James Goudie, QC: Council commercial investments and treasury management

Revised investment guidance gives local authorities a “green light for prudent commercial investments”, including investments in commercial property, writes James Goudie, QC.

Local authorities in England now have power potentially to do almost anything. This is the General Power of Competence (GPOC) in the Localism Act 2011.

It is a very broadly expressed power, which overlaps other powers. GPOC, however, has important limits. First, it cannot be used in breach of other legislation.

Second, as with any other source of power, it must be exercised reasonably and properly. Acting reasonably includes complying with fiduciary duty. Acting properly includes not acting for the purpose of circumventing statutory controls.

Third, there are special regimes where charging or trading is concerned. In particular, if an authority is acting for a commercial purpose it must do so through a company, which does not include a LLP.

Significant powers

Specific powers that the authority can exercise itself therefore remain significant. These include powers to acquire land and buildings, and powers under the Local Government Act 2003, to borrow (Section 1) and to invest (Section 12).

As is well known, these are broad powers in like terms. They exist when the authority is acting for any purpose relevant to its “functions” under any enactment. “Functions” is a very wide concept. It embraces all an authority’s activities, the sum total of its duties and powers.

The borrowing and investment powers also exist when an authority is acting for the purposes of the “prudent management of its financial affairs”. This therefore brings in the concept of prudential financing. It is however to be noted that there is no geographical constraint on the existence of the power, or the location, and no limitation on the type of investment. “Invest” is not defined. It is to be interpreted in its normal sense.

Limitations

The important limitation is in Section 15 of the 2003 Act. In carrying out its investment and borrowing functions an authority must have regard to guidance. This is both guidance from the secretary of state and guidance prescribed in regulations, i.e. CIPFA guidance.

It has been suggested that it is not possible to borrow in order to invest and/or that it is possible to borrow only to finance capital expenditure and that investment does not amount to capital expenditure.

However, CLG is consulting, from 10 November to 22 December 2017, on changes to the prudential framework of capital finance, and in particular statutory guidance on local authority investments (and minimum revenue provision).

The investment guidance was last updated in 2010, following Parliamentary inquiries into local authority investments in Icelandic Banks. As a result the investments guidance was very focused on investments in financial institutions.

Over the past seven years, the economic and regulatory landscape has changed significantly. The prolonged low interest rate environment has meant that investing spare cash in banks will not generate a return.

In addition, the introduction of GPOC has given local authorities far more flexibility in the types of activity they can engage in. The changes in the economic and regulatory landscape have led the sector to consider different and more innovative types of investment activity.

Update

As a result the government feels that it is time to look into updating the investment guidance as part of the more general update of the statutory codes comprising the prudential framework.

The revised investment guidance retains the requirement for an investment strategy to be prepared at least annually.

However, in recognition that the CIPFA consultation on the Prudential Code introduces a new requirement for local authorities to prepare a capital strategy, the revised guidance specifically allows the matters required to be disclosed in the investment strategy to be disclosed in the capital strategy.

The government proposes introducing a new requirement to include quantitative indicators that will allow assessment of exposure. The government does not propose to specify particular indicators or thresholds.

The government proposes the following definitions for non-financial assets:

• Security: the revised guidance recognises that a local authority will normally have an asset that can be used to recoup capital invested. Therefore, the revised investment guidance requires local authorities to consider whether the underlying asset is impaired and if it is, to detail the actions planned, or in progress, to protect the funds invested.
• Liquidity: the revised investment guidance requires local authorities to set out the procedures for ensuring that funds invested in a non-financial asset can be accessed when they are needed.

The government proposes requiring local authorities to disclose their dependence on commercial income to deliver statutory services and the amount of borrowing that has been committed to generate that income.

The revised investment guidance requires additional disclosure by local authorities who borrow solely to invest in revenue generating investments.

The investment guidance has always required disclosure of the steps treasury management professionals have taken to ensure that they have sufficient knowledge and expertise to be able to take sensible decisions.

The government believes that it is sensible to extend this requirement to statutory officers, councillors and other key individuals in the decision making process.

Paragraph 21 of the consultation document seems to acknowledge that local authorities do borrow in advance of needs. It then seeks views only on whether authorities in such circumstances ought to disclose more information.

It does not repeat the “informal view” (expressed in Part 1 of the current guidance) that doing so is unlawful.

Borrowing, including borrowing to invest, will of course be subject to the controls on borrowing, and will usually be from the PWLB. Ultimately, the government can control what the PWLB may do.

Meanwhile, however, authorities have the green light for prudent commercial investments, including investments in commercial and other properties. Special issues arise however in connection with residential property.

Budgets come and budgets go, and one has just gone. A chancellor and government who reduce grants to local authorities and continue to impose austerity upon them is not well placed to blow the whistle on authorities looking for innovative and commercial ways of revenue raising, including by returns on investments, and does not appear to be seeking to do so.

James Goudie, QC, is joint head of chambers at 11KBW where he acts for and against clients operating in and with the public sector.

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