LOBO LOANS A citizen audit of local authority debt
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LOBO LOANS A citizen audit of local authority debt DEBT AND AUSTERITY 3 The financialisation of local government BANK DEBT 8 Expensive and risky LOBO LOANS 11 Complex financial instruments HOW DID THIS HAPPEN? Conflict of interest in council finance
18
WHO IS WATCHING? Lack of oversight and scrutiny
23
ILLEGITIMATE DEBT 28 “Don’t owe, won’t pay” A CITIZEN AUDIT OF COUNCIL DEBT What has been done so far
32
CANCELLING LOBO LOANS What the government can do
38
TAKING ACTION 41 What you can do RESOURCES 44
DEBT AND AUSTERITY The financialisation of local government Cuts imposed from central government Cuts to local government funding are forcing the closure of youth centres and libraries, pushing homeless people onto the streets and leaving disabled people without adequate support. From 2010 to 2018, funding from central government to local authorities was cut by 49.1%, according to the National Audit Office (NAO). This figure is expected to rise to 56.3% by 2020, leaving many councils struggling to meet their legal obligations to deliver services to residents. In February 2018, Northamptonshire County Council declared it was effectively bankrupt, suspending all new expenditure decisions. There is significant uncertainty as to how local government will be financed post 2020. A 2018 survey among council officials suggested that 80% of councils fear for their financial sustainability and that Northamptonshire CC is just the tip of the iceberg. Source: Room151
£60bn
Funding Net expenditure
£55bn £50bn £45bn £40bn
10/11
11/12
12/13
13/14
14/15
15/16
16/17
17/18
18/19 3
£55bn
£50bn
Local government income
£45bn
• council tax (31%) • retained income from business rates (18%) £60bn • reserves, charges for Funding Netand expenditure services other items £55bn
council (1%)
2019/20
2018/19
2017/18
2016/17
2015/16
2014/15
2013/14
2011/12
2010/11
• central government grants (50%)
2012/13
Councils have other sources of funding available aside from government grants. The percentage of£40bn income from each source varies significantly for each individual authority based on size, location, local wealth and social needs, but averaged as follows in 2017/18: 1%
80%
18% Buisiness rates
60%
50% Central government grants
31% Council tax
100%
40% 20%
0%
Source:Council MHCLG Central government tax Business rates Other
Plugging the gap £50bn
0%
With councils are £45bn central government funding diminishing, 11% 4% expected to raise more funds locally, by hiking council tax 5% 37% £40bn business rates and making residents 5% pay for services and 10/11 11/12 12/13 13/14 14/15 15/16 16/17 17/18 18/19 that were once free. These changes hit the 9% poorest hardest.
-10% -20% -30% -40%
100%
12%
18
21
80% 60%
36
19
21 Education Police Environment Health
4
-60%
51
46
£100bn
20 0%
-50%
Adult Social Care Children Social Care Highways & transport 20 Other
41
40% 20%
Source: NAO 17%
2010/11 2015/16 Banks 20% Central government (includes redistributed business rates) Business rates (locally retained)
Other 7%
£90bn
8
2019/20 Council tax Other PWLB 73%
£80bn £70bn £60bn £50bn £40bn £30bn £20bn
Central service
Environmental
Cultural
Highways & transport
Housing
Planning
Source: MHCLG
£100bn £90bn £80bn £70bn
Other
£60bn
Bank debt
£50bn £40bn £30bn
Public Works Loans Board Debt
£20bn
PWLB
Banks
2017/18
2016/17
2015/16
2014/15
2013/14
2012/13
2011/12
2010/11
2009/10
2008/9
2007/8
2006/7
2005/6
£10bn 2004/5
her
-60% Local authorities also have to deal with increasing demand for services due to the cuts, in particular crises relating to homelessness and social care. This leads to councils plugging the gap with short-term measures such as relying on reserves and more borrowing, but this is not a sustainable alternative to a long-term funding plan.
2003/4
are l Care ansport
-50%
Other
The overhaul in local government funding since 2010 is only the latest chapter in a trend to put profit before people by shrinking the role of the public sector. Austerity is more than just cuts to services. It marks a 1 relations where, with declining public deliberate shift in power spending, public scrutiny and democratic accountability are also eroded.
