Debt & democracy: a citizen debt audit of LOBO loans

DEBT & DEMOCRACY IN NEWHAM

A citizen audit of LOBO loans

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Executive Summary A dramatic withdrawal of central government funding in the last decade has exposed the crisis in local government. Austerity measures are forcing closures of youth centres and libraries, reducing bin collection and increasing council tax; the cuts are also forcing homeless people onto the streets and into crammed, sub-standard temporary accommodation and leaving disabled people and those in mental health crisis without adequate support.

Voluntary organisations plug the gaps where they can, as the local state is shrunk and withdrawn under the political smokescreen of the “big society” narrative that promotes free service provision by communities.

Within this framework of false “localism” promoted by the government, councils are expected to support themselves by raising more funds locally, including hiking council tax and making residents pay for services that were once free. This hits the poorest hardest.

The overhaul in the way local government is financed is just the latest chapter in an ongoing story.

Austerity is more than just cuts to services. It marks a deliberate shift in power relations where, with declining public spending, public scrutiny and democratic accountability are also eroded. Decisions are increasingly made as purely administrative actions, imposed from on high by unelected officials, citing neoliberal economic rationale, not social necessity.

Local authorities need to be guaranteed stable funding to fulfil their duties towards residents. Instead, they are treated as commercial actors encouraged to borrow from capital markets, hedge against risk and engage in speculative activities. Through financialisation, risk is introduced into the funding of essential services. With financial loss comes service withdrawal.

In this report, we have focused on how this happens through a type of bank debt: Lender Option Borrower Option (LOBO) loans. We have used the London borough of Newham as a case study to evaluate the legitimacy of LOBO loans. These risky and expensive loans were sold to hundreds of councils across the UK, among which Newham is the most indebted. Experts have stated LOBO loans are far too complex for council officials to know they were signing up for a “lose-lose bet”.

Exiting LOBO loans now would prove extortionately expensive.

Debt is central to disciplining councils to play by the rules of financial capital. Interest payments are ring-fenced in councils’ budgets, which means savings have to be made elsewhere as the failure to service debts would lead to hefty financial 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 cash-strapped public sector and financial institutions with balance sheets that are multiples of local authorities’ collective budgets. It is often forgotten that rescuing these very same too-big-to-fail banks with public money is what prompted the recent wave of public sector cutbacks in the first place. This is why it is important to challenge the legitimacy of the debttrap mechanism.

There are few better examples of financialisation and the contradictions of austerity Britain than the east London borough of Newham that hosted the 2012 Olympics. One of the most deprived areas in the country, Newham has since the Games seen an injection of investment that many residents we have spoken to feel has not improved their lives. Instead, they experience a housing crisis exacerbated by gentrification and impoverishment brought on by debt, cuts and neglect.

As we were working on this audit, Newham Council – as well as 14 other local authorities across England – announced they are legally ch allenging Barclays over the LOBO loans the bank sold them. We welcome this development, and see it as a testament to the work grassroots organisations, concerned residents and experts have done alongside us to raise the profile of the LOBO loan issue.

2 LOBO loans are merely a symptom of an unaccountable, undemocratic system that places the interests of finance above those of the people. This is why this report focuses not only on local government debt, but also on the democratic deficit and poor oversight structures that have enabled the LOBO loan scandal to happen.

In this report we explain why LOBO loans can be considered illegitimate. We have found the following: 1. LOBO loan contracts infringe the law and contain grossly unfair clauses that create excessive risk that was undisclosed to councils.

2. Councils were encouraged to take out LOBO loans by central government through HM Treasury reforms to Housing Revenue Account and interventions on Public Works Loan Board (PWLB) rates and repayment penalties.

3. 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 derivative 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.

4. 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 by the council and the banks, which is not standard brokerage industry practice.

5. The council administrations committed actionable breaches when taking out LOBO loans, such as contravening national policies, borrowing from foreign banks without HM Treasury approval and not appropriately benchmarking the loans against PWLB debt. Councils are also destroying documents related to LOBO loans, or restricting access to them to councillors, journalists and residents.

6. Councils were not obliged to specify for what purpose LOBO loan 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.

7. Servicing LOBO loan debt in the context of austerity is exacerbating human rights’ violations for which Britain has been criticised by the United Nations.

We have evaluated Newham Council’s LOBO debt on the basis of the evidence above and concluded that Newham’s LOBO loans can be considered illegitimate. We have looked at the terms of each contract and the responsibilities of central government, banks, brokers and TMAs in the origin of the debt. We have highlighted breaches committed by the former administration in entering the loans and have looked at how the funds were invested for uses that did not benefit residents, such as potential interest rate speculation via Icelandic banks, or the Olympic redevelopment, including a loan for the West Ham stadium that has since been written off. We are particularly concerned that by servicing LOBO loans in the context of austerity, Newham Council is violating the human rights of its residents.

We recommend that central government and Newham Council take immediate steps to act on LOBO loans, avoid accumulation of illegitimate debt in the future and improve effective scrutiny of local government finance.

To denounce illegitimate debt and reclaim local democracy, we propose the following: 1. Suspending interest payments on LOBO loans until their legitimacy is clarified.

2. Cancelling LOBO loan contracts deemed illegitimate and returning all interest paid up to now.

3. Terminating budget cuts, and implementing immediate steps to repair the damage done to people and communities by the financial suffocation of essential services.

4. Introducing 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.

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Contents 1 Introduction • A citizen audit of Newham’s debt

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• Content of the report 6

2 Illegitimate debt • What is illegitimate debt? 7 • What is a debt audit? 8 • Municipal debt cancellation 9

3 Local government finance • Structure of local government 11 • Local government income, expenditure and cuts

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• Local government borrowing 14 • Regulation and scrutiny of local government finance

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4 LOBO loans • What is a LOBO loan? 19 • Types of LOBO loans 20 • A ‘lose-lose bet’ for councils 21 • Breakage fee 21 • Interest over the lifetime of the loans

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• Risk associated with the options 23

5 Are LOBO loans illegitimate debt?

• Evaluating the legitimacy of LOBO loans

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• A. Illegitimacy based on the terms of the contract

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• B. Illegitimacy based on the role of central government in the origin of the debt

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• C. Illegitimacy based on the role of the banks and intermediaries in the origin of

the debt 28 • D. Illegitimacy based on the role of the council in the origin of the debt

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6 An introduction to Newham • One of the poorest areas in the UK

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• Cuts to council services 39 • The council’s democratic deficit

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7 Newham’s LOBO debt • Long term borrowing 42 • Types of LOBO loans 43 • Breakage cost and fair value 44 • Interest payments vs council tax 44 • Risk and reserves 45

8 Are Newham’s LOBO loans illegitimate?

• Evaluating the legitimacy of Newham’s LOBO loans

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• A. Illegitimacy based on the terms of the contract

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• B. Illegitimacy based on the role of central government in the origin of the debt

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• C. Illegitimacy based on the role of the banks and intermediaries in the origin

of the debt 49 • D Illegitimacy based on the role of the council in the origin of the debt

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9 Impact of debt on rights in Newham • Illegitimacy of Newham’s LOBO loans based on the impact of servicing the debt

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• Right to housing 55 • Right to health 57 • Rights of children and young people

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• Right to social security and adequate living

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• Right to democracy 61

10 The citizen debt audit • Documenting the audit process 63 • Who 63 • Investigation 64 • Action 66 • Impact 72

11 Conclusions and recommendations • Urgent and immediate action 75 • Recommendations for central government 75 • Recommendations for Newham Council 77 • Conclusions 78

12 Appendix 79

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1 Introduction A citizen audit of Newham’s debt This report documents Research for Action’s citizen audit of Newham’s bank debt. It evaluates the legitimacy of the council’s LOBO (Lender Option Borrower Option) debt in the current context of austerity and is intended as a template that can be adapted to address the illegitimacy of LOBO loans in other local authorities across the UK. 1. 10 reasons Newham Council is the UK’s debt capital, Debt Resistance UK, 12 Nov 2017 - http://loboloans.uk/ DebtCapital

The east London borough of Newham has been chosen as a case study as it is the largest LOBO loan borrower as well as being 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. So many people have to rely on borrowing to make ends meet that Newham has been called the ‘UK’s debt capital’1.

LOBO loans are expensive and risky loans that banks have sold to councils. They have been described by experts as a “lose-lose bet” for local authorities who could have borrowed more safely from central government. Instead, they will be saddled with this debt to the banking sector for many decades to come.

The near complete withdrawal of funding from central government is making a bad situation worse. Grants to councils have been practically wiped out as part of a wholesale change in the way local government is financed. The devastating results of this crisis are already being seen with the bankruptcy of Northamptonshire County Council, with other councils soon expected to follow.

LOBO loans are expensive and risky loans that banks have sold to councils.

Local authorities spend a significant amount of income on interest payments on their debt. Loan repayments and interest payments are ring-fenced, which means that reducing them is not an option when cuts are imposed. Essential services are impoverished instead with significant impact on residents, especially the most vulnerable.

Prioritising debt repayments over residents’ well-being and human rights is symptomatic of the way financialisation disciplines borrowers. Public authorities are forced – by contract, political imposition, and moral judgement – to prioritise their obligations towards the financial sector over duties towards residents. Yet few questions are asked about how debts were accumulated.

We are concerned that austerity and the current crisis in local government funding serve to normalise the position of power of the financial sector, instead of acting as a wake-up call to reverse the financialisation of public institutions that puts the logic of finance before the rights of people.

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.

A citizen debt audit aims to improve the accountability of a council towards its residents in managing funds in the public interest: looking at past and present processes to see what has not worked and why so failures can be avoided in the future; identifying who is responsible for the problems that have occurred so they can be held to account. A citizen audit is a bottom-up process that aims to engage residents and civil society in defining what is meant by making financial decisions in the public interest and the impact those decisions have on people’s lives.

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A citizen debt audit aims to improve the accountability of a council towards its residents in managing funds in the public interest.

Newham’s citizen debt audit builds on the investigative work members of Research for Action have undertaken with the campaign group Debt Resistance UK that uncovered the national LOBO loan scandal in 2014. Through extensive use of Freedom of Information requests, Debt Resistance UK found that at least 240 councils across the UK had taken out LOBO loans with banks, totalling at least £15 billion. Through supporting residents to raise the issue in their local councils as well as campaigning at a national level that generated media coverage and a parliamentary inquiry, Debt Resistance UK and Research for Action have successfully raised attention to the problems related to LOBO loans. In July 2018, 15 local authorities, including Newham, announced they would be taking legal action against Barclays on LOBO loans pegged to LIBOR - a rate the bank rigged.2 This citizen debt audit has had no official involvement from the council, although individual councillors have been interviewed as part of the evidence gathering process. Results will be shared with decision-makers. Its overall aim is to encourage fruitful co-operation between the council, residents and civil society to improve local democracy.

Content of the report We start this report by introducing in the next chapter the concept of illegitimate debt and by situating Newham’s citizen debt audit in the broader international context of debt audits and debt cancellations.

In chapter 3 we set the context for the audit with an overview of how local government finance works, how cuts are being implemented and the accountability structures currently in place. In chapter 4 we explain in detail what LOBO loans are and how they impact council finances, and in chapter 5 we explain why the debt can be considered illegitimate.

After this initial framing, we focus specifically on the audit of Newham’s debt. This section starts with an introduction into the political, social and economic context of the borough in chapter 6, followed by details of Newham’s LOBO loan debt portfolio in chapter 7. Chapter 8 provides an in-depth analysis of why Newham’s LOBO loan debt should be considered illegitimate, followed by an investigation of the impact of austerity on residents’ human rights in chapter 9.

The report concludes with a description of the audit process and the impact it has had in chapter 10, followed by our final recommendations in chapter 11.

Disclaimer: All information contained in this report is provided for information purposes only, and is not intended as legal advice and should not be taken as such.

2. Councils sue Barclays over controversial LOBO loans, L.Sharman, LocalGov, 16 July 2018 - http://loboloans.uk/ BarclaysCourtCase-LocalGov

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2 Illegitimate debt What is illegitimate debt?

1. ‘Illegitimate’ loans: lenders, not borrowers, are responsible, J.Hanlon, Third World Quarterly, 2006, p. 211-226

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.1 Illegitimacy can relate to: • The contracting of debt – are the terms of the loans legitimate?

• The origin of the debt – are the reasons why the debt was incurred in the first place legitimate?

• The servicing of the debt – is the way the debt is being paid for legitimate?

Illegitimacy is broader than other arguments that are usually used to justify debt cancellation, such as odiousness, unsustainability and illegality, however it can encompass them: illegitimate debt can also be odious, unsustainable or illegal.

2. Les effets de transformations des Etats sur leur dettes publiques et autres obligations financieres, A.N.Sack, 1927

The concept of odious debt has been mainly used to describe debt of dictatorial regimes. It was first introduced by Alexander Sack in 19272: “If a despotic power incurs a debt not for the needs or in the interest of the state, but to strengthen its despotic regime, to repress the population that fights against it, etc, this debt is odious to the population of all the state.”

Odiousness has often been used as an argument for the non-payment of dictator debts by campaigners for debt justice internationally, such as CADTM (Committee for the Abolition of Illegitimate Debt).

3. ‘Illegitimate’ loans: lenders, not borrowers, are responsible, J.Hanlon, Third World Quarterly, 2006, p. 211-226

Cancellation of odious debts has also happened from the self-interest of a new occupying force.

When the US invaded Iraq in 2003, the government argued that debts incurred under Saddam Hussein’s dictatorship should not be seen as the liability of the new regime. A similar argument was used when the US occupied Cuba in 1898 and refused to assume debts originating from the previous Spanish rule.3 The term unsustainable debt is used when debt cancellation or restructuring is introduced when the borrower does not have enough income to service and repay the debt without sacrificing essential services. Cancellation of unsustainable debt is usually referred to as debt relief.

4. FAQs, Jubilee Debt Campaign https://jubileedebt.org.uk/faqs

The most successful example of debt relief in recent history was a result of the Jubilee 2000 Campaign4 which led to the cancellation of $130 billion of debt to 36 poor countries between 2000 and 2015. It was undertaken via the Heavily Indebted Poor Countries (HIPC) Initiative of the World Bank and the International Monetary Fund (IMF), and to qualify for debt relief, the countries had to meet certain criteria relating to income and governance. Despite its limitations – such as the lack of focus on the structural causes of poor countries’ indebtedness or the origin of the debts – the debt cancellation and the campaign that led to it were very effective in mainstreaming the idea of debt justice. Results of the HIPC initiative were striking: in countries that had their debts cancelled, children’s primary school completion rate increased from 45% in the 1980s to 66% by 2012, and births attended by a healthcare professional increased from 37% in 2000 to 50% in 2012.

Debt can also be deemed illegal, for example if it has been taken out in contravention of legislation.

This could relate to the authority to sign off loans, to conditions attached to loans or to misconduct by the lender.

8 In 2015, the Greek Truth Commission on Public Debt found5 that much of the country’s debt owed to the European Central Bank (ECB) and the IMF was illegal. This was because the ECB had overstepped its mandate by imposing macroeconomic adjustment conditions to loans and the measures attached to IMF loans were in violation of domestic and international law as well as human rights treaties which Greece is a party to.

Examining the legitimacy of debt reverses the common focus from the responsibility of the borrower to that of the lender.

5. Preliminary Report of the Truth Committee on Public Debt, 18 June 2015 by Truth Committee on the Greek Public Debt - http://www.cadtm. org/Preliminary-Report-of-the-Truth

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. And unlike odiousness or unsustainability, the illegitimacy of debt can be independent from the status of the borrower. Dictatorship or poverty are not prerequisites for debt cancellation. In other words, the statement associated to illegitimate debt is not “can’t pay” but “shouldn’t pay”.

Illegitimacy relates more widely to the processes and power relations that have produced the debt in the first place and that are reinforced by the debt itself. Crucially, illegitimacy speaks of power imbalances between the lender and the borrower, whether they be economic, political, or based on information asymmetries. This viewpoint counters a common assumption about financial transactions: their neutrality. Economic theory sees money as neutral, 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 common focus from the responsibility of the borrower to that of the lender and makes it possible to hold lenders to account.

What is a debt audit?

Illegitimacy of debt is usually defined through an audit that involves looking in detail at the terms of the debt, the political realities of how it was accumulated and the social costs surrounding how it is repaid.

An audit can be participatory or expert-led, and the nature of it will depend on the political entity who leads the process: the indebted government; social movements, civil society or concerned citizens; the lender itself; an independent external body; or combinations of the above.

The most successful debt audit by an indebted government was realised in Ecuador in 20086 by the government of Rafael Correa, following pressure from social movements. It examined the country’s loans from international financial institutions, found that much of it resulted from corruption and lack of transparency and did not benefit the people of Ecuador. It brought the country to the default on $3.2bn. Ecuador later strategically bought back much of the debt for a third of the original value, freeing up funds to be used for social spending instead of debt repayments.

6. Ecuador postpones debt repayment, launches critical audit report, Eurodad, 24 Nov 2008 https://eurodad.org/3124/?lang=es

Following the financial crisis and the bailouts that brought the debt crisis to the global North, social movements in Europe started demanding the non-payment of loans they deemed illegitimate. This was the case especially in Greece and the Spanish state, hit hardest by the Eurozone crisis.

In Greece in 2015, as part of the first Syriza government, the Speaker of the Parliament Zoe Konstantopoulou initiated an official debt audit after years of pressure from social movements. The Truth Commission produced an interim report that declared a lot of the country’s debt, resulting from the Troika’s (European Union, IMF, ECB) bailouts, illegal, illegitimate and odious. Unfortunately, the commission’s work was cut short by the change of government following the July 2015 referendum.

Since the onset of the crisis, concerned citizens across the Spanish state have organised local debt audits as part of the PACD (Platform for a Citizen Debt Audit) and have collectively worked on exposing the illegitimacy of loans that did not serve the public interest. Loans were often taken out in the pre-crash lending boom and used for infrastructure projects that quickly proved to be white elephants. The PACD describes7 an audit as: “a process to, collectively, understand how we have arrived at the current situation; what economic, social, cultural, environmental, gender and political impacts has this indebtedness created.”

Following the Spanish 2015 municipal elections that lifted progressive citizen platforms into power, many debt audits were replicated within the institutions. Many councils have been disobeying article 135 of the Spanish constitution that forces local authorities to prioritise debt payments over social spending.8 Madrid initiated an official audit of debt and public policy that analysed the council’s economic policies through a lense of economic and gender inequality as well as environmental

7. What the PACD means by ‘citizen debt audit’ and ‘illegitimate debt’, PACD, 8 June 2013 - https:// auditoriaciudadana.net/2013/06/08/ what-the-pacd-means-by-citizen-debtaudit-and-illegitimate-debt/

8. Oviedo Manifesto 28 Oct 2016 http://www.cadtm.org/OviedoManifesto

9 9. Auditoría de la deuda y las políticas públicas, Ayuntamiento de Madrid http://loboloans.uk/MadridAudit

sustainability.9 The plan was to have a participatory phase that would engage neighbourhood assemblies in the discussion of illegitimacy. Unfortunately, the audit was jeopardised when the Councillor for Treasury Carlos Sanchéz Mato, who was driving the institutional part of the process, was removed in late 2017.

10. Norway makes ground-breaking decision to cancel illegitimate debt, Eurodad, 27 March 2007 https://eurodad.org/302/

An example of the lender deciding unilaterally on debt cancellation is provided by Norway.10 In 2007, Norway cancelled US$80million it deemed it had illegitimately lent to five countries (Egypt, Ecuador, Peru, Jamaica and Sierra Leone) admitting that the lending was irresponsible and motivated by domestic interests: the loans had been granted in the 1970s to allow the countries to import ships from Norway. In cancelling the debt, the Norwegian government acknowledged that the loans had been provided mainly to secure employment for the domestic shipbuilding industry in crisis, rather than for the needs of the borrowing countries.

11. “Resolution on sovereign debt restructuring adopted by General Assembly establishes multilateral framework for countries to emerge from financial commitments”, United Nations, 9 September 2014 https://www.un.org/press/en/2014/ ga11542.doc.htm

Examples of external independent bodies judging the legitimacy of debt at a national level are provided by the case laws of each country, like the municipal cases described below. At the international level, there is currently no agreed process for debt cancellation. In 2014, the UN General Assembly11 voted overwhelmingly for a resolution “towards the establishment of a multilateral legal framework for sovereign debt restructuring processes” that urges debtors and creditors “to act in good faith and with a cooperative spirit to reach a consensual rearrangement” on sovereign debt.

However, a binding mechanism for sovereign debt restructuring is yet to be created.

Municipal debt cancellation 12. Closing the swap shop, D.Campbell Smith, 2008 - http:// duncancampbellsmith.com/pdf/ ftm_chapter_6.pdf

13. British court invalidates some financial swaps, M.Quint, The New York Times, 6 Nov 1989 - https://www. nytimes.com/1989/11/06/business/ british-court-invalidates-somefinancial-swaps.html

14. UK-based banks accused of massive mis-selling in Italy, J.Lynam, BBC, 11 Sep 2012 https://www.bbc.co.uk/news/ business-19545849 15. Mis-selling derivatives: Milan court finds four global banks guilty, L.Brinded, IBTimes, 2 July 2014 - https://www.ibtimes.co.uk/ mis-selling-derivatives-italy-city-milandeutsche-416758 16. French towns launch debt strike over “toxic” Dexia loans, L.Laurent, Reuters, 2 Oct 2012 http://loboloans.uk/Dexia-France

Most of the attention on unjust debt has been at the country level. However, debt cancellation can also occur at the municipal level. One example is the Hammersmith and Fulham vs Hazell case in the UK.12 In the 1980s, 137 UK councils were encouraged by banks and brokers to enter into multiple interest rate swap agreements. Hammersmith and Fulham Council was the largest player in the market and had signed hundreds of swap contracts with Goldman Sachs, placing taxpayers on the hook for £300 million in potential losses as interest rates moved against the councils in favour of the investment banks. The government as the lender of last resort to councils took an interest in the case, as council defaults became a realistic proposition. Ultimately, judges in the High Court ruled in 1989 that councils entering into standalone swaps and derivatives contracts was ‘ultra-vires’, or outside councils’ legal powers. Despite an appeal by the banks13, in 1991 the House of Lords upheld the ruling, deciding it was not the 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.

More recently, Italian municipalities including Milan were mis-sold derivatives by London-based banks. When the UK’s financial regulator failed to act, Milan’s chief prosecutor Alfredo Robledo resorted to locking the banks’ employees out of their Italian offices in 2009.14 The banks settled with Milan in 2012, tearing up the offending swap contracts and paying the city almost €500m.15 In France, local authorities have refused to repay in full loans to bailed-out Dexia bank, on the basis that they were misled into taking them out. One of them, Le Chevalier, a northwestern coastal town, stopped paying the variable Swiss franc-pegged rate on their loan that had reached 13%. Instead the mayor decided to pay only a fixed rate of 3% which corresponded to the initial rate of the loan.16 “I was not elected to raise taxes and to have those taxes go directly into banks,” said mayor Xavier-Martin of Le Chevalier, “Directly or indirectly, the state will end up having to pay the bill.”

“I was not elected to raise taxes and to have those taxes go directly into banks.”

17. Saint-Etienne marque des points en justice contre la Royal Bank of Scotland, C.Ferrero, Club Finances, 25 Nov 2011 http://loboloans.uk/Etienne-RBS

Another French city disobeying its creditors is Saint-Etienne in central France.17 In November 2011, the High Court of Paris dismissed the Royal Bank of Scotland’s request for the city to pay for the swaps owed to the bank. The judge recognised the elected officials’ argument that the “speculative product [had been] wrongly proposed” to the cities.

18. UBS, others reach $100 million muni bond rigging settlements, J.Stempel, Reuters, 24 feb 2016 http://loboloans.uk/USMunicipalities

In the US, a group of cities led by Baltimore and the Central Bucks School District18 in Pennsylvania accused banks of conspiring to fix prices for municipal derivatives, causing them to receive lower interest rates than they would have got in a competitive marketplace. The resulting legal action prompted settlements against the banks amounting to hundreds of millions of dollars.

19. Notes on Wall Street’s bid-rigging scandal, M.Taibbi, Rolling Stone, 22 June 2012 http://loboloans.uk/USMunicipalities

Journalist Matt Taibbi who covered the municipal bid rigging scandal for Rolling Stone19 said: “To me the most disturbing thing that came out in the Carollo trial was how easy it is for financial companies to rip off cities and towns once they start cooperating. Municipalities really have no defense against this sort of behavior; it’s not like they can arrange the bond issues themselves. So it surprises me that there hasn’t been more of an uproar from local

10 officials over this behavior. One can hope the only reason for that is that they don’t know about it.”

Local authorities’ illegitimate debt drains resources from the public sector as severely as on the national level. Often, these cases receive little attention from campaigners, media and regulators, but are fundamental in showing how local democracies can stand up to too-big-to fail banks. With this report, we hope to provide some tools to do so in the UK .

Template 1: Evaluating Illegitimate debt The following arguments can be used to evaluate the legitimacy of debt: A. According to the contract of the debt: • Debt which terms and conditions infringed the law (both national and international) or public policy • Debt which contract contains abusive clauses that are grossly unfair and unreasonable • Debt which conditions included policy prescriptions that violate national laws or human rights standards B. According to the origin of the debt: • Debt resulting from excessive power of the lender over the borrower • Debt contracted under threat or pressure, or imposed on democratically elected institutions • Debt contracted to the detriment of the population, for the benefit or preservation of those in power • Debt where the lender profited extortionately from the borrower • Debt contracted fraudulently or due to corruption of public institutions • Debt resulting from breaches of regulation or due process • Debt contracted by a public body to lend to a third party • Debt public institutions have assumed on behalf of private companies without the approval of the population or their representative • Debt for which part or all of the information regarding its contracting was omitted or for which there is currently no access to the information • Debt contracted to finance projects or processes that generate – directly or indirectly – environmental impacts, social inequality or violate economic, social, cultural and environmental rights • Debt contracted to subsidise poorly designed or programmed projects that have not benefitted the majority of the population C. According to servicing the debt: • Debt which payment interferes with the sovereignty of the population • Debt which interest payments are excessive, preventing social expenditure and causing the impoverishment of the population • Debt which interest payments generate violations of economic, social, cultural and environmental rights.

Source: adapted from PACD 20

20. Descifra tu deuda, Yago Alvarez Oct 2016 http://www.cadtm.org/Descifra-TuDeuda-Guia-de

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3 Local government finance Structure of local government Local government in the UK is made up of democratically elected bodies referred to as local authorities or councils, responsible for the economic, social and environmental well-being of their residents and the local area.

The sovereign body of a local authority is the full council meeting, in which all councillors, elected by us every 4 years, vote. The council meeting is responsible for: • agreeing the budget

Local authorities are organised in different ways and vary in size and structure:

•

In most of England there is a two-tier system composed of county councils, which provide 80% of services for the entire area, and district councils, which cover local services for smaller areas.

•

In some areas of the UK there is a single-tier structure, which can be a metropolitan area or a unitary authority.

•

London is a unique two-tier system composed of 32 unitary authorities (plus the City of London) called boroughs, which provide local services, and the Greater London Authority, which provides some of the city-wide services.

• appointing chief officers • setting policy framework • making constitutional decisions While councillors are responsible for the overall decision-making, the implementation of decisions along with day-to-day operations is managed by unelected officers. By law, every local authority must appoint three key officers: • a Chief Executive who advises on policy, procedure and legislation • a Monitoring Officer who advises on the legal framework in which the council can operate • a Section 151 Officer who monitors the council’s financial affairs The three officers have delegated authority to sign financial contracts, such as loans, on behalf of the council.

However, given the progressive financialisation of local government and the complexity of financial markets, many local authorities lack inhouse specialised knowledge and skills required for investing and borrowing, so they hire external firms for advice called treasury management advisors (TMAs).

TMA’s advice and opinion is unregulated and not always independent, as we will see in chapter 5 when we look at how councils entered LOBO loan agreements.

The 2000 Local Government Act imposed the following governance structures for councils in England and Wales: • a directly elected mayor with a cabinet • a directly elected mayor and a council manager • a cabinet with leader • alternative arrangements for a committee system, which smaller English councils and Welsh councils can opt in to.

1.

Who stole the town hall, P. Latham, 2017

Several London boroughs, including Newham, have a Directly Elected Mayor (DEM) with a cabinet.

The system has been criticised1 as it makes councils vulnerable to corruption due to the concentration of power in fewer hands. This is perhaps most evident in the way in which outsourcing business has

12 expressed enthusiasm over the system. In his 2017 book Who Stole The Town Hall, Peter Latham quotes evidence by the outsourcing giant Capita on the Draft 1999 Local Government (Organisation and Standards) Bill, saying “the introduction of [directly] elected mayors”, had made it easier to “develop and negotiate effective leading edge(...) partnerships”, and noting that a leader in control of the council was helpful. Worryingly, DEMs cannot be removed if evidence of corruption emerges.

Latham also criticises the DEM system for being undemocratic and creating a new political class, where getting elected focuses on personality, not politics. The mayoral referendum system has not increased voter turnout either.

The cabinet overview and scrutiny system also marginalises non-executive councillors. According to research by the Association for Public Service Excellence quoted by Latham, 65% of executive members thought the reforms introduced by the Act had worked well, compared to 37% of nonexecutive members. The respective percentages for how many thought transparency had increased by separating transparency from scrutiny were 58% of executive members and 30% of non-executive members.

Local government income, expenditure and cuts The UK has the highest population size per local authority in Europe and is one of the most centralised countries in the world.2 Most decisions on local government finance are taken by central government which determines how funds are allocated to each council and for what use.

2.

Decentralisation: An assessment of progress, Greg Clark MP, 2012 http://loboloans.uk/centralisedUK

The 2011 Localism Act strengthened the power of central government over local government even further, as academics George Jones and John Stewart explain:3

3.

Who stole the town hall, P. Latham, 2017

4.

Local authority revenue expenditure and financing: 2018-19 budget, England, MHCLG http://loboloans.uk/2018Budget

According to the National Audit Office (NAO), from 2010 to 2018, funding from central government to local authorities has been cut by 49.1%. This figure is expected to rise to 56.3% by 2020,5 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.6 More councils are expected to soon follow.

5.

Financial sustainability of local authorities 2018, NAO https://www.nao.org.uk/wp-content/ uploads/2018/03/Financialsustainabilty-of-local-authorites-2018. pdf

There is significant uncertainty as to how local government will be financed post 2020. A recent survey among council officials7 suggested that 80% of councils fear for their financial sustainability and that Northamptonshire CC is just the tip of the iceberg.

7.

State of local government finance survey, LGiU MJ, 8 Feb 2018 https://www.lgiu.org.uk/report/lgiu-mjstate-of-local-government-financesurvey/

Councils do have other sources of funding available aside from government grants. The percentage of income from each source varies significantly for each authority based on size, location, local wealth and social needs, but is projected to average as follows for 2018/19:8

8.

Local authority revenue expenditure and financing: 2018-19 budget, England, MHCLG http://loboloans.uk/2018Budget

“It is ironic that a Localism Act contains so many means by which central government can prescribe how local authority powers are to be used, their procedures developed and criteria to be applied by them… [it] could as well have been called the Centralism Act.” Local authorities find out their individual grant allocations from central government for the next financial year through the Local Government Finance Settlement, which is published in December and approved by Parliament in February. Councils then set their budgets for the following year that runs from April to March. Local government funding amounts to approximately a quarter of all UK public spending. In the 2018/19 financial year, the total amount of grant funding from central government to councils in England is projected to be £48bn.4 Local authority income from central government has been progressively reduced since 2010 with the introduction of austerity measures. Under the coalition government’s plans that presented a major overhaul to public finances following the 2008 bank bailouts, local authorities were singled out to bear the highest proportion of cuts. The reforms to local government funding were phased in over a decade, resulting in today’s mounting crisis where local services are on the brink of collapse.

Following the bank bailouts of 2008, local authorities were singled out to bear the highest proportion of cuts.

Chart 3.1: The jaws of doom £60bn Funding Net expenditure £55bn

£50bn

Source: Room151

2019/20

2018/19

2017/18

2016/17

2015/16

2014/15

2013/14

2011/12

2012/13

£40bn

2010/11

£45bn

•

central government grants (50%)

•

council tax (31%)

•

retained income from business rates (18%)

•

reserves, charges for council services and other items (1%)

The relative percentages between these different sources of income 100%

1%

18

21

21

6. Struggling Northamptonshire County Council bans spending, BBC News, 2 Feb 2018 - https:// www.bbc.co.uk/news/uk-englandnorthamptonshire-42920716

£60bn

13

Funding Net expenditure £55bn

have changed significantly since the introduction of austerity measures and devolution legislation for councils, such as the rights to retain some income from business rates, to increase council tax and to introduce a social care levy. These rights were granted by central government to encourage £50bn councils to raise more income locally.

