The Bank's motives are pure. It wants to protect London's reputation as a financial centre, and is worried about the erosion of the old practice of setting a price in the market before knowing the identity of the counterparty to the deal. In effect, the presumption is that all the houses and their leading clients should be treated as equal risks by any prospective lender.
However, the markets do not see it that way, especially when it comes to local authority borrowers. Banks have been fuming ever since the House of Lords ruled in January 1991 that the many interest rate swaps deals (exchanges of interest rate obligations between borrowers) entered into by 130 local authorities in the 1980s were invalid. The ruling cost the banks pounds 600m, and the Government refused to stand behind the councils.
The name of local authorities was muddied further in July 1991 when the Western Isles Council and others were found to have put funds on deposit with the collapsed Bank of Credit and Commerce International. Indeed, the BCCI experience precipitated a strengthening of the voluntary London code.
In practice, institutions are pressuring brokers to reveal the counterparty to a deal beforehand so they can avoid local authorities with poor credit records. But trying to stop the rumour mill in markets is quite futile.
The Bank warned the Treasury that letting councils default on swaps would damage both their reputation and London's. It should hardly be surprised that its warnings are now coming true.Reuse content