity Rates (%) PWLB interest rates are lower today across all maturities than they were at 01 April 2010 (before the increase to gilts +100 bps). 01 PWLB Rates since April 2010 5 -5½ 10 -10½ 20 -20½ 30 -30½ In excess of 50 5, 4 4, 9 4, 4 3, 9 3, 4 2, 9 2, 4 1, 9 5

PWLB historic data The historic net lending and balance of principal outstanding for Scottish LAs at the PWLB has been: Net lending/£m 2006 -07 2007 -08 2008 -09 2009 -10 2010 -11 GB 825 2, 836 108 365 1, 918 Scotland -125 51 -84 205 694 Principal outstanding/£bn 2006 -07 2007 -08 2008 -09 2009 -10 2010 -11 GB 47. 9 50. 7 50. 9 51. 2 53. 1 Scotland 7. 09 7. 14 7. 05 7. 26 7. 95 Scotland as % of PWLB 14. 80 14. 06 13. 87 14. 17 14. 96 PWLB GB net lending data to end-January in 2011 -12 has been £ 1, 319 m and has been subdued compared to previous years however we have seen drawdown of local authority investments over this period to finance capital expenditure. 6

PWLB gross/net lending 1999 -2012 Gross Lending (GB) Net lending (GB) Gross Lending (Scotland) RHS Net lending (Scotland) RHS 14 000 2 500 12 000 10 000 1 500 8 000 1 000 6 000 £m 500 4 000 0 2 000 -500 0 -2 000 1999 -00 2000 -01 2001 -02 2002 -03 2003 -04 2004 -05 2005 -06 2006 -07 2007 -08 2008 -09 2009 -10 2010 -11 2011 -12 (to end Jan) -1 000 -4 000 -1 500 -6 000 -2 000 7

Housing Revenue Account (HRA) reform English LAs currently surrender any HRA surplus to the UK Government. Under HRA reform, English LAs are effectively buying themselves out of the system in England by taking on up-front debt instead of surrendering future surpluses. Implementing self-financing is a key plank of the Government's Localism agenda. The objectives of this reform are: • to give councils in England the resources, incentives and flexibility they need to manage their own housing stock for the long-term and to drive up quality and efficiency; and • to give tenants the information they need to hold their landlord to account, by replacing the current opaque system with one which has a clear relationship between the rent a landlord collects and the services they provide. In effect, Government will require English local authorities to borrow £ 13. 365 bn to finance payments to central Government which will then be used to reduce national public borrowing by the same amount. This transaction will all take place on 28 March 2012. 8

HRA reform: reduced PWLB rate There was significant market interest in the HRA transaction. The rationale for the decision to reduce the PWLB rate to gilts plus c 20 bps for the HRA transaction, announced by the Chief Secretary on 18 September 2011, was: • Borrowing to fund self-financing is a Machinery of Government change and is not a local decision; • HRA reform is a one-off transaction arising from this transfer of finance from central to local government; • It will not give rise to an increase in public debt; • Concerns there was insufficient capacity in the market to deliver the transaction; • Products designed to “beat the PWLB rate” not necessarily reflecting the best product for individual LAs; plus • Arbitrary arrangements for pooling of LAs to achieve ‘optimum’ transaction size. NOTE: existing housing debt is not subject to the reduced PWLB rate. 9

Local authority bonds The increase in the PWLB rate has led LAs to look at market led alternatives to finance capital expenditure. LA bonds have been particularly widely discussed. “Beating the PWLB rate” is more than just coming in at gilts +99 bps – LAs need to consider associated costs, questions of flexibility and how any such issuance sits with their wider treasury management portfolio. Some of these questions seemed to get drowned out in the dialogue that took place prior to the reduction in PWLB rates for HRA reform in England. Current market conditions mean that it is unlikely that the markets can offer a product that is consistently priced below the PWLB at a level that also takes account of the flexibility offered by PWLB. A fairly recent local authority bond issuance shows the volatility in the markets comparable to the PWLB rate over time. A recent LA bond issuance compared to PWLB equivalent 120 115 110 Bps over gilts 105 100 95 90 85 80 75 12 09 . 0 2. 20 12 12 02 . 0 2. 20 20 12 26 . 0 1. 12 20 1. . 0 19 12 . 0 1. 20 12 11 05 . 0 1. 20 20 11 2. . 1 29 20 2. . 1 22 2. . 1 15 20 11 11 11 20 2. . 1 08 01 . 1 2. 20 11 11 24 . 1 1. 20 20 11 1. . 1 17 20 1. . 1 10 1. . 1 03 20 11 11 11 20 27 . 1 0. 20 11 20 . 1 0. 11 20 0. . 1 13 06 . 1 0. 20 11 11 20 29 . 0 9. 20 9. . 0 22 . 0 9. 20 11 70 15 In this economic context, LA bond issuance does not look attractive. To avoid sending mixed messages, it was decided not to introduce legislation to amend ‘withholding tax’ rules at Budget 2012. 10

Bonds: Local Government collective Agency LAs In response to the increase in PWLB rates and reflecting some of the restrictions around existing market vehicles in terms of size, access, compliance etc, the local authority community has worked up a business case for an agency using collective buying power to deliver lower cost borrowing. • Welcome sector led exploration of alternative lending models; • as always the ‘devil is in the detail’; • HMT will work closely with the LGA to look at issues both as part of the consultation and arising from the consultation; • This model may reconcile some of the price and scrutiny issues not currently addressed. 11

Derivatives and Investments Derivatives • CIPFA guidance on derivatives issued in November 2011; • Some pressure within sector to legislate specifically on this; and • With introduction of GPC highly unlikely to see specific legislation. Investments • In a period of significant financial uncertainty active management of investment portfolios is very important; • Emphasis on security, liquidity and yield (in that order); • Evidence suggest LAs are being more proactive but no room for complacency; • The amount of cash held by LAs regularly raises questions – particularly against a backdrop of low returns and higher investment risks; and • Service pressures and sensitivity around the level of taxes. 12