Sponsored article: Jon Coane and Olwen Brown examine how local authorities can think like a bank when lending to boost jobs, infrastructure and a green economy.
When lending money local authorities can create income and help boost their local economy—however, what are the issues that they need to be aware of?
Acting as a lender to kick-start the economy
With the UK economy struggling to cope with the effects of Covid-19, local authorities can play an important part in kick-starting their local economies. One way they can do that is to provide loans to certain organisations (including the local authority’s subsidiaries) where that loan can help:
- retain or grow jobs; and/or
- fund key infrastructure such as housing; and/or
- develop a green economy by either: lending to organisations that are part of that sector; or include environmental, social and governance (ESG) conditions to the loan, such as reducing energy-use or improving work conditions or improving corporate governance.
What is more the loan should be interest-bearing which should cover any financing costs and provide a return. Local authorities can then use that return to invest in other services.
Sounds like a win-win for local authorities?
Well, not always. There are risks with lending money and so it is important to take advice early on to save time and money. Local authorities should always take financial advice from firms like Arlingclose which will undertaker due diligence on the prospective borrower, its business case and financial projections, while advising on, among other things, an appropriate interest rate.
There is always a chance that the borrower will have financial difficulties and so the local authority needs as much protection as possible in the worst-case scenario which will include taking security from the borrower and/or connected persons.
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Issues to be aware of
For any proposed loan a local authority has to (a) think like a bank; and (b) be aware of local authority related issues.
a) Think like a bank
A bank always wants its loans repaid and will structure a loan to maximise that. While the local authority should focus on whether the loan will help its local economy, it too has a responsibility to ensure there is a high probability that the borrower will be able to repay the loan and pay the interest due in the time period required. This means, among other things:
- Financial due diligence on the borrower;
- Taking adequate security over the borrower’s assets and/or guarantees from related parties such as shareholders to ensure that the loan can be repaid from the proceeds from enforcing such security;
- Ensuring the loan agreement is sufficiently robust to protect the local authority. For example, limiting the amount of further borrowing the borrower can do;
- Having sufficient expertise to understand the borrower’s business and the purpose of the loan. If the loan is to develop property then the local authority need to involve colleagues with skills in understanding property construction;
- Monitoring the loan and the borrower. The loan agreement should contain requirements for regular information that is key for the loan arrangements. Once the finance documents have been entered into, it’s important to analyse the information received and monitor the borrower. Local authorities need to have available skilled personnel to deal with this.
b) Local authority issues
The LGA 2003 gives a local authority the power to invest for any purpose relevant to its functions or for the purposes of the prudent management of its affairs; all of the financial assets of a local authority held primarily or partially to make a profit are covered by the definition of ‘investment’.
This also covers the making of loans to a third party; including any loans which are made by a local authority to one of its own wholly owned companies, or to a joint venture in which the local authority is involved. There are special arrangements however for loans to another authority.
The act also requires the local authority to have regard to guidance issued by the Secretary of State. The statutory guidance on local government investments issued in 2018 sets out the requirement for each principal local authority (and some larger parish councils) to prepare an annual investment strategy, which must be approved by full Council and be publicly available. Investments then need to be made in accordance with the strategy.
The guidance specifically allows local authorities to make loans to local enterprises, charities, wholly owned companies and joint ventures as part of a wider strategy for economic growth, even if these would not necessarily be seen as ‘prudent’ in terms of prioritising security and liquidity.
Care must however be taken to ensure that the State aid requirements are observed in making any loan; not only in terms of the interest rates charged, but also the other terms of the loan, and it is wise to take advice that the terms of the loan are such that they do not contravene these requirements. State aid is any advantage given by a public authority which can distort competition in the EU and can apply to funding given to charities and other non-profit making bodies. The Competitions and Markets Authority will oversee State aid as Britain leaves the EU.
Conclusion
While there are a number of issues that local authorities need to be aware of in either using their reserves or borrowing from the Public Works Loan Board (PWLB) to lend money, they can create a vital income stream through interest payments and fees.
These can then be used to pay for other vital services and at the same time lend to organisations that can lead to inward investment, create new jobs, develop or deliver environmentally friendly technology and social-purpose businesses.
Jon Coane and Olwen Brown, Anthony Collins Solicitors LLP.
