The Return of Local Authority Lending? - a look at the banking community’s renewed interest in the local authority sector as a result of the Private Finance Initiative
Jonathan Beckitt looks at the banking community’s renewed interest in the local authority sector as a result of the Private Finance Initiative
Background
Years ago, local authorities presided over a broad fiefdom of responsibilities for public services ranging from prisons hospitals and utilities such as gas, electricity, water and sewerage to local airports, polytechnics and further education colleges. They have seen those responsibilities gradually drawn back to the centre and equivalent responsibilities either assumed by central government departments or privatised.
Another significant change has been in the ways in which public services are financed. Whereas financing was mainly achieved through local taxes and charges, local authorities now rely on central government for 80% of their funding.
What remains in terms of local authorities’ responsibilities for public services is nevertheless substantial. They still run education and social services and they have a wide range of other responsibilities ranging from street cleaning to public leisure facilities. They also own a considerable amount of land. Given the inherently stable nature of local authorities, their responsibilities and basis of their funding they are an attractive prospect for lenders.
What went wrong
During the 1980’s there were a number of decisions of the courts where banks saw various contractual arrangements with local authorities struck down on the basis that the contracts were outside the powers and capacity of the local authorities concerned. The cases in question include Hazell v Hammersmith and Fulham London Borough Council, Credit Suisse v Borough Council of Allerdale and Credit Suisse v The London Borough of Waltham Forest. Each of these decisions has been well documented and reviewed and the particular circumstances do not bear repetition here. Although none of the cases created new law, the effect was to remind banks of the peculiar risks attached to any dealing with local authorities, namely their capacity to enter into transactions with third parties and protection against any related procedural irregularities. Not surprisingly, these decisions discouraged banks from lending to local authorities even in the limited situations in which such opportunities existed.
The Private Finance Initiative
First introduced in 1992, the Private Finance Initiative has steadily gathered momentum moving through various sectors such as prisons, hospitals and roads. Any doubts as to the immediate future of the Private Finance Initiative were dispelled by the Bates Review last year. The Review reaffirmed and refined the PFI process to some extent but provided little comfort for those who had been anticipating that central government funding for capital projects by local authorities might be made available by means other than the Private Finance Initiative. Local authorities, particularly in the areas of social services, where they provide residential accommodation and care for elderly people, and in education where, as local education authority, they are responsible for most of the nation’s school buildings, are having to address an urgent need for capital expenditure. They do so in the knowledge that the expenditure will not be financed by government through conventional means. In many cases, this leaves local authorities with little option but to pursue projects by means of the Private Finance Initiative.
The new regime
Around the time of the Bates Review, there was a recognition that vires issues in relation to the hospital’s PFI programme had caused major difficulties in the financing of those transactions. The difficulties were resolved latterly by primary legislation. In order to avoid the local authority sector suffering a similar fate, and in response to lobbying from various interested parties, legislation was brought forward on a fast track resulting in the Local Government (Contracts) Act 1997. This legislation has attracted extensive comment and has generally been welcomed. It introduces a certification procedure whereby local authorities may "certify" PFI contracts, in which case the local authority is deemed by the Act to have had the power to enter into that contract. Since enactment, some significant PFI transactions in the local authority sector have achieved financial close and it is to be hoped that the legislation will provide a clear way forward for the financing of other PFI transactions.
However, that is not quite the end of the story. Local authorities are bound by various regulations which control capital expenditure and it was recognised therefore that specific regulations amending these controls would be required to enable local authorities to enter into transactions under the Private Finance Initiative. This yielded the Local Authorities (Capital Finance) Regulations 1997 and, earlier this year, the Local Authorities (Capital Finance) (Amendments) Regulations 1998. Although further changes may be necessary, these regulations seem to provide a satisfactory framework within which to operate.
It is to be hoped that the lessons of the past have been learnt and that problems can be anticipated rather than be allowed to compound.