Chart 3.2: Local government income (2018/19)

2019/20

2018/19

2017/18

2016/17

2015/16

2014/15

2013/14

consequence of the cuts, over 90% of councils in England plan to raise council tax and increase charging for services in 2018.9 This will have significant impacts on residents, especially those on low incomes, who will end up paying more for less services. £40bn 2011/12

£45bn As a

2012/13

Financial sustainability of local authorities 2018, NAO https://www.nao.org.uk/wp-content/ uploads/2018/03/Financialsustainabilty-of-local-authorites-2018. pdf

2010/11

9.

Chart 3.3: Variations in local government income (2010/11-2019/20)

100% 18

1%

21

21

19

20

80%

18%

36

60%

50% 41

40%

31%

51

46

20%

20 £60bn

0%

2010/11

Funding Net expenditureCouncil tax Central government Business rates Other £55bn

Central government (includes redistributed business rates) Business rates (locally retained)

-10%

11%

4%

Council tax Other

0% Source: NAO (data excludes direct schools funding & grants outside aggregate external finance)

Source: MHCLG £50bn

8 2019/20

2015/16

Local5%authority spending falls -20% into two main areas: revenue spending for running services; and 37% spending for capital projects, like building infrastructure and schools.

5%

£45bn capital

-30%

80%

• Environmental (5%)

60%

18% • Children’s social care (9%)

18

• Administration (3%) • Cultural (2%) 19

36

21

20

• Fire and rescue (2%)

• Planning and development (1%) 41

40%

51

£100bn are 20% changing £90bn

46 These relative considerably as councils adapt to reductions in central Other percentages 7%grants by introducing cuts to local services.11 government 20 £80bn 0% £70bn

Banks 20%

Chart 3.4:government Local government Central Council tax Business (2018/19) rates Other spending

Council tax Other

-10% £20bn

Source: MHCLG

Source: NAO

£90bn

2017/18

2015/16

2014/15

2013/14

2012/13

2011/12

2010/11

2016/17 Central service

1

Environmental

Adult Social Care Children Social Care Highways & transport Other

£100bn

Other

Other

Cultural

-60% Education Police Environment Health

Banks

-50%

Planning

17%

2009/10

PWLB

-40%

12%

2008/9

-30%

Highways & transport

Other

9%

2007/8

Banks

£10bn -20% 2006/7

37%

Housing

5%

2005/6

11%

PWLB

£60bn 3.5: Chart Central government (includes redistributed business rates) Business ratesgovernment (locally retained)spending (2010-2017) £50bn Variations in local

2004/5

5%

8 2019/20

2015/16

£40bn 0% £30bn

PWLB 73% 4%

2010/11

2003/4

11. Financial sustainability of

local authorities 2018, NAO https://www.nao.org.uk/wp-content/ uploads/2018/03/Financialsustainabilty-of-local-authorites-2018. pdf

21

• Housing (2%)

50% • Highways and transport (5%) 31%

Environmental

Children Social Care

Cultural

Police

1%Highways & transport • Environment Police (12%) Health Other

• Public health (4%) Highways & transport

• Education Adult social care Adult Social(17%) Care

Planning

-60% 100%

Housing

• Education (37%)

Central service

2019/20

2018/19

2017/18

2016/17

2015/16

2014/15

2013/14

2012/13

2011/12

9%government delivers services either directly, or in partnership with others or by commissioning Local -40% services from a third party. Revenue expenditure on services is expected to be broadly distributed 10 12% for 2018/19, but will vary from council to council: as follows 17% -50%

£40bn

2010/11

10. Local authority revenue

expenditure and financing:

2018-19 budget, England, MHCLG http://loboloans.uk/2018Budget

14 Local authorities have, with varying success, tried to protect spending on areas such as adult and children’s social care, where they have statutory responsibilities. For these services they receive specific support grants from central government and have been allowed to introduce a social care levy to raise more funds locally. Cuts have hit hardest in spending areas that are more discretionary.

According to the NAO,12 spending on housing services in England has fallen by 45.6% since 2010, while spending on planning and development and highways and transport have fallen respectively by 52.8% and 37.1%. Spending on cultural and related services also fell by 34.9%. Unfortunately, a lack of consistent categorisation and data documenting changes in these areas makes it difficult to assess the impacts of spending reductions on the population.

The number of households assessed as homeless in England increased by 33.9%.

12. Financial sustainability of

local authorities 2018, NAO https://www.nao.org.uk/wp-content/ uploads/2018/03/Financialsustainabilty-of-local-authorites-2018. pdf

Alongside reductions in funding, local authorities have had to deal with growth in demand for key services, in particular relating to crises in homelessness and adult and children’s social care.

From 2010/11 to 2016/17 the number of households assessed as homeless and entitled to temporary accommodation in England increased by 33.9%; the number of looked-after children grew by 10.9%; and the estimated number of people in need of care aged 65 and over increased by 14.3%.13

13. Financial sustainability of

local authorities 2018, NAO https://www.nao.org.uk/wp-content/ uploads/2018/03/Financialsustainabilty-of-local-authorites-2018. pdf

A combination of reduced funding and higher demand has meant that a growing number of local authorities have not managed to remain within their budgets and have relied on reserves to balance their books. These trends are not financially sustainable. The NAO14 estimates that 10.6% of local authorities with social care responsibilities have the equivalent of less than three years’ worth of reserves left if they continue to use them at the rate they did in 2016/17. The government has used multiple short-term funding initiatives in recent years to address some of the funding gaps, especially with regards to social care. However, this is not a sustainable alternative to a long-term funding plan.

According to the NAO:

14. Financial sustainability of

local authorities 2018, NAO https://www.nao.org.uk/wp-content/ uploads/2018/03/Financialsustainabilty-of-local-authorites-2018. pdf

“Financial uncertainty creates risks for value for money as it encourages short-term decision-making and undermines strategic planning.”

“Financial uncertainty, both short term and long term, creates risks for value for money as it encourages short-term decision-making and undermines strategic planning.”

Outsourcing has also increased markedly since 2010 with the UK becoming the world’s second-largest outsourcer of public services and contracts after the US. Public money spent on outsourcing contracts has doubled since 2010; in local authorities the increase has been from £16bn to £32.5bn.15

15. Who stole the town hall, P. Latham, 2017

It appears that the policy intentions of central government are to reduce the role of local government to a provider of a narrow core of social care services, that in many cases will be then outsourced to private companies. This model is known as commissioning councils, and is already been experimented with in local authorities such as the London borough of Barnet.

Local government borrowing When income is not sufficient to run and maintain services, or when local authorities need to invest in new infrastructure, they borrow funds to cover their costs. Borrowing can be either short-term or long-term.

Short-term borrowing is limited to a year and is usually used for managing cash flow for revenue spending. Long-term borrowing should be only for capital purposes, or for managing the council’s debt portfolio. Loans to local authorities are secured by statute on their overall revenue, rather than by a specific asset, income or collateral in their accounts.

Councils can borrow from ‘any willing lender’. The amount and sources of borrowing vary for each individual council but overall, local government in 2017/2018 held outstanding debt in the form of:16 • loans from central government via the Public Works Loan Board (73%) • loans from private banks (20%)

16. Borrowing and investment live tables, MHCLG, Q4 2017/18 https://www.gov.uk/government/ statistical-data-sets/live-tables-onlocal-government-finance#borrowingand-investment

• bonds (5%) • loans from other sources (2%) The statutory body through which central government lends to local authorities is called the Public Works Loan Board (PWLB). The PWLB borrows from the National Loans Fund, which is the account that HM Treasury holds at the Bank of England. The PWLB offers both fixed (up to 50-year) and variable rate (up to 10-year) loans and its interest rates are determined by the Debt Management Office (DMO) using a specific methodology17 defined by HM Treasury in accordance with the 1968

17. PWLB Annual Report and Accounts 2017-2018 - https://dmo.gov.uk/ media/15575/pwlbrep2018.pdf

18. Arlingclose written evidence to 2015 CLG Committee parliamentary inquiry “Local Council Bank Loans” http://loboloans.uk/Arlingclose

2019/20

2018/19

2017/18

2016/17

2015/16

2014/15

2013/14

2011/12

2012/13

2010/11

£40bn

15 100%

National Loans Act. The maximum duration of PWLB fixed rate loans 21 was increased to 5021years from 18 1% December 2005.18 30 years on 1st 80% 18%

19

20

Borrowing from central government is the safest 36 option for councils due to the transparent way in 60% which interest rates and breakage costs are calculated. The PWLB also offers lower interest rates for 50% loans that are to be used for specific purposes, for example infrastructure, and is in theory, the lender 41 40% of last31% resort to local authorities: should a council be in financial difficulty, the PWLB can51intervene.

In November 2016 the government announced46that the PWLB will be abolished and its functions 20% transferred to HM Treasury. It is yet to be seen what changes this will bring.

20

8

0%

Borrowing from banks is usually expensive 2010/11 and often risky. However, 2015/16 it became frequent 2019/20 in the 2000s.

Borrowing was mainly in the form of LOBO loans, described in detail in the next chapter.

Central government Council tax Central government (includes redistributed business rates) Council tax Business rates

19. Local government in England: capital finance, Commons Library Standard Note, 2014 - http:// loboloans.uk/CommonsLibrary2014

Other

Business rates (locally retained)

Other

Some local authorities also issue bonds.

A bond is a type of loan that gives the bondholder the right 0% to receive regular payments in the form of interest until a specified time in the future. When bonds a council has -10% value of the loans must be paid in full to all bondholders at the 11%issued expire, the original same4% time. Bonds allow councils to raise substantial sums of capital immediately, but can be risky -20% to repay the bonds when they mature. Municipal bonds were 5% authority becomes if a local unable 37% 5% used regularly throughout the early and mid-20th century, but fell into disuse during the 1970s and -30% 1980s, when the PWLB became the main source of borrowing. The Greater London Authority (GLA) 9% and Transport for London (TfL) are -40%the main bond issuers among UK local authorities as they have access12% to substantial revenue streams.19 17%

-50%

Central service

Environmental

Cultural

Housing

Planning

Chart 3.6: Local government debt (2017/18)

Highways & transport

There is another form of financing used in local government called Private Finance Initiative (PFI) -60% which involves setting up a partnership with the private sector to finance, construct and maintain Education Adult Social Care public services.

PFI financing is complex in the way it is set up, accounted for and impacts local Police Children Social Care Environment finances.

Highways &We transport government will not go into detail about PFI in this report, however it will appear when Health Other we look at council expenditure on interest payments.

Chart 3.7: Variations in local government debt (2003/4-2017/18) £100bn

Other 7%

£90bn £80bn £70bn

Banks 20%

£60bn £50bn £40bn

PWLB 73%

£30bn £20bn

PWLB Source: MHCLG

20. Borrowing and investment live tables, MHCLG, Q4 2017/18 https://www.gov.uk/government/ statistical-data-sets/live-tables-onlocal-government-finance#borrowingand-investment

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

Other

2005/6

Banks

2004/5

PWLB

2003/4

£10bn

Other

Source: MHCLG

Outstanding local authority long-term debt in 2017/2018 totalled £95bn.20 Over the last 10 years, long-term debt of local authorities has nearly doubled with the sharpest increase of £21.9bn 1 last year.

This was mainly in the form of PWLB debt, likely due to current favorable rates.

Outstanding local authority long-term debt in 2017/18 totaled £95bn.

As a result of borrowing through PFI, PWLB and bank LOBO loans, councils spend a significant amount of their income on interest payments – sometimes as much as nearly 70% of what they receive in council tax income.

Regulation and scrutiny of local government finance Local authorities are supposed to be accountable to central government through the Ministry for Housing, Communities and Local Government (MHCLG) and HM Treasury, but also through other departments for specific grants and related services, for example the Department of Education for education and children’s services, and the Department of Health for adult social care and public

16 health. The MHCLG also publishes statutory guidance for councils on investments and minimum revenues provision.

Concerns regarding the effectiveness of scrutiny of local government by the MHCLG were raised in June 2018 by the Public Accounts Committee inquiry on the “Financial sustainability of local authorities”:21

21. PAC inquiry on the “Financial sustainability of local authorities”, 2018 - http://loboloans.uk/PACinquiry

“There is no shared definition of what financial sustainability means in practice in the local authority sector.”

“The Department does not have a consistent and transparent method to assess financial risk in local authorities. [...] There is therefore no shared definition of what financial sustainability means in practice in the local authority sector. In particular, the Department is not able to say at what specific point it would have a concern either about individual local authorities or the sector as a whole.

This lack of information on the Department’s understanding of financial risk amongst local authorities complicates both assessing risk in the local authority sector and holding the Department to account. It also raises a concern that the Department lacks a clear methodology for assessing risk on a consistent basis. Similarly, the Department does not make public any of the work underlying its bid as part of the government’s 2015 Spending Review, which determined how much money the Department will have over the following four years, and how much government funding local authorities will receive.”

The Chartered Institute of Public Finance and Accountancy (CIPFA) has the responsibility to produce the Prudential Code and the 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. CIPFA also issues guidance for council finance officers and public finance auditors.22

22. PWLB Annual Report and Accounts 2017-2018 - https://dmo.gov.uk/ media/15575/pwlbrep2018.pdf

Local authorities may borrow from ‘any willing lender’, as long as it is ‘socially sustainable’.

Prior to 2003 council borrowing was very much controlled by central government. The Prudential Code,23 introduced by the 2003 Local Government Act gave local authorities powers to set their own borrowing limits and to borrow from ‘any willing lender’ (as long as in GBP sterling) without consulting central government, provided the borrowing was ‘socially sustainable’.24 However, the code did not clarify how in practice individual councils should determine and measure the social sustainability of borrowing. The introduction of the Prudential Code resulted in a substantial increase in borrowing post 2004, which appears to be neither prudent, nor sustainable.25

23. Prudential Code, CIPFA http://loboloans.uk/PrudentialCode

Local government finance is unregulated26 by the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA) which has considered local authorities to be ‘sophisticated’ borrowers. The term suggests that councils are expected to hold the necessary experience and knowledge to fully understand risks when borrowing and investing, as if they were equals with investment banks. We will address this further in chapter 5 where we examine the illegitimacy of LOBO loans based on the power imbalance and information asymmetry between councils and banks.

26. Handbook, FCA, 2007 http://fshandbook.info/FS/html/ handbook/COBS/3/5

The following organsations, among others, submitted evidence in favour of the abolition of the Audit Commission:30 • Deloitte LLP • BDO LLP • Mazars LLP • Grant Thornton LLP UK • CIPFA • DCLG • Local Government Association • District Councils Network • County Councils Network

Local government finance is subject to external audit and scrutiny by specific bodies: in Scotland by Audit Scotland27, in Wales by the Wales Audit Office28 and in Northern Ireland by the Northern Ireland Audit Office29. 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. English councils can now either choose their own private auditing firm, or opt to have one assigned to them by the Public Sector Audit Appointments31 (PSAA). This arrangement was put in place in 2015 following the closure, under the pretext of cuts, of the Audit Commission, the public 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 fee-paying clients. Following the collapse of Carilliion in January 2018, calls for UK regulators to break up the big four accountancy firms have intensified.32 The Competition and Markets Authority (CMA) is being prompted to act, with Liberal Democrats leader Vince Cable stating:33 “It’s time that the CMA bared its teeth. The audit market has had too many structural problems over far too many years for it to be soft on the Big Four.”

Shadow Chancellor John McDonnell has also heavily criticised the firms:

24. Local government in England: capital finance, Commons Library Standard Note, 2016 - http:// loboloans.uk/CommonsLibrary2016 25. PAC inquiry on the “Financial sustainability of local authorities”, 2016 - http://loboloans.uk/ PACDRUKevidence

27. Audit Scotland www.audit-scotland.gov.uk 28. Wales Audit Office http://www.audit.wales/ 29. Northern Ireland Audit Office https://www.niauditoffice.gov.uk/ 30. Abolishing the Audit Commission, K.Tonkiss, C.Skelcher, 2015 https://research.aston.ac.uk/portal/ files/18843949/Abolishing_the_Audit_ Commission.pdf 31. Public Sector Audit Appointments https://www.psaa.co.uk/

32. Regulator urges inquiry into breaking up big four accountancy firms, A.Monaghan, The Guardian, 16 Mar 2018 - https://www.theguardian. com/business/2018/mar/16/frc-inquirybig-four-accountancy-kpmg-deloittepwc-ey 33. Pressure mounts on the CMA to break up accountancy’s Big Four, L.Ashworth, City AM; 1 Oct 2018 http://www.cityam.com/264093/ pressure-mounts-cma-break-upaccountancys-big-four

17 34. McDonnell takes aim at “big four” accountancy firms, J.Miller, BBC, 26 Jan 2018 - https://www.bbc.co.uk/ news/business-42833048

“There is almost a monopoly, a cartel that’s going on.” 33 Local government is first and foremost accountable to its local residents. The 2014 Local Audit and Accountability (LAA) Act sets out the process residents can use to address the financial accountability of the council. The LAA Act gives residents the right to 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 LAA Act rights can be exercised once a year during the summer, once the council’s draft accounts have been published. The council’s external auditor has the role to respond to the questions and objections submitted.

When filing an objection, residents can either ask for a public interest report on the issue raised, or ask the auditor to refer the case to the high court. The objector must specify why they believe the item in the accounts referring to iscan unlawful.

This is your definedcouncil’s as something the council: Didthey youareknow you inspect • spent or received without powers to do so accounts and challenge

spending decisions?

• took from orHere’s added tohow. the wrong fund or account

• spent on something that they had the power to spend on, but the decision to spend the money Is your council cutting jobs and services whilst paying extortionate sums in interest was wholly to unreasonably or irrational – as in, no reasonable person would have made the banks? decision.

Do you want to know how much public money is going to private companies

35. Reclaim local democracy, Research for Action, 2017 - https:// researchforaction.uk/project/reclaimlocal-democracy

running council services?

Research for Action produced in 2017 a guide explaining how to exercise these rights called “Reclaim local democracy: to challenge thefrustrated financial decisions of your council”. It is available Not getting thehow information you want and by lack of transparency? for free online.35

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 objectAudit to items in the local authority’sAct accounts Diargram 3.1: 2014• Local and Accountability rights 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 File an objection TAKEACTION ACTIONAS ASAARESIDENT! RESIDENT! TAKE Ask for a Ask report in the a question the auditor publicto Interest

Take the #LOBOloans to 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

Take Take thethe Ask for a High #LOBOloans #LOBOloans to to Court declaration high court thethe high court

4 Source: Research for Action guide: Reclaim local democracy 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

36. Corruption in UK local government: mounting risk, Transparency International, 2013 - http://loboloans. uk/TransparencyInternational

Overall the local government accountability and scrutiny system demonstrates widespread failings, making local government highly prone to corruption risk and unfair dealing as stated clearly in a 2013 report by Transparency International:35 “Here, a disturbing picture emerges, and one on which experts and interviewees were agreed.

On the one hand, the conditions are present in which corruption is likely to thrive – low levels of transparency, poor external scrutiny, networks of cronyism, reluctance or lack of resource to investigate, outsourcing of public services, significant sums of money at play and perhaps a denial that corruption is an issue at all. On the other hand, the system of checks and balances that previously existed to limit corruption has been eroded or deliberately removed. These changes include the removal of independent public audit of local authorities, the withdrawal of a universal national code of conduct, the reduced capacity of the local press and a reduced potential scope to apply for freedom of information requests.”

Having encountered many of these problems in our work, we believe that 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.

18 Diagram 3.2: Local government scrutiny and accountability

Parliament

• Legislates for statutory duties of local authorities and approves their annual funding

• Legislates fiscal rules to control national debt

HM Treasury

• Sets PWLB borrowing rates • Approves local authority requests to borrow in foreign currency

• Approves significant changes to the prudential system

Ministry for Housing, Communities and Local Goverment

• Is responsible for statutory

framework and policy for local authority capital finance

• Provides capital funding to local

National Audit Office

Other Goverment Departments

• Are responsible for setting policy across a range of services delivered by local authorities

• Provide grants to local authorities

authorities through grants

• Publishes guidance on local

• Scrutinises public spending for Parliament

• Produces Code of Audit Practice • Issues guidance to auditors to explain or supplement the Code

• Publishes reports on local

issues such as the financial sustainability of local authorities

authority investment and revenue provision for debt repayment

Local Authorities

• Are subject to a range of statutory duties • Are free to borrow without specific permission from central government

• Are required to ‘have regard’ to the Prudential

Code and to ensure the capital plans are prudent, affordable and sustainable

External Auditors

• Work in accordance with Code of Audit Practice • Audit council accounts • Respond to residents’ objections

• Must submit capital forecast, estimate and outturn returns to the MHCLG

• Must publish annual capital, treasury management and investment strategies

Chartered Institute of Public Finance and Accountancy

• Is responsible for the Prudential Code and the Treasury Management Code of Practice

Local residents

• Can vote in council election every 4 years • Can use the Freedom of Information Act • Can inspect and ask a question about the financial accounts • Can object to an item in the financial accounts Source: National Audit Office

Funding Intervention Scrutiny/Guidance Accountability

19

4 LOBO loans What is a LOBO loan?

Councils can borrow from any willing lender. Borrowing from central government via the Public Works Loan Board (PWLB) is usually cheaper and safer, however councils also borrow from banks.

Investors highly prize local government debt because, in theory, councils cannot default on debt obligations, as central government should intervene when a council gets into trouble. However, to win business, banks have to compete with the loan rates available from the PWLB. To compete, banks provide loans with ‘teaser rates’ (interest rates much lower than the PWLB rates for a short period at the start of the loans) and/or with interest rates slightly lower than the PWLB rate, but spread out over a significantly longer time period than loans available from the PWLB (30 years up to 2005, now 50 years).

Debt owed to banks by local authorities comes mainly in the form of Lender Option Borrower Option (LOBO) loans. The main feature of a LOBO loan, as the name suggests, is the embedded option. LOBO loans are typically very long-term loans (for example 40 to 70 years) and start with a given interest rate that can be fixed or variable. As part of the contract the lender (bank) has the option to propose, on predetermined future dates, such as every 6 months or every 5 years, a new rate. The borrower (the council) then has the option to either accept the new rate or repay the entire loan in full, without penalty. If the bank does not exercise its option to change the interest rate, the council can only exit the loan by paying a very high exit fee (breakage fee) which is entirely at the discretion of the bank.

Many LOBO loans also feature a teaser rate which may last from a few months to four or five years.

After the initial teaser period, the interest rate ‘steps up’ to a higher agreed interest rate. Such LOBO loans are called stepped LOBO loans.

1. CLG Committee parliamentary inquiry “Local Council Bank Loans”, 2015 http://loboloans.uk/CLGinquiry 2.

End of LOBO ‘lender’ option

by Barclays both criticised and praised, C.Marr, Room151 30 Jun 2016 - http://www.room151.co.uk/ treasury/end-of-barclays-borroweroption-on-lobo-loans-both-criticisedand-praised/

3.

NoLOBOs, Debt Resistance UK http://lada.debtresistance.uk/

4.

PAC inquiry on the “Financial sustainability of local authorities”, 2016 - http://loboloans.uk/ PACDRUKevidence

240 councils across the UK have taken out loans from financial institutions in the form of LOBO loans, with an estimate of £15bn in outstanding debt.1 This includes about £5bn that was originally taken out with Barclays in the form of LOBO loans, but that the bank restructured into fixed rate loans in 2016/17. Newham Council is by far the largest borrower of LOBO loans.2

240 councils across the UK have taken out LOBO loans, with an estimate of £15bn in outstanding debt.

The first LOBO loan contracts we are aware of were signed in the mid 1980s by a handful of small Scottish local authorities (Motherwell District Council, Monklands District Council and Ross and Cromarty District Council) and Westminster Council.3 The lender in these cases was the life assurance company Scottish Amicable, now Prudential Financial. Whether these were the first LOBO loans to local authorities or just the earliest loans for which documentation has been released under FOI remains unknown. LOBO lending to councils appears to have remained a minor activity for life assurers and building societies until the early 2000s. From then on, Barclays and a number of European banks, including Dexia, Depfa and Bayerische Landesbank, began LOBO lending in earnest. The use of LOBO loans grew markedly in a relatively short space of time from around 2003 until it peaked in 2007. From then on LOBO lending started to decline, with the exception of the Royal Bank of Scotland (RBS) who from 2010 suddenly became very active in the market. The loans eventually disappeared as it became more difficult to make them look attractive in a low interest rate environment with rates expected to rise.4 LOBO loans were also sold to housing associations. In mid 2009, they became one of the only

20 sources of funding for housing associations to refinance existing debts or to borrow anew, as a consequence of government policy and the collapse in longer-term lending in financial markets.5 Around 30 housing associations entered LOBO transactions despite clear warnings from analysts and advisers at the time about the punitive loan terms.6 Unfortunately data relating to such loans is not publicly available since housing associations are not subject to the Freedom of Information Act.

5.

LOBO loans explained, Inside Housing 9 Jan 2009 - http://loboloans. uk/InsideHousingLOBOs

6.

Associations court danger in bid for cash, C.Dowler, Inside Housing 9 Jan 2009 - http://loboloans.uk/ InsideHousingHA

7.

Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018

Chart 4.1: Top 50 local authorities with bank debt (2017/18) £600m £500m £400m £300m £200m

£0m

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 Aberdeenshire Brent Dorset Aberdeen North East Combined Authority

£100m

Source: MHCLG

Types of LOBO loans For all LOBO loans, the principal is only expected to be repaid in full on maturity, therefore there are no loan principal repayments during the term of the loan. However, there are different types of LOBO loans based on how the interest rate is calculated and paid.7

Vanilla LOBO loan A vanilla LOBO loan is a standard LOBO loan that starts with an agreed fixed interest rate that can be changed by the lender on the option dates. If the lender changes the interest rate, the council can choose to accept the new interest rate, or repay the loan principal without a penalty. The interest is usually paid yearly or every six months.

Zero to Par LOBO loan A Zero to Par (ZTP) LOBO loan is a LOBO loan that starts with an initial fixed interest rate where the interest is not paid regularly to the lender but instead is added to the loan principal. The interest is reffered to as compounded interest as the borrower will also pay interest on the interest as it goes to compose the new outstanding principal. If the lender exercises their call option, only the interest compounded to that date is paid by the borrower. After the option is called, the loan is converted to a vanilla LOBO loan with the borrower paying interest to the lender annually or semi-annually. If the lender does not exercise their option, the principal plus the total compounded interest is repaid in one go on the maturity date.

Inverse floater LOBO loan Inverse floater LOBO loans have a variable rate as their initial interest rate. Such rate is inversely connected to a fluctuating market index. RBS appears to be the only issuer of this type of LOBO loan. For RBS inverse floater LOBO loans the interest rate is given by an agreed fixed rate (usually above 8%) minus the GBP 10 year swap rate (known as ISDAfix). Most inverse floaters are also stepped LOBO loans and were sold with extremely low initial teaser rates.

Range LOBO loan Range LOBO loans also have a variable interest rate as their initial rate. Such rate assumes different values over time in connection with a specified market index (e.g. LIBOR) as follows: • If the index remains within a given range (say between 4% and 7%) the borrower will pay a certain agreed low interest rate (for example 3%).

• If the index moves outside of the range (say below 4% or above 7%), the borrower will pay a higher agreed interest rate (for example 8%).

21 Range LOBO loans were issued by Barclays which, in most cases, used the GBP 6 month LIBOR as the reference market index. Since 2016, the bank has restructured most of its range LOBO loans and transformed them into fixed-rate loans.

A ‘lose-lose bet’ for councils LOBO loans have been described by financial experts as a ‘lose-lose bet’ for councils because no matter what happens to interest rates, the one-sided terms of the loans ensure the banks always win.

8.

CLG Committee parliamentary inquiry “Local Council Bank Loans”, 2015 http://loboloans.uk/CLGinquiry

In the 2015 parliamentary inquiry on “local council bank loans” by the Committee for Communities and Local Government (CLG),8 the former Barclays trader Rob Carver explains why: “The important point here is that the borrower has no option to exercise until the lender has exercised theirs. The economic value lies with the lender. They are not going to exercise their option unless it is favourable for them to do so.”

A council could only make a small gain on LOBO loans if interest rates stayed at mid-2000s levels for the entirety of the loan duration, which was highly improbable, given the ultra long terms of the loans.

9. PWLB - https://www.dmo.gov.uk/ responsibilities/local-authority-lendingpwlb/ 10. FOI request on WhatDoTheyKnow - http://loboloans.uk/WDTKNorthamptonshire

11. Treasury and Capital Management Panel Bulletin, CIPFA, 2015 - http:// loboloans.uk/CIPFAbulletin

“The important point here is that the borrower has no option to exercise until the lender has exercised theirs.”

With LOBO loans, some councils are now paying interest rates above 11%, which is exceptionally expensive in the current interest rate climate where councils could be borrowing from the PWLB at around 1.7% for a 50 year loan.9 As an example, Northamptonshire Council is paying 11.375% on a loan from HSBC.10 Particularly expensive are the inverse floater loans sold by RBS designed to inversely reflect market interest rates, which are leaving councils paying interest rates above 7%.

The current low interest climate also means it is very unlikely banks will use their option to change the interest rate, as they would risk the council exiting the loan deal without paying a break penalty.

The Chartered Institute of Public Finance and Accountancy (CIPFA) explains:11 “As the option to change the rate rests with the lender, it may be assumed that the offered rate will always be higher than the headline rate. It is also likely that a new rate will be offered in an environment of higher interest rates.

LOBO loans may therefore look attractive to local authorities because the value of the options they have given can result in an interest rate which is (initially) below PWLB. However, the price for this is the risk that the lender’s option will be called at some future date. A LOBO is likely to be called when it advantages the lender and disadvantages the borrower.”

“A LOBO is likely to be called when it advantages the lender and disadvantages the borrower.”

It should be noted that CIPFA’s analysis ignores the risk of interest rates falling and councils being locked into LOBO loans with high interest rates until maturity.

12. Treasury Management Code, CIPFA - http://loboloans.uk/TMAcode

CIPFA’s Treasury Management Code also states:12 “An authority should put in place formal and comprehensive objective, policies and practices, strategies and reporting arrangements for the effective management and control of their treasury management activities. It is concerned with both interest rate risk (the risk that fluctuations in the levels of interest rates create an unexpected or unbudgeted burden against which the authority has failed to protect itself adequately) and refinancing risk (the risk that borrowing cannot be refinanced on terms that reflect the provisions made to do so or on terms inconsistent with prevailing market conditions at the time).”

We examine below both the interest rate and refinancing risk in the case of LOBO loans.

Breakage fee Should a council want to exit a LOBO loan without the bank exercising their option, they will be charged a very high breakage fee, in some cases 90% of the loan principal on top of the principal itself. This fee will include both the expected profit the bank would have made from future interest payments and the value of the derivative associated to the option of increasing the interest rate.

22 An indication of what the breakage fee could be is given by the fair value of the loan at a given time which is defined as:13

13. IFRS standards - https://www. iasplus.com/en/standards/ifrs/ifrs13

“the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”.

Fair value can only be calculated with sophisticated pricing tools that the council does not have direct access to and therefore cannot easily monitor without relying on external financial experts.

Fair value only gives an indication of the breakage fee, as the effective cost remains completely at the discretion of the bank.

Fair value only gives an indication of the breakage fee, as the effective cost remains completely at the discretion of the bank.

Financial expert Abhishek Sachdev and former Barclays trader Rob Carver explain this clearly when asked by MP Bob Blackman during the 2015 parliamentary inquiry.14

14. CLG Committee parliamentary inquiry “Local Council Bank Loans”, 2015 http://loboloans.uk/CLGinquiry

Bob Blackman MP:

“The bank will have a variable exit cost for the loan. Any local authority with one of these LOBOs at the moment will not know what they would have to pay to exit the deal. Is that right?”

Abhishek Sachdev: “They would only know if they asked the bank or they could ask a treasury adviser.”

Bob Blackman MP: “They apply and say, ‘We would like to exit this. What is the cost of exiting?’”

Abhishek Sachdev: “Correct, because you would need to have very specialist technical derivative pricing software to be able to price these things at any one point. You cannot go online and have a look, “What’s the rate today? Therefore, let me work it out myself.” That is not possible with these.”