5
Introducing financial risk Local authorities should be guaranteed stable funding from central government to fulfil their duties towards residents. Instead, they are treated as commercial actors encouraged to borrow to engage in speculative activities. Through financialisation, risk is introduced into the funding of essential services. With financial loss comes service withdrawal. Research for Action has focused on how this happens through a type of bank debt called LOBO (Lender Option Borrower Option). These risky and expensive loans were sold to hundreds of councils across the UK and have been called a “lose-lose bet” by experts. £600m
Source: MHCLG
Top 30 LOBO loan borrowers (2015)
£500m £400m £300m £200m
£0m
6
Newham Kent Glasgow Manchester Leeds Cornwall Fife Newcastle upon Tyne Sheffield Salford Northumberland Edinburgh Birmingham Rotherham Croydon Suffolk Somerset Liverpool Warrington Wirral Hertfordshire Northamptonshire Lewisham Barking & Dagenham Rochdale Greenwich Oldham Haringey Camden Bristol Gateshead Stockport Highland Kirklees Harrow Redcar & Cleveland Wolverhampton Leicestershire Inverclyde Walsall Medway Towns Nottinghamshire Plymouth Swansea Leicester
£100m
The debt trap Councils spend a significant amount of their income on interest payments – sometimes as much as 70% of what they receive in council tax income. Debt is central to how councils are disciplined to play by the rules of financial capital. Interest payments are ring-fenced in councils’ budgets, as the failure to service debts would lead to hefty penalties and the imposition of government administrators. This forces councils to prioritise paying banks above everything else. It also lays bare the power dynamic between the cashstrapped public sector and financial institutions. Rescuing these very same too-big-to-fail banks with public money is what prompted the wave of cuts to public services in the first place. LOBO loans are merely a symptom of a political and economic system that places the interests of finance above those of the people. We must challenge the legitimacy of the debt trap mechanism and its intended consequences.
7
4%
BANK DEBT Expensive and risky
5%
-10%
11%
5%
37%
-30%
9% -40%
12%
17%
Local government borrowing Adult Social Care Children Social Care Highways & transport Other
Councils can borrow from any willing lender. The amount and sources of borrowing vary for each council but overall, local government in 2017/2018 held £95bn of outstanding long term debt in the form of: Other 7%
£100bn £90bn £80bn £70bn
Banks 20%
• loans from private banks (20%)
£60bn £50bn
PWLB 73%
• bonds (5%)
£40bn £30bn £20bn
• loans from other sources (2%)
£10bn
PWLB
Source: MHCLG Banks Other
The cost of borrowing from banks Local government debt is highly prized by private investors because councils theoretically cannot go bankrupt: should a council get into trouble, central government could intervene as lender of last resort. If a council were to default on debt obligations, natural recourse for the banks would be to seize public assets such as housing association stock, hospitals and schools. Effectively, privatising public assets or services. Up to 2011, local authorities borrowed extensively from private banks even if it was more expensive and risky than borrowing from central government via the Public Works Loan Board (PWLB). As a result, profit on lending is going to 8
-50% -60%
Education Police Environment Health
• loans from central government via the Public Works Loan Board (73%)
-20%
private banks rather than re-circulating in the public sector. In addition, every time a bank loan is signed, restructured or renegotiated by a public body, banks, advisors and brokers make large profits by way of additional fees and charges, unnecessarily wasting public funds. Derivatives and risk Banks can sell loans on to other lenders if they wish, and/or hedge risk with the use of derivatives. Derivatives are very profitable for banks as they can be used for speculation. A typical derivative used to make loans more attractive is an interest rate swap which can be described as a bet on future changes to interest rates. Banks usually offer swaps to borrowers in conjunction with loans so that the borrower can hedge the interest rate risk. Local authorities were prohibited from using standalone derivatives contracts such as swaps following a ruling in 1991 called Hammersmith and Fulham vs Hazell. Therefore until the 2011 Localism Act legalised derivatives use again, councils were not allowed to hedge against interest rate risk. The ruling did not stop bankers from finding inventive ways of engineering around the legal restrictions on public sector borrowing. They designed LOBO loans so that they could still profit from derivatives sold to councils by embedding them in the loans. With LOBO loans, the bank takes all the benefits of the hidden derivates, the council takes all the risk.
9
The Hammersmith and Fulham vs Hazell case In the 1980s, 137 UK councils had entered into hundreds of interest rate swap agreements with banks. Hammersmith and Fulham Council was the largest player among local authorities in the UK interest rate swaps market. The council had signed hundreds of swap contracts with Goldman Sachs, placing UK taxpayers on the hook for £300 million in potential losses as interests rates moved against the council in favour of the investment bank. Ultimately, judges in the High Court ruled in 1989 that councils entering into stand-alone swaps and derivatives contracts was “ultra-vires”, or outside council’s legal powers. Despite an appeal by the banks in 1991, the House of Lords upheld the ruling, deciding it was not a council’s role to be speculating upon interest rates, and taxpayers should not be held liable. The contracts were cancelled, much to the anger of banks.
10
LOBO LOANS Complex financial instruments Embedded derivative LOBO stands for Lender Option Borrower Option and is typically a very long term loan (40-70 years). The initial interest rate of a LOBO loan is usually lower than the corresponding PWLB rate and often includes an introductory teaser rate. At pre-agreed call dates, such as every six months or five years, the bank (the lender) has the option to increase the rate. The council (the borrower) then has the option to either accept the new rate or repay the loan in full. If the bank does not use its option, the council can only exit the loan by paying an exorbitant exit penalty which is at complete discretion of the bank.
Barnet
Harrow
Haringey Brent
Hillingdon
Ealing
w nslo Hou d s on me hm ha Ric on T up
Camden We stm inst er
Redbridge
Barking and Dagenham Tower Newham Hamlet
Havering
Greenwich Lewisham Merton Sutton
Source: DCLG (2015)
Walt h Fore am st
From the 1980s onward, more than 200 councils across the UK took out loans from banks in the form of LOBO loans, totalling approximately £15bn.
