Code revision will end ‘intentional misinterpretation’

A revised code will be amended in response to concerns that it either lacked clarity or was “not appropriate”.

CIPFA’s revision of the Prudential Code has proved controversial but concerns about proposed changes appears to have been heeded.

Proposed new wording for the code published at the end of last month followed earlier amendments that had prompted objections and worries that they might limit the ability of local authorities to borrow for some projects.

However, CIPFA chief executive Rob Whiteman declared the fresh proposals are set to head off behaviour among councils considered unacceptable and an underlying cause of the revision. “We are confident that the proposals we will be implementing will put an end to actions that either push the boundaries of the Prudential Code or intentionally misinterpret its provisions.”

The words that caused  worries were contained in paragraph 45 of the code. “Authorities must not borrow more than or in advance of their needs purely in order to profit from the investment of the extra sums borrowed.”

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The version was described as “a hammer to crack a nut”, and potentially tieing the hands of section 151 officers. Most readers of the revised document were concerned about pinning down a definition of the term “in advance of needs” and the restrictions implied by the word “purely”.

The amendments were widely viewed as aimed at closing down some borrowing for commercial purposes, especially investment in property. They followed a report from the National Audit Office last year that found that local government had spent £6.6bn on commercial property from 2016 to 2019. Around 80% of all local government property spending was undertaken by just 49 out of 352 councils. Around 38% of all property purchases were outside the boundaries of the councils that acquired them.

MPs on the House of Commons public accounts committee described “borrowing for yield” to offset the financial pressures faced by councils as a “risky approach” and “not within the spirit of the framework within which local authority borrowing and investment takes place…”. They called for measures to address “extreme risk taking” by councils, and a review of the prudential framework.

“Be specific”

It should be noted that the revision comes on top of government guidance introducing new criteria for borrowing from the Public Works Loan Board (PWLB): finance directors must now certify they have no intention to use borrowed money to buy investment assets primarily for yield.

But it seems not everyone in the sector was impressed by the initial changes. From 92 responses 51 disagreed with changes in paragraph 45, more than the 41 who said it passed muster or just need amendments.

One council, Vale of White Horse District Council, expressed the view of many in wanting clarity about what CIPFA considers legitimate borrowing reasons and what it does not. Simon Hewings, interim head of finance, writes to CIPFA: “At a course I attended a couple of years ago over half the room admitted to not knowing exactly what borrowing in advance of need was. Please be specific as to what we are or are not allowed to borrow for.”

A submission from Warwickshire County Council, says that paragraph 45 is “unclear” and “open to interpretation”. The council also sought clarification before a new code go ahead. “Clear guidance is required on how an authority can define ‘generation of yield’ and when this becomes a primary objective or a by-product of a project or investment.”

Perhaps the most direct view comes from the Local Government Association which concludes that redrawing the code is unnecessary.

“The intention of the changes proposed in the current review of the Prudential Code are to prevent local authorities through the provisions of the Prudential Code from borrowing in order to invest in yield generating investments such as commercial property.

“We do not believe that such a change is either appropriate for the code or proportionate to any problem that it seeks to solve.

“Recent changes to the lending terms of the Public Works Loans Board coupled with the changes in 2018 to the Investment Guidance issued by the government have already covered this area.”

The LGA also disputes that CIPFA’s proposals are a clarification and calls it a “change” given that the “wide interpretation since the code was introduced has been that a council’s capital financing requirement can include the acquisition of commercial properties primarily for yield and that this can be financed through prudential borrowing.”

“Bad apple”

Revised wording for paragraph 45 now says councils can borrow for: “Any function of the authority under enactment; for prudential financial management.” In a new paragraph 47 it adds: “An authority must not borrow for the primary purpose of commercial return.” And: “Local authorities should not borrow to finance acquisitions where obtaining commercial returns is a primary aim.”

According to David Green, strategic director at Arlingclose: “This covers off a major flaw in the current code where the need to borrow was not defined—many authorities decided that once contracts had been exchanged on a commercial property, they ‘needed’ to borrow to complete the purchase.” But he adds: “The new wording will only work if a clear definition of a ‘commercial return’ is given.”

There are wider concerns though, as recently expressed by think tank Localis, that there is a general attack underway on councils being commercial.

In a new report, The Commercial Edge, Renewing the Case for the Local Investment State, Localis says councils have seen an upsurge in opposition to commercial activity. Amending PWLB lending criteria is a primary example of central government turning on councils because of a small number of bad examples despite powers of competence granted in the 2011 Localism Act which say councils have that councils have the power to do anything an individual may and a “power to do it for commercial purpose or otherwise for a charge, or without charge” and for “the benefit of the authority, its area or persons resident or present in its area.”

“By latching onto ‘bad apple’ examples, this media-fuelled narrative depicts council commercial activity as something inherently risky and to be avoided,” says the Localis report.

“This is short-sighted and wrong. Undertaken with diligence, professionalism and conviction, commercialism can unlock latent placed potential and deliver conspicuous and inconspicuous benefits to councils and the communities they serve.”
According to Andrew Hardingham, former finance director for Plymouth City Council, labelling all councils as commercially incompetent misses the true picture.”It’s a broad judgement to say local authorities aren’t competent. Many are competent and put in place the governance frameworks to make the right decisions.”

Localis makes a case for “local authorities to have the right to engage in commercial activity.” After all, it says, local government has been doing it since the 12th century when King John and the City of London raised revenues from commercial land changes to build London Bridge.

In the current environment with long-term local government funding still unresolved through a fair funding review and a plan for social care still out of sight, commercialism is likely to remain a key way of coping with the costs of running services.