At another point of the inquiry Sachdev also explains: “If the council wants to get out of these LOBO loans, they basically have to go to the bank and repurchase these call options that they sold. Whether they knew they sold them or not is a separate issue. They have to repurchase them and that adds to the cost as well.”

Rob Carver adds: “Can I make a further point? Even then, let us say Abhishek’s software says it would cost £15 million to get out of the deal, the bank could say £20 million and there is not really much the borrower could do, except try to find somebody else to assign that loan to, who would be willing to accept a more reasonable price.”

Interest over the lifetime of the loans LOBO loans are extremely expensive, as not only do they have high interest rates, but also very long terms. Councils are locked into them for many decades due to the punitive exit fees that make restructuring nearly impossible. The result is very costly total interest payments over the lifetime of the loan. For example, a £10m vanilla LOBO loan with a 60-year maturity at an interest rate of 4% will cost £24m in interest payments over the lifetime of the loan, more than twice the loan principal.15 This is assuming the bank doesn’t use its option to raise the interest rate, in which case the interest paid will be even higher.

The longer the term of the loan, the more interest rate risk the loan will carry. In other words, it is harder to predict how much money the council will be losing as a differential between the LOBO interest rate and both the market and PWLB rates over the lifetime of the loan. A bank, when issuing a loan, will hedge against the interest rate risk with an interest rate swap. A large borrower would usually do the same, but local authorities, from 1991, following the Hammersmith and Fulham vs Hazell ruling,16 were prohibited from taking out standalone swap contracts and therefore did not have the same capacity as the banks to protect themselves from interest rate risk. Since the 2011 Localism Act councils have been permitted again to enter derivative contracts.

In a quote provided directly to Research for Action, actuary Peter Crowley said:

15. LOBOs – Long term pain for short term gain?, J.Alexander, Collyer Bristow, 11 Aug 2015 http://loboloans.uk/CollyerBristow

16. Closing the swap shop, D.Campbell Smith, 2008 - http:// duncancampbellsmith.com/pdf/ ftm_chapter_6.pdf

23 “LOBOs are like a financial straitjacket that locks councils into an ultra long-term bet on interest rates for up to 70 years. While LOBOs are often likened to fixed-rate loans or described in error as interest rate hedging, the financial risk involved for council taxpayers is horrendous. Whether they know it or not, councils are taking on the banks risk, not ‘hedging’.”

“LOBOs are like a financial straitjacket that locks councils into an ultra l ong-term bet on interest rates for up to 70 years.”

Risk associated with the options 17. Treasury and Capital Management Panel Bulletin, CIPFA, 2015 - http:// loboloans.uk/CIPFAbulletin

Added to the interest rate risk is the derivative risk of the options. As explained by CIPFA:17 “A LOBO loan can be analysed in terms of its financial components, as follows: 1. a loan at a floating rate which reflects the lender’s cost of capital, the credit risk of the borrower, and the “LOBOs are lender’s profit margin inherently risky 2. an interest rate swap converting the variable rate into as a result of a fixed rate their embedded 3. a series of options, one for each option date; these optionality.” are known as Bermudan swaptions.

LOBOs are inherently risky as a result of their embedded optionality.[...] Authorities considering LOBOs will need to review LOBO quotes over a period of time, and understand the way in which pricing is sensitive to both swap rates and option value. The value of options is highly sensitive to volatility in market (swap) rates. The more unsettled long-term interest rates are, the greater the value in the options, and the better the LOBO rate should be.”

CIPFA adds:

18. LOBOs – Long term pain for short term gain?, J.Alexander, Collyer Bristow, 11 Aug 2015 http://loboloans.uk/CollyerBristow

19. CLG Committee parliamentary inquiry “Local Council Bank Loans”, 2015 http://loboloans.uk/CLGinquiry

“It is risky to take LOBOs with six-month or annual option dates; better to have options at five-yearly intervals which can be staggered for different loans.”

The more options there are associated to a loan (based on the length of the loan and the frequency of the call dates) the more risky the loan is, as it increases the probability of the interest rate being changed and the associated refinancing risk. This is reflected by the fact that the more options are included in the contract the more valuable the package of options is to the bank. The council, by signing the contract is effectively selling to the bank derivatives in the form of options.18 These options have a value so we should expect loans with many options to have lower interest rates than those with less, however this is not always the case.

Abhishek Sachdev explains this in the 2015 parliamentary inquiry:19 “If you look at the nature of a LOBO, it effectively has an embedded complex derivative within it. [...] What is that complex derivative? It is a series of options that have been sold by the Council to the bank, and the bank is in theory supposed to use the value of these options to give a superficially low, attractive teaser rate.”

A consequence of the option risk is that the council might decide to put aside reserves for the year the option falls so it can repay the loan if the bank calls the option. This ring-fences funds that could otherwise be used for benefitting residents. The more frequent the option dates and the larger the loan principals, the more reserves will be put aside to guard against refinancing risk.

20. Lancashire accounts’ sign off delayed over £50m LOBO loan, D.Brady, Pulbic Finance, 9 Aug 2018 http://loboloans.uk/GTdelay

In summer 2018, Grant Thornton, one of the external auditing firms, refused to sign off the accounts of 12 councils with inverse floater LOBO loans until CIPFA and the NAO provided more clarity on how the refinancing risk should be accounted for. They warned:20 “If councils with ‘inverse floating rate’ LOBOs have to change the accounting arrangements for the loans this ‘would knock £0.5bn off of local government reserves’ across those councils.’”

Local authorities have taken out complex financial instruments, introducing risk to the delivery of public services. LOBO loans are expensive and highly problematic products due to their duration and the embedded derivative. Why did councils take out LOBO loans? How was this allowed to happen? Who is responsible? In the next chapter we tackle these questions and argue that LOBO loans are illegitimate debt.

24

5 Are LOBO loans illegitimate debt?

Evaluating the legitimacy of LOBO loans Debt is illegitimate when it has been improperly granted or repayments are preventing the basic rights of a population from being met. There is no official definition - rather, illegitimacy is a concept where the interpretation depends upon the context and the power relations between the borrower and the lender.

We have examined the legitimacy of LOBO debt according to the following criteria: • The contracting of debt - are the terms of the loans legitimate?

• The origin of the debt - are the reasons why the debt was incurred in the first place legitimate?

• The servicing of the debt - is the way the debt is being paid for legitimate?

In this chapter, we focus on the analysis of the legitimacy of LOBO debt solely based on the terms of the contracts and the origin of the loans. We do not include the analysis regarding the social sustainability of servicing the debt: this needs to be done on a case by case basis, as it is specific to the impact the debt has on each council’s budget.

Here we examine the issues that apply to most councils that have taken out LOBO loans and provide a framework each council can use to autonomously assess the legitimacy of their LOBO debt. At the end of this chapter are questions that a local authority audit of LOBO loans can pose. In chapters 8 and 9 we address these questions specifically in relation to Newham Council.

Most arguments made in this chapter on the legitimacy of LOBO loans are based on evidence that was provided as part of the 2015 parliamentary inquiry “Local council bank loans” by the Communities and Local Government (CLG) Committee1 that was generated by a Channel 4 Dispatches documentary on LOBO loans called “How councils blow your millions”.2

1.

CLG Committee parliamentary inquiry “Local Council Bank Loans”, 2015 http://loboloans.uk/CLGinquiry

2.

How councils blow your millions, Channel 4 Dispatches, 2015 http://loboloans.uk/C4press

3.

Hazell v Hammersmith & Fulham LBC (1991), Maitland Chambers http://loboloans.uk/HvHFruling

A. Illegitimacy based on the terms of the contract 1. LOBO loans infringed the law and public policy as they contain derivatives and it has been deemed ultra-vires for councils to speculate with taxpayer money All LOBO loans contain embedded derivatives in the form of future options (see chapter 4). Councils were banned from taking out derivative contracts following a ruling in 1991 called Hammersmith and Fulham vs Hazell involving Goldman Sachs and other banks.3 The House of Lords ruled it was not councils’ role to speculate upon interest rates, and taxpayers should not be held liable (see chapter 2). Since the 2011 Localism Act, councils have been legally allowed to enter standalone derivative contracts again.

The above case law can be used to challenge all LOBO loans that were entered into between 24 January 1991, when the ruling was announced and 15 November 2011, when the Act was signed.

25 However, it could be argued that following the Hammersmith and Fulham vs Hazell case, councils were only prohibited from taking out standalone derivatives contracts and that the ruling should not be applied to LOBO loans where the derivative is embedded within the loan.

It is ultra-vires for councils to borrow to speculate with taxpayers money.

The underlying argument – that it is ultra-vires for councils to borrow to speculate with taxpayer money – remains in any case valid and can be used to challenge the legitimacy of LOBO loans, as with LOBO loans councils were effectively speculating on future interest rates. This is especially true for range and inverse floater LOBO loans.

4. FOI request on WhatDoTheyKnow http://loboloans.uk/Iceland-Kent 5. FOI request on WhatDoTheyKnow http://loboloans.uk/Iceland-Newham

Evidence is also emerging that would demonstrate that councils were intentionally using LOBO loans for speculative purposes. It appears from recent Freedom of Information (FOI) requests that some councils including Kent County Council4 and Newham Council5 were using LOBO loans as part of a co-ordinated investment strategy, referred to as a ‘carry trade’. LOBO loans taken out with short term low teaser rates were invested in Icelandic banks at higher rates of interest, with the council profiting from the interest rate differential.

The above evidence shows that LOBO loans can be considered illegitimate on the basis that they infringed the law and public policy as it is ultra-vires for councils to borrow to speculate with taxpayers’ money.

2. LOBO loans are a lose-lose bet with banks LOBO loans are a lose-lose bet for councils: because of the options, whether interest rates go up or down, a council will always lose out, while the lender will always benefit (see chapter 4). LOBO loans are therefore grossly unfair. Barclays even state openly in some of their contracts that: “The nature of this loan is that interest rates are likely to increase at a time that is least advantageous to you.”

6.

Arlingclose written evidence to 2015 CLG Committee parliamentary inquiry “Local Council Bank Loans” http://loboloans.uk/Arlingclose

The treasury management advisor (TMA) Arlingclose use these words in their written submission to the 2015 parliamentary inquiry:6 “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.”

“So heads the lender wins and tails the borrower loses.”

LOBO loans can be considered illegitimate on the basis that they are grossly unfair as the council will lose out almost whatever happens to interest rates.

3. Breakage fees on LOBO loans are excessive The terms for exiting a LOBO loan are grossly unfair. If the council wants to exit a LOBO loan without waiting for the bank to exercise its option, it will have to pay an exorbitant exit fee which is at the discretion of the bank (see chapter 4). The current low interest rate environment makes the breakage fee even more expensive, due to the value of the embedded derivatives, as financial expert Abhishek Sachdev explains in the 2015 parliamentary inquiry: “After the credit crunch when interest rates effectively collapsed, the breakage costs of cancelling these options and swaps absolutely ballooned.”

7. FOI request on WhatDoTheyKnow http://loboloans.uk/FOI-FCA

The terms for exiting a LOBO loan are grossly unfair.

Even the FCA, who otherwise has been reluctant to tackle LOBO loans as it claims to not regulate local authority finance, stated in a response to an FOI request by campaign group Move Your Money:7 “Supervision have done some work to look at whether LOBOs have unfair terms. [...] They looked at a sample of individual LOBOs and found that a handful may have unfair terms (e.g. big repayment penalties).”

The legitimacy of LOBO loans can be challenged on the basis that their breakage fees are excessive.

26

4. LOBO loans’ embedded options pose excessive risk for councils The more frequent the option dates, the more risky the loan is for the council.

The more frequent the option dates, the more risky the loan is for the council and the more valuable it is for the bank (see chapter 4).

Therefore, the interest rate offered should reflect the extra value of the options, but it very rarely does. In such cases the terms of the loans are grossly unfair.

Particularly risky and very common are LOBO loans with option dates occuring every 6 months.

Even more problematic are some of the first LOBO loans of the 1990s, where the bank is entitled to use its option whenever they want as long as they give the council a certain amount of days notice, effectively meaning that every day of the year can be considered an option date.

The following is taken from a loan to East Dunbartonshire Council:8

8. LOBO loan contract https://goo.gl/WhvJjx

“The Lender only has the option on the 18th August 1999 or any day thereafter to change the interest rate of the deposit giving one months notice. If the new rate is not agreed the Borrower will repay the loan on the expiry of the notice period having given one months notice.”

LOBO loans’ legitimacy can be challenged on the basis that options pose excessive risks for councils and the interest rates offered do not compensate for such risk.

5. Notice and response times for interest rate changes for LOBO loans are unreasonably short Councils, in many cases, are given less than 24 hours to decide what to do, and if they want to exit the loan, they have very little time to secure the funds to do so.

For most LOBO loans, the notice period associated with the options is excessively short. Some contracts state that, if the bank wants to exercise its option to change the interest rate, it is only obliged to inform the council 2-3 business days in advance. If the council then wants to exit the loan without a penalty, it is usually given up to 2 business days before the option date to notify the bank. Councils are in many cases given less than 24 hours to decide what to do, and if they want to exit the loan, they have very little time to secure the funds to do so. These are grossly unfair terms. In the current context, where councils cannot rely on reserves that are being rapidly depleted by austerity, this becomes particularly problematic.

Here is an example taken from a Barclays LOBO loan:9 “If a Registered Holder (the bank) notifies the Council by no less than two business days prior notice that an increase in the rate of interest will occur on a Lender’s Option Date, then the Council may, if it has given the Registered Holder prior written notice to that effect by no later than 5pm on the Business Day preceding such proposed increase, prepay the Loan on the date of such proposed increase together with accrued interest thereon to the day of prepayment.” 8 In other words, a council could find itself in the situation in which it has to respond to the bank within 17 hours from the notification.

LOBO loans can be considered illegitimate as they contain grossly unfair clauses such unreasonable notice times for when the options are called.

B. Illegitimacy based on the role of central government in the origin of the debt 1. Councils were encouraged by central government to take on risk by borrowing from banks Between 2003 and 2010, the Department for Communities and Local Government (DCLG) and HM Treasury introduced legislations and policies which made borrowing from banks more attractive, opening the road for a sharp increase in LOBO loan debt issuance. The policy levers that influence

9. LOBO loan contract https://goo.gl/uPiWKL

27 the amounts and type of borrowing undertaken by councils are retained within HM Treasury.

10. Local government in England: capital finance, Commons Library Standard Note, 2016 - http:// loboloans.uk/CommonsLibrary2016 11. PAC inquiry on the “Financial sustainability of local authorities”, 2016 - http://loboloans.uk/ PACDRUKevidence 12. Finance unlocked, G.Robertson, Inside Housing, 15 Mar 2013 - http:// loboloans.uk/HRAreforms

13. Arlingclose written evidence to 2015 CLG Committee parliamentary inquiry “Local Council Bank Loans” http://loboloans.uk/Arlingclose

The 2003 Local Government Act gave local authorities freedom to set their own borrowing limits and to borrow from any willing lender without consulting central government, as long as it was in GBP sterling and provided the borrowing was ‘socially sustainable’.10 The introduction of the Prudential Code resulted in a substantial increase in borrowing post 2004, including LOBO loans.11 Under a package of housing finance reforms known as the Housing Revenue Account (HRA) reforms,12 introduced between 2009 to 2012, central government offered councils the option to transfer housing stock to housing associations in exchange of a reduction of their Public Works Loan Board (PWLB) debt. Depending on the amount and type of debt they had, the councils were entitled to either a write-off or a removal of penalties for early repayments of their PWLB debt. Many local authorities used LOBO loans to refinance their historic PWLB debt.

DCLG and HM Treasury introduced legislations and policies which made borrowing from banks more attractive.

The TMA Arlingclose explain in their evidence to the 2015 parliamentary inquiry how, the method councils use to account for debt restructuring in their financial accounts, made LOBO loans attractive for refinancing existing PLWB debt:13 “When a loan is restructured a premium or discount is generated. A premium will arise if the loan repaid has an interest rate above prevailing refinancing rates whilst a discount will be received by the borrower if the loan repaid has an interest rate below prevailing refinancing rates.

Accounting regulations allow for the premiums paid to be held on the balance sheet and amortised to the revenue account over the life of the replacement loan. This was attractive because the lower refinancing rate would immediately benefit the revenue account (the figure often quoted as representing a saving) whilst the premium could be spread to the revenue account over time depending upon the length of the refinanced loan.

If [a] LOBO was over a period longer than that available from the PWLB then [...] the premiums arising from debt restructuring could be amortised over that longer period. The premiums, where they are held on the balance sheet, are typically excluded from the figures often quoted as representing savings.”

14. All change again at the PWLB, D.Green, Room151, 23 Mar 2012 http://www.room151.co.uk/latest/allchange-again-at-the-pwlb/

In November 2007, HM Treasury introduced new early loan repayment penalties14 which made it substantially more expensive to refinance existing local government debt borrowed from the PWLB at historically high interest rates during the 1980s and 1990s. Prior to 2007, local authorities restructured their PWLB debt on a relatively frequent basis, but the number of loans refinanced dropped sharply thereafter. According to Arlingclose the increase of the PWLB repayment penalty made LOBO loan borrowing even more attractive.

15. Council borrow costs rocket 25%, J.Illman, LGCplus, 22 Oct 2010 http://loboloans.uk/PWLB25pc

Changes in PWLB interest rates also made PWLB debt more expensive and LOBO loans more attractive. In September 2010, Chancellor George Osborne raised the interest rate premium paid by councils to borrow from the PWLB by 1%, resulting in 25%15 increase in the cost of borrowing and a 75%16 reduction in PWLB borrowing by councils.

16. Borrowing slumps following shock rate rise, J.Illman, LGCplus, 10 Feb 2011 - http://loboloans.uk/PWLB75pc 17. Analysis claims Labour councils secure worse PWLB rates, C.Marr, Room151, 14 Jan 2016 -http:// loboloans.uk/PWLBbias

Financial analyst Nick Dunbar, who has also investigated LOBO loans, is quoted17 in an article by Room151 saying that the government should remove repayment penalties all together and stop treating PWLB loans to local authorities like private sector loans.

“After all, if taxpayers’ money is being shunted from central to local government and back again, why is a market rate necessary? Isn’t the point of central government that it can insulate small players, such as councils, from forces such as interest rate shifts, which they can’t control?”

18. Analysis claims Labour councils secure worse PWLB rates, C.Marr, Room151, 14 Jan 2016 -http:// loboloans.uk/PWLBbias

Nick Dunbar also noticed a pattern where Conservative councils found themselves with loans at lower PWLB rates than Labour councils (by 0.48%) or than councils with no overall control (by 0.62 %), suggesting political bias in how the rates were set. In response, HM Treasury has emphasised18 that the same rates apply to all borrowers: “The PWLB applies the same high standards of impartiality consistently across all local authorities regardless of political complexion. [...] They vary depending on the type and length of loan and repayment method, which is down to individual authorities to decide upon. [...] The PWLB does not take into account the political control of a local authority.”

We would expect HM Treasury to act in the public interest and not try to profit from councils or push them towards financial markets.

28 As local authorities are public bodies, we would expect HM Treasury to act without political bias and in the public interest, not try to profit from councils or push them towards financial markets.

LOBO loans contracted after November 2007 can be considered illegitimate on the basis that councils were encouraged by central government to take on higher risk by borrowing from banks rather than from the PWLB.

C. Illegitimacy based on the role of the banks and intermediaries in the origin of the debt 1. LOBO loans are the result of an excessive power imbalance between too-big-to-fail banks and public institutions The banks that sold LOBO loans, such as Barclays and Royal Bank of Scotland, are some of the most powerful organisations in the world.

The banks that sold councils LOBO loans, such as Barclays and the Royal Bank of Scotland (RBS), are some of the most powerful organisations in the world. These banks have balance sheets many times the size of local authorities and larger than some countries, so councils have little influence on the terms of the contract when they need to borrow. Councils are legally obliged to balance their budgets and cannot default on debt; instead, they are forced by central government to introduce cuts to services or hike taxes.

Banks in turn are seen as too big to fail and can count on being rescued by taxpayer money. Either way, public institutions are impoverished when crisis hits, and people, especially the poorest, have to bear the brunt of failure. The power of banks over the media makes it near impossible to expose their wrongdoing, and banks’ influence over regulatory and legal systems makes it difficult for councils to fight back.

LOBO loans can be considered illegitimate because they result from the excessive power banks who sold them wield over society, including town councils.

2. Banks booked extortionate upfront profits on LOBO loans The fair value of LOBO loans on the day they were sold can be used as an indication of the vast profits made by banks. Profit margins on LOBO loans were huge compared to those for sales of loans or derivative products to corporate clients. Because of the way derivatives sales are accounted for, profits predicted for the 60-70 years of the loans were booked upfront by banks on the day the deals were made and paid out as bonuses that financial year.

Abhishek Sachdev explains in the 2015 parliamentary inquiry: “The analysis we did [...] showed that actually, across the country [...] we estimated £1.5 billion was generated effectively as upfront trading income and profit from these transactions [on £15bn of LOBO loans]. By any standard of derivatives, because we advise corporates on derivatives, even corporates that do hundreds of millions of borrowing, that was a phenomenal profit margin to generate. That profit margin effectively rips out so much profit on day one that it is expected to work against the best interest of the authority over that 60 or 70 year period, regardless of what happens to interest rates.”

“By any standard of derivatives, that was a phenomenal profit margin to generate.”

MP Mary Robinson asks: “£1.5bn is generated as upfront profits. [...] That compares to the £15bn of borrowing. Would that be something that would be appropriate?”

Abhishek Sachdev responds: “No. That £1.5bn is massively excessive. [...] That is 10%; that is far too high.”

The Chair (MP Clive Betts) also asks: “It is not something the bank can actually get hold of on the first day, is it?”

Rob Carver, a former Barclays banker who used to trade and hedge LOBO loans, explains: “The actual money comes in over a number of years [...], but the economic value of the deal

29 can be booked to the bank’s trading income on day one, under accrual accounting.”

Abhishek Sachdev adds: “The bank would have reported it in its annual accounts at that year and it would have paid out bonuses to all its investment banking staff at the end of that financial year, based upon the income for the whole 70 years, taken upfront on day one.”

Of particular note are the profits earned from councils via LOBO loans by RBS. By the end of 2010 fewer and 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: when market rates remain low, inverse floater rates stay high, and vice versa. 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. However, this has not been the case for a decade.

Alison Thewliss MP asks in the 2015 parliamentary inquiry: “RBS has said that it does not treat local authorities any differently from other customers. [...]

I just wondered what your view would be.”

Abhishek Sachdev responds: “In terms of RBS saying they treat them differently, from looking at the numbers, I think they treated them worse if that is what they mean, because they took more profits.”

While councils are dealing with austerity cuts imposed as a consequence of the bailout of RBS, the same bank is hugely profiting from the public authorities through extortionate interest rates.

“In terms of RBS saying they treat councils differently, I think they treated them worse, because they took more profits.”

LOBO loans can be considered illegitimate on the basis that banks booked extortionate upfront profits when selling them to councils.

3. LOBO loans were used to circumvent regulation LOBO loans could be seen as a way for banks to circumvent restrictions put in place by the 1991 Hammersmith and Fulham vs Hazell ruling. Embedding the derivative in LOBO loans provided a loophole to avoid the letter, if not the intent of the law.

19. Hidden swaps in fixed rate loans & TBLs, LexLaw, http://loboloans. uk/LexLaw

20. FCA written evidence to 2015 CLG Committee parliamentary inquiry “Local Council Bank Loans” http://loboloans.uk/FCAevidence

Furthermore, the marketing and sale of derivatives is regulated and the products have to be carefully explained when sold, since they carry serious and complex risk and can be very costly to exit.

Instead, regulation for the marketing and sale of loans is lacking and does not contemplate the embedding, or hiding, of complex financial instruments. It is possible that banks sought to avoid regulation with LOBO loans by asserting they were simply selling loans, not contracts containing derivative products.19

Embedding the derivative in LOBO loans provided a loophole to avoid the letter, if not the intent of the law.

They appear to have done so successfully. The following comment is from the Financial Conduct Authority (FCA) written evidence to the 2015 parliamentary inquiry:20 “Because it is commercial lending, activities related to making these loans, including arranging, advising or entering into a loan agreement, do not typically constitute regulated activities.”

Abhishek Sachdev commented in his oral evidence to the inquiry: “The FCA’s view is that these are just commercial loans. They are just a regular loan; you are signing a contract and, if you are not happy with it, go deal with a contract lawyer. The point is that my view is that these are commercial loans, but they have within them or they subject the council to the risks of a derivative and, therefore, these should actually be treated as regulated products. That is a very big debate going on, like I said, for corporates as well.”

It appears the banks packaged up an illegal product into a loan which is unregulated, and sold them to councils without adequately disclosing their true nature and the inherent risks. LOBO loans can be considered illegitimate on the basis that banks used them to circumvent regulations.

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4. Brokers were incentivised by banks’ high undisclosed commissions to act against councils’ best interests when arranging LOBO loans Banks and councils relied on brokers to arrange LOBO loans. There were many brokerage firms involved but the most common were ICAP, Tullet Prebon, Tradition and RP Martin.

The council would pay the 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 £10m loan a broker would receive £24,000 from the council.21

21. Arlingclose written evidence to 2015 CLG Committee parliamentary inquiry “Local Council Bank Loans” http://loboloans.uk/Arlingclose

At the same time, brokers were compensated by the banks with large commissions since they provided the banks with such high margins on the deals. As Arlingclose explain in their written evidence to the 2015 parliamentary inquiry, it was unusual for a lender to be paying such large commissions: “It is standard market practice for borrowers to pay brokerage, but we also understand in the case of LOBOs that the lending banks also paid brokers to facilitate transactions.”

“I did not see how the brokers could be giving their ultimate clients, the councils, independent advice when they were being paid by us.”

Rob Carver, the former Barclays trader, highlights why this was problematic in his oral submission to the inquiry: “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.“

LOBO loans arranged by brokers can be considered illegitimate as brokers were incentivised by high bank commissions to sell LOBO loans to councils against their interest and without disclosure.

5. Treasury management advisors’ advice to councils on LOBO loans was highly conflicted Due to the increase in complexity of local government finance, councils are relying more and more on external advisors to make decisions on borrowing and investments.

Chart 5.1: Councils advised

by TMAs (2009) 9% 9%

51% 31%

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.

Data from 2009 shows the following breakdown of advisors per council at the time:22

22. 2009 CLG Committee parliamentary inquiry “Local Authority Investment” - http://loboloans.uk/ IcelandInquiry

• Sector Treasury Services advised 250 councils • Butlers advised 144 councils • Arlingclose advised 40 councils Sector Arlingclose

Butlers Other

Source: Competition Commission

• Sterling Consultancy Services did not disclose the number of councils it advised • At least 16 councils did not have advisors

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. When the Icelandic banks collapsed in 2008, 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.

A CLG Committee inquiry into local authority investments launched in 2009 stated:23

23. 2009 CLG Committee parliamentary inquiry “Local Authority Investment” chapter 7- http:// loboloans.uk/IcelandInquiry

31 “The evidence which we have examined has raised concerns about potential conflicts of interest and questions as to whether there are any financial transactions between treasury management advisers and brokers that might compromise the independence of advice being given to local authorities. There is a strong case for a full investigation by the FSA [Financial Services Authority] of the services provided by local authority treasury management advisers. We recommend that such an investigation be carried out as soon as possible.”

Unfortunately the FSA, the financial regulator at the time, refused to undertake any inquiry into TMA firms.

Research by Debt Resistance UK has shown that TMA advice was highly conflicted in the case of LOBO loans. As explained in detail below, TMAs were receiving commission payments from brokers when LOBO loans were arranged. The conflict of interest of TMAs was mentioned in the Channel 4 Dispatches documentary on LOBO loans and was the main reason the 2015 parliamentary inquiry into bank loans was launched.

When interviewed in the Channel 4 documentary, Abhishek Sachdev commented: “Councils weren’t even getting independent advice they thought they were. It’s not really the councillors, its the Treasury Advisors and banks who I think mis-sold a lot of these LOBO loans.”

Clive Betts MP, Chairman of the CLG Committee said in the same documentary: “Outrageous, in the end if a council appoints and pays for an independent outside adviser 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”

“Outrageous, in the end if a council appoints and pays for an independent outside adviser to come in, they expect that advice to be independent.”

Unfortunately the Committee did not officially call on the FCA to take further action and decided to close the inquiry, without documenting the reasons why.

Diargram 5.1: Treasury management advisors’ conflict of interest

fee

Council

kickback

TMA

Broker

fee

Bank

fee LOBO loan

Butlers and ICAP

24. STS Butlers report, Competition Commission, 2011 - http://loboloans. uk/CCreportButlersSTS

Butlers was one of the most prolific TMAs advising councils on LOBO loans. Many local authorities were not aware that Butlers was a trading division of ICAP, one of the brokers involved in arranging LOBO loans, and that kickbacks were being paid to its own Butlers subsidiary when LOBO loans were brokered by ICAP. This is clearly stated in the 2011 Competition Commission report on the merger between Butlers and Sector Treasury Services (STS)24 that says the main source of Butlers revenue came from: “transactional income [...] arising from Butlers referring its clients to ICAP and receiving a share of the brokerage fees from any resulting transactions involving certain money market instruments (eg LOBOs)” “There was a relatively high degree of overlap between Butlers’ public authority clients and other areas of ICAP. About half the clients of ICAP’s Non-Banking desk (which is involved, among its other activities, in arranging LOBO transactions) were also Butlers’ clients.”

32 In the 2015 parliamentary inquiry, Abhishek Sachdev said: “Where Butlers were the treasury adviser, ICAP happened to be the chosen broker on 77% of the occasions.”

Sector Treasury Services and Tullet Prebon Sector Treasury Services (STS), a subsidiary of Capita, was also one of the TMAs advising councils on LOBO loans. At the same time it was receiving kickbacks from the broker Tullet Prebon when LOBO loans were sold. This information is contained in the 2011 Competition Commission report: “A share of the brokerage fees earned by the money broker Tullet Prebon, paid to STS if an STS client elects to transact through Tullet Prebon in relation to the arrangement of LOBO loans.”

Abhishek Sachdev also said in the 2015 parliamentary inquiry: “Where Sector was the treasury management adviser, we found that Tullet Prebon was chosen on 58% of the occasions”.

Sector Treasury Service and ICAP Sector Treasury Services (STS) was also receiving kickbacks from ICAP, whenever they brokered a loan. This is not reported in the Competition Commission report, but was up to May 2015 stated clearly on the website of Capita (of which STS was a subsidiary) under the heading nonexclusive business relationships:25

25. CapitaAssetServices, web-archive - http://loboloans.uk/CapitaSite

“We also receive referral commissions from Tullet Prebon, Siemens and ICAP, when Lender Option Borrower Option (LOBOs) transactions are arranged by them.”

Antony Barnett, the Channel 4 Dispatches reporter, told the CLG Committee that: “The evidence that we saw in the programme was that the financial advisers Sector, for example, was indeed getting a chunk of the commission that the brokerage earned from the bank. We heard from some sources that it was about a third, 33%.”

Only one council (Leeds) questioned or consulted on the matter has up to now been able to demonstrate they were aware or had been made aware of the conflict of interests with regard to commission payments between the brokers and the TMAs. All LOBO loans arranged between TMAs Butlers and Sector Treasury Services and brokers ICAP and Tullet Prebon can be considered illegitimate as they were contracted on the basis of conflicted advice and non-disclosed commissions.

6. LOBO loans pegged to LIBOR were sold to councils by banks and brokers complicit in rigging the rate LIBOR, a global benchmark for interest rates, stands for London InterBank Offered Rate. Up to 2013 it was set in the following way: 16 to 18 leading global banks provided to the Londonbased British Bankers Association (BBA) an estimate of what they would be charged if they were to borrow from each other – hence the name interbank offered rate. Now LIBOR is administered by the Intercontinental Exchange (ICE) and its rates are calculated for five currencies and seven borrowing periods ranging from overnight to one year. LIBOR is often called “the financial markets’ most important number” because it is so widely used as a reference to set interest rates for loans, mortgages and credit cards. It is estimated that at least $350 trillion in derivatives and other financial products are pegged to LIBOR.26

26. Behind the LIBOR scandal, New York Times, 10 Jul 2012 - http:// loboloans.uk/NYTlibor

In 2012 it was uncovered that between 2006 and 2009 the LIBOR interest benchmark had been systematically rigged by the banks responsible for setting it, including RBS, Barclays, Deutsche Bank and HSBC – banks that were at the same time selling LOBO loans to councils.