Croydon
More than £200m in LOBO loans £150m-£200m in LOBO loans £100m-£150m in LOBO loans £50m-£100m in LOBO loans Less the £50m in LOBO loans No LOBO loans
11
Barnet
Harrow
Haringey Brent
Hillingdon
Ealing
slow Houn d on es hm am Ric on Th up
Camden Wes tm inste r
Walth Forest am
More than £200m in LOBO loans £150m-£200m in LOBO loans £100m-£150m in LOBO loans £50m-£100m in LOBO loans Less the £50m in LOBO loans No LOBO loans
Redbridge
Barking and Dagenham Tower Newham Hamlet
Havering
Greenwich Lewisham Merton Sutton
Croydon
Source: DCLG (2015)
12
A lose-lose bet with the banks With LOBO loans, local authorities are essentially locked into a lose-lose bet with the banks: • If PWLB and market interest rates go up, the bank is likely to use its option. The council will in most cases have to borrow new funds if it wants to pay back the LOBO loan. To make the deal cost-effective, this new loan must have an interest rate lower than the one offered by the bank. So to keep the council trapped in the LOBO loan the bank will offer a new interest rate just below the rate at which the council could borrow from the PWLB or the market. • If PWLB and market interest rates go down, the bank will keep the LOBO loan rate as it is. In other words it will not exert its option and the council will be paying a higher interest rate than those available at the time. This is the scenario councils find themselves in today with some councils now locked into 11% interest rates, about 4 times the current rate of borrowing from the PWLB. If a local authority does decide to exit a LOBO loan without waiting for the bank to exercise its option, it will be charged a breakage fee which will be based on the profit the bank expects to make from the loan. The fair value of a loan gives an indication of what the fee would be at a given moment in time, but effectively the final cost remains completely at the discretion of the bank. For some loans the estimated breakage fee is higher than 100% of the LOBO loan principal.
13
The council signs a LOBO loan with a bank at an interest rate just below what it could get from the PWLB
PWLB interest rates go down
PWLB interest rates go up
The bank will not use its option to change the interest rate on the LOBO loan
The bank will use its option and will raise the interest rate of LOBO loan to just below the PWLB rate
The council cannot exit the LOBO loan without paying an exorbitant penalty
The council can exit the LOBO loan by paying it back in full without a penalty. To do so in most cases the council will have to take out a new PWLB loan at a higher rate than the LOBO loan
â‰
As it is not cost effecitve it is likely the council will not exit the loan
The council remains locked into bank loans that have higher interest rates than those available from the PWLB
%
Some councils are now paying interest rates as high as 11% on LOBO loans, about 4 times the current rate of borrowing from the PWLB. 14
“So heads the lender wins and tails the borrower loses. Only if the coin lands on its edge every time, and rates remain broadly flat for decades, does the local authority win.” Arlingclose, a tresury managment advisor, commenting on LOBO loans in the 2015 parliamentary inquiry
“Also, the nature of the risk itself means it is the kind of risk that makes traders and hedge fund managers, as I also used to be in the past, wake up at night screaming. It is just horrible stuff. I do not think anyone who fully understood it would do it. [...] I would not do these deals if you put a gun to my head.” Rob Carver, a former Barclays trader, commenting on LOBO loans in the 2015 parliamentary inquiry
15
Hidden cost Due to the “optionality” and length of LOBO loans, the overall cost to the council over the life of the loan is very difficult to price without sophisticated pricing tools that the majority of local authorities do not have direct access to. Councils have to rely on private sector advisors to monitor the risk of the option being called, adding expenses to the council’s budget. Furthermore, due to lax accounting standards, only recently councils have been obliged to account for the risk associated to derivatives in their financial accounts. The true cost of LOBO loans remained hidden off balance sheet for many years. As a result, many officers and councillors were unaware of the impact on council finances. New international accounting standards (IFRS9) were introduced in April 2018 making the cost and risk of offbalance-sheet derivative use more transparent. However the new accounting standards prompted external auditors of councils with particularly toxic RBS LOBO loans (inverse floaters) to ring fence the councils’ strained cash reserves, against liabilities associated with the loans. To avoid council bankruptcies, central government explored the use of a “statutory over-ride” to exempt councils and their auditors from applying the new audit standards, until a solution could be found that did not involve other local authorities following Northamptonshire into bankruptcy.
