Council bonds could hold the key

This month brings the chancellor George Osborne’s third budget. Briefings from Number 11 have already started - we are being softened up for another “cupboard is bare” event. 

Unemployment is up, debt is up.The UK’s “triple-A” crown is apparently at risk of slipping according to the ratings agency Moody’s. Growth is at best aneamic. 

Politicians are arguing about the need for fiscal easing. All major political parties agree that growth is pivotal to secure the country’s long term economic future.  One way of delivering that is Keynesian style investment. 

But in these straitened times, with banks hoarding cash and public spending constrained, the question remains how to best to secure resources for badly needed infrastructure.

With the demise of many of the “monoline” bond insurers, the PFI  as we know it and banks’ new conservatism, the Treasury is keen to find alternative ways of funding and financing roads, schools and broadband networks.

A report from Infrastructure UK says some £170bn-200bn is required over the next five years. There is also a pressing need for pension funds to boost their returns. UK pension funds have historically invested around 2.5% in this asset class. 

The government is hoping for £20bn-30bn, which may require a doubling in pension investment levels. A pension funds “platform” is being discussed to allow efficient and direct investment.  

At present a lack of liquidity and arguably hefty management fees deter pension investors. European Commission proposals to bring pension-fund regulation in line with that of banks and insurance companies could lead to a flight by pension funds from long term growth assets. 

Pension fund representatives have talked of the need for government to guarantee income for their investments. There is clearly much work to do. 

With localism firmly back in political fashion, perhaps local government could play a crucial role in solving the infrastructure financing problem.

Local authorities in the UK generally have an enviable record of demonstrating financial competence and prudence

The other day, my brother handed me a 1974 flyer from a house clearance. In bold black type face it calls out: “Invest in Hackney Bonds. Not only will you get a high rate of interest on your savings, but you will also have the satisfaction of knowing that your money is helping to provide essential services in the borough. All expenses borne by the council. The procedure is simple… Trustee Security. Your investment is safe and secure.(Issued by the London Borough of Hackney)”

Bonds have a number of advantages over other forms of project finance.  They are tradeable, allow a portfolio of projects and risks to be blended by investors and avoid many of the fee structures that make other investment structures less attractive. Local authorities in the UK generally have an enviable record of demonstrating financial competence and prudence. 

Whilst public sector net debt as a percentage of GDP  ballooned from 26% in 1990/91 to around 53% in 2009/10 excluding bailing out the banks, local government debt halved from 8% to around 4%. 

Local authorities such as Cornwall and Birmingham City Council are rightly proud of their “triple A” ratings, which is more than many sovereign governments enjoy these days. With greater financial freedoms, local government infrastructure could match the long term liabilities that funds need to cover. Pensioners would be able to get a stable rate of return but with the sort of security that comes with gilts. 

Making this work will require sustained effort by not just the Treasury. 

The UK is still regarded as one of the most centralized democracies in the world. The Scottish Government is remarkably unable to borrow a single bean. There is an opportunity for the Government to create a new lasting framework for funding infrastructure with local government at its centre. This would need to be stable and long term to give funders certainty. It would also require the government to make bold reforms to the balance of power between Whitehall and city halls.

Getting pension funds to work for Britain will undoubtedly require technical reform. It may also need ‘devo-max’ for England.  

Now that would be a budget give-away worth softening us up for.  

Alexander Jan is head of transport and transaction advice at Arup