In April 2020, Arlingclose helped a local authority secure an Interest Rate Swap (Swap) that fixed a 0.56% rate on £75 million over 20 years. This groundbreaking transaction marked the first use of such financial instruments by a UK local authority since the early 1990s.
Interest rate swaps convert a floating interest rate into a fixed rate, offering predictability and protection against rate fluctuations. This financial tool allows local authorities to stabilise their borrowing costs independently of their underlying short-term debt.
For illustration, the bank pays the Council interest on a floating rate notional amount at SONIA, and the Council pays the bank a fixed rate on the same amount. This arrangement results in a net interest payment, securing a fixed cost of borrowing irrespective of market fluctuations.
In late 2019, the Council faced significant exposure to short-term debt, with 71% of its £503 million debt portfolio vulnerable to interest rate movements. With short-term rates at 0.86% and long-term PWLB rates at 2.97%, a swap provided an affordable way to hedge against interest rate risk by locking in a low rate and mitigating future cost increases. From an interest rate risk management perspective, a swap can offer significant benefits:
The swap secured a 0.56% rate for £75 million of short-term debt for 20 years, saving the Council approximately £1.42 million annually compared to fixing with the PWLB. This transaction not only reduced risk but also provided substantial financial savings over two decades.
The swap has proven beneficial, providing a fixed rate well below the volatile PWLB rates. As of July 2024, rates for the remaining swap term were seven times higher. The swap's increased mark-to-market value has further strengthened the Council's financial position.
The legality of swaps for local authorities has been contentious since the 1992 ruling in Hazell v Hammersmith and Fulham, which declared such transactions beyond council powers under the Local Government Act 1972. However, the Localism Act 2011 introduced the General Power of Competence, enabling councils to engage in activities similar to those of individuals, including swaps for risk management purposes.
Additional considerations at the time were that swaps can be terminated before maturity with breakage costs calculated based on the difference between the contractual rate and current rates, which diminish as the swap approaches maturity, and there was also a minor risk of negative interest rates in 2020 that may have impacted the net payment structure but would also have lowered the Council’s funding cost.
Arlingclose played a pivotal role in advising and executing the swap, ensuring compliance with legal and regulatory standards. Our ongoing support includes swap valuation and hedge accounting, demonstrating our commitment to prudent risk management for local authorities.
For further insights and guidance on debt management, local authorities can reach out to Arlingclose for expert advice and tailored solutions.
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