16
“I would categorically say that I do not believe you would be able to find a finance officer or a treasury officer in a council who would be able to accurately assess the relative risks and rewards of one of these LOBO products. I would even have to say that it does not matter if you are a qualified accountant or a chartered accountant at all. We deal with some very large corporates and even FTSE 250 businesses’ treasurers would not be able to analyse this on their own. They would literally need a specialist hedging advisor or for the bank to explain things in a very transparent manner to them.” Abhishek Sachdev, financial expert, commenting on LOBO loans in the 2015 parliamentary inquiry
17
Banks’ exorbitant profits Banks on the other hand have sophisticated software to predict how much they will earn from a loan. Due to the way banks account for loan and derivative sales, on the day a deal is signed, they book upfront the profits they expect to make over the lifetime of a loan. It has been estimated that on £15bn of LOBO loans banks have already booked an upfront profit of £1.5bn. The banks’ exorbitant profits show just how bad the deals are for councils. Especially concerning are the profits earned via LOBO loans by the Royal Bank of Scotland (RBS). By the end of 2010, fewer banks were offering LOBO loans due to changes in interest rates and a decline in interbank lending following the financial crash, but the recently bailed out RBS suddenly became very active in the market. The bank provided exceptionally risky LOBO loans called inverse floaters, whose interest rates were designed to inversely reflect market rates. These LOBO loans were designed to be attractive in a scenario where interest rates were expected to return to the 4-5% rates of the 2000s, which has not been the case for more than a decade. While councils were dealing with austerity cuts imposed as a consequence of the bailout of RBS, the same bank was profiting off public authorities by selling extremely unfair loans to UK councils.
18
Banks went even further in abusing their power. Most LOBO loans and their breakage fees are dependent on LIBOR or ISDAfix. These are benchmark rates that impact loans and derivatives sold across the world. It has been proven that both LIBOR and ISDAfix were deliberately manipulated by banks and brokers. The major banks who were providing LOBO loans, like Barclays and RBS, were involved in the scandals as well as the brokerage firm ICAP. Surely if the councils had known the banks could manipulate the rates, they would have not agreed to the deals. The investigations into benchmark rigging have highlighted the preferential information brokers and banks have in relation to market indexes and how insiders can profit immensely to the detriment of the borrower. Since LOBO loans have been exposed, Barclays has removed the options from its loans and RBS has allowed councils to cancel LOBO loans with a reduced breakage fee. However, this does not change the fact that their LOBO loans were illegitimate in the first place and therefore can still be challenged. In early 2019, seven councils filed a legal challenge against Barclays in relation to LIBOR, and Newham council filed its own cases against both RBS and Barclays.
19
HOW DID THIS HAPPEN? Conflict of interest in council finance The role of the council LOBO loans could be challenged on the basis that they are unlawful, since no-one would rationally decide to enter loans that are so expensive and risky while having the option of borrowing more cheaply and at a lower risk from the PWLB. The choice to enter the loans could have been based on incorrect or inadequate benchmarking of LOBO loans with respect to PWLB loans and/or lack of expertise and appropriate tools by the council to understand their terms. In some cases, council officers should be held to account for the decision to enter LOBO loans. However, in most cases, local authorities relied on the private sector for advice and guidance on how to borrow and invest. Private firms not only charged high fees, but acted with significant conflicts of interest, encouraging councils to behave like short term, profit-driven companies.
20
The role of the brokers When councils take out a loan they do not always deal directly with the banks. Often they rely on brokers, who charge substantial fees to obtain and structure the deals. In the case of LOBO loans there were many brokerage firms involved but the most common were ICAP, Tullet Prebon, Tradition and RP Martin. Councils would pay a broker a fee corresponding to a percentage of the loan, typically 0.24%. Given the magnitude of the loans, these were very large sums. For example in the case of a ÂŁ10m loan a broker would receive ÂŁ24,000 from the council. At the same time, the brokers received undisclosed payments from the banks as they competed for deals. Commissions were exceptionally large since the brokers provided banks with such high margins on LOBO loans. Insiders have said it was unusual at the time that brokers should receive commissions from both sides of the deal.
21
“We were paying commissions to the brokers as well and this made me very concerned, because I did not see how the brokers could be giving their ultimate clients, the councils, independent advice when they were being paid by us. [...] The brokerage fees were quite large compared with the fees we normally paid, and there was lots of pressure always to pay higher fees.� Rob Carver, a former Barclays trader, commenting on LOBO loans in the 2015 parliamentary inquiry
22
The role of the Treasury Management Advisors Due to the increase in complexity of local government finance, councils rely on external advisors to make decisions on borrowing and investment. Companies providing this service to councils are called treasury management advisors (TMAs). When LOBO loans were being sold, the main TMAs in the market were Butlers, Sector Treasury Services (STS), Capita Asset Services, Sterling Consultancy Services (SCS) and Arlingclose. SCS was acquired in 2012 by Arlingclose, while the three other companies are now operating under the name of LINK Asset Services. TMA firms are generally contracted for several years and are paid an annual retainer fee for their advice. They are contractually obliged to provide independent advice in the sole best interests of their council clients. However, the independence of TMA firms has been brought into question on more than one occasion. For example, when Icelandic banks collapsed in 2008 and millions were lost by councils who had invested in them, the conflicted relationship between TMAs and interdealer brokers was at the centre of the story.
23
The conflict of interest TMA advice was also highly conflicted in the case of LOBO loans as they were receiving commission payments from brokers when LOBO loans were arranged. • Butlers and ICAP. Butlers was one of the most prolific TMAs advising councils on LOBO loans. However, many councils were not aware Butlers was a trading division of ICAP, one of the brokers involved in arranging LOBO loans, and that ICAP was transferring funds to its subsidiary Butlers when the TMA advised councils to take on LOBO loans via ICAP. • Sector, Tullet Prebon and ICAP. Sector Treasury Services was also a TMA advising councils on LOBO loans. At the same time it was receiving kickbacks from the brokers Tullet Prebon and ICAP whenever LOBO loans were brokered via them. All scenarios call into question the independence of advice upon which councils relied. Given the high profits being made by brokers and advisors when councils borrowed from banks, it is hard to believe that LOBO loans were recommended with the interests of taxpayers in mind.
