Our municipal investments are a lower risk investment but, as with any investment, there are still risks when lending money to a council. As a local authority is a different type of legal entity to a company, the risks to your capital and returns are different and there are certain mitigations that reduce the risk to your investment.
When assessing the risk of investing in a council there are a few key things to understand:
Local authorities, unlike companies, are not subject to general bankruptcy or winding up rules so they cannot be declared bankrupt and then avoid repaying their debts through this route. If a company is unable to meet its obligations to a creditor (people who have lent it money), the company can be declared bankrupt and the company would be wound up. While the assets of the business could be sold to try and recover money to repay creditors, the company itself would no longer exist and therefore the debt obligation would also no longer exist. As a local authority has statutory obligations to its residents that it must fulfil, it cannot be declared bankrupt and wound up. Therefore its debt obligations to creditors will always remain even if the council runs into financial difficulties.
A council’s ability to borrow money and its revenue sources are different to a company’s. A council typically has a range of revenue sources, including council tax, business rates and fees and charges from local services amongst others, which have different characteristics to a company’s.
The way in which councils manage their budgets is tightly managed and regulated. The Local Government Act 2003 provides the framework for how all councils manage their finances and stipulates that each must maintain a balanced budget. It is illegal for them to not do so (it is a personal liability for the financial officer of the council). The Act also stipulates that borrowing must be affordable and that, should a local authority be borrowing beyond its means, then the central government can step in. Also, local authority finance officers must work in accordance with the Prudential Code of the Chartered Institute of Public Finance and Accounting which stipulates that all such borrowing must be “sustainable, prudent and affordable.”
What happens if a council gets into financial difficulty?
As explained above, it is technically not possible for a council to become bankrupt, but it is possible that they could run into financial difficulties, in the sense that their revenues do not cover their expenditure, which may prevent or delay payment of your interest and capital on an investment.
If a local authority does run into financial difficulties, there are legal provisions that allow central government to step in and take control of the local authority until it is returned to a financially stable position. In simple terms, it is unlawful for a local council to spend more than its income. If a financial officer sees that a council is going to fail to keep a balanced budget it must issue a notice known as a Section 114 Notice. By issuing a Section 114 Notice the council’s chief financial officer takes full control of council spending and will typically immediately freeze all non-statutory spending and look to make rapid cuts in order to return the council to a balanced budget. The Local Government Act 2003 also has provisions to enable central government to take direct control of the running of an authority if it fails to return to a balanced budget. Over the last 20 years, a total of 2 councils have issued a Section 114 Notice, with the most recent being Northamptonshire County Council in 2018.
In the case of Northamptonshire, and in spite of some well-publicised criticisms of the way it had been run, the Treasury decided not to directly intervene and the council regained control of its finances and returned to a balanced budget in 2019. The Treasury however did allow the council to sell capital assets to cover day to day expenses, which is against standard operating rules, thereby providing the council with the space required to reorganise its spending.
Though the risk of a council issuing a Section 114 notice is low, before allowing a local authority to raise money through Abundance we run our own credit assessment of the council to reduce the risk that our investors lend money to councils that may be at risk of not delivering a balanced budget in the near term.
Other risks to consider
While the risk of a council being unable to return your capital or make interest payments may be lower than for a company investment, there are still other risks that are important to understand.
Municipal investments are fixed term investments so you cannot access your invested money before the repayment date(s) (some municipal investments will repay capital in instalments over the life of the investment and others will repay all your capital at the maturity date). The investments on Abundance are transferable which means you can look to sell some or all of your investment if you need to receive money back before the maturity date, however there is no guarantee you will be able to do so and it depends on there being an interested buyer. You can use the Abundance marketplace to look for a buyer but the price offered for your investment will vary and might be lower than you originally invested. The value of your investment may be affected by a number of factors, including a change in interest rates available on other similar products. You can learn more about how interest rate changes can affect the value of your investment here.
Please read the Offer Document or Factsheet for each municipal investment to learn more about the risks for that particular investment.