Local government investment failures prompt Prudential Code review

CIPFA is consulting on proposals to strengthen the Prudential Code, following growing concerns over local government commercial property investments which have seen councils take on disproportionate levels of commercial debt to generate yield

The Code currently states that ‘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’. This has been clarified previously to include ‘therefore, local authorities must not borrow to fund primary yield generating investments’.

Since the Prudential Code’s last review in 2017, over three years (2016/17 – 2018/19), £6.6bn was spent by councils on commercial property, with £2.3bn of that on retail acquisitions. This represents 14.4 times more spend on commercial property acquisitions when compared with the preceding three years.

A National Audit Office (NAO) report published in February last year drew attention to potential financial stability and value-for-money risks associated with what the watchdog called a ‘striking’ increase in the scale of investment of public funds in property.

The key changes outlined in the consultation include clearly stating that borrowing for debt-for-yield investment is not permissible under the Prudential Code, as it does not constitute the primary purpose of investment and represents unnecessary risk to public funds.

The proposals are also designed to ensure that any commercial investment is consistent with statutory provisions, proportionate to service and revenue budgets, and consistent with effective treasury management practice.

They strengthen the requirements to assess the affordability of commercial activity within local authorities’ capital strategies, and require sustainability issues to be considered to ensure that capital expenditure is consistent with a local authority’s corporate objectives (such as diversity and innovation) and to the objectives in the Prudential Code.

In addition, the revisions introduce new prudential indicators on affordability, as well as a Liability Benchmark to promote good practice and understanding of local authority’s debt management in relation to capital investment.

Rob Whiteman, CIPFA CEO, said: ‘A minority of councils are currently misinterpreting or not having regard to the current provisions of the Prudential Code. If this trend continues without strengthened provisions, local authorities risk further government intervention into the Prudential Framework.

‘Strengthening the Prudential Code will ensure local authorities are protected from unnecessary risk and reduce the threat to the existing principles-based system that allows councils the self-determination to innovate responsibly.’

The consultation is open for 10 weeks and responses must be submitted by 12 April.   

Croydon Council

Separately, local government secretary Robert Jenrick has announced further developments in the probe into Croydon Council’s financial management, after it became the first London borough in 20 years to issue a section 114 notice banning all new non-essential spending following the discovery of a £66m budget shortfall.

A public interest report by external auditor Grant Thornton heavily criticised the council for its ‘dysfunctional’ financial governance. The report noted Croydon Council had increased the level of borrowing significantly in recent years (£545m in three years) and used the money to invest in companies it established and to purchase investment properties.

This was followed by the government’s rapid response review in autumn of last year. The review team, led by Chris Wood, found ‘significant failings in the leadership and management’ at Croydon Council which had led to failures in identifying, escalating and addressing financial risk.

The report highlighted the council’s poor track record in managing budgets, poorly managed commercial ventures and low levels of reserves which caused significant issues.

In response, an improvement and assurance panel, comprised of local government and finance experts, has been appointed to support and challenge Croydon’s improvement progress and make regular reports to the Secretary of State.

The panel will be led by Tony McArdle, who will be supported by Margaret Lee and Phil Brookes.

Jenrick said: ‘The rapid review into Croydon Council found serious failings in governance, financial strategy and commercial investments which have led to taxpayers and residents being severely let down over a number of years.

‘This must end now, and I have appointed an expert panel to help the council urgently address the issues they face and deliver a comprehensive recovery plan. I will be monitoring progress closely and will not hesitate to take further action if necessary.

‘In the event of a failure by the council to demonstrate significant progress, a more formal statutory intervention will be considered, including the appointment of commissioners.’

Prudential Code consultation - closing date for comment 12 April 2021

NAO report on Local authority investment in commercial property

London Borough of Croydon: rapid review

London Borough of Croydon: Chair of the Improvement and Assurance Board appointment letter 

Pat Sweet |Reporter, Accountancy Daily [2010-2021]

Pat Sweet was the former online reporter at Accountancy Daily and contributor to the monthly Accountancy magazine, pub...

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