Prudential Code for Capital Finance in Local Authorities: LGA Consultation Response

1. The Local Government Association (LGA) is the national voice of local government. We are a politically led, cross party membership organisation, representing councils from England and Wales.
   
    
2. Our role is to support, promote and improve local government, and raise national awareness of the work of councils. Our ultimate ambition is to support councils to deliver local solutions to national problems.
   
    
3. We welcome the opportunity to comment on this consultation. This response has been cleared by lead members of the LGA’s Resources Board.

4. The changes in the 2003 Local Government Act and 2003 Capital Finance Regulations that introduced the Prudential Code were a major step in freeing local government from centrally imposed borrowing controls and the Government placing genuine trust and reliance in local government’s ability to manage its own affairs according to the sector’s own professional standards. It is imperative that the benefits of the 2003 Act and Parliament’s intentions with respect to empowering councils are enabled and not undermined by the Prudential Code. Maintenance of the code was delegated to CIPFA to enable an effective technical control framework to be set up. There is a danger that those benefits will be lost if CIPFA introduces policy objectives into the code.

5. The Prudential Code, along with the Treasury Management Code form two parts of what is known as the Prudential Framework. In England, the other two parts are statutory guidance published by MHCLG - Guidance on Local Authority Investments (“Investments Guidance”) and the Guidance on Minimum Revenue Provision (“the MRP Guidance”). All four parts were last revised in 2017 and came into effect from 1 April 2018.

6. The current review is being undertaken in response to the report last year of the Public Accounts Committee into local authority investment in commercial property. The 2003 Act gives local authorities the power to invest: Section 12 of this Act (“Power to invest”) states that “A local authority may invest – (a) for any purpose relevant to its functions under any enactment, or (b) for the purposes of the prudent management of its financial affairs”. However, the report raised questions about funding these investments through borrowing and some of the proposed changes seek to tighten the codes’ rules over such investments. In its introduction to the consultation CIPFA states that “Since the Prudential Code’s last review in 2017, over three years (2016/17 – 2018/19), £6.6 billion was spent by councils on commercial property, with £2.3 billion of that on retail acquisitions.” The revised code came into effect with effect from April 2018 at the start of the financial year 2018/19 so the introduction to the consultation document quotes figures for two years before the new code took effect.

7. The consultation includes 16 questions. Our response will concentrate on questions 1 and 2 which cover the words in paragraphs 45 and 46 of the code; we will also give brief answers questions 3 to 10, but feel that questions 11 to 16 would be answered better by practitioners in local authorities.

8. Question 1 asks for views on the wording on the current paragraph 45 and question 2 asks for views on proposed changes to the wording and on a new paragraph 46.

9. Paragraph 45 currently refers firstly to borrowing purely to generate a return (“more than need”) and secondly to the timing (“advance of need”) of loans taken out to fund capital expenditure and while it acknowledges that the timing of taking out a loan can be influenced by value for money considerations (for example better Treasury Management) it does not allow for borrowing early purely to invest the sums to make a return.

10. The words in paragraph 45 are also included in the Statutory Guidance on Local Authority Investments which is issued by MHCLG for England. With effect from April 2018 MHCLG changed the definition of investments relating to this in the guidance. It stated “By bringing non-financial investments within the scope of the Investments Guidance, the consultation proposals made it clear that borrowing to fund acquisition of non-financial assets solely to generate a profit is not prudential” (MHCLG Investment guidance consultation outcome).

11. 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.

12. CIPFA has stated that the proposed changes “clarify” the current position and that the current wording already prevents local authorities from borrowing to invest in assets primarily for yield. We do not agree that it is a clarification, we believe it is a clear change. It is clear 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; the changes to the MHCLG Investment Guidance that took effect from 1 April 2018 sought to change this.

13. The deletion of the clause outlining that borrowing in advance of need can be undertaken for value for money reasons is an acknowledgement that the current words do not support the interpretation being put on them in the consultation and the change is a “change” and not a “clarification”.

14. The further change from “purely for yield” to “primarily for yield” introduces the need for interpretation and judgement. 'Purely' is appropriate because it defines itself and is unequivocal. 'Primarily' is not because it demands judgement, part of which is a political judgement about where the optimum public good lies. There is a danger that this will lead to beneficial capital investment schemes not proceeding where councils are unclear as to the impact of the Prudential Code.

