CIPFA president’s blog: Commercial risk needs commercial capabilities, enhanced governance and transparency

CIPFA’s new president Andrew Burns says “well run” local authorities have long had the skills to manage commercial ventures but it requires the right internal and external advisers to mitigate the risk.

It is a real privilege and a huge honour to become CIPFA President and I’m very proud to have the opportunity represent 15,000 members and students throughout the world.

I intend to focus on three themes in my presidential year:

• The importance of medium term financial planning and the sustainability of the public finances, with an emphasis on managing balance sheets and capital investment programmes as well as revenue budgets.
• Better alignment and collaboration between public services in local places and integrated reporting, focusing on the value created by public services not just on financial outcomes.
• The role of digital developments, artificial intelligence and automation and its impact on the accountancy profession and in particular the opportunities it presents to improve public financial management and outcomes for the people and places we serve.

The biggest challenges facing CIPFA involve getting the right balance between growing our global influence and membership whilst continuing to focus on developing the core UK service offer in a volatile, uncertain, complex and ambiguous post-election and pre-Brexit environment.

There is a risk for CIPFA that the UK is seen as inward looking, insular and nationalist but we should take the opportunity to position ourselves as international in outlook.

Strong public financial management is critically important, irrespective of geographical, political and national boundaries.

Future

This need for strong and effective management of the public finances has been brought into focus by financial commentators in the national press have recently voiced concerns about potential problems being stored up for the future from local councils increasing investment activity, especially in commercial property.

And earlier this year the Public Accounts Committee expressed reservations about levels of risk, expertise and complacency from council’s increasing commercialism.

FT columnist John Plender wrote: “UK local councils are borrowing at rates much lower than the private sector can obtain in order to invest in property that shows a higher yield. Money borrowed at less than 3% interest is typically going into property yielding 6% or more.”

Private sector investors are unhappy being outbid for sites; some argue that borrowing the full purchase price of property in markets they don’t understand for short-term income gain is an “accident waiting to happen”.

So, are these comments sour grapes or are they good questions about the role and risks for publicly funded local democratic organisations?

There is no question of the legality of these sorts of investments, but councils need to be sure that they understand the risks alongside the rewards that come from them.

In the commercial world, there are many examples of where companies have diversified outside their core competencies, with disastrous results.

Councils have had greater freedoms to invest in commercial projects since being granted the power of general competence through the 2011 Localism Act, including income generation, improving asset portfolios and sweating those assets.

With any commercial activity, assessing the risks is vital and the more commercial the venture, the more savvy the due diligence needs to be. Well run councils have long had the skills and expertise to do this successfully.

Providing councils are following the rules that dictate making sound and affordable investment decisions, using specialist internal and external advisers to identify and mitigate any investment risks, these activities bring benefits for councils and taxpayers.

Indeed, there is a strong case for greater borrowing freedoms, for example in relation to social housing, but councils should not take higher commercial risk without the necessary improvement in commercial capabilities, enhanced governance and transparency.

Enshrined

This is all enshrined in the principles underpinning CIPFA’s prudential code, which supports councils in borrowing and making investment decisions. While councils pay low interest rates because of their high credit scores, low rates are never a reason to borrow: it’s about what you borrow for.

CIPFA is currently reviewing its prudential code to ensure it continues to provide the right balance between flexibility and prudence.

Chief Finance Officers (section 151 Officers) know how important the code is as a permissive framework for local government but, in the current climate, there are risks with that framework.

First is the concern that councils are not carrying out adequate due diligence and ongoing governance around their commercial risks. Second is the sense that some councils are taking on disproportionate levels of debt and aggregate levels of risk, especially when buying commercial property primarily for yield purposes. These perceptions are often fuelled by the actions of a small minority of councils but the perception can attach to all.

Emerging thinking from this review is that the prudential code needs to make more explicit what is implicit and in particular that:

• Commercial risk warrants explicit recognition, appropriate independent and expert advice and higher levels of transparency, scrutiny and governance.
• A need for enhanced skill sets for members, officers and independent advisers.
• A requirement for local authorities to take account of proportionality with regard to their commercial investments, particularly in relation to the level of debt put on the books, especially to buy yield.
• CIPFAs review of the prudential code is timely and provides an opportunity to demonstrate effective self-regulation, enhanced local democratic accountability and strong and effective public financial management and governance.

Andrew Burns, director of finance and resources,
Staffordshire County Council
& CIPFA President from 11 July 2017.