What potential does a peer-to-peer municipal debt marketplace hold? Alex Collingwood and Daniel Cotti, advisors to Munix, explain.
Introduction
Local authorities in the UK face a substantial debt burden of £135bn, with £97bn funded by the central government (Department for Levelling Up, Housing and Communities, 2023). Traditional funding methods are costly and limit access to diversified, efficient financing options from private investors. A municipal debt marketplace could significantly reduce costs, enhance financial sustainability, and provide funding diversification for local authorities.
The financial landscape for UK local authorities
Local authorities primarily rely on Public Works Loan Board (PWLB) lending and traditional bank financing, which are often costly and inefficient. Central government funding incurs an interest rate of 60 basis points (bps) or more above gilts, translating to an additional £582m annually on £97bn of debt (Debt Management Office, 2023).
Research suggests these costs can be halved to 30 bps above gilts, representing savings of £291m with a peer-to-peer private municipal debt marketplace. Without such savings, local authorities face limited funding and continued reliance on PWLB loans.
The Local Government Association (2024) highlights that without access to competitive market rates for infrastructure projects, local authorities face increased financial pressure. This strain jeopardises their ability to provide essential services, such as statutory responsibilities for children, amidst rising demand and shrinking financial resources.
Need for a municipal debt marketplace
A peer-to-peer municipal debt marketplace offers a transformative solution by enabling local authorities to tap into private sector financing at competitive rates. The recent enactment of the Electronic Trade Documents Act (ETDA) in September 2023 facilitates the use of electronic promissory notes to evidence debt, reducing issuance costs and complexities associated with traditional bond markets.
A fully functional marketplace with secondary market trading of the underlying debt instrument can increase liquidity and halve the non-base interest rate costs of central government funding, saving £291m annually. It would also enable more efficient and diversified funding options, addressing the financial pressures local authorities face in delivering core services.
Legislative and technological enablers
The potential of this marketplace is unlocked through recent legislative and technological advancements. The ETDA provides the legal framework for electronic promissory notes, which are essential for modernising municipal debt instruments.
LEMI has developed a Central Electronic Bill Depository (CeBD) tailored to the ETDA’s requirements. This infrastructure enables the secure issuance, storage, transfer, and delivery of electronic promissory notes. The Munix platform connects and leverages the CeBD to match borrowers with lenders intelligently for price discovery.
LEMI’s CeBD: a game changer
LEMI’s CeBD is poised to revolutionise municipal debt financing with features such as:
Single Source of Truth: All transactional parties and the general market can trust and rely on the CeBD as central custody.
Electronic Signatures and Security: Ensuring secure and exclusive control over the notes.
Integration and Compliance: Adapting to ETDA legal requirements and offering a standard API for seamless integration into debt marketplaces such as Munix.
Marketplace Integration: Facilitating primary and secondary trading through platforms like Munix, enhancing liquidity.
Advantages of the Munix peer-to-peer marketplace
The introduction of a CeBD-based peer-to-peer Munix marketplace presents several advantages:
Cost Savings: Halving the non-base interest costs associated with PWLB loans, reducing borrowing costs by 30 bps.
Market Efficiency: Ensuring fair pricing and higher liquidity through facilitated price discovery in primary and secondary markets.
Financial Transparency and Inclusion: Promoting transparency and easier access for investors to trade municipal debt instruments.
Unlike the UK Municipal Bonds Agency (UKMBA), which relies on a complex structure with intermediaries, the CeBD offers a straightforward, cost-effective peer-to-peer approach. While blockchain-based fintech companies are entering the market for electronic trade documents, they do not currently offer solutions tailored to municipal debt and its tradability.
Future prospects and immediate actions
With planned investments totalling £700bn to £775bn over the next decade (Infrastructure and Projects Authority, 2023), there is a clear need for an efficient debt marketplace to reduce funding costs. Munix and LEMI are developing short- and long-term electronic promissory notes, with initial transactions scheduled for June 2024. Early adopters among local authorities will validate this proof of concept, paving the way for broader implementation.
Conclusion
Establishing a peer-to-peer municipal debt marketplace through LEMI’s CeBD represents a significant opportunity to enhance financial sustainability for UK local authorities. By reducing costs, increasing liquidity, and ensuring financial transparency, this innovative approach promises to address the pressing financial challenges faced by local governments and support their critical public services.
Now is the perfect time for local authorities to embrace this new financing model to ensure sustainable funding and better public services through the Munix platform and CeBD integration.
Originally published on Room 151, on the 28th June 2024.
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