15. The words in current paragraph 45 are repeated exactly as the second half of paragraph E16 of the executive summary of the code. This makes the context and meaning of the words clear. Paragraph E16 states:

15.1 “In order to ensure that over the medium term net debt will only be for a capital purpose, the local authority should ensure that gross external debt does not, except in the short term, exceed the total of the capital financing requirement in the preceding year plus the estimates of any additional capital financing requirement for the current and next two financial years. 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. Authorities should also consider carefully whether they can demonstrate value for money in borrowing in advance of need and can ensure the security of such funds.”

16. It is clear from this that the current words about “borrowing more than or in advance of needs” are about HOW a local authority borrows to cover its capital financing requirement not about WHAT that capital financing requirement can contain. The proposed change to paragraph 45 and the addition of paragraph 46 do therefore represent a change in the scope of the Prudential Code, and one that exceeds the brief of the code.

17. The proper place for any national policy for the application of the local authorities’ power to invest is the Investment Guidance from MHCLG (or the Welsh Government for Wales). The purpose of the Prudential Code is to enable local authorities to assess the affordability of borrowing not to decide what that borrowing is for. The code needs to be timeless and policy neutral and not affected by changes in government policy. The changes to paragraph 45 proposed in the consultation take it beyond that, possibly laying up problems in the future.

18. Finally, the meaning of the wording of the new suggested paragraph 46 could be clearer. The meaning of the phrase “This prohibition does not cover borrowing where the primary aim is rooted in the function of the authority and the making of a return is incidental to the function eg regeneration” is obscure and is likely to cause problems if used.

19. In summary, for the reasons set above we believe the current wording should be retained.

Questions 3 to 16

20. Questions 3, 4, 5, 6, 7 and 8 of the consultation cover proposed changes to the objectives of the code, largely introducing additional objectives relating to proportionality of commercial investments and to sustainability (as well as asking general questions on objectives). Both the setting and prioritisation of objectives and the taking of decisions are matters for elected decision makers. It is a matter of judgement for politicians where the balance of risks and benefits lies in relation to any particular scheme and it would be helpful if the Prudential Code said that to clarify the terms of the debate.

21. Question 3: Do you agree with CIPFA’s proposal to add proportionality to the objectives within the Prudential Code especially with regard to commercial investments? If not, why not? What alternatives would you suggest?

22. This reinforces the current position and can be supported.

23. Question 4: Do you agree with the introduction of an objective in relation to commercial investments? If not, why not? What alternatives would you suggest?

24. It is hard to see that the new objective makes a lot of difference as it largely repeats what the position should already be. For example, it should not be necessary for the Prudential Code to state that commercial investment “should be consistent with statutory provisions”, that should be taken as read. But it is equally hard to see that the additions would do any harm.

25. Question 5: Do you agree with the proposal to add sustainability and ensuring that the capital expenditure is consistent with a local authority’s corporate objectives (such as diversity and innovation) to the objectives in the Prudential Code? Please provide a reason for your response.

26.This should already be the case and can be supported.

27. Question 6: Do you consider the current objectives of the Prudential Code to be relevant? Please provide a reason for your response.

28. Subject to the points made in response to questions 4 and 5, we consider that the current objectives of the code, as outlined in paragraph 1 of the code and also in paragraph E3 of the executive summary of the code, remain relevant.

29. Question 7: Do you consider that the provisions in the Prudential Code achieves these current objectives? If not, why not? Please provide reasons for your response.

30. We believe the Prudential Code currently achieves these objectives.

31. Question 8: Do you consider that there are any areas which are not fully covered by these objectives? If yes, please expand, describing how these areas could be covered within the objectives.

32. We do not consider that there are areas that should be covered but are currently not.

33. Question 9: Do you agree with the proposals to include the status of the Prudential Code within the body of the Code itself. If not, why not? What alternatives would you suggest?

34. This is not a major objection but this does seem to be an unnecessary complication. The status of the code is defined by legislation and could be changed by legislation. Including the current status within the code makes it less stand alone and timeless.

35. Question 10: Do you agree with the proposals to include additional commentary on the assessment of affordability and the details of risks of undertaking commercial activity within the commercial activities section on determining the capital strategy? If not, why not? What alternatives would you suggest?

36. We believe that this will make risks better understood and so aid decision making and is, therefore, supported.

37. Questions 11 to 16 cover proposed revisions to technical indicators used to calculate how much a local authority can afford to borrow. The views of individual local authorities and of finance practitioners within the sector on these proposed changes will be important.

Proposed changes to the prudential code for capital finance for local authorities