Barclays was at the center of the LIBOR scandal and was the first bank to be successfully prosecuted by the Serious Fraud Office (SFO).27 The first case against Barclays was based on the involvement of four of its traders who were charged in April 2014 with conspiracy to defraud by manipulating global interest rates. The conspiracy was stated by the SFO to have been undertaken between 1 June 2005 and 1 September 2007, a period during which Barclays was very active in the LOBO loan market. Kent County Council alone signed 15 LOBO loans totalling £261 million with Barclays.28

27. LIBOR US Dollar, SFO, 15 Jan 2015 - https://www.sfo.gov.uk/cases/ libor-barclays/ 28. NoLOBOs, Debt Resistance UK - http://lada.debtresistance.uk/localauthorities/kent/

33

Diagram 5.2: How LIBOR worked up to 2013

%

British Bankers’ Association

Banks Each weekday, 16 to 18 leading banks around the world submitted a figure to the BBA based on the rate at which they estimated they could borrow from other banks.

LIBOR

The BBA would throw out the highest and lowest 25 percent of submissions and averages the remaining rates.

The average would define LIBOR. The rate was calculated for 10 different currencies and 15 borrowing periods.

What does the rate affect?

Derivatives

Loans

LIBOR is often used to price financial instruments like swaps. At least an estimated $350 trillion in derivatives and other financial products are tied to it.

To calculate interest rates on loans, such as mortgages or student loans, some lenders use LIBOR as a base and add additional interest according to the borrower.

Source: New York Times

29. The Big Bank Fix, BBC, 5 May 2017 - https://www.sfo.gov.uk/cases/ libor-barclays/ 30. Barclays LIBOR rigging, the ‘Ricardo Master Fund’ and the unravelling coverup, J.Benjamin, Debt Resistance UK 15 April 2017 http://loboloans.uk/LiborRMF

The other period of interest in relation to Barclays LIBOR rigging is the period of so-called ‘lowballing’ where the Bank of England instructed Barclays to lower its rates between 1 September 2007 and mid-2009, including the key period in autumn 2008 when the financial markets went into meltdown.

As BBC journalist Andy Verity explains in The Big Bank Fix,29 emails obtained via legal action between Paul Tucker at the Bank of England and Mark Dearlove at Barclays confirm the Bank of England was instructing Barclays to rig LIBOR lower to make it appear the financial sector was healthier than it was.30 LIBOR rigging is particularly crucial in the case of Barclays LOBO loans, as the range LOBO loans the bank sold to councils were pegged to the GBP 6 month LIBOR rate by contract. Based on the impacts of LIBOR manipulation on the interest rates councils pay on their LOBO loans, 15 councils announced in July 2018 they would be challenging Barclays in court.

LIBOR rigging is a strong basis on which even LOBO loans that are not pegged to the rate by contract can be challenged, since LIBOR impacts the fair value of the loans. Arlingclose explain clearly how LIBOR was a crucial part of the LOBO puzzle in their submission to the 2015 parliamentary inquiry:

Barclays range LOBO loans were pegged to the GBP 6 month LIBOR rate by contract.

“The majority of banks funded long dated LOBOs via short-term deposits they receive on a variable rate basis, usually based on LIBOR. As Local Authorities pay interest on LOBOs at a fixed rate, and the bank’s cost of funds are variable, most LOBO lenders used swaps to eliminate interest rate risk from their investment.”

31. FT Q&A: Interdealer brokers, http:// loboloans.uk/FTbrokers 32. ICAP, RP Martin, Tullett Prebon brokers face Libor trial, CNBC, 5 Oct 2015 - http://loboloans.uk/ LIBORbrokers

Less well publicised in the LIBOR scandal was the leading role of the broker firms31 such as ICAP Plc, Tullet Prebon, and RP Martin. Six brokers from these companies, along with a former UBS trader, Tom Hayes, were charged by the SFO for their involvement in influencing the Japanese Yen LIBOR between August 2006 and December 2009.32 The broker firms were also arranging LOBO loans at the time. All the brokers were ultimately discharged, while Hayes remains convicted.

Though this case cannot be used to challenge LOBO loans, as it refers specifically to the Japanese Yen LIBOR, it is telling of the role that brokers had in the manipulation of market rates while at the same time selling their clients products that were pegged to them.

If LOBO loans are a bet with banks on future interest rates, clearly, if the banks had the power to manipulate those rates, the bet cannot be considered fair. LOBO loans pegged to LIBOR sold between 2006 and 2009 by the same banks and brokers complicit in rigging the rate can be considered illegitimate.

As mentioned in chapter 2, municipalities across the world have been successful in challenging banks over interest rate manipulation. In the UK, according to a legal statute of limitation, should councils want to take legal action against the banks on LOBO loans based on LIBOR rigging, they generally must do so within 6 years of the fraud being discovered.

34

7. LOBO loans pegged to ISDAfix were sold to councils by banks and brokers complicit in rigging the index In addition to LIBOR, banks and brokers rigged another obscure benchmark called ISDAfix also known as the 10 year swap rate. Set by ICAP and Thompson Reuters, it has been described by some analysts as “the oxygen that feeds financial markets”.

Inverse floater LOBO loans directly reference ISDAfix and were sold by RBS and often brokered

by ICAP.

ICAP was accused of manipulating the rate from at least 2009 to 2012 along with 14 major banks, including Royal Bank of Scotland, Barclays and Deutsche Bank.33

33. Seven big banks settle U.S. rate-rigging lawsuit for $324 mln J.Stempel, Reuters, 3 May 2016 https://www.reuters.com/article/banksrigging-settlement-idUSL2N18022V

Inverse floater LOBO loans directly reference ISDAfix and were sold to councils by RBS and often brokered by ICAP who also advised councils on LOBO trades via its subsidiary TMA Butlers.

Inverse floater loans that reference ISDAfix sold by RBS between 2009 and 2012 can be considered illegitimate on the basis that during that period RBS was involved in rigging the rate the loans were pegged to. ICAP and Butlers should also be held to account for arranging RBS inverse floater loans for councils during the same period they were involved in ISDAfix rigging.

8. Banks, brokers and advisors abused information asymmetry with councils when selling LOBO loans 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 from deals pegged to them, such as LOBO loans. This is emblematic of the abuse of the huge information asymmetry that lies between councils and financial institutions that can be used as a basis for declaring LOBO loans illegitimate.

9. Risk associated with the options and breakage cost were not explained clearly to councils when the loans were sold The embedded form of the options in the case of LOBO loans made it particularly difficult for councils to understand the risk they were taking when borrowing in this way. The Chartered Institute for Public Finance and Accountancy (CIPFA) states in its 2015 bulletin on LOBO loans:34

34. Treasury and Capital Management Panel Bulletin, CIPFA, 2015 - http:// loboloans.uk/CIPFAbulletin

“A key difficulty for local authorities using LOBOs is the lack of transparency to the authority: it is difficult to understand what is driving the pricing, what margin the bank is taking, what level of risk is being taken in the option structure, what is the likelihood of option calls, etc.”

This is confirmed by Abhishek Sachdev in the 2015 parliamentary inquiry: “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 adviser or for the bank to explain things in a very transparent manner to them.”

The sale of complex financial instruments such as options and swaps is highly regulated in commercial law.35 Firms breach the relevant regulation and a legal duty of care if they: • do not explain to their customers the possible detrimental effects of a derivative and the associated risks; and • fail to consider that the derivative may not be the most suitable product for the customer.

However, it is not clear from the FCA’s position in which specific circumstances such laws would or should apply to local authorities. In Abhishek Sachdev’s words from the 2015 parliamentary inquiry: “The regulator takes an interesting view here, because the FCA actually commented on this, saying that councils are essentially sophisticated borrowers. I do not know where this ‘sophisticated’ word really comes from, because it is not a regulatory term as such. They may be relying on the SME redress scheme that was out there, which has non-sophisticated and

35. Hidden Swaps in Fixed Rate Loans & TBLs, LexLaw, http://loboloans. uk/LexLaw

35 sophisticated businesses. [Note: Sachdev was paid to advise the FCA on the scheme]. My view is, forgetting the labels you attach to this, whether you are a council or a large corporate, if you are being given these kinds of products and you are not being provided them in a transparent manner, there is no way you are going to be able to understand them.”

The risk of LOBO loan embedded derivatives and their associated exorbitant breakage costs was not clearly explained, if not completely omitted in the loan contracts. Furthermore, most councils have not been able to prove that they received clear explanation of the risks, either by the banks, brokers or TMAs. Therefore LOBO loan legitimacy can be challenged on the basis of nondisclosure on the part of the banks, brokers and TMAs of the risk the council was taking on.

D. Illegitimacy based on the role of the council in the origin of the debt 1. LOBO loans taken out with foreign banks contravened national policy at the time The 1989 Local Government and Housing Act prohibited councils from borrowing from foreign lenders and in currency other than GBP sterling without HM Treasury consent. The 2003 Local Government Act removed the need for HM Treasury consent for loans from foreign lenders, but kept the restriction for loans in currency other than sterling.

LOBO loans taken out from a foreign bank between the 16th of November 1989 and 27th November 2003 (dates on which the Acts passed into law) can be considered illegitimate as contravening national policy, if they were entered without consent from HM Treasury.

36. FOI request on WhatDoTheyKnow - http://loboloans.uk/FOI-HMT

For the loans to be considered legitimate, proof that consent was given by HM Treasury should be provided either by the councils, the issuing banks, or HM Treasury. Up to now, no proof has been provided when asked for, and HM Treasury has confirmed via FOI36 that they cannot locate any records of councils seeking or obtaining approval to borrow from banks outside of the UK.

2. LOBO loans were entered without appropriate benchmarking LOBO loans can be considered unlawful as they were not taken out by the council in the public interest. Unlawful has a specific meaning in the 2014 Local Audit and Accountability Act when it relates to an item in the council’s financial accounts.

An unlawful item in the accounts is spending or income that 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 unreasonably or irrational - as in, no reasonable person would have made the decision.

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. Former Barclays trader Rob Carver says 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.”

Rob Carver adds: “I would not do these deals if you put a gun to my head.”

“I would not do these deals if you put a gun to my head.”

The choice to enter the loans could have been solely based on incorrect or inadequate benchmarking of the loan with respect to the PWLB loans and/or lack of expertise and appropriate tools by the council to understand the terms of such loans. Up to now, no council has been able to provide proof of adequate benchmarking of LOBO loans against PWLB loans.

36 In some cases it can be obvious that benchmarking was not undertaken or that the decision was completely irrational and against the public interest. Because of the extra risk associated with a LOBO loan, interest rates for LOBO loans should always be lower than the corresponding PWLB interest rate at the time the loan was taken out.

LOBO loans with higher interest rates than the PWLB rate at the time If by comparing the interest rates for loans of the same term, the LOBO loan rate appears higher than the PWLB rate, the loan should automatically be considered illegitimate. In some cases this argument may not hold since the LOBO rate is the result of the restructuring of a previous LOBO loan and therefore cannot be compared to an equivalent PWLB loan at the time of the restructuring.

LOBO loans with lower interest rates than the PWLB rate at the time Some councils have argued that LOBO loans were cost effective, as they had lower interest rates than comparable PWLB debt at the time. This is based on the erroneous assumption that the costs of the loans can be compared simply by looking at their interest rates.

CIPFA states very clearly in its 2015 bulletin on LOBO loans that this cannot be done:

“Comparing the “When evaluating a LOBO borrowing opportunity, Councils should headline rate to that compare the rate offered on the LOBO with both swap and PWLB available through rates. While a LOBO’s contractual maturity may be, for example, 50 50-year PWLB is years, comparing the headline rate to that available through 50-year overly simplistic.” PWLB is overly simplistic.”

Also, most LOBO loans have a maturity of 60 to 70 years for which there is no comparable type of loan to benchmark them against, since PWLB loans have a maximum of a 50 year term (30 years until 2005).

In an advice note we have seen produced by the TMA Butlers,37 they concede: “It is difficult to compare the [interest] rate, as there is no easy comparison. PWLB loans are only offered for up to 30 years. Lobo loans are now offered for up to 60 years. The longer maturity date generates a cheaper loan. 25 years will offer little benefit rate-wise compared to long term PWLB. The fees paid for arranging LOBOs are high compared to PWLB.” Rob Carver comments in the 2015 parliamentary inquiry:

Comparing the fair value of a LOBO loan to that of a PWLB loan is a more appropriate way of evaluating if the council will save money.

“On average, if you look at interest rates and where they are expected to go now, you would expect a LOBO loan to do much worse than a PWLB loan. The reason you know that is that is what the break cost tells you. The break cost essentially is the expected value of that loan going into the future. The fact that it is so much larger for a LOBO loan tells you that, on average, all the kinds of derivative pricing models think that it is going to be a worse deal than a PWLB loan.”

Comparing the fair value of a LOBO loan to that of a PWLB loan is a more appropriate way of evaluating if the council will save money over the term of the loan. This will be the case for very few LOBO loans which have for the term of the loan extremely low interest rates compared to the PWLB rates available when they were taken out.

LOBO loans that had a fair value higher than that of the corresponding PWLB loan when they were taken out, can be considered illegitimate as it is evident that no benchmarking was undertaken or if it was, the decision to take out the loans was irrational or against the public interest.

LOBO loans that have interest rates above or only a few points below the corresponding PWLB loan can be considered illegitimate on this basis, as the fair value of the LOBO loan would have been higher. In any case for LOBO loans to be considered legitimate the onus should be on the council to prove that benchmarking was done appropriately.

3. LOBO loans breached internal rules on borrowing The 1989 Local Government and Housing Act requires councils to set out on an annual basis in a Treasury Management Policy their: • overall borrowing limit (Part IV Section 45 1(a))

37. This document is not publicly available as it was part of the response to an objector who has been prohibited from publishing the findings.

37 • short-term borrowing limit (Part IV Section 45 1(b)) • limit on the proportion of interest payable with variable rate (Part IV Section 45 1(c)) The policy needs to be approved by the members of the council.

In some cases, when taking out LOBO loans councils breached their own internal limits of borrowing and the amount they could borrow in variable rates. So LOBO loans can be deemed illegitimate when internal policies were not followed.

CIPFA advise that councils should limit their borrowing of LOBO loans to not more than a third of their debt portfolio. Though the guidance is not enforceable legislation, some councils may have adopted such a recommendation as an internal policy. In such cases, if the amount of LOBO debt taken on by the council did not respect the limit, it should be considered illegitimate.

When evaluating the percentage of LOBO loans with respect to PWLB loans in a council’s debt portfolio, it should be considered that historic PWLB loans were repaid or written off in bulk as part of the HRA reforms (see paragraph B.1 of this chapter). This will have had a large impact on the ratio between the two types of loans between 2009 and 2012.

4. Councils have destroyed or restricted access to documents related to LOBO loans In most cases, given the time that has elapsed since LOBO loans were taken out and the standard retention policies of councils, many local authorities have destroyed documents related to the decision-making process and advice associated with the loans, including the reasons why the loans were taken out in the first place and benchmarking/value for money assessments. Where documentation was available, some council officers refused to allow access to the information, not only to residents and journalists, but also to councillors.

Local authorities have destroyed documents related to the decision-making process and advice associated with the loans.

In addition, external auditors have refused to provide public interest reports on LOBO loans as requested by residents through the objections process (see chapter 10). They have also prohibited residents who objected to publish their responses in what amounts to a punitive gag clause. So even if auditors have undertaken an investigation, public interest information remains concealed from the public eye by decision of the auditor.

The destruction or concealment of information related to LOBO loans can be used as a basis to challenge the legitimacy of LOBO loans, as the onus should be placed on both the borrower and the lender to demonstrate that the deal was done in good faith, following appropriate procedures, and the borrowing was undertaken in the public interest.

5. LOBO debt was contracted to finance projects or processes that did not benefit the local population When taking out long-term debt, councils are not obliged to specify what the funds will be used for. We argue that for debt to be considered legitimate, councils should demonstrate that it was taken out in the public interest and prove that the funds obtained have been used for initiatives that benefitted the population. In the absence of such proof, what can be undertaken is an audit of investment and capital expenditure of the council for the years in which LOBO loans were taken out and those immediately after.

When taking out long term debt, councils are not obliged to specify what the funds will be used for.

Such an audit should involve local residents through participatory processes so their voices can be included in the judgment of the legitimacy of the debt based on the way the funds were used.

It could assess whether the financial decisions of the council have generated, directly or indirectly, environmental impacts, social inequality, or violations of economic, social or cultural rights. The assessment can be done based on domestic legislation or international human rights conventions, as we have done in chapter 9.

38 Template 2: Evaluating the legitimacy of LOBO debt Questions to ask when assessing the legitimacy of a council’s LOBO debt: A. Illegitimacy based on the terms of the contract • Do the terms and conditions of the council’s LOBO loans infringe the law or public policy?

• Are the council’s LOBO loans a lose-lose bet with the banks?

• Are the breakage fees on the council’s LOBO loans excessive?

• Do the embedded options of the council’s LOBO loans pose excessive risk for the council?

• Are the notice and response times for interest rate changes on the council’s LOBO loans unreasonably short?

B. Illegitimacy based on the role of central government in the origin of the debt • Was the council encouraged by central government to take on risk by borrowing from banks?

C. Illegitimacy based on the role of the lender and intermediaries in the origin of the debt • Are the council’s LOBO loans the result of an excessive power imbalance between too-big-tofail banks and councils?

• Did banks book extortionate upfront profits on the council’s LOBO loans?

• Were the council’s LOBO loans used to circumvent regulation?

• Were brokers incentivised by banks’ high undisclosed commissions to act against the council’s best interests when arranging LOBO loans?

• Was the treasury management advisors’ advice to the council on LOBO loans conflicted?

• Were LOBO loans that are pegged to LIBOR sold to the council by banks and brokers complicit in rigging the rate?

• Were LOBO loans that are pegged to ISDAfix sold to the council by banks and brokers complicit in rigging the index?

• Did banks, brokers and advisors abuse information asymmetries with the councils when selling LOBO loans?

• Were the risks associated to the options and breakage cost explained clearly to the council when the loans were sold?

D. Illegitimacy based on the role of the borrower in the origin of the debt • Did the council’s LOBO loans taken out with foreign banks contravene national policy at the time?

• Were the council’s LOBO loans entered without appropriate benchmarking?

• Did the council’s LOBO loans breach internal rules on borrowing?

• Has the council destroyed or restricted access to documents related to its LOBO loans?

• Was the council’s LOBO debt contracted to finance projects or processes that did not benefit the local population?

E. Illegitimacy based on to servicing the debt • Have the interest payments on LOBO loans become excessive, preventing social expenditure and causing the impoverishment of the population?

• Have the interest payments on LOBO loans generated a violation of economic, social, cultural and environmental rights?

39

6 An introduction to Newham One of the poorest areas in the UK 1.

London’s poverty profile, Newham Trust for London - https://www. trustforlondon.org.uk/data/boroughs/ newham-poverty-and-inequalityindicators/

2.

More children living in poverty in Newham than anywhere else in London Newham Recorder, S.Morton, 5 Feb 18 - http://loboloans. uk/ChildPoverty

3.

Understanding Newham 2015, Newham Council, July 2016 https://www.newham.gov.uk/ Documents/Misc/ResearchHouseholdSurvey8.pdf

4.

5.

London’s Poverty Profile, Newham Trust for London - https://www. trustforlondon.org.uk/data/boroughs/ newham-poverty-and-inequalityindicators/ Britain’s debt hotspot: how Newham is making ends meet R.Partington, The Guardian, 18 Sep 2017 - https://www.theguardian.com/ business/2017/sep/18/britain-debthotspot-newham-borrowing

6. 10 reasons Newham Council is the UK’s debt capital, Debt Resistance UK, 12 Nov 2017 - http://loboloans.uk/ DebtCapital 7. Homeless rates grow to 1 in 25 in parts of London as total UK figure outstrips population of Newcastle, ITV 8 November 2017- http:// loboloans.uk/NewhamHomelessness 8.

London’s Poverty Profile, Newham Trust for London - https://www. trustforlondon.org.uk/data/boroughs/ newham-poverty-and-inequalityindicators/

9.

Facing debt: economic resilience in Newham, LSE, 2014 http://eprints.lse.ac.uk/58039/1/ CASEreport83.pdf

10. Annual Accounts 2009/10 and 2017/18, Newham Council - https:// www.newham.gov.uk/Pages/Services/ Annual-accounts.aspx

Newham is an east London borough perhaps best known for hosting the London 2012 Olympic Games. It is one of the poorest boroughs in London: the poverty rate is 37%,1 second only to neighbouring borough Tower Hamlets, and 43% of Newham’s children grow up in poverty.2 Incomes in Newham are low: according to the latest (2015) Newham Household Panel Survey, household income before housing costs is 79% of the national average. When housing costs are included, this falls to 72% of the national average, leaving Newham households with only £258 a week.3 Working poverty is rife with 36% of employees on low pay – the highest proportion in London.4 It is no surprise that as a result, Newham is one of Britain’s personal debt hotspots: one in four residents has problem debts.5 In 2017, Newham was named by the BBC as the “UK’s debt capital”.6 One in 25 residents is homeless:7 Newham has the highest number of homeless people housed outside the borough as well as the highest number of people in temporary accommodation in London.8 But pressures extend to those who have a roof over their heads: the share of social housing tenants and owner occupiers has fallen since the turn of the millennium, with the share of owner occupiers less than half of the national average. This is contrasted by a steep rise in private renting: from 17% in 2001 to 37% in 2012.9 Combined with rising rents and low incomes, it is no wonder the borough is facing such a severe housing crisis.

Newham is also one of the most ethnically diverse local authorities in the UK, and many residents face uncertain immigration statuses. This exacerbates many of the problems people face, especially those with low income who should be entitled to support but are too worried about their legal status in the country to seek assistance. In the case of families, this also affects children’s access to services, and often makes it harder for women to flee domestic violence.

Cuts to council services Despite growing pressures on its residents, since 201010, Newham Council has cut total spending on services by £500m – ulmost a third. This has resulted in what people we interviewed described as “a state of collapse” where “everything is just bursting at the seams”.

“Everything is just bursting at the seams.”

Charities try to plug the gap when statutory services all but disappear, but are limited by resources as they often cannot get funding for work that should be covered by the council’s statutory duties.

It is extremely difficult to piece together an accurate picture of the council’s cuts by service area: changes in the way accounts are presented by the council makes year-on-year comparison of key spending areas very hard. To our Freedom of Information (FOI) requests asking for more details on changes to budgets, Newham Council replied only with a link to their annual accounts.

40 According to our findings, frontline services seem disproportionately affected. Between 2010/11 and 2017/18, Newham’s service budget has been reduced by £71m. Children and young people’s services alone appear to have been reduced by nearly £10m, from £94.3m in 2010/11 to £83.9m in 2017/18. Business efficiency savings in the area of children and young people’s services show worrying reductions to support for the most vulnerable, such as the £300,000 cut in leaving care services or £200,000 in special educational needs’ home to school transport in 2016/17 only.

Housing and community infrastructure has been reduced from £14.4m in 2013/14 (only appears in the budget from this year onwards) to £8.3m in 2017/18.11

11. Budgets 20010/11 and 2017/18, Newham Council - https://www. newham.gov.uk/Pages/Category/ Council-budgets-and-spending.aspx

This contrasts sharply with the words of former Mayor Robin Wales:12

12. Mayor proposes no cuts budget and freeze in Council Tax for tenth year in a row, Newham Council, 14 Feb 2018 - http://loboloans.uk/ Newham-Taxfreeze

“I will continue to stand up for residents and make sure they are not bearing the brunt of the Government’s savage cuts. But more than making sure our services are protected from cuts this budget proposes investment in areas and new programmes. That means more properties for homeless households, pilot schemes in adult social care and opportunities for our young people.”

For our report “Cuts and Contempt: experiences of austerity and council democracy in Newham”,13 we interviewed 51 Newham residents. All were aware that cuts were happening, and half had been personally affected.

13. Cuts and Contempt, Research for Action, May 2018 - http://loboloans.uk/ CutsContempt

The most common ways in which people described the cuts were: • lack of staff and increased bureaucracy • closures of community centres, venues and libraries • charges on services that had previously been free • changes to benefits • increased need to justify eligibility for services and benefits • increased travel time to services that had previously been near Interviewees described the impact of cuts in the following ways: “I feel rejected, cheated, promises not kept… I lost my job due to council cuts at school, I used to be a teacher. “ “We’re a bit stretched – many people here have not got much money, council should listen to people who have lived here long. There’s been more cuts and changes in the last 10 years.”

“I feel rejected, cheated, promises not kept…”

“I have become poorer. It causes stress, also to the kids – and stress gives bad health to the whole family. I feel ditched, I have paid tax all my life. Christmas is coming and I can’t buy anything. I’ve paid my tax and all, now just getting cuts.”

In addition to the poverty and inequality already affecting residents’ everyday life, deprivation and lack of services are also taking their toll on the community. Newham Council’s youth budget has been cut by 81% since 2010,14 and many residents link the disappearance of youth services to the increases in violent crime: in 2017, Newham recorded the highest number of murder investigations of all London boroughs15 and an increase in violent crime by 7% compared to the previous year. A quarter of the capital’s acid attacks between 2010 and 2017 took place in Newham.16

14. London’s lost youth services, S.Berry January 2017- https://www. london.gov.uk/sites/default/files/ london_lost_youth_services_sian_ berry_jan2017.pdf

The council’s democratic deficit

16. Newham revealed as acid attack hotspot, J.King, Newham Recorder, 21 March 2017 - http://loboloans.uk/ Newham-acid

Newham Council is 100% controlled by one party, Labour. In a report in 2015, the Electoral Reform Society warned that “one party councils” are “a cause for concern across England in terms of quality of public services, value for money, and government responsiveness to citizen needs” due to the absence of checks and balances provided by opposition. They estimate that these inefficiencies cost English councils £2.6bn annually.17

17. The cost of one-party councils, M.Fazekas, Electoral Reform Society, 2 Oct 2015 - http://loboloans.uk/ OneParty

Newham Council is 100% controlled by one party.

According to one of the local campaigners we interviewed the lack of elected representatives’ accountability and approachability was due to the electoral system that makes their seats so safe:

“At the moment there is no benefit in engaging people because councillors get elected anyway.”

Until deselection in 2018, Sir Robin Wales was the UK’s longest serving directly elected mayor

15. More Newham murder investigations than in any other London borough, Met figures show, J.King, Newham Recorder, 27 April 2018 - http://loboloans.uk/Newhammurder

41 (DEM). Having led the council since 1995, he became mayor when the system was introduced in 2002 and since then lead the council as DEM with a cabinet until he was replaced in the 2018 election.

The DEM and cabinet system has been strongly criticised. It makes councils vulnerable to corruption due to the concentration of power in fewer hands and the marginalisation of non-executive councillors, as explained in chapter 3.

Sir Robin Wales was the UK’s longest serving directly elected mayor.

In Robin Wales’s Newham, this was particularly apparent. Councillors who did not belong to the mayor’s inner circle were often sidelined, even from obtaining information (as in the case of LOBO loans as described in chapter 10), while cabinet members were free to exert power over the council.

18. Audit committees: practical guidance for local authorities and police, CIPFA, 2013- http://loboloans. uk/AuditCommittees

Cabinet members also held conflicting roles like in the case of former Cabinet member for Finance Lester Hudson who at the same time chaired the Audit Board, meaning he effectively scrutinised his own work. This was against the advice from CIPFA (Chartered Institute of Public Finance and Accountancy) which states:18 “Membership from executive members on the [audit] committee has been discouraged as it could deter the committee from being able to challenge or hold to account the executive on governance, risk and control matters.”

19. £40m loan for West Ham to move into Olympic Stadium ‘may never be repaid to council’, P.Crerar, Evening Standard, 13 September 2017- http://loboloans.uk/WestHam 20. Annual accounts approved by Newham Council after £40m loan controversy, K.Hopps, Newham Recorder, 28 Sep 2017 - http:// loboloans.uk/StadiumLoan

Cabinet members also held conflicting roles.

Councillor Hudson frequently abused his power as Chair. An example of this was in September 2017, when the Audit Board voted on closing the 2016/17 accounts. Several members raised concerns regarding a £40m ‘impairment’ in the accounts – a loan to the West Ham Olympic Stadium19 the council did not expect to recover (see chapter 8) – and voted to delay closing the accounts until the situation of the loan was clarified. However, in a chaotic end to the discussion, Councillor Hudson decided that as the Chair he had a casting vote, and pushed the accounts to a closure.20 The Audit Board under Lester Hudson also went for lengthy periods without meeting, for example between 8 November 2017 and 29 March 2018, while external auditors’ investigations into LOBO loans were ongoing.

21. Newham Council burys head in sand over mounting LOBO loan losses J.Griffiths, DRUK, 1 April 2016 - http://loboloans.uk/Newham-sand

Another example of concentration of power is the case of Councillor Andrew Baikie, who was Robin Wales’s Advisor on Housing while also being a Director of the housing association Local Space, which was gifted 450 properties by Newham Council in 2006, when the charity was formed.21

22. Alarming’ lack of financial controls at Newham raises concerns, R.Cusack, Local Government Chronicle, 13 April 2018 - http:// loboloans.uk/Newham-financialcontrol

Concerns regarding Newham Council’s financial scrutiny were also raised in 2017 by EY, the council’s external auditors at the time, after it emerged that £7.5m had been misplaced in the annual accounts.22 The accounts also overvalued the council’s pensions investments by £19.7m. EY warned mistakes in the accounts would delay signing them off and indicated “lack of control in basic finance controls and quality control over the accounts production process”.23

23. Newham in danger of missing deadline to publish accounts, C.Marrs, Room 151, 19 April 2018 http://loboloans.uk/delayacccounts 24. Newham calls on CIPFA for financial health check, C.Marrs, Room 151, 27 June 2018 - http://www.room151. co.uk/treasury/newham-calls-on-cipfafor-financial-health-check/

The newly elected mayor, Rokhsana Fiaz, has called in CIPFA to do a “financial health check” on the council’s finances.24 While it will not undertake any auditing work, CIPFA will look at the assumptions underpinning the council budget, future budget pressures and the council’s assets. It will look at best practice from other public sector bodies and options for income generation, as well as including councillors and residents in its financial decision-making process.

We welcome the new leadership’s commitment to addressing Newham’s democratic deficit which, as we explain in the following chapters, has played a significant role in the accumulation of the council’s LOBO debt.

42

7 Newham’s LOBO debt Long term borrowing Newham’s total long-term borrowing (excluding Private Finance Initiative debt) in 2017-2018 was £793m of which £207.5m owed to the Public Works Loan Board (PWLB) and £585.5m to private banks.1 Newham is by far the council with the most bank debt in the UK. Total bank debt can be broken down into three elements:2

1.

Borrowing and investment live tables, MHCLG, Q4 2017/18 https://www.gov.uk/government/ statistical-data-sets/live-tables-onlocal-government-finance#borrowingand-investment

2.

Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018

3.

Derived by calculation

4.

Derived from contracts see Appendix

• £315m in in the form of LOBO loans • £248.5m in loans from Barclays that were originally LOBO loans, but were restructured by the bank in 2016 into fixed rate loans • £22m3 owed in interest on a specific type of LOBO loan called Zero to Par, for which the interest is not paid on yearly basis, but is compounded and paid with the principal at maturity Newham’s LOBO debt was taken out from six different banks:4 • £10m from Bayerische Landesbank in 2002 • £40m from Dexia in 2002 and 2005 • £75m from Depfa in 2006 • £40m from Merrill Lynch in 2007 • £248.5m from Barclays in 2007 and 2008 • £150m from Royal Bank of Scotland (RBS) in 2009 Chart 7.1: Newham’s debt (2017/18)

Chart 7.2: When Newham’s LOBO loans were taken out £250m £200m

26%

31%

£150m

£100m

3% 40%

£50m

2001 PWLB Interest

LOBO Barclays

Source: Newham Council £350m

2002

2003

2004

Bayerische Landesbank Barclays

2005

2006

2007

Dexia Credit Local Merrill Lynch

2008

2009

2010

Depfa RBS

Source: Orignal contracts obtained by Debt Resistance UK

Most LOBO debt is very long term, with terms ranging from 40 to 71 years. The largest sums will to be paid back between 2057-2060 and between 2077-2079. The largest payment will be Merrill Lynch’s Zero to Par loans as it will include both principal and compound interest. £250m £300m need

£200m £150m £100m £50m

40%

£50m £200m 2001

PWLB Interest

2002

LOBO Barclays

2003

2004

2005

Bayerische Landesbank Barclays

2006

2007 31%

26% 2009

2008

Dexia Credit Local Merrill Lynch

2010 43

£150m

Depfa RBS

£100m

3%

Chart 7.3: Newham’s LOBO loans’ repayments

40%

£350m

£50m

£300m £250m

PWLB Interest

£200m

LOBO Barclays

Depfa

• 8 vanilla LOBO loans totalling £125m from Bayerische 43% Depfa, Dexia Landesbank,

•

£248.5m from Barclays that were converted from LOBO loans (10 range LOBOs and 1 vanilla £120m LOBO loan)

18%

£40m Below are the details of the different types of loans.6 For more 15% information on13% the charachteristics£20m of each type of loan see chapter 3. For complete details of each loan see the Appendix.

