Written evidence submitted by Debt Resistance UK [LOB 12]

1. Executive Summary

1. Debt Resistance UK hold strong concerns regarding the systemic use of LOBO loans in the public sector and the implications they can have on Local Government finance and consequently on the general public. In our research we have identified the following issues:

1. Local Authorities are borrowing from banks even if it is more risky and expensive than borrowing from Central Government via the Public Works Loan Board (PWLB).

2. To compete with the PWLB, banks are providing Local Authorities with “teaser rate” loan contracts with embedded derivative called LOBO loans. These Loans are potentially illegal following the 1989 Hammersmith and Fulham vs Goldman Sachs case.

3. Local Authorities rely on private institutions to help manage, advise on, structure and borker their financial affairs. These firms, not only charge high fees, but operate with significant conflicts of interest. Given the high commissions being paid on LOBO loan trade it is hard to believe that LOBO loans are recommended with the interest of taxpayers in mind and should therefore be considered iillegitimate.

4. Local Authority borrowing is unregulated by the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority (PRA).  The Audit Commission whose role was “to protect the public purse[1]” by “appointing auditors, publishing analysis and comparing data” was closed in March 2015.[2] Since then there is no body designated to maintain a comprehensive oversight on Local Government finance. At a local level, transparency and accountability is limited as documents regarding borrowing from private banks are not made easily available to the public or to elected councillors.

2. We believe a full investigation is needed to determine which LOBO loan contracts are illegal and/or illegitimate, and that Central Government should take immediate action to protect public finance of Local Authorities , ultimately taxpayers’ money, from the use of mechanisms such as LOBO loans.

2. Introduction to Debt Resistance UK (DRUK)

1. Debt Resistance UK (DRUK) is a collective of activists and researchers who investigate debt and its implications for the public sector and society. We acknowledge that debt affects all of us, whether it is personal debt, local government debt or national debt. We research, inform and take action with the aim to shine a light on exploitative lending practices and help people understand the mechanisms of debt.

2. DRUK was featured in the Channel 4 Dispatches documentary “How Councils blow your millions” as one of the sources of information on LOBO loan contracts. We are submitting evidence as we have  strong concerns regarding LOBO loans and the implications they have for the public sector and the general public.

3. Methodology of DRUK’s research into LOBO Loans

1. In late 2014, DRUK decided to further develop research into LOBO loans already initiated by Joel Benjamin (also member of DRUK) and Ranjan Kamuran, whose work was featured in Nick Dunbar’s article “Lost LOBOs”[3].

2. Based on initial analysis of the Department of Communities and Local Government (DCLG) Borrowing and Investment Tables[4], DRUK sent around 300  Freedom of Information (FOI) requests to more than 220 Councils inquiring about LOBO loans. DRUK used the platform www.whatdotheyknow.com so the FOI requests and the outcomes would be publically available. DRUK also published some of the information received on the site http://lada.debtresistance.uk 

3. DRUK’s requests contained variations of the following questions:

●        How many LOBO loans and of what kind does the Council hold?

●        What are the principal values, the interest rates and call dates, for each LOBO loan the Council holds?

●        Which banks and financial institutions has each LOBO loan been taken out with?

●        Who were the brokers for each LOBO loan?

●        Who advised the Council on LOBO loans?

●        Were the LOBO loans benchmarked against PWLB loans when they were taken out?

●        Has the Council considered restructuring of LOBO loans?

4. Around a third of our inquiries were successful in providing the information requested. We are now in the process of appealing to the Information Commissioner for the requests that were refused and have recently won two cases[5], notably with the Councils of Cornwall[6] and Swansea[7].

5. Our FOI requests were picked up by financial journalist Nick Dunbar who has written about LOBO loans on his blog[8] and produced the Channel 4 Dispatches Documentary “How Councils blow your millions”.

4. Findings of DRUK’s research into LOBO Loans

1. We have so far analysed over 700 LOBO loans contracts from 69 Local Authorities across the UK. The total outstanding LOBO debt for these 69 Councils is £7.4bn. This compares with a figure of £7.7bn long term debt outstanding to UK banks and ‘other sources’ indicated in the DCLG Borrowing and Investment Live Tables Q4 2014-15.[9] The close correlation of these two figures leads us to believe that the total outstanding amount of LOBO loans to UK Local Authorities is in line with the Dispatches estimate of £15bn.

2. LOBO loan stands for “Lender Option Borrower Option” and is typically very long term (50-70 years). Usually the loan is offered with an initial low “teaser rate”. The Lender then has, at pre-agreed call dates, the “option” to change the rate. The Borrower can then either accept the new rate, or repay the loan in full. To note, the Borrower can only fully repay a loan without a penalty if the Lender “calls his option”. Should the Borrower want to exit the loan under other circumstance it will incur exorbitant exit fees.

3. LOBO loan interest rates, terms and conditions vary from contract to contract. We have found loans that start from an interest rate of 0,1 % that is then raised to 7,6% [10], others where Councils are paying interest rates higher than 11%[11].

4. In most cases Councils rely on brokers to obtain and structure the deals while charging substantial fees. Based on the analysis of 186 LOBO deals where brokers and fees are known to us:

●        ICAP and Tullett Prebon were the most popular brokers

●        The average fee is £23,147 or 0.183% of the loan principal

●        The highest brokerage fee encountered for a single loan is £96,000

●        Brokerage fees for LOBO loans have cost Councils overall at least £30m

5. Due to the “optionality" and length of LOBO loans, the overall interest rate that a Council will pay over the life of a loan is very difficult to price without complex pricing tools that the majority of Local Authorities will not have direct access to. Banks on the other hand use sophisticated software to predict upfront how much they will earn over the lifetime of the loan. This creates an information asymmetry that clearly puts Councillors and Finance Officers in an unfavourable position.