24
fee Council
kickback TMA
Broker
fee Bank
fee LOBO loan
25
“Outrageous, in the end if a council appoints and pays for an independent outside advisor to come in, they expect that advice to be independent and not to be paid for by somebody else who is gaining a profit from these loans being set up. That really is scandalous if it has happened. I think the FCA now ought to investigate this and if it hasn’t got the powers the government should give it the powers to regulate this in the future. I think the Committee will want to look into this very seriously indeed.” Clive Betts MP, Chairman of the CLG Committee commenting for the Channel 4 Dispatches documentary on LOBO loans
26
WHO IS WATCHING? Lack of oversight and scrutiny A failing system The local government accountability and scrutiny system demonstrates widespread failings, making local government highly prone to corruption risk and unfair dealing. Responsibility of scrutiny is spread over various bodies, none of which seems to have a clear oversight on local government finance. LOBO loans are symptomatic of much wider issues around unaccountability and lack of regulation and enforcement in local government, a direct result of central government policy. Oversight bodies The 2003 Local Government Act gave local authorities powers to set their own borrowing limits and to borrow from any willing lender without consulting central government (as long as in GBP sterling), provided the borrowing was “socially sustainable�. However, it was not indicated how in practice individual councils should determine and measure the social sustainability of borrowing. The Chartered Institute of Public Finance and Accountancy (CIPFA) produces a Prudential Code and a Treasury Management Code for local government. English councils are required to have regard to the codes, but are not obliged by law to follow them.
27
Parliament
HM Treasury
Ministry for Housing, Communities and Local Goverment
National Audit Office
External Auditors
Local Authorities
Funding
Chartered Institute of Public Finance and Accountancy
Intervention Scrutiny/Guidance Accountability
Local Residents 28
Local authorities are supposed to be accountable to central government via the Ministry for Housing, Communities and Local Government (MHCLG) and HM Treasury. However, concerns regarding the effectiveness of scrutiny of local government by the MHCLG have been raised on an number of occasions by the Public Accounts Committee. Local government finance is also subject to external audit and scrutiny in Scotland by Audit Scotland, in Wales by the Wales Audit Office, and in Northern Ireland by the Northern Ireland Audit Office. In England the external audit process is undertaken by private auditing companies, mainly the big four accountancy firms (EY, KPMG, Deloitte, PwC) and a few smaller players such as BDO, Grant Thornton and Mazars. This arrangement was put in place in 2015 following the closure, under the pretext of cuts, of the Audit Commission, the central government body responsible for audit and scrutiny of councils in England. The big four accountancy firms undertake audit and consultancy work for both councils and corporations councils have contracts with. Concerns have been raised regarding the auditors’ conflicts of interest and their reluctance to flag corruption that could affect high-fee-paying clients. Local government finance is unregulated by the Financial Conduct Authority (FCA). Furthermore local authorities are considered to be “sophisticated” borrowers according to the FCA. This means that councils are expected to hold the necessary experience and knowledge to fully understand complex financial risks when borrowing and investing public funds. 29
Do you want to know how much public money is going to private companies running council services? Not getting the information you want and frustrated by lack of transparency? This guide is to help you navigate your legal rights to: • inspect a local authority’s accounts and ask for related documents • ask questions to the local authority’s external auditor • object to items in the local authority’s accounts Council publishes draft accounts (April-May) Council publishes a public notice for the inspection period (June) Inspection period #NoLOBOs (June-August) TAKE ACTION AS A RESIDENT!