Vanilla LOBO loans LOBOs Barclays PWLB PFI

Pension

2010/11

2011/12

2012/13

Interest payments

2013/14

2080

2079

2078

2077

2076

2075

2074

2053

2052

2051

2050

2049

2048

2047

2046

7% 27% LOBOs Barclays

23%

Principal

Fair value

43%

Inverse floater Vanilla

Range Zero to Par

Source: Newham Council

32%2015/16 2014/15

£120m £100m

22% 2016/17

2017/18

Council tax income

Newham has eight vanilla LOBO loans (of which 2 are stepped) totalling £125m with call dates varying from between 6 months to 10 years. The loans were all taken out from foreign18% banks (Bayerische Landesbank, Depfa and Dexia) between 2002 and 2008, and15% have terms that vary 13% from 40 to 70 years and interest rates that vary between 4.09% to 4.95%.

Newham also took out in 2007 a £10m 70 year vanilla LOBO loan from Barclays. It had a 5 year option period and a 3.9% interest rate. In June 2016 Barclays removed theLOBOs option from the loan, Barclays PWLBso PFI Pension it is now treated as a fixed-rate loan with a 3.9% interest rate.

Zero to Par (ZTP) LOBO loans

Dexia C

£200m

£100m

Derived from contracts see Appendix

2045

Bayerische Landesbank

£400m

PWLB

Range loans Zero to totalling Par

Some of these loans 22% are also stepped loans, meaning they start with32% an initial teaser rate before stepping up to the agreed interest £80m rate. All Newham’s Inverse floater LOBO loans and 2 of the vanilla £60m LOBO loans are stepped LOBO loans.

6.

RBS

Chart 7.4: Newham’s LOBO loans

• 2 Zero to Par LOBO loans totalling £40m from Merrill Lynch • 6 inverse floater LOBO loans totalling £150m from RBS

2044

23%

Newham Council’s portfolio is composed of the following types of loans:5

2043

£600m

2042

7%

Inverse floater 11 fixed rate Vanilla

2073

2072

2069

2070

Merrill Lynch

£100m £800m £50m

Types of LOBO loans 27% Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018

£200m

Barclays £150m

Source: Original contracts obtained by Debt Resistance UK

5.

2068

2067

2066

2065

2064

2063

2062

2061

2060

2059

2058

2057

2056

2055

2054

2053

Dexia Credit Local

£250m

2041

Bayerische Landesbank

2052

2051

2050

2049

2048

2047

2046

2045

2044

£300m

2043

£50m

2042

£350m

2041

£100m

2071

£150m

1

Newham has two 50-year Zero to Par LOBO loans taken out from Merrill Lynch in 2007, both with call dates every 5 years. The loan principals are £25m and £15m with 4.4625% and 4.39% interest rates respectively. The interest is compounded and paid with the principal at loan maturity.

Inverse floater LOBO loans Inverse floater LOBO loans have a variable rate connected to a varying market index. In the case of Newham, the interest rate payable is given by an agreed fixed rate minus the GBP 10 year swap rate. Newham has six inverse floater loans totalling £150m taken out from RBS in 2009, all of which started with a teaser rate of 2-3%. All loans have 50-year terms, call dates vary from 1 year to every 5 years and interest rates are between 8.60% - GBP ISDA swap and 8.98% - GBP ISDA swap. For 2017/18 the effective interest rates were between 7.233% and 7.667%.

£80m £60m £40m £20m

44

Range LOBO loans

4

2005

ank

s

A range LOBO loan’s interest rate varies over time in connection with a specified market index, which in the case of Newham is the GBP 6 month LIBOR. The interest rate of the loan varies as follows: 2006 2007 2008 2009 2010 • If the index falls between a given range (say 4% and 7%) the LOBO loan interest rate will be Dexia Credit Local a certainDepfa value Merrill Lynch RBS • If the index falls outside the range, the interest rate will have a different value.

Newham had ten range LOBO loans taken out in 2007 and 2008 with Barclays totalling £238.5m.

Of these six were also stepped loans. The range LOBO loans had 69-71 year terms and option dates every 6 months. Interest rates varied between 4.09% and 7.6% depending on where the index fell.

Barclays

2080

2079

2078

2077

2076

2075

2074

2073

2072

2071

2070

2069

Breakage cost and fair value

2068

2067

2066

2065

In 2016 Barclays restructured the range LOBO loans into fixed rate loans. In the case of range LOBO loans, simply removing the options was not sufficient to transform the loans into fixed rate loans, so new interest rates were assigned to each loan. The new fixed interest rates introduced vary between 4.152% and 6.625%.

The exit cost for PWLB debt is based on a specific formula provided by the PWLB. The total fair value of Newmham’s £207.5m PWLB debt is £259m, 125% of the principal.7

7.

Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018

The total fair value of Newham’s £315m LOBO loans in March 2018 was £685m, more than twice the value of the original loans (218%).8 Fair value of LOBO loans will vary with time based in the interest rate environment. In the current situation where interest rates are low, exit costs for LOBO loans are very high.

8.

Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018

The total fair value of Newham’s £248.5m Barclays restructured vanilla and range LOBO loans is also high: £674.5m (271% of principal)9 suggesting that Newham did not gain much from the restructuring.

9.

FOI request on WhatDoTheyKnow http://loboloans.uk/FOI-fairvalue

Merrill Lynch RBS Chart 7.5: Newham’s loans’ fair value (2017/18) £800m

For LOBO loans the fair value can be used as an indication of the cost to exit a loan without waiting for the bank to exercise its option.

It is based on current market rates, however the actual breakage cost is at the discretion of the bank and cannot be entirely predicted.

Determining the fair value of a LOBO loan is extremely complicated due to the embedded options and can only be calculated with sophisticated pricing tools that the council does not have. To price the fair value, the council has to rely on external experts, usually its Treasury Managment Advisors (TMAs).

£600m

£400m

£200m

PWLB

Barclays

Principal

LOBOs

Fair value

Source: Newham Council

Interest payments vs council tax 2013/14

2014/15

2015/16

2016/17

2017/18

In the year 2017/2018 Newham spent £75m on interest payments on its debt.10 Council tax income

To put this in perspective, Newham’s income from council tax in the same year was £68m.11 In other words, interest payments were equivalent to 110% of the council tax income.

10. Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018 11. Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018

Interest payments can be broken down as follows: • £16.8m for LOBO loans12 • £13.7m for Barclays (restructured LOBO) loans

13

• £9.5m for PWLB debt14 • £11.2m for PFI debt15 • £24.4m for pension interest costs16 Interest on LOBO loans and Barclays restructured LOBO loans therefore accounts for about the equivalent of 45% of Newham’s income from council tax. Interest on the Zero to Par LOBO loans does not appear in these figures as it is not paid on yearly basis, but at loan maturity.

The interest paid on each loan for 2017/2018 is indicated in the Appendix.

12. Derived from contracts see Appendix 13. FOI request on WhatDoTheyKnow http://loboloans.uk/FOI-fairvalue 14. Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018 15. Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018 16. Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018

£400m

£200m

43%

floater Range ChartInverse 7.6: Newham’s interest Vanilla Zero to Par payments per type (2017/18)

45 PWLB

Barclays

LOBOs

2016/17

2017/18

Chart 7.7: Newham’s total interest payments vs council tax income Principal Fair value (2010-2011) £120m £100m

22%

32%

£80m £60m

18% 15%

13%

£40m £20m 2010/11

LOBOs PFI

Barclays Pension

2011/12

PWLB

Source: Newham Council

2012/13

2013/14

2014/15

Interest payments

2015/16

Council tax income

Source: Newham Council

Risk and reserves The longer the term of the loan, the more interest rate risk the loan carries with it. In addition to 1 interest rate risk, there is the derivative risk and refinancing risk associated with the options (see chapter 3).

The more frequent the option dates, the more risky the loan is, as it increases the possibility of the interest rate being increased and the associated refinancing cost. Should the bank decide to increase the interest rate on a LOBO loan, the council could consider exiting the loans by borrowing from the PWLB, or using its reserves.

To reflect the option risk, option dates are indicated as possible repayment dates of loans in the council’s financial accounts. The council needs to ensure it holds enough reserves for possible future repayment, ring-fencing these funds as reserves. In the 10 years from 2008 to 2018, Newham’s useable reserves have increased from £77m to £519m.

Chart 7.8: Newham’s reserves (2008/9-2017/18) £2,000m

£1,600m

£1,200m £800m

£400m

2008/9

2009/10

2010/11

2011/12

Unusable reserves Source: Newham Council

2012/13

2013/14

2014/15

2015/16

Useable reserves

2016/17

2017/18

46

8 Are Newham’s LOBO loans illegitimate?

Evaluating the legitimacy of Newham’s LOBO loans In this chapter we evaluate the legitimacy of Newham’s LOBO debt based on the nature of the contracts and the origin of the debt, scrutinising each LOBO loan through the lens of arguments presented in chapter 5. In chapter 9 we analyse separately the illegitimacy of the debt based on the impact servicing the debt is having on the local population in the context of austerity.

A summary of the terms of the loans is available in chapter 7. Details of each loan can be found in the Appendix. Though Newham’s Barclays LOBO loans were restructured into fixed rate loans in 2016,1 we still consider them in this analysis. The fact that the loans were restructured does not resolve the issue that the loans were illegitimate in the first place. Conversion of debt to avoid it being deemed illegitimate is referred to as loan laundering2 and Barclays restructuring should be viewed from this perspective.

1.

End of LOBO ‘lender’ option

by Barclays both criticised and praised, C.Marr, Room151 30 Jun 2016 - http://www.room151.co.uk/ treasury/end-of-barclays-borroweroption-on-lobo-loans-both-criticisedand-praised/

2. ‘Illegitimate’ loans: lenders, not borrowers, are responsible, J.Hanlon, Third World Quarterly, 2006, p. 211-226

A. Illegitimacy based on the terms of the contract 1. Do the terms and conditions of Newham’s LOBO loans infringe the law or public policy?

Newham’s LOBO loans were taken out between 2002 and 2009. Therefore they were contracted after 1991, when the Hammersmith and Fulham vs Hazell3 ruling prohibited councils from taking out derivative contracts, and before 2011, when the Localism Act legalised them. Therefore all Newham’s LOBO loans can be deemed illegitimate as they contain derivatives, namely Bermudan swaptions.

3.

Hazell v Hammersmith & Fulham LBC (1991), Maitland Chambers http://loboloans.uk/HvHFruling

4.

FOI request on WhatDoTheyKnow http://loboloans.uk/Iceland-Newham

As explained in chapter 5, should the legal argument above not be accepted for embedded derivatives, the underlying argument that it is ultra-vires for a council to speculate with taxpayers’ money still remains. Therefore all Newham’s LOBO loans can be considered illegitimate on this basis, in particular Newham’s range and inverse floater LOBO loans.

In addition, Newham Council lost £7 million in investments in Icelandic banks when they collapsed in August 2008. There is growing evidence4 that councils including Newham were using LOBO loans as part of a carry trade investment strategy, where they borrowed money from UK banks in order to invest the funds in high interest paying Icelandic banks. Where proven, use of an Icelandic carry trade strategy would confirm that Newham Council was deliberately speculating on interest rates with public money (see paragraph D.5 of this chapter for more details).

Newham’s LOBO loans can be considered illegitimate on the basis that they infringe the law and public policy as it is ultra-vires for councils to borrow for speculative purposes.

47

2. Are Newham’s LOBO loans a lose-lose bet with the banks?

All Newham’s LOBO loans can be considered illegitimate on the basis that they are grossly unfair as the council will lose out (and the bank will win) almost whatever happens to interest rates.

3. Are the breakage fees on Newham’s LOBO loans excessive?

4.

Newham Council Annual Accounts 2017/18 - http://loboloans.uk/ NewhamAccounts2018

The breakage cost is another aspect that makes Newham’s LOBO loans grossly unfair. The fair value of a loan can give an indication of what the breakage cost could be. The unfair terms of Newham’s LOBO loans become apparent when comparing the current fair value of Newham’s PWLB debt with that of its bank debt. In Newham’s 2017/2018 accounts the cost to exit the council’s £207.5m PWLB debt is indicated as £259m (125%) while for its £315m LOBO debt the fair value is shown as £686m (218%), more than twice the face value. In detail:4 • the fair value of £125m vanilla LOBO loans is £252.6m (202%) • the fair value of £40m Zero to Par LOBO loans is £93.6m (234%) • the fair value of £150m invese floater LOBO loans is £339.8m (226%) The fair value is only an indication of what the breakage fee could be at a given point in time, as it varies based on the interest rate environment. In the current situation where interest rates are low, exit costs for LOBO loans are very high. From chart 8.2 we can see how the fair value has progressively increased over time. Loans with such high and unpredictable breakage fees are clearly unfair and should be deemed illegitimate.

All Newham’s LOBO loans can be considered illegitimate on the basis of their excessive breakage cost.

Chart 8.1: Newham’s LOBOs’ fair value (2017/18)

Chart 8.2: Change of fair value of Newham’s LOBO loans (2013 -2018)

£400m

£800m

Principal Fairvalue

£200m

£400m

£100m

£200m

Vanilla

Inverse floater

£600m

Zero to par

£300m

Source: Newham Council £120m

2013/14

2014/15 Zero to par

2015/16

2016/17

Vanilla

2017/18

Inverse floater

Note: The total fair value of vanilla LOBOs drops in 2016/17 as one is transformed into a fixed rate loan by Barclays and is not counted in the total anymore.

Source: MHCLG

£100m

4. Do Newham’s LOBO loans’ embedded options pose excessive risk for £80m the council?

2

£60m

10 years

5 years

3 years

2 years

The more frequent the option dates, the more risky the loan is for the council and the more valuable 4 it£40m is for the 4 bank. Therefore, the interest rate offered should reflect the extra value of the option, but it very rarely does. Particularly problematic are LOBO loans with option dates occuring every six £20m months or yearly, where 2 the increased risk should be reflected in a proportionally lower interest rate.

2 should Otherwise such2loans 1 be deemed illegitimate.

1 year

6. FOI request on WhatDoTheyKnow http://loboloans.uk/FOI-fairvalue

A specific point needs to be raised in relation to Newham’s Barclays loans that were restructured in 2016. It was argued at the time that Newham Council had saved £94 million with the restructuring.5 The council however has not provided any supporting evidence to back these claims. Research for Action instead has obtained via FOI request the fair value of each of Barclays restructured loans as indicated in the Appendix. The fair value has significantly increased. The fair value of it £238.5m range LOBO loans was £591m (248%) in 2016/17 (latest available data on LOBO loans), while the fair value of the restructured loans was £653m (274%) in 2017/18, which appears to confirm our suspicion that Newham did not get a good deal.6

6 months

5. Newham to save up to £94 million on its debt portfolio, Newham Council, 16 Feb 2017- https:// www.newham.gov.uk/Pages/News/ Newham-to-save-up-to-94-million-onits-debt-portfolio.aspx

2

£200m

£100m

2013/14

Inverse floater

Vanilla

Zero to par

48

Chart 8.3: Newham’s LOBOs’ option periods £120m £100m

2 4 4

2 3 years

Inverse floater Vanilla Zero to par

2 1 5 years

2 2 years

1 year

6 months

£20m

10 years

£40m

2015/16 Vanilla

2016/17

2017/18

Inverse floater

As shown in chart 8.3, eight of Newham’s LOBO loans fall within this category, totalling £175m, more than half the council’s LOBO debt. Their interest rates are between 4.09% and 4.95% and do not reflect the additional risks associated to the options.7

7. Derived from contracts see Appendix

The original £238.5m of LOBO debt taken out in the form of range LOBO loans from Barclays bank also had option dates every 6 months, adding immense risk to the council’s debt portfolio. The restructuring of the Barclays LOBO loans involved the removal of the options and has thus reduced the associated interest rate and refinancing risk, but has not made the loans fairer as the new loans still have very high interest rates and fair value/breakage fees.

£80m £60m

2014/15 Zero to par

The legitimacy of all Newham’s LOBO loans can be challenged on the basis that their interest rates do not reflect the excessive risk associated with the options, especially in the case of loans 2 with 6 or 12 month option periods.

Source: LOBO contracts

5. Are the notice and response times for interest rate changes on Newham LOBO loans unreasonably short?

Newham’s LOBO loan contracts state how much notice the bank needs to give to the council should it want to exercise its option to increase the interest rate and how much time the council has to notify the bank on wether it will accept the new rate or repay the loan in full. In most of Newham’s LOBO loans the period between the two notifications is very short, usually not more than four business days. The worst cases are the range LOBO loans issued by Barclays and the vanilla LOBO loans issued by Depfa.

For most of Barclays range LOBO loans the council could have found itself in the position of having to respond within 17 hours from the notification by the bank. In the case of all LOBO loans issued

by Depfa the council could end up having only 26 hours to respond to the bank as shown by this excerpt:8 “On [...] (the ‘Change Event Date’) and semi-annually thereafter the Bank may change the Interest Rate to a new interest rate, by giving notice to the Borrower before 10:00 (London time) three Business Days before that Interest Payment Date in writing. The Borrower shall notify the bank of its acceptance of the new rate or of its intention to prepay the Loan before 12:00 (London time) two business days before that Interest Payment Date in writing.”

Such conditions are grossly unfair as they leave very little time for the council to make a decision and to find the necessary funds to pay back the loan should it want to. The wording of the conditions could also be seen as deliberately deceiving as they are unnecessarily convoluted. All Newham’s LOBO loans can be considered illegitimate on the basis that the notice period and response time for when the options are called are unreasonably short and unfair.

B. Illegitimacy based on the role of central government in the origin of 1 the debt 1. Was Newham council encouraged by central government to take on risk by borrowing from banks?

Central government intervened to increase PWLB early repayment penalties on existing loans in November 2007 and increased PWLB interest rates on new loans in September 2010. As explained in chapter 5, this incentivised borrowing from banks rather than the PWLB. Newham took out 18 LOBO loans after November 2007, totalling £385.5m.

Therefore 18 of Newham’s LOBO loans can be deemed illegitimate on the basis that the council was effectively encouraged by central government to take on higher risk by borrowing from banks instead of the PWLB.

8. Depfa contract https://goo.gl/GbBRCf

49

C. Illegitimacy based on the role of the banks and intermediaries in the origin of the debt 1. Are Newham’s LOBO loans the result of an excessive power imbalance between too-big-to-fail banks and councils?

Newham Council could not fully influence terms of the contracts when they borrowed from banks, as they were dealing with some of the most powerful organisations in the world. Newham’s LOBO loans can be considered illegitimate because they are a result of the excessive power banks who sold them wield over society.

2. Did banks book extortionate upfront profits on Newham’s LOBO loans?

9.

Lost LOBOs part 3, N.Dunbar, Risky finance, 10 oct 2015 https://riskyfinance.com/2015/11/10/ lost-lobos-part-3/

According to financial analyst Nick Dunbar,9 the banks booked a total upfront profit of £65m on the day Newham’s LOBO loans were issued, corresponding to around 11.5% of the total principal of loans. This is an extortionate percentage, even above the 10% figure Abhishek Sachdev referred to as “massively excessive” in the 2015 parliamentary inquiry (see chapter 5). Nick Dunbar does not provide a breakdown of the upfront profits for each loan, but one can assume that the worse the deal was for the council, the higher the profit margin was for the bank. Particularly profitable are the inverse floater LOBO loans sold to Newham by the Royal Bank of Scotland (RBS) after it was bailed out.

The banks booked a total upfront profit of £65m on the day Newham’s loans were issued, corresponding to around 11.5% of the total principal.

All Newham’s LOBO loans can be considered illegitimate on the basis that the banks booked extortionate upfront profits, especially the inverse floaters sold by RBS.

3. Were Newham’s LOBO loans used to circumvent regulation?

As all LOBO loans sold to councils, all Newham’s LOBO loans can be considered illegitimate on the basis that the banks used them to circumvent around regulation by opaquely packaging derivatives into a loan agreement to maximise their own profits at the cost of the council and its residents.

4. Were brokers incentivised by banks’ high undisclosed commissions to act against Newham Council’s best interests when arranging LOBO loans?

10. FOI request on WhatDoTheyKnow - http://loboloans.uk/FOINewhambrokers 11. Annual Treasury Report 2009/10, Newham Council- http://loboloans.uk/ Newham-TreasuryReport

Newham Council states that less than 10% of their LOBO loan portfolio was executed through brokers: £28.5m via Martin Brokers, and £25m via Tullet Prebon.10 For the rest of the loans, the council claims that they dealt directly with the banks.11 “Officers developed direct relationships with banks to identify loans that best met the needs of the council, provided competitive rates and also avoided payment of brokerage fees.“ The information provided by the council does not allow us to identify exactly which loans were arranged by brokers. The only identifiable loan is the £18.5m Barclays range LOBO loan which must contribute to the total principal of loans arranged by RP Martin Brokers as it is the only one which is not a multiple of £5m. We can also exclude any loans above £25m, as that was the maximum amount arranged through a broker. Further investigation and co-operation by the council would be needed to identify exactly which loans were brokered by whom.

As explained in chapter 5, Newham’s LOBO loans arranged by brokers can be considered illegitimate on the basis that brokers were incentivised by high bank commissions to sell LOBO loans to the council against its interest.

50

5. Was the treasury management advisors’ advice to Newham Council on LOBO loans conflicted?

Newham Council relied both on Butlers and Sector Treasury Services as treasury management advisors (TMAs) during the period it took out LOBO loans. As explained in chapter 5, there is a substantial body of evidence demonstrating advice from TMAs was conflicted. Of particular relevance are loans arranged by Tullet Prebon, for which it is known the broker was sharing part of its fees (from both the council and the bank) with Sector Treasury Services. Identifying the exact loans for which this argument is valid would require further investigation and the co-operation of Newham Council. However we can exclude all the loans that have a principal above £25m, which is the total amount brokered by Prebon, and the £18.5m Barclays range LOBO loan that was brokered through Martin Brokers.

Even if it cannot be directly proven that in Newham money was going from brokers to TMAs, all of Newham’s LOBO loans can be considered illegitimate on the basis that its TMAs’ (Butlers and Sector Treasury Services) advice on the loans was highly conflicted as the TMAs were receiving payments from brokers when arranging LOBO loans for other councils.

6. Were Newham’s LOBO loans that are pegged to LIBOR sold to the council by banks and brokers complicit in rigging the rate?

As explained in chapter 5, LIBOR (London Interbank Offering Rate) was deliberately rigged by banks, including Barclays and RBS, between mid 2005 and mid-2009. In 2008, during the period of so-called ‘lowballing’, Barclays sold Newham ten range LOBO loans which interest rates were explicitly pegged to the 6 month GBP LIBOR rate. These loans are highly contentious and their legitimacy should be challenged.

Ten of Newham’s LOBO loans signed with Barclays can be deemed illegitimate as the bank was rigging LIBOR, to which the loans were pegged, when the loans were sold. Newham Council announced in July 2018 that on the basis of LIBOR manipulation it would be legally challenging Barclays on the LOBO loans it was sold.12 The LIBOR rigging argument cannot be used for the all the rest of Newham’s LOBO loan portfolio as either the signing of the loans fall out of the period in which there is evidence that LIBOR was being rigged (RBS LOBO loans), or the loans were issued by banks who were not involved in the rigging (Bayerische Landesbank, Dexia, Depfa and Merrill Lynch).

7. Were Newham’s LOBO loans that are pegged to ISDAfix sold to the council by banks and brokers complicit in rigging the index?

Both ICAP (of which Newham’s TMA Butlers was a subsidiary), and RBS were accused of rigging ISDAfix between 2009 and 2012. All Newham’s inverse floaters taken out with RBS are explicitly pegged to the ISDAfix index and were taken out in 2010.

Therefore all Newham’s RBS inverse floater LOBO loans that are pegged to ISDAfix can be deemed illegitimate as RBS and ICAP were rigging the rate in the same period in which they sold the loans to the council.

8. Did banks, brokers and advisors abuse information asymmetries with Newham Council when selling LOBO loans?

As explained in chapter 5, the clear abuse by banks, brokers and TMAs of information asymmetries with the council can be used to argue that all Newham’s LOBO loans are illegitimate.

9. Were the risks associated to the options and breakage cost explained clearly to Newham Council when the loans were sold?

According to the documentation available, only the Barclays, RBS and Merrill Lynch LOBO loan contracts explicitly explain how the breakage fee is estimated. The other loans do not mention breakage fees at all. All loans describe how the options work, but none clearly explain the various risks associated with them. As mentioned in chapter 5, the risks associated with a LOBO loan and its

12. Mayor’s statement on loans legal action, Newham Council, 17 Jul 2018 - https://www.newham.gov.uk/Pages/ News/Mayors-statement-on-loanslegal-action.aspx

51 breakage cost cannot be easily evaluated without expert knowledge and sophisticated pricing tools.

The council has not been able to provide evidence that the risk was clearly explained either by the banks, the brokers or the TMAs. Until evidence that the risk was clearly explained to the council is provided, Newham’s LOBO loans can be considered illegitimate.

D Illegitimacy based on the role of the council in the origin of the debt 1. Did Newham’s LOBO loans taken out with foreign banks contravene national policy at the time?

All LOBO loan contracts signed between the 16 November 1989 and the 27 November 2003 (date of commencement of the 2003 Local Government Act) with foreign banks needed previous consent from HM Treasury.

Newham holds two LOBO loans that were signed with foreign banks within this period: a £10m loan with Bayerische Landesbank signed on the 9th of August 2002 and and a £10m loan with Dexia signed on the 26th of September 2003.

13. FOI request on WhatDoTheyKnow - http://loboloans.uk/FOI-HMT

HM Treasury has confirmed13 that no evidence exists of the council seeking approval to borrow from banks outside the UK. When asked, neither Newham Council nor Dexia or Bayerische Landesbank provided evidence of consent from HM Treasury. Dexia simply responded they had no legal obligation to reply.

Until it is proven otherwise, the Bayerische Landesbank and Dexia bank LOBO loans signed before 27th of November 2003 can be considered illegitimate on the basis that they contravened national policy (the 2003 Local Government Act), as they did not receive necessary consent from HM Treasury.

2. Were Newham’s LOBO loans entered without appropriate benchmarking?

14. Lost LOBOs part 3, N.Dunbar, Risky finance, 10 oct 2015 https://riskyfinance.com/2015/11/10/ lost-lobos-part-3/

For LOBO loans to be considered legitimate they should have been benchmarked against the rates available from the PWLB when they were entered into. By comparing the fair value of the loans when they were taken out, financial analyst Nick Dunbar estimated that Newham Council could have saved £10m every year by using PWLB loans rather than LOBO loans.14 Dunbar does not provide a breakdown of the savings for each loan, but some initial observations can be made on the basis of their interest rates, which should be much lower than a comparable PWLB loan to account for the added risk of the embedded options.

Loans with higher interest rates than the PWLB rate at the time Newham has four vanilla LOBO loans from Depfa for which the interest rate is higher than the comparable PWLB interest rate at the time. These loans could be considered illegitimate based on the fact that either appropriate benchmarking was not undertaken or the decision to enter the loans was irrational as they were more expensive than PWLB loans. The external auditor has argued in response to a resident’s objection that these loans are the result of the restructuring of previous loans with high rates. We do not have the details of the original contracts, advice and full costings surrounding the restructurings. Determining the legitimacy of the Depfa loans on this basis would therefore require further investigation.

Loans with lower interest rates than the PWLB rate at the time For the remaining vanilla LOBO loans the difference between the PWLB and the LOBO loan rate is positive, and goes from 0.18% to 0.45%. For the Zero to Par LOBO loans the difference is around 0.2%. For the range and inverse floater loans, this direct comparison cannot be made due to the varying interest rate. In comparable cases, the difference in interest rate appears to be too small to justify the council taking on more risk with LOBO loans.

The council has not been able to provide any proof of benchmarking of the loans, however Nick Dunbar’s analysis confirms that the council lost money in taking out LOBO loans instead of PWLB loans.

Therefore until proven otherwise, all Newham’s LOBO loans can be considered illegitimate, as either benchmarking did not occur or the decision to spend more on repayments and risk public funds by entering LOBO loan instead of borrowing from the PWLB was irrational.

52

3. Did Newham’s LOBO loans breach internal rules on borrowing?

The external auditor of Newham, EY, following a residents objection, examined if there had been any breaches of internal rules on borrowing when the LOBO loans were taken out and concluded that there had not. Therefore the argument that the council breached its internal rules cannot be used as a basis for deeming Newham’s LOBO loans illegitimate. However, the reason there was no breach is because Newham Council failed to set internal limits as recommended by the Prudential Code, which should be considered when evaluating the breaches by the administration with respect to borrowing.

In EY’s words:15 “[Newham Council] has not set authorisation limits in respect of fixed and variable borrowing.

The Prudential Code for Capital Finance in Local Authorities suggests best practice is to have limits set for each type of debt.”

15. This document is not publicly available as it was part of the response to an objector who has been prohibited from publishing the findings.

4. Has Newham Council destroyed or restricted access to documents related to its LOBO loans?

EY, in response to a resident objector, stated that:16 “Given the age of the loans (and the normal deletion policies of local authorities including the Council), there is little contemporaneous documentation available setting out the Council’s decision making and what was taken into account.”

The lack of such information can be used to challenge the legitimacy of Newham’s LOBO loans since the council should be able to prove that the decisions to enter the loans were undertaken in the public interest, and that due process was followed.

In addition, documentation that was retained by the council has not always been made available by the executive officers and external auditors to residents, journalists or even councillors, as described in detail in chapter 10. Until the council can provide elected members, journalists and the public with the appropriate documentation on why and how the loans were taken out, Newham’s LOBO loans can be considered illegitimate.

5. Was Newham’s LOBO debt contracted to finance projects or processes that did not benefit the local population?

When taking out long-term debt, Newham is not obliged to specify exactly what funds will be used for. However, we argue that LOBO loans should not be considered legitimate unless the council can prove that they were used for the direct benefit of the population. Up to now, the council has not revealed why LOBO loans were taken out.

In absence of such proof, what can be undertaken is an audit of the impact and legitimacy of investments and capital expenditure by Newham Council since 2002 when the first loans were taken out. Such an investigation is beyond the scope of this report, however below we briefly look at two of the activities the council was involved in during those years: the Olympic development, and the Icelandic carry-trade.

A comprehensive evaluation of the consequences of the financial decisions of the council on the local population should involve residents’ judgement through a participatory process. Though not exhaustive, we organised workshops to involve the voices of residents in evaluating the legitimacy of Newham’s debt (see chapter 10). Here are some of the comments we collected: “If Newham has taken out all these loans, why are they not used for social housing?”

“There is a role for loans, but there has to be a balance.”

“Part of the problem is councils think that they are businesses.”

“They have enough money, they should get their priorities right.”

“I have paid taxes since I was 15, I want my money back!”

“The council is messing up and they should stop punishing the poor.”

16. This document is not publicly available as it was part of the response to an objector who has been prohibited from publishing the findings.

53

LOBO loans and the Olympic development London won the bid for the Olympics on 6 July 2005. Only three of Newham’s 27 LOBO loans predate the bid, meaning £533.5m was borrowed by the council from immediately after the announcement up to 2010. It is therefore hard to argue that there is no relationship between the contracting of the loans and the fact that Newham was to host the Games.

17. The Olympic investment in East London has barely scratched the surface of the area’s needs, A.Power, LSE blog, 15 Aug 2012 http://blogs.lse.ac.uk/politicsandpolicy/ olympics-newham-investment-power/

A full analysis of the legacy of the Olympic Games for the borough is still to be done. However, there are strong indicators that they did not benefit the local population. For example between 2005 and 2010 – when the Olympic development frenzy was at its peak – unemployment in Newham rose faster than the London average.17 Many of the residents we spoke to felt that the Olympic developments had not served the local community, but rather pushed up house prices and led to gentrification.

There is an increasing body of research that indicates that large events such as the Olympics do not bring wealth to the host cities, but on the contrary, leave host cities saddled in debt and with mega structures that they have no use for, or are unable to maintain.

