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
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
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
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
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.
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.
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.