Guidance introduced last year on how councils should account for controversial Lender Option Borrower Option (LOBO) loans has been clarified after causing confusion among auditors.
A group of audit firms raised questions over two separate lines in the Local Authority Accounting Code which appeared to give contradictory advice on how to account for derivatives embedded in LOBO loans.
In response, a joint board of the Chartered Institute of Public Finance and Accountancy (CIPFA) and the Local Authority (Scotland) Accounts Advisory Committee (LASAAC) has removed a key sentence, which it said had been misinterpreted.
In a statement on the guidance, the board said: “CIPFA/LASAAC has been asked whether the current code provisions are sufficiently clear to enable local authorities to understand the appropriate accounting treatment for the various types of LOBO clauses.”
According to the statement, questions were raised about the relationship between two separate sentences in the code, which appeared to give differing opinions on when embedded options contained in LOBOs should be accounted for separately.
One audit firm told CIPFA/LASAAC it was “confused by the adaptation relating to LOBOs which states that the authority shall not separately account for the derivatives embedded in a LOBO, whilst allowing authorities the option to do just that if they feel that the terms of the loan justify it.”
However, CIPFA/LASAAC said that a reference in the code to “options embedded in a LOBO” related specifically to the call options within the loans, not embedded derivatives.
In a statement, the board said it has now removed the wording and clarified that two other paragraphs of the code “have been amended to state that options embedded in a LOBO shall not be accounted for separately.”
Don Peebles, head of CIPFA’s policy & technical team, said LOBO’s are “complex financial instruments and my advice to local authorities is to ensure that they have reviewed all LOBO’s and are satisfied with the accounting treatment.
“Consult your appointed auditor. Seek specialist advice from your appointed treasury advisor. And, finally, ensure that you maintain contact with CIPFA’s Finance Advisory Network, who will be issuing a briefing note as soon as possible.”
Conrad Hall, chief financial officer at London Borough of Brent, said: “This whole area is fearfully complicated and audit firms have been looking into it to make sure they were adopting a consistent approach.”
He said that the clarification mainly related to “inverse floater” LOBOs and other forms of the loans which relied on external factors, such as derivatives.
He said: “CIPFA and LASAAC are in an impossible position — they can’t give guidance that copes with every single instance.”
Another leading voice in the sector told Room151: “The fact that CIPFA/LASAAC has felt the need to issue the clarification suggests that the code has, perhaps, been interpreted unintentionally as exempting authorities from asking questions about some of the accounting intricacies of LOBOs coming in flavours other than vanilla.”