June -July 2017
Ask Inspect to inspect the Council the accounts accounts
#NoLOBOs #NoLOBOs Ask for a Take the File an Ask objection report in the #LOBOloans to AARESIDENT! a question TAKE ACTION AS RESIDENT! TAKE ACTION AS the auditor publicto Interest the high court June-July -July2017 2017 June
? Ask inspect Ask Ask to to inspect Ask forfor aa Ask for a Council report thethe Council report in in thethe public interest report accounts public Interest For more information visit ouraccounts website lada.debtresistance.uk public Interest
or get in touch: @DebtResistUK or lada@debtresistance.uk
4
30
Take Take thethe Ask for a High #LOBOloans #LOBOloans to to Court declaration high court thethe high court
more information visit website lada.debtresistance.uk ForFor more information visit ourour website lada.debtresistance.uk in touch: @DebtResistUK lada@debtresistance.uk or or getget in touch: @DebtResistUK or or lada@debtresistance.uk
Citizen auditors Local government is first and foremost accountable to its local residents. However LOBO loan contracts are not publicly available without Freedom of Information (FOI) requests, and have been in many cases refused even to councillors. For a month a year in the summer, during what is called the “inspection period”, residents have additional rights granted to them by the 2014 Local Audit and Accountability Act. Residents can then inspect, ask questions about and object to items in the council’s financial accounts. The right to inspect the accounts extends also to journalists and bloggers. The council’s external auditor has the role to respond to the questions and objections submitted. When filing an objection, residents can ask for a public interest report on the issue raised and/or ask the auditor to refer the case to the high court. The objector must specify why they believe the item in the accounts they are referring to is unlawful. This is defined as something the council: • spent or received without powers to do so • took from or added to the wrong fund or account • spent on something that they had the power to spend on, but the decision to spend the money was wholly unreasonable or irrational – as in, no reasonable person would have made the decision. Research for Action has produced a guide explaining how to exercise these rights called “Reclaim local democracy: how to challenge the financial decisions of your council”. 31
ILLEGITIMATE DEBT “Don’t owe, won’t pay” What is illegitimate debt There is no official definition of illegitimate debt, but it can be broadly interpreted as debt that was improperly granted and is thus the responsibility of the lender and should not be repaid. Illegitimate debt is not a legal or financial term. Instead, it encompasses more broadly debt that was not incurred in the public interest and where debt servicing and repayment is detrimental to the rights of the population. Illegitimacy relates to the processes and power relations that have produced the debt in the first place and that are reinforced by it. Crucially, illegitimacy speaks of power imbalances between the lender and the borrower, whether they are economic, political, or information asymmetries. This viewpoint counters a common assumption about financial transactions: their neutrality. Money is seen as neutral in economic theory, omitting the power that in the real world comes with it. When a borrower needs funds and enters into a contract with a lender with a balance sheet many times its size, it cannot realistically influence the contract terms. Examining the legitimacy of debt reverses the responsibility of contracting the debt from the borrower to the lender and makes it possible to hold lenders to account.
32
Illegitimacy can relate to: • The contracting of debt - are the terms of the loans legitimate? • The origin of debt - are the reasons why the debt was incurred in the first place legitimate? • The servicing of debt - is the way the debt is being paid for legitimate? The socio-economic context in which the debt is contracted and serviced is central to the evaluation of the legitimacy of the debt. In the case of LOBO loans we must therefore consider what it means to be servicing the debt in the aftermath of the financial crisis, while facing extreme cuts imposed from central government as part of the implementation of austerity. Finally, when analysing the legitimacy of debt, it must also be considered if the funds borrowed were actually used in the public interest.
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LOBO loans are illegitimate debt 1. Illegality. LOBO loan contracts may infringe the law and contain grossly unfair clauses that create excessive risk that was undisclosed to councils. 2. Power imbalance. LOBO loans result from an excessive power imbalance between too-big-to-fail banks and public institutions and were used by banks to circumvent regulation on derivatives sales. Banks and brokers not only abused information asymmetries with councils, but also were involved in rigging the rates (LIBOR and ISDAfix) the loans were pegged to. 3. Conflict of interest. Treasury management advisors (TMAs), who are hired by councils to provide independent advice, recommended LOBO loans to councils while receiving commissions from brokers arranging the loans. Brokers in turn were being paid high fees by both the council and the banks, which is not standard brokerage industry practice. 4. Council mismanagment. In some councils administrations committed actionable breaches when taking out LOBO loans. Councils are also destroying documents related to the loans, or restricting access to them to councillors, journalists and residents. 5. Use of the funds. Councils were not obliged to specify for what purpose LOBO debt was taken on, however there is evidence that in certain cases funds were not invested to benefit the population, and may have been used to speculate in financial markets. 6. Interest vs services. Servicing LOBO debt in the context of austerity is exacerbating human rights violations for which Britain has been criticised by the United Nations. 34
What needs to happen Research for Action is calling for: 1. A suspension of interest payments on LOBO loans until their legitimacy is clarified by the High Court. 2. The cancellation of LOBO loan contracts deemed illegitimate and all interest paid up to now returned to councils. 3. Prosecution of those responsible for the fraudulent misselling of LOBO loans. 4. An end to budget cuts and immediate steps to repair the damage done to people and communities by the financial suffocation of essential services. 5. The introduction of radical policy alternatives to ensure decisions are made transparently in the public interest, with meaningful resident participation and effective oversight not constrained by private sector profiteering and conflicts of interest. Research for Action is conducting an audit of local authority debt with the aim to improve the accountability of councils towards their residents in managing funds in the public interest. We place our work within a broader movement building counter-power at the municipal level to resist the financialisation of public institutions and to demand a more accountable and participatory local democracy. People across the world are using audits to challenge illegitimate debt and the power structures that have imposed it.
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A CITIZEN AUDIT OF COUNCIL DEBT What has been done so far Local action A citizen debt audit is a bottom-up process that aims to engage residents and civil society in deciding if debt is legitimate and defining what is meant by making financial decisions in the public interest. Research for Action in collaboration with Debt Resistance UK is conducting a citizen audit of LOBO loans, involving local residents and campaign groups, councillors and financial experts. Concerned citizens from across the political spectrum have been encouraged to take on the issue of LOBO loans autonomously without having to be affiliated to any group, with the aim to build multiple local residents’ audits rather than a single centralised campaign. The citizen audit builds on the investigative work of Research for Action and Debt Resistance UK who through extensive use of Freedom of Information requests unveiled the details of approximately £15 billion of LOBO loans sold to more than 200 councils across the UK. Research for Action and Debt Resistance UK have supported more than 50 residents and councillors to object to LOBO loans in their councils’ accounts. We have also helped them raise the issue in council meetings and build awareness within their community via local media outlets and in collaboration with local groups.