18. £40m loan for West Ham to move into Olympic Stadium ‘may never be repaid to council’, P.Crerar, Evening Standard, 13 September 2017- http://loboloans.uk/WestHam

The financial legacy of the Olympics has recently started to unravel: a £40 million loan used to finance West Ham’s move to the Olympic stadium, was provided in 2012 to Newham Legacy Investments Limited, a subsidiary company wholly-owned by the council. However, the loan was declared “impaired” in 2017. Although this technically means that the loan cannot currently be paid back but could be in the future if the financial performance of the stadium improves, many councillors have said it effectively means a write-off.18

LOBO loans and the Icelandic carry trade 19. Carry trade blocked by Iceland in bid to avoid crisis teplay, O.Valdimarsonn, Bloomberg, 4 June 2016- http://loboloans.uk/CarryTrade

Evidence is emerging to suggest councils intentionally used LOBO loan funds for speculative purposes. It appears from recent Freedom of Information (FOI) requests that some councils including Kent County Council and Newham Council were using LOBO loans as part of a co-ordinated investment strategy, referred to as the Icelandic carry-trade.19 This means investing money borrowed with short-term low teaser rates at a higher interest rate, profiting from the interest rate differential.

20. Risk and return, Audit Commission, Mar 2009 - http://loboloans.uk/ AC-Iceland

A major event during the 2008 financial crisis was the complete collapse of Iceland’s banking sector.

In the run-up to the crisis, UK local authorities had invested heavily in Icelandic banks that offered high interest rates for deposits. When the banks collapsed, these assets were frozen. 127 councils had a combined total of £1bn frozen in Iceland.20 Newham had £7m frozen when Landsbanki collapsed on 7 October 2008. While four council officers were disciplined21 for their role in the Iceland losses, none of the financial firms (ICAP, Capita) that advised on, and profited from, councils’ Iceland trades have ever been held to account for their actions.

21. Four bankers jailed in Iceland. Four Council officers ‘disciplined’ in UK, Move your Money, Dec 2013 - http:// loboloans.uk/MYM-Iceland

22. FOI request on WhatDoTheyKnow - http://loboloans.uk/FOI-Iceland

In response to a FOI request,22 Newham confirmed it placed at least £22m in Iceland’s banks between 2007 and 2008, benefitting from interest rates as high as 7%. The council denied any borrowed money was invested in Iceland.

However, Newham took out three LOBO loans in 2007, totalling £90m with average interest rates of 4.4%. Some of these loans were drawn down within a month of large sums being invested in Icelandic banks. For example, on 6 August 2007 Newham drew down £50 million via a Barclays LOBO loan and on 31 August 2007 there appear to be two deposits with Landsbanki paying 6.3% interest.

We asked Newham’s press office for clarification on their LOBO borrowing and Iceland deposits, but none was forthcoming.

23. 2009 CLG Committee parliamentary inquiry “Local Authority Investment” chapter 10- http:// loboloans.uk/Icelandinquiry2

According to MHCLG and CIPFA23 it is considered illegal to borrow money to invest, without any clear public purpose. Newham Council has not provided any compelling evidence LOBO loan funds were not used for Iceland carry trade activity. This form of gambling with taxpayer money would make LOBOs illegitimate and illegal.

54

9 Impact of debt on rights in Newham Illegitimacy of Newham’s LOBO loans based on the impact of servicing the debt Newham residents’ rights are being neglected through cuts to essential services. Austerity measures imposed by central government are exacerbating poverty caused by low wages and high living costs in one of the most deprived boroughs in the country. The cuts are also causing significant physical and mental health problems, and ultimately contributing to the violent crime epidemic Newham, alongside the rest of London, is suffering.

Newham’s LOBO loan debt can be considered illegitimate on the basis that the council should not be restricting funds to already depleted services by spending millions on interest payments and ring-fencing reserves to account for the risk of options being called. Servicing of LOBO loans is therefore contributing to the violations of humans rights occuring in the borough in the current context of austerity.

The 1998 Human Rights Act states in Section 6 (1):1

“It is unlawful for a public authority to act in a way which is incompatible with a Convention right.”

1.

1998 Human Rights Act https://www.legislation.gov.uk/ ukpga/1998/42/contents

2.

You and Yours, BBC R4 24 Sep 18 https://www.bbc.co.uk/sounds/play/ b0bkpjc4

3.

Cuts and Contempt, Research for Action, May 2018 - http://loboloans.uk/ CutsContempt

4.

Universal Declaration of Human Rights http://www.un.org/en/ universal-declaration-human-rights/

5.

European Convention of Human Rights https://www.echr.coe.int/ Documents/Convention_ENG.pdf

6.

Convention on the Rights of the Child https://www.ohchr.org/en/ professionalinterest/pages/crc.aspx

7.

Convention on the Rights of Persons with Disabilities http:// www.un.org/disabilities/documents/ convention/convoptprot-e.pdf

“It is unlawful for a public authority to act in a way which is incompatible with a Convention right.”

The Act though notes that this does not apply if “as the result of one or more provisions of primary legislation, the authority could not have acted differently”, which highlights the ultimate responsibility of central government.

Financial expert Abhishek Sachdev said in a recent BBC interview:2 “All taxpayers and residents across the country should care about this [LOBO loan] issue, because talking from my experience as a Councillor in my Borough, the kind of efficiency gains that can be achieved by sharing services or cutting down on benefit fraud and that type of thing doesn’t come anywhere near what councils could save, by cutting down on these very high rates of interest paid on LOBO loans.”

The content presented in this chapter is the result of interviews with local campaigners, charities and community organisations as well as evidence we previously published in our report “Cuts and contempt: Experiences of austerity and council democracy in Newham”,3 for which we interviewed 51 randomly selected residents in different parts of Newham.

We examine our findings from Newham in light of several international human rights declarations and conventions. They are: • Universal Declaration of Human Rights (UDHR)4 • European Convention of Human Rights (ECHR)5 • Convention on the Rights of the Child (UNCRC)6 • Convention on the Rights of Persons with Disabilities (CRPD)7

55 8.

9.

Convention on the Elimination of All Forms of Discrimination Against Women http://www.un.org/ womenwatch/daw/cedaw/text/ econvention.htm

• Convention on the Elimination of All Forms of Discrimination Against Women (CEDAW)8

International Convention on the Elimination of All Forms of Racial Discrimination - https://www.ohchr. org/en/professionalinterest/pages/ cerd.aspx

• International Covenant on Economic, Social and Cultural Rights (ICESCR)11

10. International Covenant on Civil and Political Rights https://www.ohchr. org/en/professionalinterest/pages/ cescr.aspx 11. International Covenant on Economic, Social and Cultural Rights - https://www.coe.int/en/web/ conventions/full-list/-/conventions/ rms/090000168007cf93 12. European Social Charter and Revised European Social Charter - https://www.coe.int/en/web/ conventions/full-list/-/conventions/ rms/090000168007cf93

• International Convention on the Elimination of All Forms of Racial Discrimination (CERD)9 • International Covenant on Civil and Political Rights (ICCPR)10 • European Social Charter (ESC) and Revised European Social Charter (RESC)12

Right to housing The right to housing is recognised in the following international declarations, conventions and charters: UDHR (Article 25[1]), CRPD (Article 14[2]), CERD (Article 5[e]iii), ICESCR (Article 11[1]I), RESC (Part 1[31]).

The UDHR, CRPD and ICESCR all include the rights to adequate or reasonable housing. The other conventions mentioned create a legal basis to guarantee the right to housing, for instance by protecting the right to life, the right to the family, or eliminating discrimination from the right to housing.

The RESC also obligates state parties to take measures to prevent and reduce homelessness with a view to its gradual elimination (Article 31[2]).

Homelessness and temporary accommodation 13. Concluding observations on the sixth periodic report of the United Kingdom of Great Britain and Northern Ireland, UN, Committee on Economic, Social and Cultural Rights, 14 July 2016 http://loboloans. uk/UNreport

The UN Committee on Economic, Social and Cultural Rights wrote in its report from a country visit to the UK in 2016:13

14. Homeless rates grow to 1 in 25 in parts of London as total UK figure outstrips population of Newcastle, ITV 8 November 2017- http:// loboloans.uk/NewhamHomelessness

Housing is one of the most prominent problems Newham residents face: the council has the highest rate of homelessness in the UK,14 and more people in temporary accommodation and housed outside the borough than anywhere else in London.15

15. London’s poverty profile, Newham Trust for London - https://www. trustforlondon.org.uk/data/boroughs/ newham-poverty-and-inequalityindicators/

“The Committee is concerned about the significant rise in homelessness in the State party, particularly in England and Northern Ireland, affecting mainly single persons, families with children, victims of domestic violence, persons with disabilities and asylum seekers. The Committee also notes with concern the adverse impact that reforms of social security and reductions in financial support to local authorities have had on the right to adequate housing, especially with regard to the criminalization of rough sleeping in the State party (art. 11)”

Newham has the highest rate of homelessness in the UK.

Our interviewees described the following issues with the council’s approach to homelessness and temporary accommodation: • People who find themselves homeless are in many cases rehoused out of the borough, far from their support networks • People are housed in properties that are unsuitable for their health or mobility needs • Temporary accommodation is often unsuitable and even dangerous for small children: heating does not work, bathrooms are shared between too many families, bedrooms are lice or bed bug infested and there is not enough space for children • Parents have been told their children could be housed separately by taking them into care • People are stuck in temporary accommodation for too long • Temporary accommodation is too expensive • People consider the council to be discriminatory, unaccountable and unsupportive when dealing with people that are homeless or in temporary accommodation • Newham Council refuses to rehouse people it considers “intentionally homeless” which applies to those who for example leave their rental property before eviction or refuse a housing offer by the council, however unsuitable it may be We spoke to a group of families living in temporary accommodation. Many were single parents and faced some or several of the following problems: domestic violence, uncertain immigration statuses, mental and physical health conditions and extreme poverty, including zero income.

One of them told us: “I’ve been in a hostel for one year and four months, and there is no space for my baby to crawl. It is cold, I’ve been complaining [to the council] since I have had my baby. I explained the situation to them, the place is not suitable for a child. I’ve had bed bugs in the room. I was told it would be temporary.”

56 For residents, rents in temporary accommodation can be nearly as high as those in the private rented sector. Newham Council’s reliance on the private sector is not economically sustainable either: according to a recent investigation by 24 Housing,16 the council last year spent £60 million on temporary accommodation provided by private companies.

16. Councils spend near £500m on temporary accommodation, 24 Housing, B. Tanner, 8 June 2018 https://www.24housing.co.uk/news/ councils-spend-near-500m-ontemporary-accommodation/

As one interviewee told us: “There is the whole narrative of no money – but there is so much, and it is going to private landlords and offshore.”

The parents we interviewed felt they were not listened to by the council. Phone calls were not answered, and workers seemed uninterested or too busy to take into account their personal circumstances. They also voiced concerns regarding the unaccountability of decisions, finding little coherent logic in who was housed in a suitable property and who not. However, they felt frightened to complain or raise the issues with elected representatives, as they were afraid that ‘being difficult’ would lead to discrimination and make their cases even harder.

“If we take any step to complain, it will undermine our case.“ We also spoke to local housing campaigners. One of them, a single mother, told us: “I was under 18 when I fell pregnant, I had to ‘choose’ between street homelessness and going into social services, so I chose street homelessness.”

“There is the whole narrative of no money – but there is so much, and it is going to private landlords and offshore.”

The council’s abuse of the concept ‘intentionally homeless’ also means that in order to have any chance of being rehoused, when people fall into rent arrears and start receiving threatening letters from their landlord, they have to stay in their accommodation until bailiffs come and for the entire process of eviction.

As one person living in temporary accommodation told us:

“Even when my landlord asked me to leave, they [council] came to the conclusion that I’m not homeless. I have been on the [council housing waiting list] since 2013, but they do not count me as homeless unless the landlord takes me to court, but that is more stress.”

“When I call the council, they do not even pick up the phone. They tell me I’m not homeless.”

One professional working with families described this as “a game of chicken” making people feel “judged and frightened”. The process is especially traumatising for young children, and causes unnecessary anxiety in addition to the stress caused by living in low-quality temporary accommodation.

Social housing and the private rental sector The UN Committee on Economic, Social and Cultural Rights also raised concerns about the lack of social housing and the inadequacy of the private rental sector in the UK: “The Committee is concerned about the persistent critical situation in terms of the availability, affordability and accessibility of adequate housing in the State party, in part as a result of cuts in State benefits. The Committee also notes with concern that the lack of social housing has forced households to move into the private rental sector, which is not adequate in terms of affordability, habitability, accessibility and security of tenure.”

These concerns certainly apply in Newham. The share of both social housing tenants and owner occupiers has fallen since the turn of the millennium. This has been accompanied by a steep rise in private renting – from 17% in 2001 to 37% in 201217 – that has lifted Newham to one of the boroughs with highest levels of private renting. Of total housing stock in the borough, it was estimated in 2016 that 46% was owned by private landlords, more than doubling from 21% in 2006.18 In the current context of rising rents and low incomes, the lack of social or affordable housing is a major problem. Furthermore, landlords in the private market require proof of employment and income to pay several months’ deposit upfront, which makes it impossible for those without stable employment to get housed in the private sector.

Newham Council has not up to now made it a priority to protect social housing.

However, Newham Council has not up to now made it a priority to protect social housing. An example of their approach is the Carpenters Estate. Built in the 1960s, the estate lies in the heart of Stratford, close to the Olympic Park. Its redevelopment has been

17. Facing debt: economic resilience in Newham, LSE, 2014 http://eprints.lse.ac.uk/58039/1/ CASEreport83.pdf 18. Half of landlords in one London borough fail to declare rental income, The Guardian, P:Collinson 13 Aug 2017 https://www.theguardian. com/business/2017/aug/13/half-oflandlords-in-one-london-borough-failto-declare-rental-income

57 19. Shadow housing secretary joins mayor of Newham on Carpenters Estate visit S.Morton, Newham Recorder, 11 May 2018 -http://www.newhamrecorder. co.uk/news/shadow-housingsecretary-joins-mayor-of-newham-oncarpenters-estate-visit-1-5513283

subject to major controversies for over a decade. Plans to demolish it have been in place for at least 15 years and currently more than half of the 710 homes are empty after residents have been forced to leave.19 For those that remain, conditions are extremely poor as maintenance to the buildings has been kept to the bare minimum, adding to the difficulties they face in not knowing their future housing situation.

One of the campaigners interviewed told us about the effects on her mother, once a resident of the estate, of the uncertainty of her housing situation: “I feel [the cuts in housing] contributed to her death. She was so fit, until the worry they put on my mum... Every time someone came through the door, it worried my mum. And she was just one of many residents in that estate. Obviously it makes them ill.”

In our interviews with randomly selected residents across the borough, housing was one of the main issues brought up in the open-ended questions about what the council could do better. Some of the issues people raised were: • need for more council housing • need for more affordable housing • excessive waiting times for repairs in council properties • unacceptable and unenforced standards in the private rental sector • excessive and unregulated pricing in the private rental sector

20. Half of landlords in one London borough fail to declare rental income, The Guardian, P:Collinson 13 Aug 2017 https://www.theguardian. com/business/2017/aug/13/half-oflandlords-in-one-london-borough-failto-declare-rental-income

• increased mental health problems, stress and difficulties to work and contribute to society in the absence of stable housing These problems persist despite the fact that Newham was one of the first local authorities to introduce a landlord licensing scheme.20

Right to health The right to health is guaranteed in the UDHR (Article 25[1]), UNCRC (Article 24), CRPD (Article 25), CERD, (Article 5[e]iv), ICESCR, (Article 12) and ESC (Part 1(11)) and RESC (Part 1(11)). The ECHR also contains provisions related to health.

The UN Committee on Economic, Social and Cultural Rights wrote in its report on the UK in 2016: “Despite the legal duty introduced by the Health and Social Care Act 2012 to deliver ‘parity of esteem’ between mental and physical health, the Committee is concerned about the lack of adequate resources provided to mental health services.”

Our findings point to severe shortcomings with mental health services in Newham. Our interviewees mentioned insufficiency of integration of mental and physical health services as a problem, as well as the lack of early intervention, causing health and other problems to escalate.

“My child is autistic, and there is not much support at the moment. Would be good if Newham offered some therapy. Education, health and care, mental health as well, if it was available obviously I’d use it.”

Residents also told us: “Lack of funding in mental health services is absolutely diabolical. I think most people are gonna end up having nervous breakdowns because of lack of services. It’s absolutely terrible.”

“I don’t know anyone who is not stressed and depressed.”

21. Homelessness, health and housing: participatory action research in East London, K.Hardy and T.Gillespie December 2016 http://www.e15report.org.uk/

“Lack of funding in mental health services is absolutely diabolical. I think most people are gonna end up having nervous breakdown because of lack of services.”

Homelessness and poor housing also strongly impact mental health, as documented by Kate Hardy and Tom Gillespie in their report “Homelessness, health and housing”.21 According to the researchers, people facing eviction should be automatically considered at higher risk of mental health problems, and counselling should be offered to those approaching the council for help with housing and homelessness.

A single mother in temporary accommodation told us: “My housing situation makes me more stressed, more anguished. They [social worker] said I

58 got mental problems so they took me to a psychiatrist. They found out it was more of a social problem, not a mental problem.”

The mental health risks of those who are being made vulnerable and marginalised due to cuts are not being adequately addressed. Many of those who face financial hardship due to reduction in benefits, loss of council tax support and closure of essential services are at risk of ill mental health, often also worsening existing physical health conditions.

Rights of children and young people Newham has one of the youngest populations in the entire UK.

Newham has one of the youngest populations in the entire UK – a quarter of residents are under 18. This places specific importance on the rights of the child when assessing the legitimacy of Newham’s debt against human rights.

Many of the abovementioned rights are also guaranteed in the Convention on the Rights of the Child (UNCRC). It outlines the state authorities’ obligations: • to ensure every child receives equality in provisions (Article 2[1]) • to ensure both the survival and development of every child (Article 6[2]) • to ensure disabled children live a full and decent life (Article 23[1]) • to promote children’s right to the highest quality of health (Article 24) • that no child should be denied social security (Article 26), • to support every child’s well-being to live adequately (Article 27) • to provide children a right to leisure, recreation and play (Article 31) As well as childhood, motherhood is entitled to special protection, including according to the UDHR (Article 25).

However, we found worrying evidence that these rights are not being upheld for all children.

Child poverty More than four in ten children in Newham grow up in poverty.

More than four in ten children in Newham grow up in poverty, the worst ratio in the country.22 The human rights violations described in this chapter – from lack of suitable housing to food poverty – affect children to a greater extent.

22. More children living in poverty in Newham than anywhere else in London Newham Recorder, S.Morton, 5 Feb 18 - http://loboloans. uk/ChildPoverty

Many of the single mothers we spoke to felt that housing them was not the council’s priority, or that unlike in the past when families were prioritised on the council’s housing waiting list, it was now impossible to get housed unless one had a job.

“I feel discriminated against, I cannot work and they have admitted if you are not employed you’re at the bottom of the [housing] list.”

We also heard concerns from teachers and parents alike that the lack of resources in schools was harming children’s education, especially for those with special needs who were not receiving adequate support. Schools are facing greater pressure due to the increased poverty in the borough as they try to support families in need. For example, a teacher we interviewed told us that some schools did not close down during a heavy snow one winter because children would have gone hungry without school lunch.

Parents also lamented the lack of play schemes and reading clubs as well as changes in libraries that had made them less safe and child-friendly. Parents also now have to pay for many school activities that had previously been free, making them unaccessible for families on low or no income or with many children.

“There is nothing for the children”, said a mother-of-five.

Youth and cuts One of the key issues raised by residents in our interviews was cuts in youth services. With an 81% reduction in the council’s youth budget since 2011/12,23 it is no wonder that youth services have been practically wiped out.

23. London’s lost youth services, S.Berry January 2017 - https://www. london.gov.uk/sites/default/files/ london_lost_youth_services_sian_ berry_jan2017.pdf

59 There was less of a range of services for children and young people, our interviewees described.

The shortage in funding was affecting the provision of services for specific groups, such as disabled children. The cuts also reduced the availability of seed funding for new ideas and projects that would reflect today’s changing world: “A good example [of what would need funding] is social media and its impact on young people, which will mean new ways of working to deal with issues arising.”

A founder of a youth charity told us that fewer and fewer young people’s needs were being met, and many of the current failures could have been preventable. He described a pyramid, where the bottom band was composed of stable young people. The next band up were young people who were mainly stable, with some problems. The next band up had some problems, for example with drugs, while on the top of the pyramid were those with severe issues such as abuse or mental illness.

“You should have less young people at the top. But in Newham, the bottom bands are narrower and the ones at the top are wider. And if you look at Newham, all the money is spent at the top, and not enough at the bottom preventing kids rising up the pyramid. More and more is being directed to fewer who have higher needs. But if you invested more in the bottom, you could save money in the long term as it is always easier to go up the pyramid, and harder to go down.

My main concern is we are missing opportunities to lay down some real legacies. We need to invest in the prevention and we will reap that in the future.”

Violent crime was one of the main themes the residents interviewed for Cuts and Contempt brought up in relation to cuts in youth services. Also those working for charities supporting young people recognised violence as a major issue. One interviewee explicitly linked the escalation in violent crime and more blatant drug dealing to the cuts as people are finding it increasingly hard to manage.

“If the system won’t offer a decent chance, then someone else will, and that someone is usually not good.”

“If the system won’t offer a decent chance, then someone else will, and that someone is usually not good.”

Right to social security and adequate living The right to social security is recognised in the UDHR (Articles 22, 25), UNCRC (Articles 3, 18, 23, 26), CRPD (Articles 26, 28), CEDAW (Articles 11, 13), CERD (Articles 2, 5), ICCPR (Article 25), ICESCR (Articles 9, 10,11), and RESC (Articles 8[1], 12, 13, 14, 15, 16, 17, 23).

The right to adequate living is recognised in UDHR (Article 25[1]), UNCRC (Article 27[1]), CRPD (Article 28[1]) and ICESCR (Article 11).

Although we recognise that much of the hardship our interviewees referred to regarding insufficient income results from central government imposed reforms such as universal credit, it is worth noting that local authorities have significantly contributed to the reduction of residents’ social safety net by cutting spending on services and support that enable everyone to participate in their community.

24. Inquiry concerning the United Kingdom of Great Britain and Northern Ireland carried out by the Committee under article 6 of the Optional Protocol to the Convention, Committee on the Rights of Persons with Disabilities 6 October 2016 https://www.ohchr. org/Documents/HRBodies/CRPD/ CRPD.C.15.R.2.Rev.1-ENG.doc

Furthermore, when the UN Committee on the Rights of Persons with Disabilities visited the UK in 2015 (followed by a report in 2016 condemning the UK for violating the rights of disabled people through austerity) it wrote:24 “Local authorities and councils did not cooperate with it during the visit, despite several invitations addressed to them to participate.”

The UN Economic and Social Council also expressed concern about changes in social security in 2016, especially: “the adverse impact of these changes and cuts on the enjoyment of the rights to social security and to an adequate standard of living by disadvantaged and marginalized individuals and groups, including women, children, persons with disabilities, low-income families and families with two or more children.”

60

Changes in benefits hit the poorest hardest The poverty rate is 37%, second only to neighbouring Tower Hamlets.

Poverty is an acute problem in Newham: the poverty rate is 37%, second only to neighbouring Tower Hamlets.25 Several of our interviewees working in charities or community organisations mentioned that their priority had become meeting the immediate needs of people who often had very little income or no income at all. One major community organisation told us they were in the process of registering a food bank, because for many people who approached them, food was the first priority.

25. London’s poverty profile, Newham Trust for London - https://www. trustforlondon.org.uk/data/boroughs/ newham-poverty-and-inequalityindicators/

Lack of income, changes in benefits and cuts to public services are also forcing people to take on increasing amounts of debt. Newham is one of Britain’s personal debt hotspots: one in four residents has problem debts.26 Central government, by using the cuts to reduce national debt, has simply shifted the burden of the debt on individuals. This is hitting hardest the poorest who usually get credit on the worst terms. It is also telling of the inadequacy of the social safety net as most problem debt now comes in the form of utility bills, council tax arrears and repayment of overpaid benefits.27 People can be summoned to court and jailed for the non-payment of council tax, which makes recent changes to council tax benefit particularly problematic.

26. Britain’s debt hotspot: how Newham is making ends meet R.Partington, The Guardian, 18 Sep 2017 - https://www.theguardian.com/ business/2017/sep/18/britain-debthotspot-newham-borrowing

In 2013, council tax benefit was replaced by local council tax support, which does not cover 100% of council tax for the poorest residents, something the previous system did. In Newham, the maximum reduction in council tax a working age person can receive is 80%,28 meaning that many people already on low incomes are now hit by extra living costs. The change was also communicated poorly. One mother, who was living in hostel accommodation in Stratford in 2014, told us that all the residents, who had previously received a 100% benefit, were summoned to court following arrears in council tax they did not even know they had to pay.

Cuts to services, reductions in housing benefits and the removal of council tax benefit have increased financial hardship especially for the poorest residents.

Inadequate support and lack of services As explained in chapter 6, Newham Council has made major cuts to services, including frontline services. It is hard to get exact data of the cuts, but residents’ experiences of lack of staff, closures of and charges to services, increased bureaucracy and difficulties to prove eligibility to changing benefits speak for themselves.

The practical barriers for people to access the services they are entitled to have also increased, especially for the most marginalised residents. They told us of the following difficulties: • not having enough money to physically get to a different part of the borough • not being able to attend appointments due to uncertain housing situations • feeling inadequate to attend appointments due to poor living conditions, for example children not clean enough • having to increasingly present proof for circumstances that are hard to document for practical and emotional reasons, such as domestic abuse, mental health issues or illness • finding it hard to deal with heavy bureaucracy due to lack of English • feeling intimidated due to immigration status Our interviews also suggest that there is a level of discrepancy in the support people receive based on the judgement of the individual workers who undertake the assessment, and the recipients’ assertiveness. Especially those who are disabled or have long-term illnesses expressed frustration for having to prove their condition over and over again.

This is a worrying sign that all residents might not be treated equally, as they should. It is especially concerning considering the high level of Newham’s population who does not have English as their first language, and might not be able to obtain support in their own language.

Charities plugging the gap left by cuts in statutory services There seems to be a significant number of people who have fallen beyond the reach of services.

However, as one of our interviewees working in the charity sector noted: “During the previous [Robin Wales’] administration, it wasn’t seen as a wonderful thing that we were finding [people in need for support] who were invisible. It was seen that we were

27. UK households face hidden debt of almost £19bn – Citizens Advice, R.Partington, The Guardian, 21 Aug 2018https://www.theguardian.com/ money/2018/aug/21/uk-householdsface-hidden-debt-of-almost-19bncitizens-advice 28. The impact of the abolition of council tax benefit in London: A new poll tax? S.Ashton, Child Poverty Action Group, July 2014http:// www.cpag.org.uk/sites/default/ files/A%20new%20poll%20tax_0.pdf

61 making more work [for the council]. The idea was out of sight – out of mind.”

“Newham are so defensive, they are just literally trying to bat people away.”

Another interviewee working for a charity said: “It does just feel that everything in Newham is bursting at the seams. Issues that we would refer to social services in another borough do not make the threshold here.”

Several people working for community organisations and charities told us that referring people to services they need has become more difficult. As one person from a youth charity put it: “There are far less people [working for council services] to link in with than before. And the services have a lot higher threshold than before, so they are doing a lot less preventative work. You can only get into the services when the problems are extreme.”

“You can only get into the services when the problems are extreme.”

We also heard that people are increasingly seeking support for multiple and complex problems, as in the absence of early intervention, their issues escalate. This contrasts to the council’s approach that strictly deals with one issue at a time. In the words of one interviewee from the third sector: “We want to deal with people not problems. But it is difficult, when services are [separated] in the council.”

One of our interviewees had a bleak view of the third sector’s ability to plug the gap left by cuts in council services.

“What we are seeing is a drawback from frontline services by the council. So we are seeing churches, community groups and charities stepping forward into a space previously statutory.

It has been a major issue for a while but it is now at crisis point.”

However, it is hard for charities to do these activities, as many funders do not out of principle give funding to work that should be statutory.

Our interviewees also mentioned the loss of funds for community groups and charities due to the cuts, whether it was directly through reduction or removal of funding they used to receive from the council or as increased costs such as having to pay rent for spaces for which the council previously charged ‘peppercorn rent’. Our interviewees also raised concerns about the sustainability of smaller community initiatives following the cut of the council’s small grants programme.

Right to democracy The equal right to access public services and similar economic, social and cultural rights are granted in UDHR (Article 22), ECHR (Article 1), UNCRC (Article 2), CRPD (Article 3, 4, 5) and CEDAW (Article 3).

This includes special provisions to participate in and access information relating to key decisionmaking processes that affect one’s life and well-being: • children have the right to participate in their welfare, once old enough to participate (UNCRC Article 12); • state authorities must raise awareness of disabled people’s rights and services (CRPD Article 8[2]d); • state authorities are obliged to allow everyone – regardless of gender – to participate in the formulation of governmental policy (CEDAW Article 7[b]); • state authorities must enable everyone to take part in the conduct of public affairs, directly or through freely chosen representatives (ICCPR Article 25[a]); • state parties are to encourage the participation of individuals and voluntary or other organisations in the establishment and maintenance of social welfare services (ICESCR Article 14[2]).

However, when interviewing residents, we found that most had little access to information about council’s decision-making even if they wanted to. We found severe shortcomings in the availability of elected representatives to meet with residents, and more alarmingly, many residents felt there was little to gain from contacting the council at all. Those most marginalised expressed such mistrust that they had not even considered contacting their councillor or mayor.

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“I feel like an ant.

It’s a big authority and I’m an ant, that’s how I feel, they won’t listen to me anyway.”

“I feel like an ant. It’s a big authority and I’m an ant, that’s how I feel, they won’t listen to me anyway.”

“I’ve never thought there’s any point, they don’t listen anyway. It’s very corrupt as well you know, very corrupt... from the top. That’s all this council is really interested in, lining their own pockets.”

Of those who had contacted their councillor or mayor (16 out of our 51 randomly selected interviewees), 63% had received a response and only half felt their issue was resolved, an alarmingly low response and satisfaction rate.

Newham, like all councils, regularly consults residents through surveys and questionnaires. However, according to our findings, these do not reach many of the people in the borough, even if they have strong views they would like to express. The vast majority of people interviewed had not even heard about the 2015 consultation on the cuts and changes to services Newham was undertaking, despite the fact that most wanted to contribute to the council’s decision-making and thought that residents should have a say in how the council spends money.

As a councillor put it to us: “[Under the previous administration] there have been quite a few consultations that did not take into account many people, and we suspect they were rather cosmetic than real. There was not a feeling either by myself as a councillor or by a lot of the residents that they were meaningful.”

These findings are echoed in the experiences of housing campaigners we spoke to, who felt that instead of trying to work with them to find a solution to their housing problems, the council had treated them in a hostile way and refused to engage.

Our interviewees from the charity sector also raised concerns about the council’s priorities: “The council does not try to spend money in the right place or on right people.”

“They need to genuinely listen. Sometimes residents know best – not the council. It is having the maturity to say: ‘we got it wrong’ and ‘let’s review what we are doing and take it forward’.

I think you need more of that and then you will get real change and people being listened too. So it is not superficial, but it is real consultation, more than just a questionnaire. There is a need to listen to the people. We need a bottom-up approach. We have gone too far with a top-down approach in my view.”

We also asked the people we approached in the vicinity of council services if they thought residents should have a say in how Newham Council spends money and which services it prioritises. 63% strongly agreed. 25% agreed somewhat, usually emphasising that it would be important to give the final decision to those who had a bigger picture and to make sure people were not acting out of selfinterest. The rest did not know or reply – no respondent disagreed.

“They need to genuinely listen.

Sometimes residents know best – not the council.”

Some suggestions that were brought up in our interviews were participatory budgeting, open forums, public meetings and consultations, and visits to the community. Residents also expressed the need for better communication from the council. This shows that residents have a desire to participate in matters that concern them, as long as they are approached in a way that is accessible for them.

One of the aims of this report is to provide both residents and their representatives the tools and information needed to understand Newham’s debt position and the arguments they can use to discuss and decide on the illegitimacy of the debt.

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10 The citizen debt audit Documenting the audit process In this chapter we describe how the citizen debt audit was developed: who was involved, the difficulties experienced and the impact it has had up to now. This part of the report should be considered as more than a mere description of the process. Its aim is to highlight the failures of current accountability structures, so that they can be improved to work effectively in the public interest.