6. To support financial decisions regarding borrowing and investing, Councils pay for supposedly independent advice from the financial sector through firms known as Treasury Management Advisers (TMA). The main TMA’s in place when LOBO contracts were signed were Butlers (part of ICAP) and Sector (part of Capita). From our analysis of LOBO loans where both brokers and advisors were known:

●        In Councils where Butlers acted as TMA, ICAP brokered 84% of the contracts

●        In Councils where Sector/Capita were TMA, Tullett Prebon brokered 62% of the contracts

5. Concerns DRUK would like to raise regarding LOBO Loans

1. In this document the terms hereafter have the meaning assigned to them below[12]:

1. Illegal Debt: Debt in respect of which:
1. proper legal procedures were not followed
2. or which involved clear misconduct by the lender
3. as well as debt contracted in violation of domestic and international law
4. or had conditions attached thereto that contravened the law or public policy.

2. Illegitimate Debt: Debt that the borrower cannot be required to repay because:
1. the loan, security or guarantee, or the terms and conditions attached to that loan, security or guarantee infringed (national or international) law or public policy,
2. or because such terms or conditions attached to the loan, security or guarantee included policy prescriptions that violate national laws or human rights standards,
3. or because such terms or conditions were grossly unfair, unreasonable, unconscionable or otherwise objectionable,
4. or because the loan, security or guarantee was not used for the benefit of the population or the debt was converted from private to public debt under pressure to bailout creditors.

2. Local Authorities are AAA rated so we see no legitimate justification for Councils to pay such high interest rates to banks. Such interest rates are unfair and unreasonable and therefore LOBO debt should be considered illegitimate.

3. The use of LOBO loans is systemic across the country and appears to be a way in which banks have “engineered around” financial legislation. In 1989 following the Hammersmith and Fulham vs Goldman Sachs case[13], the High Court ruled that Councils entering interest rate swaps contract was “ultra vires”, as it was not in the power of Local Authorities to gamble with taxpayers’ money and that taxpayers should not be held liable.[14] We believe that for the same reason, LOBO loans should be considered illegal and illegitimate.

4. DRUK have requested evidence, via FOI, from several local authorities that LOBO loans were benchmarked against borrowing from the Public Works Loan Board (PWLB). No Council has up to now provided us with such evidence. Should there have been no benchmarking of the loans, we believe that these loans are illegal and illegitimate as due procedures were not followed to ensure that the loans were taken out in the interest of citizens and that fiduciary duty was undertaken appropriately.

5. LOBO contracts have interest rates that are linked to the LIBOR interest rate, and were mostly sold to Councils by the same banks (Barclays and RBS) and brokers (ICAP) that have been fined/ prosecuted for manipulating benchmark interest rates. As misconduct by the lender has been proven LOBO loans should be considered illegal.

6. Brokerage fees on LOBO Loans are exorbitant compared to the cost of taking out a loan from the PWLB. Considering that brokers also receive extensive commissions from the banks we believe these costs were not incurred in the interest of taxpayers, that fiduciary duty was not followed and therefore LOBO debt should be considered illegitimate.

7. We question the role of TMA companies and believe that their proven conflict of interest with the brokers renders LOBO debt illegal and illegitimate.

8. The role of TMAs has previously been criticised by the CLG committee inquiry into Local Authority investments following the Icelandic banking crisis when Local Authorities lost £1 billion on deposits when Icelandic banks crashed in 2008.[15] The main TMA firms then were the same: Butlers and Sector. The Parliamentary Inquiry[16] then strongly recommended the Financial Services Authority (FSA) to fully investigate TMA firms, and yet the FSA did not proceed. With the closure of the Audit Commission in 2015, and the FCA stating that regulating Local Authority borrowing is out of their remit, we have great concerns that there is currently no independent comprehensive oversight over Local Government Finance.

6. Conclusions and Recommendations

We recommend the following:

1. That an in-depth investigation is undertaken by the appropriate bodies into the use of LOBO loans in Local Governments across the country to identify if LOBO loans were taken out in the interest of taxpayers, or if they are illegal and/or illegitimate.

2. Should LOBO loans be found to be illegal and illegitimate that all future payments and interest payments are cancelled as in the Hammersmith and Fulham vs Goldman Sachs case.

3. That Local Authorities are instructed by DCLG to set up local debt audit commissions on the model of the Greek Public Debt Truth Committee.

4. That the Serious Fraud Office and the FCA investigate the specific cases of conflict of interest between brokers and Treasury Management Advisors in Local Government Finance.

5. That a separate inquiry is undertaken by the Department of Communities and Local Government, National Audit Office, HM Treasury and the Financial Conduct Authority into the role of the Treasury Management Advisors in Local Government.

6. That all LOBO loan repayments and interest payments are suspended until the inquiries have been concluded.

7. That regulations and regular independent scrutiny is introduced for Treasury Management Advisors and Local Government borrowing and investment.

8. That Local Authorities are instructed by DCLG to make information related to their finance, including contracts and reports, transparent and accessible by default to Councillors, the press and the general public.

December 2015