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A national campaign Research for Action and Debt Resistance UK have also campaigned at the national level by submitting evidence to parliamentary inquiries, lobbying MPs, coordinating open letters signed by councillors and shareholder activism at bank AGMs. These actions generated media coverage, which prompted a parliamentary inquiry into local authority bank loans in 2015. Since then central government has made no public commitment to address LOBO loans. However, via FOI we have discovered that the NAO has held ongoing private meetings with CIPFA, government departments and external auditors as a consequence of resident objections. As a result of the meetings, councils that were at risk of bankruptcy were allowed to use a “statutory override” and not account for the true risk associated to LOBO loans in their 2017/18 financial accounts. In July 2018, 15 local authorities, including Newham, announced they would be taking legal action against Barclays on LOBO loans. Of these, eight filed their claim in January 2019. Newham announced in February 2019 it was also challenging RBS on LOBO loans. In May, Newham council withdrew the claim against RBS and instead terminated its LOBO loans with the bank. Exiting these very unfavourable loans will save the council £3.5m per year over 41 years - a total of up to £143m. Instead of profiting the bank, these millions will go into services urgently needed by residents.
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Newham’s citizen debt audit Research for Action published a report on the citizen debt audit of Newham’s LOBO loans in October 2018. It details why the council’s LOBO debt is illegitimate, and calls for action by the council, government and related bodies. Newham, an east London borough, is the largest LOBO loan borrower and has some of the worst types of LOBO loans. Newham is also one of the most impoverished local authorities in the country: the housing crisis, declining wages and cuts to benefits and services are causing widespread deprivation in the borough, where 4 in 10 children grow up in poverty and one in 25 residents are homeless. Research for Action and Debt Resistance UK supported Newham residents and councillors to inspect and object to their council’s accounts in relation to LOBO loans. In Newham, the right to inspect accounts was a crucial source of information, providing documents previously refused via FOI requests. As part of the research for the report we interviewed and held workshops with campaigning organisations, community groups and charities in Newham, asking for their views on the impacts of cuts in services and how the council is meeting residents’ needs.
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The evidence gathering was combined with sharing information about LOBO loans and the council’s financial situation, adding strength to arguments groups and residents could use when dealing with the council. We interviewed randomly selected residents in the vicinity of council services to broaden our understanding about the effects of the council’s financial decisions on residents. We also supported councillors in raising concerns on LOBO loans in council meetings. While we worked on the citizen debt audit, the political situation in the borough changed drastically. In 2018 one of the councillors who had been active on the LOBO loan issue, Rokhsana Fiaz, was elected as the Mayor of Newham. Since, the council has initiated legal action against Barclays and RBS, and is taking steps to improve accountability and democracy locally.
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RESEARCH FOR ACTION & DEBT RESISTANCE UK MEDIA COVERAGE
Ongoing campaign involving residents and councillors
Open letter asking for a Treasury Select Committee inquiry
Residents submit objections on LOBO loans Shareholder activism at AGMs of financial institutions Submissions to public inquiries
Channel 4 documentary “How councils blow your millions”
The CLG Committee launches a parliamentary inquiry into “Local Council Bank Loans”
No action
First extensive coverage of LOBO loans
Coverage of Barclays removal of options
MPs Betts & Mann call for a Treasury Select Committee inquiry
No action
New guidance published
COUNCILS
CENTRAL CIPFA GOVERNMENT
Ongoing investigation with use of FOI requests
BANKS
Barclays removes options from its LOBO loans 2015
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2016
2017
Publication of report on Newham’s LOBO loans
Coverage of legal cases
Ongoing undeclared private meetings between NAO, CIPFA, MHCLG and auditing companies
Coverage of report on Newham’s LOBO loans
Coverage of legal actions
Coverage and repayment of RBS loans
Statutory override introduced for councils with worst LOBO loans
14 councils announce they are taking Barclays to court over LIBOR
Newham files claim against Barclays over LIBOR
7 councils file claim against Barclays over LIBOR
Some German banks allow councils to exit LOBO loans
Newham files claim against RBS over LIBOR
RBS allows councils to exit LOBO loans 2018
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CANCELLING LOBO LOANS What the government can do Taking action at the national level Research for Action calls on central government and councils to coordinate collective action against banks, brokers and treasury management advisors, and to put pressure on the banks to cancel the remaining loans and waive breakage fees. Mainstream, independent and local media all play a fundamental role in pushing public institutions and banks to act. If you are a journalist and would like to cover the story, get in touch. We can respond to your queries and provide data for your investigation. What central government can do 1. Re-open the parliamentary inquiry into the legitimacy of LOBO loans and consider the additional evidence which has emerged 2. Call on the Financial Conduct Authority (FCA) and the Serious Fraud Office (SFO) to investigate the mis-selling of LOBO loans to councils, including the conflict of interest of the treasury management advisors 3. Support a coordinated legal action on LOBO loans by the councils against the banks and/or the advisors 4. Demand that all councils’ external auditors who have received objections on LOBO loans publish a public 42