Though the report focuses on Newham’s debt, this chapter will also refer to work that has been undertaken at the national level or in other councils. We document these activities not only because they were instrumental in the development of Newham’s audit but also because highlighting them can be useful when replicating the audit process in other councils.

Who 1.

Research for Action members are also part of Debt Resistance UK, however they remain separate organisations with different aims and structures. MoveYorMoney seized to exist in 2016.

Newham’s debt audit is a project by Research for Action and it builds on work done by two other organisations: MoveYourMoney, as part of which Joel Benjamin and Ranjan Balakumaran initiated the investigation into LOBO loans, and Debt Resistance UK, who extended the research to the whole of the UK and built a campaign around it.1 All organisations involved have been explicit that concerned citizens should 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. This process has successfully engaged different actors across the political spectrum, including local residents, councillors, journalists and financial experts who have contributed on their own behalf.

Research for Action obtained grant funding in 2017 to develop a citizen debt audit in Newham as a pilot project that could be replicated across the country. Until then, the bulk of the work had been done on a voluntary basis and the progress of the audit was dependent on the availability and spare time of its participants, making it hard to provide continuity to the work and limiting the impact it could have. This combined with the inaction of our regulators and public institutions and delays on the part of auditors has meant that LOBO loans are only now, four years from their initial media exposure, being effectively addressed by local authorities. Funding has allowed Research for Action to accelerate and add depth to the process at a time when it was absolutely needed.

Although working without funding at the start allowed for complete autonomy in the approach to the audit, we do not vouch for the idea that the scrutiny of local government finance should be left solely to voluntary and unremunerated civic action, or ‘armchair auditors’ as suggested by Eric Pickles when he closed the Audit Commission in 2015. People must be provided with effective democratic tools to keep their representative bodies to account, but the responsibility of scrutiny of local government finance should not rely solely on residents’ individual motivation and free labour.

We need a functioning accountability system based on independent public bodies and processes that truly serve the public interest. As we will see in this chapter, we are far from it.

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Investigation 1. Using government data and the Freedom of Information Act The first phase of the investigation, initiated by Debt Resistance UK, identified which councils across the UK had LOBO loans and the amounts they had borrowed. To do so Freedom of Information (FOI) requests were sent to all the councils that appeared as having bank debt in the borrowing and investment live tables2 for local government published by the Department for Communities and Local Government (DCLG).

2.

Borrowing and investment live tables, MHCLG, Q4 2017/18 https://www.gov.uk/government/ statistical-data-sets/live-tables-onlocal-government-finance#borrowingand-investment

3.

Live list of FOIs sent to Newham https://goo.gl/p7MBY9

The FOI requests asked if councils had LOBO loans and for copies of the loan contracts accompanied by a spreadsheet listing the loan terms (principal, interest date, maturity date, option dates, etc).

Many councils refused to provide the information requested until the Information Commissioner’s Office (ICO) ruled that the public interest in disclosing how taxpayer money had been spent overruled the commercial confidentiality councils had relied on to withhold the loan documents.

Thanks to the FOI Act, Debt Resistance UK showed that 240 councils across the UK had taken out LOBO loans totalling £15.6bn and managed to obtain contracts for more than 80% of them. Newham was identified as the council with most LOBO debt and with some of the worst cases of loans.

Debt Resistance UK also found major discrepancies between the data collected by DCLG and the information obtained via FOI.

Debt Resistance UK also found major discrepancies between the data collected by DCLG and the information obtained via FOI, suggesting that the reporting procedure between councils and DCLG received limited oversight. For example, one year Newham Council reported £4m in LOBO debt to DCLG rather than £400m and the data was not corrected until Debt Resistance UK brought it to the attention of DCLG. Another issue encountered in the investigation was that DCLG in their spreadsheets group debt from foreign banks under the heading ‘other sources’, rather than labelling it clearly as bank debt. Many LOBO loans were taken out from foreign banks and therefore could have been missed if Debt Resistance UK had not interrogated the data under the heading of ‘other sources’.

The second phase of the investigation used the FOI Act to request information about financial intermediaries – brokers and treasury management advisors (TMA) – involved in arranging LOBO loans. Details about who was involved and the fees paid were released in most cases, however the great majority of the documents requested (contracts, standard terms of business, tender documents and invoices) were not provided, either due to commercial confidentiality or because they were not retrievable anymore. Councils in fact are not legally required to keep documents for more than a decade. This is of great concern, especially in relation to long-term borrowing where councils can find themselves saddled with debt for decades without knowing or being able to prove why and how the debt was incurred in the first place.

Debt Resistance UK and Research for Action also used the FOI Act to request information from other public bodies such as: • The Financial Conduct Authority (FCA) • The Department for Communities and Local Government (DCLG) • Her Majesty’s Treasury (HMT) • The Competition and Markets Authority (previously Competition Commission) • The Local Government Association (LGA) • The Audit Commission (closed in April 2015) • The National Audit Office (NAO) All FOI requests were sent through the website www.WhatDoTheyKnow.com so enquiries and responses would be freely available to the public and journalists.2

All FOI requests were sent through the website WhatDoTheyKnow so enquiries and responses would be freely available to the public and journalists.

Debt Resistance UK published details of the loans for each council on the website lada.debtresistance.uk, effectively contributing towards making local government finance more transparent. Research for Action maintains the database, and aims to update it and develop it further so that all LOBO loans and related documents can be easily searchable and accessible to anyone and protected from obliteration by councils. We are involving citizens in the process by organising hackdays in which attendees actively participate in analysing documents and contribute to the national database.

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2. Inspecting the council’s financial accounts 4.

Newham Council Annual Accounts 2009/10 and 2017/18, - https://www. newham.gov.uk/Pages/Services/ Annual-accounts.aspx

An important source of information when investigating local government finance are a council’s annual accounts. The council must publish a draft of the accounts on their website in May/June, while the final version should be published in September/October once the external auditor has signed them off. This report quotes information from Newham’s 2017/2018 annual accounts and compares it with data from the accounts of the previous years.4 However, financial accounts are not presented in a clear and accessible way and often reporting conventions change from one year to another, making comparison of data between years highly complicated. Research for Action found this particularly problematic when trying to find data to paint the picture of the cuts to services in Newham.

5.

Reclaim Local Democracy, Research for Action, 2017 - https:// researchforaction.uk/project/reclaimlocal-democracy

The 2014 Local Audit and Accountability (LAA) Act provides rights to residents to inquire about their councils’ financial accounts: residents are entitled to ask questions to the external auditor on items in the accounts of the last financial year and to ask to inspect all books, deeds, contracts, bills, vouchers and receipts relating to them. The right to inspect the accounts also extends to journalists and bloggers. For more information on how these rights can be exercised, Research for Action has published a guide called “Reclaim local democracy: how to challenge your council’s financial decisions”.

Financial accounts are not presented in a clear and accessible way and often reporting conventions change from one year to another.

Research for Action used the rights granted by the LAA Act to obtain details regarding Newham’s LOBO loans and Barclays 2016 restructuring. This proved a lengthy process that gave access to a limited amount of information, but was very telling of the limitations of the Act. On 11 July 2017, we requested an appointment to inspect documents we considered relevant to understand the restructuring. Despite attempted follow-ups by phone and twitter, it took three days for the council to acknowledge our request. The reply stated: “The Council fully accepts its duty to co-operate with its external auditors, the general public, and any journalist in accordance with the Local Audit (Public Access to Documents) Act 2017 vis a vis Local Audit and Accountability Act 2014.”

“With specific regards to the last two items of information requested [the itemised accounts of PwC audit 2015/16 and ledger 2008-10 when the council borrowed via LOBO loans], I believe this is outside the scope of the Act [...] The information you have requested is outside of the period of the 2016/17 accounts. If you hold a contrary view, please could you reply to myself setting out your reasons why.”

We informed the council that the LAA Act states that one can: “inspect the accounting records for the financial year to which the audit relates and all books, deeds, contracts, bills, vouchers, receipts and other documents relating to those records.”

Therefore we had the right to view all the documents related to LOBO loans, which were items in the 2016/17 financial accounts.The following week, we received a partial reply: “With regards to item number 5 [ledger 2008-10 when the council borrowed via LOBO loans]; I have considered your response below. I have consulted with peers and the consensus is that this does fall outside the scope of the information requested. If you wish to review and clarify your query, I will be happy to request this.

In relation to items number 1 and 3, [documents relating to Barclays LOBO loan restructuring and advice note from Capita on current value of LOBO loans] I am awaiting a response from the firms involved before considering, alongside internal legal counsel, whether or not there is an overriding public interest in favour of disclosure of what is currently subject to legal confidentiality clauses.

I will keep you updated with progress in relation to items number 1 & 3.”

We followed up on 13, 21 and 30 August, and received a holding reply. We contacted the council again on 11 September and finally received the agreements between Barclays and Newham Council on the loan restructuring and Capita’s valuation of Newham’s portfolio. However, all documents were heavily redacted, concealing essential information such as the new interest rates offered by the

66 bank. We requested the documents unredacted, and received instead a clarification on the role of the auditors in providing an opinion on the accounting treatment of the restructuring.

After following up once to twice a month between September and March, we finally received the council’s final position on the 21 March 2018. Attached was a document that noted that the LAAA 2014 “does not confer an unqualified right of access to information and is narrower than other information legislation, such as the Freedom of Information Act 2000” and stated that “the Council does not intend to disclose further documentation.”

3. Interviewing councillors, objectors and civil society As part of the evidence collection for this report, Research for Action interviewed Newham residents who objected to the council’s accounts and councillors involved in raising the issue of LOBO loans. We gathered their views on the way the council was dealing with the cuts and their experience of the council’s accountability processes.

We also approached campaigning organisations, community groups and charities in Newham for their views on the impacts of cuts in services and how the council is meeting residents’ needs.

Ideally, we were asking to run workshops that would combine evidence gathering from affected communities with information-sharing about LOBO loans, but access to groups’ precious time proved hard and we had to modify our approach depending on the situation. This resulted in a mixture of types of interviews: four one-to-one and three group sessions.

Although some interviewees agreed to be quoted, contributions have been mainly anonymised to protect those who did not want to be identified. Some were worried about jeopardising their relations with the council, others told us that they could risk losing their funding if what they said came across as too political. It is concerning that those best placed to comment on the problems in the borough were feeling constrained by possible repercussions on the work they are doing for the community.

4. Interviewing residents We interviewed people in the vicinity of council services to gather evidence on the effects of the council’s financial decisions on residents. We conducted 51 interviews between November 2017 and January 2018 in four different parts of the borough. People were approached at random. The selection criteria for interviewees was that they had lived in Newham for more than a year, still lived in the borough or had moved out less than six months prior, and that they had some familiarity with council services either from current or past use.

Topics covered by the questionnaire were: use of council services and their importance; residents’ satisfaction with council services and how they had helped them and how cuts in services had affected them personally. On council decision-making and democracy, people were asked about their experiences of contacting the council (both staff and elected representatives) and their participation in and awareness of public consultations on the cuts. We also asked respondents questions about the level of their council tax and whether they felt they were getting enough back from the council.

The questionnaire concluded with open questions about what the council could do better, how it could be made more accountable and whether the council’s priorities reflect the needs of the community.

The comprehensive findings of the interviews were published in May 2018 in the report “Cuts and contempt: experiences of austerity and council democracy in Newham” and have been used as evidence for evaluating the illegitimacy of Newham’s LOBO loans on the basis of the servicing of the debt in the context of austerity.

Action 1. Filing objections under the 2014 Local Audit and Accountability Act Between 2015 and 2018, Research for Action and Debt Resistance UK supported over 50 local residents in using the 2014 Audit and Accountability Act to inspect and object to LOBO loans.

Objecting to a council’s accounts consists of raising an issue related to an item of the financial accounts and asking the external auditor to either produce a public interest report on the issue and/or request a declaration from the high court that the item is unlawful. An objection can only be submitted by a resident. A summary of the objection process can be found in chapter 3, and a

6.

Cuts and Contempt, Research for Action, May 2018 - http://loboloans.uk/ CutsContempt

67 detailed explanation is provided in our guide mentioned above.

Though the right to object might appear a powerful tool for residents to hold the council to account, we have encountered many shortcomings of the process. Firstly, objectors to LOBO loans received our support in filing their objection, but not all residents have expert advice at their disposal or hold the expertise themselves to address financial issues. Residents find themselves having to battle alone both the auditor and the council who have internal knowledge on the issues and can rely on external experts to help them make their case.

7.

As public pressure builds, is Newham moving closer to legal action on LOBOs?, 14 July 2018 J.Griffiths, Debt Resistance UK http://lada.debtresistance.uk/newhammoving-closer-legal-action-lobos/

Though the right to object might appear a powerful tool for residents to hold the council to account, we have encountered many shortcomings of the process.

Newham Council was not supportive at all towards residents’ objections, seeing them as a waste of public money rather than an opportunity to challenge wrongdoings that could help the council recover millions.7 However, the objection process did force the council to discuss LOBO loans publicly in their meetings, a step forward from not addressing the issue at all.

Rachel Collinson, a Newham resident who used the right to inspect the 2014/15 accounts to obtain LOBO loan contracts, told us about how frustrating the process was: “[When they invited me to the library to view them] I turned up and they didn’t have them.

They gave me an appointment with the auditor. So I then had an appointment with the auditor, who in the end just emailed the [contracts]... Why couldn’t they just do that in the first place?”

Collinson’s inspection was a very important step for Newham’s audit, as it allowed us to obtain the contracts from the council who had previously refused them via FOI request. After having examined the contracts with the support of Debt Resistance UK and a financial expert, she raised the issue with the auditors that the loans were pegged to LIBOR. “I said to the auditor: ‘wouldn’t LIBOR fixing make this illegal?’ He went quiet and said: ‘very good point’. Meeting ended soon after and I never heard back from them.”

“It was almost like ‘we’re not gonna touch this, too hot a potato’.”

“It was almost like ‘we’re not gonna touch this, too hot a potato’.”

She therefore decided to file an objection asking for a public interest report and that the auditor refer the case to the high court. She had to wait until 2018, after years of chasing up the case, to receive a reply from the auditor saying they would not take the matter forward. She told us that she thinks the objection process “absolutely does not work”.

“I am absolutely livid. The government is stripping away all accountability mechanisms and I’m taking time off work to do this.”

She was also told by the auditor that she was not allowed to make their initial response and evidence public, or she would be liable for prosecution and an unlimited fine.

“It feels like I’m at the bottom of the to do list although this is about public money. It’s taken three years, and in those three years Newham has spent another £150 million in loan repayments, and that’s gonna go on for over 50 years.

There’s no urgency to deal with it and I risk prosecution if I talk about it. I’m not doing this for my own gain, I’m doing this because the world ought to be better, and I’m threatened with jail!”

“I am absolutely livid.

The government is stripping away all accountability mechanisms and I’m taking time off work to do this.”

“I’m not doing this for my own gain, I’m doing this because the world ought to be better, and I’m threatened with jail!”

Councillor John Whitworth who also objected to LOBO loans told us: “I was amazed [to hear from a Channel 4 documentary that] Newham had so many more LOBO loans than anybody else, and not by a small margin either. I found it remarkable that they appeared to be so damaging, and that different experts agreed that they were very prejudiciable to the borrower.

My reason for [objecting to LOBO loans] was to ultimately get the council to take some action to try to get redress from the banks and renegotiate the loans, and to find out what had happened in the process, how they had got to take out so many of these damaging types of loans.”

68 However, his experience of the process has been far from positive.

“There has been a whole series of delays...

Stonewalling basically.”

“There has been a whole series of delays... Stonewalling basically.

Lack of attention to me as the complainant. I was not informed for example that the external auditors had been changed until a couple of months after the event. I thought I was working with them to produce a report for me, and then to find out they had passed it on to somebody else and I hadn’t been told!”

“[The outcome of the objection process has been] completely unsuccessful because it seems the external auditors have backed the council at every turn.”

Both objectors felt strongly that the process was not fit for purpose.

Councillor Whitworth said: “[The outcome of the objection process has been] completely unsuccessful because it seems the external auditors have backed the council at every turn. They have said look, it might not look particularly good, but on balance of things there was nothing particularly wrong with their decision, and they say it time and time again. They are really making a series of excuses for them I think.”

Rachel Collinson said: “There should be an independent organisation that looks at local government. It’s like the suspect paying the police force to investigate itself... How are you ever going to convict anyone? The leaders of accountancy firms should have highlighted conflicts of interest when government was drafting the legislation.”

Research for Action also questions how accountability of local government can be left in the hand of highly conflicted private firms such as the big four accountancy firms. Nowhere in local government is this more apparent than at Newham Council, where PwC, assumed the role of external auditor while at the same time auditing Barclays bank, from which Newham took out half of its LOBO loans.

Research for Action also questions how accountability of local government can be left in the hand of highly conflicted private firms such as the big four accountancy firms.

The need to question the independence of PwC’s work in responding to the objections on LOBO loans becomes apparent if we compare the fees paid to them by each institution. In 2013/14, PwC’s fees were £44m8 for Barclays and £357,0009 for Newham Council. The objection was requesting PwC to refer Barclays’ £250m LOBO loans to the high court so they could be deemed unlawful, which would clearly impact their high fee paying client.

PwC also advised central government on reforms to the Housing Revenue Account (HRA) which as explained in chapter 10 resulted in councils taking on new LOBO debt.10

Research for Action have viewed the auditor’s responses to some of the objections. They contain substantial evidence of how superficially the issue was dealt with: • They initially looked at only a sample of loans, until the objectors insisted that they should look at them all • They argued that LOBO loans were a cost-effective option for the council by simply comparing the initial short term teaser rates of 60-70 year LOBO loans with the interest rates of 50 year PWLB loans • They made sweeping generalisations like “PWLB loans are also subject to exit fees” even though the substantive point is breakage fees on LOBO loans are extremely high compared to PWLB loans • They initially ignored the fact two LOBO loans were borrowed from foreign banks without HM Treasury approval

2. Involving councillors Research for Action and Debt Resistance UK have been supporting councillors across the country who have wanted to address LOBO loans within their council. We have done so by providing them with all the information we had related to their council’s LOBO loans and supporting documentation that could be useful for them to make their case, both in council meetings or by filing objections to the auditors. We have been available for any questions and clarifications needed to fully understand the issue and aim to continue to do so in the future.

8.

Barclays to end 120-year audit relationship with PwC, Accountancy Age, R.Crump, 7 March 2014 http:// www.accountancyage.com/aa/ news/2332870/barclays-to-end-120year-audit-relationship-with-pwc

9. London Borough of Newham, Report to those charged with governance. PwC, December 2014 https://www.newham.gov. uk/Documents/Council%20 and%20Democracy/ AuditBoardISA260Report2014.pdf 10. Making the most of HRA reform, PwC, June 2011 - http://www. smith-institute.org.uk/wp-content/ uploads/2011/06/HRA-reform.pdf

69 11. Open Letter on LOBO loan misselling to the Local Government Association and Communities Secretary, DRUK, 20 Feb 2018 http://lada.debtresistance.uk/openletter-local-government-associationcommunities-secretary-re-lobo-loanmis-selling/

In early 2018, Debt Resistance UK initiated an open letter11 for councillors to undersign asking the Local Government Association to take action on behalf of councils. The letter has been signed by 30 councillors from several councils and across different parties.

The promotion of the letter was paused once it was announced councils were autonomously taking legal action.

Councillors can play a crucial part in the audit process, and it has been encouraging to see some take a stand.

Councillors can play a crucial part in the audit process, and it has been encouraging to see some take a stand in the name of the public interest of the residents they represent. However, the audit process has also exposed how little power councillors have.

12. Newham Council gambling/ financial strategy meeting. 08 Dec 2015 https://soundcloud.com/ jmb1982-1/newham-council-gamblingfinancial-policy-meeting-8-dec-2015 13. Newham Council burys head in sand over mounting LOBO loan losses J.Griffiths, DRUK, 1 April 2016 - http://loboloans.uk/Newham-sand

14. Councillor John Gray’s written evidence to 2015 CLG Committee parliamentary inquiry “Local Council Bank Loans” http://loboloans.uk/JGray

Newham’s case is particularly extreme. As explained in chapter 6, Newham is a one party council led by a directly elected mayor (DEM) with a cabinet: there is no official opposition questioning the decisions being made and the scrutiny by councillors of the same party is limited. Under the previous administration, a few councillors who were not members of the cabinet raised LOBO loans as a problem on more than one occasion, tabling the issue for discussion both at audit board meetings and in the full council meeting.12 When doing so their observations were dismissed and they were verbally attacked.13 Information was also withheld from councillors by council officers.

As Councillor John Gray explains in his submission14 to the 2015 parliamentary inquiry: “3. [..] over the past twelve months we have engaged with the Council’s Executive and senior officers in an attempt to receive reassurances and evidence that the financial position of Newham is not undermined in light of its LOBO exposure – given the alleged ‘toxicity’ of these products. Specifically, we requested copies of the original LOBO loan agreements and the advice given by our advisors.

4. While we have received assurances that Newham Council considered the LOBOs to have been suitable products at the time they were taken out, they have not provided us with evidence we requested to prove this is the case. After several months of frustrating email exchanges and discussions, Council officers have declined to give us copies of the contracts or the advice on the ground of ‘commercial confidentiality’.

5. This has been most disconcerting, not least because we believe that we had a common law right to see such information, since it affects our constituents. Our requests were turned down with no substantive explanation, and we have been told that if we did not agree with this then we will have to apply to the High Court. This is surprising since other Councils have freely given copies of LOBO contracts under Freedom of Information requests. The law relating to disclosure to backbench councillors needs to be revisited.

6. […] There is an additional argument as to the appropriateness of unelected officers preventing elected members from obtaining the information they need to carry out their duties and functions.

7. Councillor Whitworth [...] eventually had to make a request as a resident of Newham under provisions in the Audit Act to obtain copies of the LOBO contracts (though he was not allowed copies of the advice relating to these). It would appear that residents have more rights to access such information than elected members.”

Councillor Whitworth when interview by us also said:

“There is an additional argument as to the appropriateness of unelected officers preventing elected members from obtaining the information they need to carry out their duties and functions.”

“Myself and a couple of colleagues have raised [the LOBO loan] issue at council meetings and Labour group meetings before the council. But we have been met by on the one hand denial that there’s been any problem with LOBOs and on the contrary they were examples of good financial dealings, and on the other concealment of negotiations with Barclays bank.

We were told nothing was happening because nothing was needed, but in fact negotiations were very advanced at that particular case. The council was completely in the dark when the mayor [Robin Wales] made his stance.”

15. Councillor Ferguson’s written evidence to 2015 CLG Committee parliamentary inquiry “Local Council Bank Loans” http://loboloans.uk/Ferguson

Such difficulty in accessing information by councillors was not limited to Newham, but extended to other councils too. Councillor Ferguson of the Conservative led Cornwall Council provides the following evidence in the 2015 parliamentary inquiry:15 “I am disappointed that it needed so much digging on my part and the Dispatches Programme to obtain information on these deals. I would appreciate the help of the Committee to get access to the actual contractual terms of these deals for a full understanding. It is essential

70 that councillors understand the nature of the risks arising from these transactions (which are ongoing). Prior to the Dispatches Programme no information (or even the existence of LOBOs) was published at all by Cornwall Council. If the Council are so comfortable with these deals why the secrecy? [...] I have not got to the bottom of these deals yet because information is still being withheld.”

When councillor Whitworth used the 2014 Audit and Accountability Act to formally raise an objection on LOBO loans, he faced the same difficulties and frustrations as the other resident objectors.

What is more, the Chair of the Audit Board at the time, Councillor Hudson, attempted to publicly name and shame him. The following quotes are from an Audit Board meeting in March 2016:16 Councillor Hudson: “In terms of the objections to the accounts, I understand that one of those objections has come from a councillor in the local authority, yes?”

Councillor Paul: “Can you name the objectors and how much will this additional work cost us in terms of [inaudible]?”

Councillor Baikie: “Chair, I would suggest that if it’s a councillor we should be able to name them. I’m not sure about the legal advice but if it’s a councillor you should be able to name them. I appreciate DPA [Data Protection Act] considerations for a non-council member but if we know it’s a council member we should be able to name them.”

Councillors objecting to LOBO loans in other local authorities have described similar attitudes and incidents. In one case, a councillor was forced to withdraw his objection after having been verbally threatened by the Director of Finance.

A councillor was forced to withdraw his objection after having been verbally threatened by the Director of Finance.

The fact that information on LOBO loans was withheld from councillors and that those that tried to address the issue were treated with such abuse is of great concern and shows the limited power that councillors have in protecting the interest of their constituents. On the other hand, non-elected officers, financial advisors and external auditors appear to be given complete access to the information they request.

3. Involving the local community Research for Action and Debt Resistance UK have run participatory workshops to involve Newham’s local community in the evaluation of the illegitimacy of Newham’s debt. The workshops consisted of a presentation explaining the issues concerning LOBO loans followed by a discussion with residents on their legitimacy, combined with evidence gathering of the impact of the council’s financial decisions on their personal lives. Some of the feedback we received was: “Interesting, I want to find out more about those loans, I want to know how they spend the money.”

“I think the LOBO issue is so hard. It is too hard to get. It is too crazy. People will just say it is like gambling. And RBS? We own RBS…”

“It just makes me angry, I’m only aware by coming to this meeting. People really do not know what is going on.”

“It just makes me angry, I’m only aware by coming to this meeting.

People really do not know what is going on.”

“People have not got a clue, I think people should know, they have a right to know on what the council tax goes on, what they think it is spent on and how they really spend it – people have a right.”

“With that information, I think people will get involved, they would stick together, and challenge what happens or it will just continue.”

However involving the community in evaluating such a complex issue needs a structured process to be developed with residents over several months and appropriate resources so that a representative sample of the population can participate.

16. Newham Council burys head in sand over mounting LOBO loan losses J.Griffiths, DRUK, 1 April 2016 - http://loboloans.uk/Newham-sand

71 17. Cuts and Contempt, Research for Action, May 2018 - http://loboloans.uk/ CutsContempt

Research for Action and Debt Resistance UK have also been invited by local campaign groups to explain the issues around LOBO loans so the arguments could be used to support their campaigning work. An example of this was in 2017, when Debt Resistance UK and the housing campaign Focus E15 collaborated on a spoof version of Newham’s magazine “Newham Mag”, which is criticised17 for acting as a PR machine for the council. The publication titled “Newham Nag” included articles on the council’s LOBO loans and the borough’s housing crisis, and it was handed out to locals at events and street stalls.

18. Tell Newham Council: We want our money back from Barclays and RBS! - https://you.38degrees.org. uk/petitions/tell-newham-council-wewant-our-money-back-from-barclaysand-rbs

A petition18 was also started in 2016 by local Green Party campaigner Elisabeth Whitebread. It gathered more than 900 signatures from people urging the then Mayor of Newham, Sir Robin Wales to “take the banks to court for mis-selling LOBO loans to Newham Council, just like we can do with PPI.” The petition was presented to the Mayor by councillor Rokhsana Fiaz (current Mayor of Newham), but elicited no response. However, it was useful in raising awareness locally on LOBO loans and allowing residents to voice their concerns. Here are some comments form the petition site: “This is not why we pay council tax. The council is accountable to its residents. When did they ask them about this? And why, oh why was it even necessary?”

“We need any spare cash for our local services and we want back what is rightfully the borough’s.”

“We need any spare cash for our local services and we want back what is rightfully the borough’s.”

4. Raising awareness in broader networks Members of Research for Action and Debt Resistance UK have been invited to speak about LOBO loans at events and conferences. These have included panel discussions at academic institutions such as the London School of Economics, the Royal Geographical Society, Goldsmiths University, and workshops at conferences organised by Jubilee Debt Campaign and Transforming Finance. We have also presented to Unite members in Edinburgh at the Merthyr Rising Festival in Wales and the International Crime Symposium in Oxford. Our audit has been shared in convergences of networks working on debt in Brussels, Madrid and Barcelona. Various academics in the UK and abroad have included our findings or used our data in their research on the financialisation of local government.

20. Experiences of debt audits in Europe since 2011, Research for Action, 22 March 2018 https://www.youtube.com/

To increase the awareness in the UK about debt audit movements abroad, in March 2018, Research for Action organised a roundtable on experiences of debt audits in Europe since 2011 with speakers from Greece, Spain and the UK. A recording of the event is available online.20

5. Submitting evidence to inquiries 21. The financial sustainability of local authorities, Public Accounts Committee, 14 November 2014 http://loboloans.uk/PAC 22. Overview and scrutiny in local government, HCLG Committee, 2017 - http://loboloans.uk/HCLG 23. CLG Committee parliamentary inquiry “Local Council Bank Loans”, 2015 http://loboloans.uk/CLGinquiry

Debt Resistance UK submitted evidence to the following inquiries relating LOBO loans to failures in accountability in local government: • Public Accounts Committee – 2014 Financial Sustainability of Local Government inquiry21 • Communities and Local Government Committee – 2017 Overview and Scrutiny inquiry22 • Communities and Local Government Committee – “Local Council Bank Loans” inquiry23

6. Using shareholder activism Shareholder activism has been used to bring LOBO loans to the attention of banks, brokers and advisors. In particular, members of Debt Resistance UK have supported residents and participated themselves in attending the annual general meetings (AGMs) of some of the financial institutions involved in the scandal, including RBS, HSBC, Barclays, ICAP and Capita.

24. Barclays, RBS on LOBOs: we’ve had no complaints, DRUK, 21 May 2016 - http://lada.debtresistance. uk/barclays-rbs-lobos-weve-nocomplaints/

25. LOBO Loans a “Fraud on the People” – RBS AGM Q: via Newham Cllr John Whitworth, DRUK, 31 May 2018 - http://lada.debtresistance.uk/ lobo-loans-fraud-people-rbs-agm-qvia-newham-cllr-john-whitworth/

Thanks to his participation in AGMs, Newham Councillor John Whitworth managed to obtain important statements from the banks. At Barclays 2016 AGM, Councillor John Whitworth was invited for a follow up meeting with Barclays to discuss the councils LOBO loans24. They said: “As a point of reference, we weren’t actually marketing these structures in the past, these were brought to us through intermediaries. We weren’t dealing with local authorities directly.

To the extent that local authorities would like to talk about the situation, to restructure or refinance, then of course we can put you in touch with the right people. We haven’t actually, as far as I’m aware, had any formal complaint with the product, but if you do have concerns I’d be more than happy to discuss that with you.”

At the 2018 RBS AGM,25 he was informed by the bank that it had been in secret negotiations with the council to restructure Newham’s LOBO loans, without the councillors being informed.

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Impact 1. Central government’s response A parliamentary inquiry titled “Local council bank loans” by the Communities and Local Government (CLG) Committee26 was announced on 15 July 2015, following the broadcast of a Channel 4 documentary on LOBO loans (see media coverage below). Three of the people who appeared in the documentary were asked to give oral evidence: financial expert Abhishek Sachdev, former Barclays banker Rob Carver, and Channel 4 reporter Antony Barnett. The hearing took place on 20 July 2015. A video and transcript are available online.

26. CLG Committee parliamentary inquiry “Local Council Bank Loans”, 2015 http://loboloans.uk/CLGinquiry

The following organisations provided written evidence: • Arlingclose LTD • Cornwall Council • Capita Asset Services • CIPFA • Debt Resistance UK • Financial Conduct Authority • London Borough of Newham • Local Government Association As did the following individuals: • Antony Barnett, Channel 4 reporter • Joel Benjamin, campaigner at the time for Debt Resistance UK and MoveYourMoney • Fiona Ferguson, Conservative Councillor for Cornwall • John Gray, Labour Councillor for the London Borough of Newham The submitted evidence was very valuable for the audit, as it provided expert commentary on LOBO loans and a picture of the issues councillors were dealing with in their councils. Importantly, the evidence submitted was under parliamentary privilege and therefore could be cited without risk of libel. Unfortunately, the inquiry was discontinued without any explanation.

In 2016 an open letter27 was co-authored by councillors, MPs, citizens and civil society organisations in support of calls by Clive Betts MP and John Mann MP for a Treasury Select Committee and Financial Conduct Authority (FCA) inquiry into LOBO loans following new media coverage on the issue by the Independent28 and the Evening Standard29. The letter was sent to Andrew Tyrie, at the time MP and chair of the Treasury Select Committee, with an initial list of 61 signatories. Thirty people added their names after that. The Treasury Select Committee and the FCA did not provide any response to the request.

