Brexit Note to the Accounts David Green

As local authorities come to finalise their annual accounts, they will be considering the need for a disclosure note on “post balance sheet events”. The referendum vote for the UK to leave the EU was clearly a momentous occasion, but what impact will it have on financial statements?

One of the big impacts on financial markets was to lower long-term interest rates considerably. The 50 year gilt yield nearly halved, falling from 2.12% to 1.11% in the five months following 31st March 2016 as the market re-evaluated the prospects for domestic growth. But credit spreads also narrowed, as some of the uncertainty evaporated, so that the yield on Transport for London’s 50 year bond, a benchmark for local authorities’ perceived creditworthiness, fell by 1.18% over the same period.

Lower interest rates will mean a large increase in the fair value of every local authority’s long-term liabilities. It may therefore be appropriate to disclose updated fair values for borrowing, PFI and pension liabilities in the Brexit note to the accounts.

We estimate that PWLB fair values have risen on average from 125% of principal to 150%, while LOBO fair values have risen on average from 160% to 220% of the sum borrowed. Despite the fall in rates, the values of the options in some LOBOs have increased due to an increase in interest rate volatility.

In theory, the large fall in interest rates will have increased the fair value of financial assets too, offsetting some of the increase in liabilities. However, few local authorities own interest bearing assets of such long durations or in such quantities as they do liabilities, outside pension funds. But for those that do, a similar disclosure should be made. For example, the 50 year gilt is now worth 37% more than in March. 

Pooled fund investors will have seen some volatility in their fund values since the 2015/16 accounts were closed in March. Bond funds are up 5% on average, and equity funds up 10%, while property funds have fallen 4% on average. These are not particularly unusual movements for these asset classes, and if you didn’t feel the need to disclose a post balance sheet increase of 3% in a property fund last year, you probably needn’t worry about this year’s fall.

Local authorities’ investments in property funds may be around £750m, but these are of course dwarfed by their direct ownership of around £300 billion of properties. Valuing these is admittedly a little more complicated than reading the fund manager’s latest statement. But any disclosure that focuses on the falling value of funds while ignoring a much greater change in value of schools, care homes and libraries is missing the bigger picture.