interest report 5. Make available to the public all information central government and regulators, including the Competition and Markets Authority, hold on LOBO loans and TMA firms that advised councils to enter them What councils can do 1. Evaluate the legality of their LOBO loans with the support of legal and financial experts 2. Take legal action against banks, TMAs or brokers based on the legal evaluation of their LOBO debt 3. Coordinate actions with other councils and call for support from national and regional institutions, including the Local Government Association 4. Demand disclosure from central government of all information they hold on LOBO loans 5. Demand disclosure by banks, brokers and TMAs of the flows of money that occured in the selling of LOBO loans 6. Undertake a review of the council’s financial decisions and act where due process was not followed or decisions were not made in the public interest. This includes holding to account who was responsible and improving processes so that failures can be avoided in the future. 7. Involve the local community in an assessment of the legitimacy of the the council’s debt, including judging if the funds were used in the best interest of residents and if servicing the debt is socially sustainable
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What Research for Action will do 1. Continue the national campaign on LOBO loans 2. Build a publicly accessible database of LOBO loans 3. Continue the investigation on LOBO loans at the national level and publish our findings 4. Support coordinated actions between councils 5. Participate in parliamentary inquiries on local government finance and accountability 6. Get national and local media to keep a focus on the issue
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TAKING ACTION What you can do Building pressure locally For LOBO loans to be cancelled, we need to build up public pressure on the banks to renegotiate the loans and on central government and councils to take action against the banks and brokers. Research for Action calls for citizens’ audits across the UK and will support people and organisations who want to take action locally and nationally. If you are a resident, local campaigner, councillor or council staff member, please get in touch. What you can do as a local resident 1. Ask your MP, mayor, council officers and councillors to take action on LOBO loans by writing to them, interacting with them on social media, or going to their surgery 2. Ask your councillor to sign and promote the open letter, hosted on Research for Action’s website, prompting the LGA and central government to take action on LOBO loans 3. Object to LOBO loans and ask that the external auditor produce a public interest report or refer LOBO loans to the high courts 4. Build awareness in your community by sharing information with your networks and local groups dealing with the cuts 45
5. Organise a workshop for Research for Action to explain the issue to local residents, campaigners and councillors 6. Ask your local media outlets to cover LOBO loans
What you can do as a councillor 1. Table concerns regarding LOBO loans in committee meetings and in the full council meeting 2. Get the council to explore legal options to exit LOBO loans 3. Organise a workshop for Research for Action to go over the issue with your council leader or mayor, council officers and councillors 4. Sign and promote the open letter, hosted on Research for Action’s website, prompting the LGA and central government to take action on LOBO loans 5. Object to LOBO loans and ask that the auditor produce a public interest report or refer LOBO loans to the high court 6. Connect with councillors from other councils to organise coordinated actions 7. Get your MP to take action on LOBO loans
What you can do as a local campaign group 1. Use the information on LOBO loans to strengthen your local campaign 2. Encourage residents to take action on LOBO loans 46
3. Ask your councillor to sign and promote the open letter, hosted on Research for Action’s website, prompting the LGA and central government to take action on LOBO loans 4. Build awareness in your community by sharing information within your networks 5. Organise a workshop for Research for Action to explain LOBO loans and how it relates to your campaign 6. Ask your local media outlets to cover LOBO loans How Research for Action can support you 1. We have a database of all LOBO loans held by councils across the UK. Get in touch if you would like specific information about your council and how it compares to other local authorities 2. We have printed material (guides, campaign booklets, etc) we can send on request 3. We can attend meetings with councillors, officers and MPs to explain the issue 4. We can organise workshops for councillors, local campaign groups and residents explaining the issues related to LOBO loans and how people can take action 5. We can assist in drafting objections for residents and councillors who want to use their rights under the 2014 Local Audit and Accountability Act to object to LOBO loans
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RESOURCES Research for Action publications Debt and democracy in Newham: a citizen audit of LOBO loans https://loboloans.uk/NewhamReport Reclaim Local Democracy: A guide on how to challenge you council’s financial decisions https://loboloans.uk/ObjectionGuide Government resources NAO report: Financial sustainability of local authorities 2018 https://loboloans.uk/NAOreport2018 DCLG/MHCLG data: Live tables on local government finance https://loboloans.uk/MHCLGlivetables
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RA for
Research for Action
@Research_Act http://researchforaction.uk info@researchforaction.uk
Research for Action is a workers’ co-operative that produces research to support social, economic and environmental justice issues and campaigns. Through in-depth investigations into vested interests and corporate power as well as researching alternative economic and democratic models, Research for Action produces informative, reliable and accessible material for the general public, the media, civil society and grassroots organisations to help strengthen their activities in bringing about long lasting change. Authors Joel Benjamin Fanny Malinen Ludovica Rogers
@Gian_TCatt @fannymalinen @ldvcrgrs