Members of Debt Resistance UK obtained a private meeting at the National Audit Office (NAO) in January 2016. They presented evidence on the issues related to LOBO loans covered by this report, but there was no follow up by the NAO. Since the first inquiry, very little public scrutiny has been applied to LOBO loans by any parliamentary department. To our knowledge, only the Public Accounts Committee (PAC) included some consideration in their 2016 report30 after the NAO had mentioned LOBO loans briefly in their report31 on the financial sustainability of local governments. This is extremely worrying, as it highlights how little priority central government gives to protecting councils from the financial sector. However, it has emerged that private conversations have been occurring on Research for Action LOBO loans between departments, auditors and local authorities, questions why but these communications were either not documented or cannot central government be released to the public. Research for Action questions why central is concealing government is concealing such information while avoiding to speak information. publicly about LOBO loans.

2. Local authorities’ legal action In July 2018, 14 local authorities announced that they are legally challenging Barclays on LOBO loans they were sold by the bank on the basis that they were pegged to LIBOR (see chapter 5).

Newham announced shortly after they were doing the same, but alone.

27. Letter to Andrew Tyrie MP and the Treasury Select Committee, DRUK, 22 March 2016 http://lada. debtresistance.uk/letter-to-andrewtyrie-mp-treasury-select-committee/ 28. MPs call on City regulators and Parliament to look at ‘lobo’ loans, M.Bow, The Independent, 12 March 2016 - https://www.independent.co.uk/ news/business/news/mps-call-on-cityregulators-and-parliament-to-look-atlobo-loans-a6927016.html 29. Council faces probe into ‘timebomb’ Lobo loans from City amid cuts in children’s services, M.Bow, Evening Standard 9 March 2016 https://www.standard.co.uk/business/ council-faces-probe-into-timebomblobo-loans-from-city-amid-cuts-inchildren-s-services-a3199581.html 30. Financial sustainability of local authorities, House of Commons Committee of Public Accounts, 14 Nov 2016 https://publications. parliament.uk/pa/cm201617/cmselect/ cmpubacc/708/708.pdf 31. Financial sustainability of

local authorities 2016, NAO https://www.nao.org.uk/wp-content/ uploads/2016/06/Financialsustainability-of-local-authoritiescapital-expenditure-and-resourcing. pdf

73 Neither Research for Action nor Debt Resistance UK are involved in the court cases, but it is hard to argue that the legal challenges would have happened without our work exposing the issue over the past years. We expect more councils to take action both against Barclays and other banks and look forward to following the developments of the court cases.

In July 2018, 15 local authorities announced that they are legally challenging Barclays on LOBO loans.

3. CIPFA’s response

32. Treasury and Capital Management Panel Bulletin, CIPFA, 2015 - http:// loboloans.uk/CIPFAbulletin

Since the exposure of the issues related to LOBO loans, the Chartered Institute of Public Finance and Accountancy (CIPFA) has published specific guidance on LOBO loans.

In April 2015, CIPFA made available to the public the Appendix A of the Treasury and Capital Management Panel Bulletin32 (previously behind a paywall) which contains information on how LOBO loans should be treated by the council and emphasises the risk associated to them. We quote this document throughout the report.

CIPFA states in the bulletin:

“There have been a number of recent press articles and Freedom of Information Requests about LOBOs and the Panel has decided, for educational purposes, to make the LOBO section of its publication available as part of this Bulletin.”

This was an important achievement as it provided official guidance for residents, councillors and journalist who were trying to engage with the issue. Even if it did not address many of the issues we cover in this report, it was another step towards making local government finance more transparent and accessible.

33. Provisions in the 2018/19 Code for Financial Instruments, CIPFA - http://loboloans.uk/ CIPFAfinancialinstruments

Following a consultation in 2016, CIPFA published new reporting requirements for financial instruments, including embedded derivatives and LOBO loans.

34. CIPFA/LASAAC Clarification statement on the provisions in the local authority accounting code on contracts with Lender Option Borrower Option clauses, CIPFA/ LASAAC, 15 May 2018 https://goo.gl/y3x4cF

Due to objections raised by residents, some of the audit firms requested further clarification on how the embedded options of LOBO loans should be accounted for in the financial accounts. CIPFA published further clarification:34

35. Lancashire accounts’ sign off delayed over £50m LOBO loan L:Brady, Public Finance, 9 Aug 2018 https://www.publicfinance.co.uk/ news/2018/08/lancashire-accountssign-delayed-over-ps50m-lobo-loan1

As a consequence of CIPFA’s extra guidance, auditor Grant Thornton delayed the signing off of the accounts in all the councils it was auditing that had inverse floater LOBO loans until the councils could clarify how they were accounting for the risk associated to them. Grant Thornton noted in a report to one of the councils that:35

“[CIPFA] received a letter from a group of auditors on 4 April 2018 requesting clarification on a number of issues relating to contracts with Lender Option Borrower Option (LOBO) clauses.

[CIPFA] understands that issues were initially raised following a local government elector objection.”

“[LOBO loans] have been subject to significant public scrutiny in recent years. [...] During this year’s audit this has led to increased scrutiny of such financial instruments.”

It is a welcome development that our citizen debt audit is forcing councils and auditors to clarify issues that would otherwise have been overlooked.

36. The World Tonight, BBC, 14 Feb 2018 http://www.bbc.co.uk/ programmes/b09r3nt1

In 2018, CIPFA CEO, Rob Whiteman went even further in suggesting that councils should consider legal action against the banks when he was interviewed for the BBC World Tonight:36 “If councils have made bad LOBO loan deals, they should not be defensive about that but go to litigation and challenge the banks and say, we think we’ve been mis-sold [these products]” Whiteman thereafter clarified his comments and since then CIPFA has avoided taking a clear position on LOBO loans when talking about them to the media.

“[LOBO loans] have been subject to significant public scrutiny in recent years. [...] During this year’s audit this has led to increased scrutiny of such financial instruments.”

“If councils have made bad LOBO loan deals, they should not be defensive about that but go to litigation and challenge the banks.”

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4. Media coverage Media coverage – although limited – has been key in bringing LOBOs into the public eye.37

37. Live table of media coverage https://goo.gl/r5jFG2

The first articles on LOBOs appeared in 2014 in blog posts by Joel Benjamin,38 currently member of Research for Action, by financial analysts Nick Dunbar39 and by former Barclay’s banker Rob Carver.40

38. Newham Council and the LOBO loan scandal, J.Benjamin, Contributoria, October 2014 http:// www.contributoria.com/issue/201410/53ebdfe6f72e46d919000088.html

Following campaign work by Debt Resistance UK, the issue was picked up by Channel 4 in 2015 who under the guidance of Nick Dunbar produced a Dispatches documentary titled “How councils blow your millions”.41 Until then, there had not been much interest from the media except for some specialist local government news platforms. The documentary was an important step for the audit as it exposed the issue and communicated it in an accessible format to the general public. It also provided expert views that could be cited in later stages of the audit. The interviewees included:

39. Lost Lobos, N.Dunbar, Risky Finance, 24 Oct 2014 - https:// riskyfinance.com/2014/10/24/lostlobos/

• Abhishek Sachdev, Chief Executive Officer at Vedanta Hedging Ltd • Rob Carver, former derivatives trader at Barclays Capital • Mark Pickering, Director of Arlingclose

40. LOBOs - The next banking scandal?, R.Carver, This Blog Is Systematic, 28 March 2014 https:// qoppac.blogspot.com/2014/03/lobosnext-banking-scandal.html 41. How councils blow your millions: Channel 4 Dispatches, 6 July 2015 http://www.channel4.com/info/press/ news/how-councils-blow-yourmillions-channel-4-dispatches

• Clive Betts MP, chair of the CLG Committee and Vice President of the LGA • Fiona Ferguson, Councillor at Cornwall Council As a consequence of the documentary, the 2015 CLG Committee Parliamentary inquiry on “Local council bank loans” was called.

As a consequence of the documentary, the 2015 CLG Committee parliamentary inquiry on “Local council bank loans” was called.

However, it effectively took until 2016 for the rest of the mainstream media to take up the issue. This mainly focused around news events such as the restructuring of Barclays loans, especially those of Newham, and the legal cases announced by councils in summer 2018. The bankruptcy of Northamptonshire County Council in early 2018 led to an increase in coverage of issues related to local government finance, including LOBO loans.42

42. Northamptonshire County Council repaying £150m in LOBO loans, C.Lewis, BBC News, 14 Feb 2018 https://www.bbc.co.uk/news/ukengland-northamptonshire-42977061

Local and independent media has been crucial in keeping the issue in the public eye, confirming the importance of media plurality for democracy.

Local and independent media has been crucial in keeping the issue in the public eye.

Journalists have had an important role in voicing some of the concerns related to the issues the public can encounter when investigating local government finance. With regards to Newham’s accounts and LOBO loans, James Moore wrote in the Independent in August 2017:43

“The council’s accounts are striking in that, despite the savings reaped through restructuring a hefty chunk of its controversial LOBO loans, interest payments have surged. Borrowing has also increased sharply. So why? You would have thought this would have been an easy question to answer, but apparently not. A week after raising it, I still don’t have an answer beyond something about the one-off financial impairment of a financial instrument. What does that even mean?”

He compares his experiences as a financial journalist in obtaining information from other big publicly listed companies, saying it can take long but usually results in receiving an answer. Moore comments: “Newham, as an elected local authority, arguably has even more of a duty to come clean about such things. Democratic accountability demands nothing less. And yet, despite repeatedly asking for clarification about that one-off impairment of a financial instrument the council gave as an explanation for the surge in its debt interest I have yet to receive an answer. [...]

The question of the sharp increase in council borrowing has also gone unanswered. This goes beyond a journalist’s natural frustration at obfuscation or at not getting a response to rather simple questions. It is deeply troubling behaviour on the part of a public body. Were the authority to have a strong opposition, it might be able to raise the question, but, of course, Newham doesn’t have that.”

Despite focusing on debt, our audit has detailed major problems with accountability and democracy both in Newham and more widely in local government. In the next chapter, we detail recommendations to Newham Council and various central government bodies on steps to take to act on LOBO loans, avoid accumulating illegitimate debt in the future and improve scrutiny in local government finance.

Most urgently, what this citizen debt audit shows is that LOBO loan repayments should be suspended until Newham’s financial situation is made sustainable and the legality of LOBO loans clarified. We believe these lessons apply beyond east London.

43. As a public body, Newham has a duty to come clean on its finances, J.Moore, The Independent, 2 August 2017 - https://www.independent.co.uk/ news/long_reads/as-a-public-bodynewham-has-a-duty-to-come-cleanon-its-dodgy-finances-a7872611.html

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11 Conclusions and recommendations Urgent and immediate action Newham Council’s LOBO loan debt can be considered illegitimate, and it is likely much of it is illegal.

LOBO loan contracts should be cancelled and interest paid returned to the council.

Until Newham’s financial situation is made sustainable and it has been clarified if LOBO loans were legally entered and are legitimate debt, interest payments on Newham’s LOBO loans should be suspended.

Debt servicing is exacerbating a humanitarian crisis caused by austerity and the strategic defunding of local services. We call for the termination of budget cuts, and immediate steps to repair the damage done to people and communities by the financial suffocation of essential services.

Addressing the crisis in local democracy is insufficient if steps are not taken to ensure fair funding and structural changes to prevent problems from reoccurring. Radical policy alternatives are needed to ensure decisions are made transparently in the public interest, with meaningful resident participation and effective oversight not constrained by private sector profiteering, conflicts of interest and regulatory failure.

Recommendations for central government Act now on LOBO loans 1. Re-open the parliamentary inquiry on the legitimacy of LOBO loans and consider the additional evidence which has emerged, included information provided in this report such as the apparent lack of approval by HM Treasury for councils to take out loans with foreign banks.

2. Undertake an inquiry into HM Treasury reforms to Housing Revenue Account and interventions on the Public Works Loan Board (PWLB) rates and repayment penalties which drove councils to borrow from more costly and risky private banks.

3. Call on the Financial Conduct Authority (FCA) to investigate: • the mis-selling of LOBO loans to councils and housing associations • co-ordinated market abuse by banks, brokers and treasury management advisors (TMAs) 4.

Call for an investigation by the Serious Fraud Office (SFO) on: • the fraudulent actions of the TMAs in advising councils on LOBO loans and Icelandic investments, while taking oversized, undeclared commissions from brokers • the fraudulent actions of the banks and brokers in selling LOBO loans while rigging LIBOR and ISDAfix

5. Demand that all councils’ external auditors who have received objections on LOBO loans publish a public interest report to the councils, providing copies to the National Audit Office.

6.

Make public all information on LOBO loans, including:

76 • FSA’s 2009 Arrow Review into Butlers/ICAP, which resulted in Butlers being sold to Capita • unredacted Competition Commission report into the Butlers/Capita merger which investigated TMA commissions • internal communication on LOBO loans between central government bodies, councils, auditors, CIPFA and TMAs

Avoid accumulation of illegitimate debt in the future 1. Reverse the decision to abolish the PWLB and to transfer its functions to HM Treasury, and ensure it works in the interest of local authorities by: • maintaining low-margin, market interest rates • removing excessive repayment penalties on existing PWLB loans • ceasing political favouritism in how rates are determined for different councils • writing off historical debt or suspending repayments where councils are in financial difficulty • remaining the lender of last resort 2. Support the creation of municipal, publicly owned banks so that wealth can be retained at the local level, and councils are not reliant upon too-big-to-fail banks.

3. Put an end to private sector wealth extraction schemes containing derivatives, such as LOBO loans and Private Finance Initiative (PFI), by introducing legislation that protects local government in principle from future financial sector mis-selling.

4. Make it compulsory for local government to: • benchmark other forms of borrowing to PWLB rates over the lifetime of the loans • specify the purpose of their borrowing and demonstrate it is undertaken in the public interest • define the social sustainability of council borrowing and monitor changes by setting clear parameters and metrics for compliance over time • provide councillors with all the information and training they need to fully participate in and effectively scrutinise council financial decisions 5. Demand that the FCA regulate local authority borrowing and investment, so that public finance is protected from co-ordinated market abuse perpetrated by the financial sector.

6. Review TMA practices and their inherent conflicts of interest, and introduce appropriate regulation and scrutiny to protect public money.

7. Stop financial firms and audit companies from sponsoring conferences and annual events of public institutions and professional bodies that are responsible for local government finance and policy development such as CIPFA and the LGA. 8. Provide sufficient ring-fenced funding to councils to increase their in-house financial expertise, either by training existing staff or hiring people with the necessary skill level.

9. Encourage residents’ involvement in councils’ financial decision-making.

Improve effective scrutiny of local government finance 1. Reinstall the Audit Commission and abolish the use of conflicted private audit firms for the external audit of councils.

2. Review the 2014 Local Audit and Accountability Act, including: • removing the punitive gag clause threatening unlimited fines for members of the public when sharing public sector financial information in the public interest • introducing financial resources to support residents both during the objection process and in the case of appeal • introducing an appeal process for when inspection requests are refused • placing specific time-limits on auditors’ response period • making a public interest report compulsory if an objection is accepted as valid 3. Review the current system of accountability and scrutiny in local government finance, including an assessment of the costs of poor financial decision-making and scrutiny failures.

4. Introduce effective regulation and scrutiny of private firms providing audit, advice and consultancy to local authorities to protect public authorities from private sector conflicts of interest.

5. Improve central government data reporting in local government spending, borrowing and investment by introducing coherent classification parameters over time, consistent data labelling and reporting standards across councils, as well as appropriate reporting and scrutiny

77 mechanisms.

6. Modify accounting standards to ensure financial sustainability and public value for money are prioritised, rather than gambling with derivatives under the guise of interest rate hedging.

7. Extend local authorities’ document retention policy to match the terms of financial products they have taken out, including benchmarking decisions by council officers and advice notes by TMAs. 8. Improve the effectiveness of the Freedom of Information (FOI) Act by introducing fines for public bodies that repeatedly delay or refuse FOI requests without a valid exemption, and introducing FOI compliance rates as a performance indicator reported in councils’ annual accounts.

9. Expand the FOI Act to private companies contracted to the public sector to increase transparency and avoid private sector impunity when under-resourced public bodies are taken advantage of.

Recommendations for Newham Council Act now on LOBO loans 1. Evaluate the legality of each of Newham’s LOBO loans with the support of legal and financial experts based on the evidence provided in this report.

2. Take legal action against banks, TMAs or brokers based on the legal evaluation either autonomously or in co-ordination with other councils on aspects common to all cases.

3. Demand disclosure by banks, brokers and TMAs of the flows of money that occured in the selling of LOBO loans, including commissions shared from both the council and lending bank.

4. Demand disclosure from central government of all information regarding LOBO loans they hold, including internal communication between central government bodies, councils, auditors, CIPFA banks, brokers and TMAs. 5. Undertake a review of the financial decisions of the previous administration to intervene 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.

6. Call for support from national and regional institutions in taking legal and political action against LOBO loans, including the Local Government Association.

7. Undertake an assessment of the legitimacy of the council’s debt involving the local community in judging if the funds were used in the best interest of its residents and if servicing the debt is socially sustainable.

Avoid accumulation of illegitimate debt in the future 1. Advocate against the closure of the PWLB and that its remit should be to support local authorities, including during a funding crisis, rather than acting as a profit centre for HM Treasury.

2. Support the growth of a local banking system by exploring the development of a municipal bank, investing and borrowing with existing local banks and building societies and encouraging ethical peer-to-peer finance.

3. Avoid private sector wealth extraction schemes containing derivatives, such as LOBO loans and Private Finance Initiative (PFI). Councillors should refuse to put taxpayers’ money at risk by gambling in the financial sector.

4. Ensure all forms of borrowing are always benchmarked in relation to PWLB debt and other available product over the lifetime of the loans.

5. Declare the purpose of borrowing in all cases and provide and retain proof that it is undertaken in the public interest.

6. Undertake an assessment of the social sustainability of the council’s borrowing on an annual basis, setting clear parameters and metrics for measuring and reporting changes over time.

7. Invest in training or hiring highly qualified officers to grow in-house financial expertise

78 and avoid reliance on conflicted, for-profit, private sector advice.

8. Invest in training for councillors to increase competency on financial issues for decisionmakers in the council.

9. Give residents a greater stake in financial decision-making, for example by introducing forms of participatory budgeting.

Improve effective scrutiny of local government finance 1. Advocate for the re-installment of the Audit Commission to avoid reliance on conflicted private firms for the external audit of the council.

2. Re-evaluate the council’s current scrutiny and accountability structures, including the directly elected mayor (DEM) and cabinet system.

3. Demand full disclosure of conflicts of interest and commission payments from private firms on which the council relies on for financial decisions such as auditors, treasury management advisors and brokers.

4. Record all audit board, scrutiny and finance meetings as default to combat the democratic deficit and to allow for enhanced scrutiny by residents who are otherwise unable to attend council meetings.

5. Improve consistency of data reporting and spending categorisation in the council’s accounts to enable meaningful year-on-year comparisons.

6. Retain all documents related to long term borrowing until maturity date, including benchmarking decisions by council officers and advice notes by TMAs. 7. Ensure councillors have access to all the information they need to both understand and scrutinise the council’s financial decisions.

8. Commit to compliance with FOI Act time frames, including monitoring compliance and reporting performance in the councils’ annual accounts.

Conclusions The practical recommendations presented here are important first steps towards a more accountable local government. However, democracy does not stop at transparency and accountability.

We urgently need a process for the declaration of illegitimate debt at the municipal level.

Laws and regulations that apply to other forms of borrowing could be adopted for local government debt. For example, the 2006 Consumer Credit Act Section 140A on “Unfair relationships between creditors and debtors” states that: “(1) The court may make an order [...] in connection with a credit agreement if it determines that the relationship between the creditor and the debtor arising out of the agreement [...] is unfair to the debtor because of one or more of the following: (a) any of the terms of the agreement or of any related agreement; (b) the way in which the creditor has exercised or enforced any of his rights under the agreement or any related agreement; (c) any other thing done (or not done) by, or on behalf of, the creditor (either before or after the making of the agreement or any related agreement).

(2) In deciding whether to make a determination under this section the court shall have regard to all matters it thinks relevant (including matters relating to the creditor and matters relating to the debtor).”

We believe the spirit of this law should be applied to loan products mis-sold to institutional borrowers such as local authorities.

Newham’s citizen debt audit provides evidence and tools for all councils and their representative bodies to act on illegitimate debt. Action is needed urgently to avoid further human rights violations and councils going bankrupt. However, more needs to be done to strengthen local democracy. As we have found, residents want to participate in financial decision-making and have a real say in how common resources are used. We welcome all initiatives towards this end in Newham and beyond.

The crisis in UK local government is severe. But it can be turned into an opportunity to reprogram local democracy, placing people’s interests at its heart.

Type

20,000,000 Vanilla

50020

01/12/09

01/12/09

01/12/09

11/12/09

01/12/09

Inverse Floater - Royal Bank of 25,000,000 stepped Scotland

Inverse Floater - Royal Bank of 25,000,000 stepped Scotland

Inverse Floater - Royal Bank of 25,000,000 stepped Scotland

Inverse Floater - Royal Bank of 25,000,000 stepped Scotland

50027

50028

50029

50030

50031

Date Signed

Inverse Floater - Royal Bank of 25,000,000 stepped Scotland

Initial Counterparty

12/12/07

Merrill Lynch

01/12/09

Type

28/09/07

Merrill Lynch

Date Signed

50026

Principal (£)

Zero to 25,000,000 Par Zero to 15,000,000 Par

Initial Counterparty

29/07/08

20/03/06

20/03/06

20/03/06

20/03/06

17/05/05

26/09/03

09/08/02

Date Signed

Inverse Floater - Royal Bank of 25,000,000 stepped Scotland

Int Ref #

50018

50015

Type

DePfa Bank Dexia Credit Local

30,000,000 Vanilla

50013

Principal (£)

DePfa Bank

15,000,000 Vanilla

50012

Int Ref #

DePfa Bank

20,000,000 Vanilla

50011

DePfa Bank

10,000,000 Vanilla

50010

Bayerische Landesbank Dexia Credit Local Dexia Credit Local

Initial Counterparty

10,000,000 Vanilla

Vanilla 10,000,000 Stepped Vanilla 10,000,000 Stepped

Principal (£)

50009

50006

50002

Int Ref #

12 Appendix Maturity Date

Maturity Date

Maturity Date

25/01/10 25/01/60

01/02/10 01/02/60

03/01/10 03/01/60

26/02/10 26/02/60

04/01/10 04/01/60

11/01/10 11/01/60

Drawdown Date

19/12/07 19/12/57

05/10/07 05/10/57

Drawdown Date

05/08/08 05/08/78

03/07/06 02/07/66

03/04/06 01/04/66

06/04/06 06/04/64

20/03/06 18/03/64

25/05/05 26/05/65

03/10/03 10/05/43

01/07/02 01/07/42

Drawdown Date

50

50

50

50

50

50

Term (yrs)

50

50

Term (yrs)

70

60

60

58

58

60

40

40

Term (yrs)

11/01/10

12 25/01/10

12 01/02/10

12 03/01/10

12 26/02/10

60 04/01/10

60

Option Date start period teaser (m) rate

60 n.a.

60 n.a.

Date start iniatial rate

Initial rate

First option date Option called

4.09 05/08/11 No

4.595 02/07/07 No

4.43 01/04/06 No

4.42 06/04/07 No

4.44 18/03/07 No

4.2 25/05/15 No

11/01/12

Date start iniatial rate

1

3.000

3.000

3.000

3.000

25/01/11

01/02/11

03/01/11

26/02/11

2.000 04/01/12

2.000

Teaser rate

n.a 19/12/07

8.65 GBP ISDA swap 8.60 GBP ISDA swap 8.98 GBP ISDA swap 8.98 GBP ISDA swap 8.85 GBP ISDA swap 8.85 GBP ISDA swap

Initial rate

Has option been called

25/01/20 No

01/02/20 No

03/01/20 No

26/02/20 No

04/01/15 No

11/01/15 No

First option date

4.390 19/12/12 NO

8.65 GBP ISDA swap 8.60 GBP ISDA swap 8.98 GBP ISDA swap 8.98 GBP ISDA swap 8.85 GBP ISDA swap 8.85 GBP ISDA swap

Current interest rate

4.390

4.4625

Current interest rate

4.09

4.595

4.43

4.42

4.44

4.2

4.45

Current interest rate

4.45 03/04/07 No

Option called

4.95

First option date

4.95 01/07/05 No

Initial rate

n.a 05/10/07 4.4625 05/10/12 NO

Date start iniatial rate

n.a 05/08/08

n.a 03/07/06

n.a 03/04/06

n.a 06/04/06

n.a 20/03/06

n.a. 25/05/05

3.5 03/04/07

3.875 01/07/05

Teaser rate

Option Date start Teaser period teaser rate rate (m)

6 n.a.

6 n.a.

6 n.a.

36 n.a.

24 n.a.

120 n.a.

24 03/10/03

6 01/07/02

Option Date start period teaser (m) rate

7.52

7.49

7.62

7.69

7.31

7.21

Average interest rate for 2017/2018

Existing Counterparty

Existing Counterparty

Contract

j8jvtU https://goo.gl/ 39mhSo https://goo.gl/ osXAF3 https://goo.gl/ dCJYoa https://goo.gl/ sLvqF7 https://goo.gl/ 7z3aYJ https://goo.gl/ bvAUzg https://goo.gl/ 53tc27

https://goo.gl/

Contract

Existing Counterparty

Royal Bank of 1,885,473 56,894,184 Scotland

Royal Bank of 1,881,706 56,897,866 Scotland

Royal Bank of 1,917,533 57,878,922 Scotland

Royal Bank of 1,943,605 57,351,322 Scotland

Royal Bank of 1,828,104 55,081,978 Scotland

Royal Bank of 1,836,412 55,676,044 Scotland

2017/18 fair value (£)

https://goo.gl/ rLjcR7

https://goo.gl/ kqyeVN

https://goo.gl/ QgWkVi

https://goo.gl/ gwyfwC

https://goo.gl/ oFASCk

https://goo.gl/ deJ8ZN

Contract

https://goo.gl/ 59,639,198 FMS Wertmanagement mxSNgr https://goo.gl/ 33,995,577 FMS Wertmanagement RFvAPp

2017/18 fair value (£)

Bayerische 16,694,447 Landesbank Dexia Public Finance 16,056,673 Bank Dexia Public Finance 19,949,640 Bank FMS 20,405,639 Wertmanagement FMS 41,199,788 Wertmanagement FMS 31,435,470 Wertmanagement Europaische 64,413,242 Hypothekenbank Dexia Public Finance 42,412,419 Bank

2017/18 fair value (£)

Interest paid in 2017/2018

0

0

Interest paid 2017/18

818,000

1,380,000

664,500

884,000

441,567

422,301

445,000

493,644

Interest paid 2017/18

79

35,000,000 Barclays Bank 31/07/08

25,000,000 Barclays Bank 11/11/08

25,000,000 Barclays Bank 11/11/08

5,000,000 Barclays Bank 11/11/08

10,000,000 Barclays Bank 11/11/08

30,000,000 Barclays Bank 11/11/08

18,500,000 Barclays Bank 01/04/08

5,000,000 Barclays Bank 01/04/08 10,000,000 Barclays Bank 06/11/07

50,000,000 Barclays Bank 31/07/07

5208

5308

5508

5608

5708

50001

50005 50019

50014

Date Signed

4708

Initial Counterparty

35,000,000 Barclays Bank 31/07/08

Principal (£)

4608

Int Ref #

Maturity Date

06/08/07 06/08/77

01/04/08 01/04/78 06/11/08 06/11/78

11/04/08 11/04/78

03/12/08 03/12/78

03/12/09 03/12/78

03/12/08 03/12/78

03/09/08 03/03/78

03/06/08 03/12/77

01/09/08 01/09/79

01/09/08 01/09/78

Drawdown Date

70

70 70

70

70

69

70

70

69

71

70

Term (years)

First option date

Has option been used

No

No

No

No

No

No No

No

3.9% if index is 4-6.5%; 6.9% if below 4%; 4.92% if above. 03/12/10

6.2% if index above 7%.

0.1% for Up to 03/12/13 7.6% if index btw index is below 0%, 0-7%, 7.6% if "reference rate"-0.6% if index below index is btwn 0-6.25%.

0%, 5.6% if After 7.6% if index below index above 4%, "reference rate"-0.6% 03/12/08 7% 03/12/10 if index btwn 4-6.2%. 03/12/11 6.2% if index above 7%.

0.1% for Up to 03/12/13 7.6% if index btw index is below 0%, 0-7%, 7.6% if "reference rate"-0.6% if index below index is btwn 0-6.20%.

0%, 5.6% if After 7.6% if index below index above 4%, "reference rate"-0.6% 03/12/09 7% 03/12/10 if index btwn 4-6.2%. 03/12/10 5.6% if index above 6.2%.

Up to 03/12/13 7.6% if index is below 0%, "reference rate"-0.6% if index is btwn 0-6.20%.

After 7.6% if index below 4%, "reference rate"-0.6% 03/12/10 if index btwn 4-6.2%. 03/12/10 4.5% for index btwn 4.75-6%; 5% otherwise. 11/04/09 4.35% for index btwn 4.75-6%; 4.65% otherwise. 01/04/09 3.900 06/11/09 3.99% if index btwn 4.75-6.5%; 4.86% otherwise 06/08/08

3.9% if index is 0-6.5%; 6.9% if below 0%; 4.92% if above. 03/09/13

Range (6m GBP LIBOR) 6 stepped

Range (6m GBP LIBOR) 6 stepped

6

6

6

Range (6m GBP LIBOR) stepped Range (6m GBP LIBOR) Range (6m GBP LIBOR) Vanilla Range (6m GBP LIBOR) n.a.

n.a. n.a.

n.a.

n.a 06/08/07

n.a 01/04/08 n.a 06/11/08

n.a 11/04/08

0.1% for index btw 0-7%, 7.6% if index below 0%, 5.6% if index above 03/12/08 6.2%

Range (6m GBP LIBOR) 6 stepped 03/09/08

No

4.09% if index 4-6.5%;; 6.8% if below 4%; 4.86% if above 6.5% 03/12/10

Range (6m GBP LIBOR) 6 stepped

4.09% if index 0-6.5%; 6.8% if below 0%; 4.86% if 03/06/08 above 6.5%. 03/06/13

No

Initial rate

3.9% for index btwn 2.5-10%, 4.65% 3.9% for index btwn otherwise 01/09/11 4.25-7%, 4.65% otherwise 01/09/09

Date start iniatial rate

Range (6m GBP LIBOR) 6 stepped 01/09/08

Teaser rate

No

Date start teaser rate

3.9% for index btwn 2.5-10%, 4.65% 3.9% for index btwn otherwise 01/09/11 4.25-7%, 4.65% otherwise 01/09/11

Type

Range (6m GBP LIBOR) 6 stepped 01/09/08

6 60

Option period (m)

6.491

4.406 3.900

4.540

6.625

6.625

6.625

5.926

5.941

4.644

4.152

11,305,962 20,757,197

42,839,641

95,464,709

31,821,570

15,910,785

71,562,147

71,966,838

82,614,329

75,042,606

2017/18 fair value (£)

3,245,500 154,257,952

220,300 390,000

839,900

1,987,500

662,500

331,250

1,481,500

1,485,250

1,625,400

1,453,200

Interest rate Interest paid following in 2017/18 restructure (£) (%)

https:// goo.gl/ o5vUp2

https:// goo.gl/ 3X47Nv

https:// goo.gl/ 65gr4D

https:// goo.gl/ xYXYwr

https:// goo.gl/ MC7w45

https:// goo.gl/ AVJAQb

https:// goo.gl/ 7Cgz9M

https:// goo.gl/ yMYNYP

https:// goo.gl/ 15WUpQ

https:// goo.gl/ qDrJXZ

Contract

80

RA for

Research for Action 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. @Research_Act http://researchforaction.uk info@researchforaction.uk Authors Joel Benjamin Fanny Malinen Ludovica Rogers

@Gian_TCatt @fannymalinen @ldvcrgrs

Collaborators Jamie Griffiths, Maria Longley, Benedetta Rogers, Steve Rushton, Marini Thorne Contributors We want to thank the following people for their contributions to this report: Rachel Collinson Peter Crowley Nick Stoop Councillor John Whitworth Nicholas Wilson Newham residents interviewed for Cuts and Contempt Focus E15 campaign & those who came to workshops at Sylvia’s Corner Kevin Jenkins, Ambition Achieve Aspire Venu Dhupa, Community Links And the interviewees who wished to remain anonymous.

The citizen audit into Newham’s LOBO loans has been a collaborative process and only made possible by the input of many people. We thank all those who have contributed including residents, objectors, councillors, financial experts and journalists.