In the 13th century, it got its Royal Charter from King Henry III; in the 21st, it received a triple-A rating from Moody’s.

Last month, Cambridge University tapped the bond markets for the second time this decade. Its £600m of newly issued debt marked the continuation of a wider trend - since the beginning of 2013, UK universities have issued £4.4bn in bonds according to Dealogic data. Previously, there were scarcely any university bonds.

In December last year, Oxford borrowed £750m through 100-year bonds, three times more than it had initially planned, while institutions from Cardiff to Portsmouth have also turned to capital markets.

The increase in borrowing has come alongside a fall in direct government support for the sector. In an age of globalised education, British universities have also felt compelled to invest aggressively in new buildings and facilities to attract-fee paying students, in competition with each other, as well as with wealthy higher education providers in the US.

Amid quantitative easing and negative yields on government debt, low borrowing costs on international markets have helped spur on the rate of issuance. Cambridge’s debt was split into £300m of bonds linked to inflation (via the consumer price index), and £300m of conventional 60-year debt which priced at a coupon of just 2.35 per cent. British universities remain quasi-public sector institutions - their credit ratings are high, and, in some cases, they are deemed to be implicitly supported by the state.

But the wave of borrowing, as well as marking an intense financial focus in the corridors of UK institutions, raises questions of financial priorities. As university bond liabilities have risen, so have pension liabilities. The Universities Superannuation Scheme (USS), one of the UK’s largest pension schemes, has seen its deficit rise significantly over recent years.

As of March 31 last year, the scheme had £77.5bn of recorded retirement liabilities, compared to £60bn of assets. Commentators such as John Ralfe have criticised the scheme’s approach to risk, and to the valuation of its deficit. Others, such as Anthony Hesketh of Lancaster university, have argued that USS is not in a “dire state”, and that fund managers should take on more risk.

Pension liabilities have been driven upwards in part by the same global financial forces which have made bonds so attractive for university financing - lower discount rates, pushed down by interest rates, which increase the present value of future obligations to retirees.

Cambridge, like many other universities, was entangled in a strike over pensions across the country’s higher education sector earlier this year. Universities UK, a representative body for university vice-chancellors, wants to reform the scheme, while the University and College Union, which represents academics, has sought to limit cuts.

At the time, a handful of observers pointed to a tension between the pension liabilities of universities and their growing need to borrow, so as to finance lavish developments in an increasingly competitive “market” for higher education.

The Cambridge bond prospectus, which is obliged to go into great detail on the financial risks facing investors in the bond, touches on this specific tension. One of the risks it highlights, perhaps unsurprisingly, is pensions. It states that “there are financial risks associated with the pensions schemes in which the Issuer participates which could have an adverse impact on the Issuer”.

Cambridge is a part of five pension schemes, three of which are closed to new members. Of the USS scheme, which is primarily for academic staff, the prospectus says:

The USS is a "last man standing" scheme so that in the event of insolvency of any of the participating employers in the scheme, the amount of any pension shortfall (which cannot be recovered) in respect of that employer will be spread across the remaining participant employers and reflected in the next actuarial valuation of the USS. Because of the comparative financial strength of the Issuer relative to many of the other participating employers in the scheme, there is a disproportionate risk that the Issuer could be the “last man standing” in the event of the insolvency of other participating employers.

The problem is not simply one of competing liabilities – it also relates to the newly competitive dynamic among UK universities.

While universities are now encouraged to compete with each other for students, aspects of their legacy infrastructure – including pensions – are designed according to a more collaborative interpretation of heavily state-funded higher education. While the USS scheme is not backed by the state, it was initiated in the 1970s, when the sector was far more heavily integrated into public finances.

From the prospectus:

The scheme is a mutual one, with a number of universities participating in it. Because of the mutual nature of the scheme, the scheme’s assets are not attributed to individual institutions and a scheme-wide contribution rate is set. The Issuer is therefore exposed to actuarial risks associated with other institutions’ employees and is unable to identify its share of the underlying assets and liabilities of the scheme on a consistent and reasonable basis.

According to the prospectus, in the financial year up to 31 July 2017, Cambridge contributed £85.5 million to the USS scheme, which amounts to 4.6 per cent of its total income over that year.

The issue is linked to the risk highlighted in Cambridge's bond prospectus: the potential future transfer from financially stronger to financially weaker universities. This risk has influenced the position institutions have taken on the question of reforming USS. As the FT’s Josephine Cumbo clarified earlier this year, Oxbridge colleges counted for a third of the institutions that “wanted less risk” in the scheme. (Michael Otsuka, an academic at the London School of Economics, has analysed the situation at some length here).

UCU, the union for academics, has pushed for more risk, as a means of maintaining benefits. Here is UCU General Secretary Sally Hunt, in February:

At the core of our proposals is for universities to accept a small amount of increased risk, but only at a level a majority have recently said they are comfortable with. Doing this would enable us to provide a decent, guaranteed pension at a more modest cost with smaller contribution increases.

In the context of the widespread abandonment of defined benefit pensions in the private sector, Cambridge indicates in the prospectus that it is "prepared to make higher contributions and take more risk to achieve an interim solution that retains the defined benefit element of the scheme”.

Aside from the finer details of potential exchanges between institutions, the tension between bond liabilities and pension liabilities also highlights a political decision across the broader UK sector that has become veiled within the complex financial architecture of the modern university. Long-term obligations to employees ostensibly put pressure on long-term obligations to creditors, and vice versa. However, the chain does not end there.

The Cambridge bond, like many other university bonds, is particularly attractive to pension fund investors who are looking for cash flows that match their long-term liabilities. Those investors are ultimately acting on behalf of pensioners, or savers, elsewhere (and perhaps, in some cases, the same people).

University pension liabilities are a kind of future transfer to staff in exchange for specialised labour in the present moment (via ongoing cash contributions). Bond liabilities are, in part, future transfers to pensioners in exchange for the receipt of cash in the present moment (setting aside the other parts of the social infrastructure, such as insurance, that also rely on bonds).

At a time when there is a relatively high supply of academic labour, a cultural shift towards temporary working practices, and a widespread perception that capital is needed to invest in new higher education projects, it is not difficult to see why universities' financial managers might have sought to increase one kind of liability, and decrease the other.

The two liabilities are not mutually exclusive. But the balance is politically explosive and unpredictable, and any given calibration incurs a certain kind of risk.

This is one reason why the Cambridge bond prospectus highlights another issue: “a deterioration in employee relations”, in light of “the need to maintain a focus on efficiency and pay restraint in the light of external financial challenges”.

The financial pressures exerted on staff elsewhere, especially in relation to the provision of housing, and the lingering threat of strike action, will be the subject of the next post.

Related Links:
Investors line up to fund living quarters for students - FT Alphaville
Universities and the allure of capital markets
- FT Alphaville
The strange economics of the university strikes
- FT Alphaville
The financing of student accommodation
- FT Alphaville

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