Localism & Derivatives
0You may not have noticed, but there was a vaguely regal air to treasury management this week. On Tuesday afternoon, HM the Queen gave her Royal Assent to the Localism Bill, while on Wednesday morning Mr King reminded us of the stately pace of growth of the UK economy in the Bank of England’s quarterly inflation report.
There are a princely 241 sections to the newly renamed Localism Act 2011, but its crowning glory is its initial phrase: “A local authority has power to do anything that individuals generally may do.” Subsequent sections clarify that this general power of competence doesn’t extend to anything that is already prohibited by legislation, but it does allow any action that was previously deemed ultra vires due to the absence of a specific enabling power.
So, while borrowing in a foreign currency without consent or securing loans on Council houses will remain illegal, local authorities should now be able to enter into financial derivatives, pool investments with their neighbours and cross-guarantee each other’s debts without fear of incurring the monitoring officer’s wrath.
Derivatives are causing the most heat at the moment, partly due to section 168 of the same Act enabling CLG to force over 100 housing authorities to borrow a combined £14bn next March under the reform of housing finance. But local authorities have been using embedded derivatives for years – callable deposits, variable rates with collars and LOBO loans all involved the council taking on additional risk by selling options to the bank in return for a higher investment return or a lower cost of debt.
CIPFA’s latest edition of the Treasury Management Code of Practice, another arrival on treasury managers’ desks this week, recommends that public bodies only use standalone financial derivatives for reducing risk. Examples would include using a forward rate agreement or an interest rate swap to fix the rate of future investment income without taking on the credit risk of locking into lending to a particular counterparty for a number of years. This guidance also precludes councils from selling (or writing) options, but would allow an authority stuck with a uncomfortably high level of LOBO debt to purchase swaptions and therefore have the right to fix the rate at which it can replace any recalled loans.
Used sensibly, derivatives can add real value to a local authority’s treasury performance. But memories of Hammersmith & Fulham in the late 1980s and ongoing controversies in the City of Milan and Jefferson County, Alabama will encourage authorities to adopt a cautious approach to this new freedom.
David Green is the Head of Sterling Consultancy Services, a provider of treasury management advice to local authorities and other not for profit organisations. This is the writer’s personal opinion and does not constitute legal or investment advice. It should not be relied upon when making investment decisions.
