Inter-authority exchange could save millions in brokerage fees

Local authorities could be spending millions more than they need to in brokerage fees, simply to lend to each other.

Statistics released by the DCLG for the financial year ending March 31, 2011 put lending between UK local authorities at around £3.3bn. With voice brokers typically charging 10 basis points (bps) to borrowers, the sector would arguably benefit from a peer-to-peer, electronic exchange which could provide a more transparent and competitive marketplace.

Boston Borough Council’s chief executive, Richard Harbord, recalls a peer-to-peer, paper-based system: “A long while ago we had the CIPFA loans bureau and instead of going to the market we all put our loans on there and lent and borrowed among ourselves.”

“It took care of a large amount of local authority surplus money in a very effective and efficient fashion. So this would work – you just need to organise it.”

Since 2008, credit risk has been at the top of most treasurers’ agendas and other local authorities have come to be viewed as a low-risk, cheap source of borrowing.

“The lack of any resolution to economic problems both here and abroad is making local authorities lending to each other a more entrenched position,” said Mark Horsfield founding director of treasury consultants Arlingclose. “It used to be a short-term tactical position but it is now a reasonably embedded strategic position: authorities view it as an essential.”

According to Arlingclose brokers charge 10-24 bps for matching local authorities with each other. This fee could be reduced substantially through an electronic exchange which would allow the lenders and borrowers to find each other directly.

Room151 understands the cost of maintaining such a platform, based on the levels of lending DCLG reported for 2010-11, could be as little as 1 basis point.

Rob Woolnough, managing director of Sterling International Brokers argues, however, that the volume of business isn’t there to attract a private sector company to launch an exchange: “The majority of local authorities are lenders. The amount that they actually borrow on a regular basis, other than in the latter stages of their financial year, isn’t large enough and we do all of our lending, in the local authority market, for nothing … If somebody’s going to set this up as a pure business venture it makes no real logical sense.”

On the strengths of voice broking, Woolnough added: “I think electronic broking is very black and white. You either decide you want to do something or you don’t do it. The voice broker can give you a bit of flavour and understanding of the markets. And there’s always opportunities to talk about slightly different offers or periods of time for a counterparty’s money that might generate better yields.”

The efficacy of the voice brokerage business model, though, is coming under closer scrutiny in the ratings world. Moody’s, for example, changed its outlook for brokerage firm Tullet Prebon to negative earlier this year, citing, “Moody’s opinion that while voice brokerage will continue to provide an important service for dealers, over the longer-term its role could diminish as more business transfers to electronic broking,” an agency spokesperson said.

Like Woolnough, Horsfield points to better pricing with a broker as an advantage. “There is potential for an inter-authority exchange, but there is a belief that the brokerage will act on your behalf and match the best available terms,” he commented. “If you go direct you may be able to tweak that a bit more but the cost in time may not be worth the effort. It may just be easiest to have someone who is practised in it, facilitating it at this reasonably modest level.”

While an exchange costing one basis point per transaction may not prove attractive in itself to a private sector firm, the benefit of creating a captive online community for local authority lenders and borrowers, with the ability to cross-sell money market funds and other investment instruments, for example, is manifest. DCLG lending stats for the financial year ending March 31, 2012 are expected within the next 2-3 weeks when the cost of lending will come into focus once more.

Richard Harbord argues that LA treasurers could take the initiative: “I think if you took London on its own, the 33 boroughs could run a mutual scheme and they could save a bit even among themselves.”

He added: “It’s something that the treasurers associations should be getting together on. They’re the sort of people who would stimulate discussion…The thing is we’re making relatively small savings all the time now to add up much bigger savings – so every bit helps.”

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The Local Authority Treasurers’ Investment Forum September 25th, 2012, London Stock Exchange
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