In our latest article looking at the evolving policy and practice of income generation by local government, Brian Ng looks at regulatory scrutiny. Is it the true price of doing business or a handbrake on innovation?

Proud history tainted by outlier failings

Income generation is nothing new for local government, right? The sector has a long track record of investing to earn with a social return, dating back nearly 200 years (as below) – starting with the gas lamp companies in the 1860s for safe warm streets through to today’s mayoral campaigns on clean air zoning for healthy green streets.

Timeline of local government considerations1

Historical context of reform

1835 - Municipal Corporations Act requires financial accounts

1860 - Edinburgh and Birmingham city gas lamp firms established

1922 - Regional stock exchanges across 22 cities from Swansea to Sheffield (all absorbed into LSE in 1973)

2007 - Global banking crisis leads to long austerity with Revenue Support Grant by 2020.

Modern day realities

2011 - Localism Act boosts General Power of Competence to invest and trade

2018 - Revised prudent finance guidance issued by CIPFA and MHCLG

2019 - COVID-19 pandemic leads to council losses from business rates, council tax and rental income

2021 - Elected mayors from Manchester introduce Clear Air Zones to reinvest in healthy green transport

Each step of the way, quite rightly, central government has intervened to try to offer the right balance of enabling powers for councils to act, and regulatory scrutiny to ensure shoddy practice is ruled out. Sometimes, however, the whole sector can be tarred with the brush of failure due to mistakes made by the odd few.

Tightening of the regulatory screw

Local government has a duty to manage resources responsibly with respect to security, liquidity and yield. The ongoing rise of commercialisation has led to intense scrutiny of the sector’s borrowing and investment activities over the past half-decade – by the Chartered Institute of Public Finance & Accountancy (CIPFA), the Ministry of Housing Communities & Local Government (MHCLG) and the National Audit Office (NAO).

This remains understandable given the scale of public sector borrowing and investment. As at 30 June 2021, the sector’s total borrowing and investment amounted to £126.7 billion and £56.4 billion respectively (per the timeline). Of this total outstanding debt, £116.1 billion is long term in nature. It has been sourced from a mix of public and private providers ranging from the Public Works Loans Board (PWLB) and loans from peer local authorities through to commercial banks in the UK or the rest of the world.

Long-term borrowing End June 2021 (£m)
Negotiable bonds and commercial paper 4,656
Other listed securities 1,795
Public Works Loan Board 85,803
Banks UK 8,434
Building societies 2
Other financial intermediaries 1,070
Public corporations 40
Private non-financial corporations 164
Central Government 2,388
Household sector 8
Other sources eg rest of world banks 9,431
Longer-term loans from Local Government 2,304
Total 116,096

Figure 1: Outstanding local authority borrowing and investment.2

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Sunlight, it is said, can often be the best disinfectant to weed out bad practice and nurture good practice. Each and every local authority is required to publish an annual capital strategy. MHCLG also publishes a live table of the sector’s borrowing and investment activities on a quarterly basis.

Sometimes, however, public policy can lag behind what is actually happening on the ground. For example, the MHCLG return figures do not always highlight product innovations in income generation, including major investments that involve nil debt/limited cash injection by councils but may incur substantial liability. Examples of this may include ‘asset-backed vehicles’, ‘income strips’ or ‘step-in rights’, whereby a parcel of land is contributed or a commitment to a long-term lease is entered into by councils with private sector joint venture partners and/or through local authority trading companies.

Is this all about to change though?

The NAO recently issued new guidance to external auditors of local government to draw their attention to these new types of asset-backing arrangements, as opposed to the more traditional debt-backed schemes.3 When external auditors are considering their Value for Money opinions, the NAO is now calling upon them to assure themselves that schemes have been entered into following appropriate and sufficient financial and legal advice. This is so that councils are fully transparent around how they are making informed management decisions and are not taking on unreasonable levels of risk.

Enhanced due diligence

So, what can councils do to better prepare for this regulatory shift? One important consideration is the approach to in-house scrutiny of trading companies and commercial transactions. This may require more frequent ‘enhanced due diligence’, so a council can assure itself and its external auditor that Value for Money is being achieved (per below). This way, if at any point a Gateway test is failed, the scheme can be aborted or exited.

Business review hurdles to provide comfort on Value for Money

Gateway 1

In order to satisfy Gateway 1, the following procedure must be carried out. 

Red flag checks

  • Checks on the company directors and beneficial owners for reputation and risk
  • Financial assessment of historical performance and financial standing

 

Gateway 2

In order to satisfy Gateway 2, the following procedure should be carried out. 

Business strategy review

  • Examination of the viability of the business going forward
  • Alignment of the company or transaction to the Council's strategic priorities

 

Gateway 3

In order to satisfy Gateway 3, the following procedure must be carried out. 

Financial model assessment

  • In-depth analysis of the input assumptions and forecasts to justify an investment
  • Appropriate sign-off of the transaction by s151 and Risk Committee
Post-gateway

After the three gateways have been completed, impact and legacy should still be considered.

Impact and legacy

  • Interim progress reporting and annual external audit
  • Exit strategy

This enhanced due diligence may not be appropriate to all income generation activities, but this should provide a useful framework for councils to adopt or adapt. It is a matter of balance. In terms of reasonableness and proportionality, the exercise should be triggered by reference to risk based on the scale or complexity of a particular scheme or transaction – a risk-based approach. This approach to due diligence should also be one part of a council’s wider plan for income strategy, with prioritised schemes aligned to corporate strategic priorities and procedures.

In conclusion

More regulatory scrutiny of income generation is here to stay and should be welcomed. It will promote good decision-making processes and sound commercial considerations, weeding out bad practice and preventing knee-jerk policy-making that inhibits the good work of most of the sector.

Councils need to revisit their approach to due diligence of trading companies and commercial investments – to ensure they remain fit for purpose, and to assure themselves and their external auditors that Value for Money is being achieved.

For support with income generation for local authorities, get in touch with Wayne Butcher.

References

1 Grant Thornton, 2021. An update on our earlier research ‘The Income Spectrum’, 2017.

2 Adapted from MHCLG; outstanding amounts of local authority borrowing and investments as at end June 2021.

3 NAO, Auditor Guidance Note 06 Local Government Audit Planning, 25 June 2021.