Rob Whiteman: Why the Prudential Code should be statutory

CIPFA has argued for the Prudential Code to be placed on a statutory footing. Rob Whiteman explains why it is necessary as a measure to “prohibit borrowing for yield” on commerical property.

CIPFA has been vocal for a number of years now regarding the issue of local authorities borrowing to invest in commercial properties purely for commercial yield. The rationale behind such decisions is clear. Against a backdrop of austerity, councils have had to come up with new ways of bridging the revenue gap. One such means of achieving this is through commercial investments. CIPFA’s Prudential Code, to which all local authorities must have regard, specifically precludes borrowing for financial yield. However, it has been clear for some time that some councils have been playing fast and loose with this guidance.
To provide some context, it is estimated that local authority spending on commercial property from 2016-17 to 2018-19 amounted to £6.6bn, 14.4 times the amount spent in the preceding three years. The lion’s share of borrowing to invest in commercial assets was taking place among a relatively small pool of local authorities. 49 out of 352 local authorities accounted for 80% of commercial property spending over the same period.

Over a third of property acquisitions over the period were retail properties, and over a third were outside of the local authority’s boundary. CIPFA has long cautioned against such investments. When acquiring properties such as department stores, shopping centres and retail parks, guarantees of prudence and affordability are difficult to come by. Prior to the pandemic, the death of the high street was already all over the headlines, with shoppers preferring to shop online rather than visit their local department store. The pandemic will likely cement this behaviour further, with the public taking time to feel safe in crowded spaces outside of their homes, evidencing that such investments have little resilience to large economic shocks.

Statutory

The pandemic has demonstrated that even those investments that seem low-risk and high-yield, such as stadiums and airports, have the capacity to be brought low by a catastrophe. The simple fact is that borrowing to invest purely for profit pits public funds against high levels of potential financial risk. Despite this, councils have continued to gain access to funds for such investments via the Public Works Loans Board (PWLB) whose due diligence was entirely reliant on local governance arrangements in councils. That is why CIPFA welcomed the announcement in the Chancellors 2020 Budget of a government consultation that would rework the PWLB’s lending terms.

Our response to the consultation, which you can view in full here, supported the overall spirit in which the government’s proposals were intended—to curtail borrowing for investment in risky, profit-making ventures. We have called on the government to make compliance with the Prudential Code a statutory requirement and have committed to strengthening the Code by early 2022.

While councils must currently “have regard to” the Code, they can choose not to follow it (though adherence is a mandatory requirement for CIPFA members). Changing the legislative requirement from “have regard to” to “must comply with” would ensure that all councils adhere to the requirements of the Code, thus explicitly prohibiting borrowing for yield or other speculative purposes.

However, we also recognise that the government’s proposals represent one of the most significant central interventions since the inception of the Prudential Framework in April 2004. To that end, we are clear that any revisions to the sector’s relationship with the PWLB are proportionate, fit for purpose, and remain principles-based rather than prescriptive.

Recovery

As we’ve already established, the current pandemic has likely supported the broader realisation of the level of risk commercial investments can entail. But the PWLB and its relationship with local authorities is still going to have an important role to play in other areas. As Covid-19 dominates the UK economy, which it will likely continue to do for some time, councils are going to be vital to the recovery of local economies. Resource constraints from a decade of austerity and the additional pressures created by Covid-19 are going to be further compounded by the impact of Brexit as we move towards the end of the year.

Local authority medium-term financial plans will require support in the form of lending terms that do not impede a local authority’s ability to undertake this vital role in society. Affordable refinancing facilities will be essential to support both recovery and emergency activities, particularly if the UK experiences “second wave” of Covid-19 later in the year.

It is therefore vital that the government, as an unintended consequence of addressing the issue of borrowing to invest, does not throw the baby out with the bath water by creating barriers to PWLB finance where local authorities require liquidity.

While the risks and merits of borrowing to invest has been a debate percolating through local government for some time, the pandemic has demonstrated without a shadow of a doubt that even for seemingly sure investments, the risks of this behaviour far outweigh the benefits. The sector’s relationship with the PWLB must reflect the role of local authorities – serving their community and protecting public funds, while at the same time maintaining the PWLB’s position as lender of last resort.

Rob Whiteman is chief executive officer at CIPFA.

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