Wise buys realised: councils and commercialism

24 May 17

Commercialisation is a current buzzword but, as always, context is everything.
 

Commercialisation is a current buzzword but, as always, context is everything

 

Local government faces three key drivers. First, austerity combined with cost pressures. Second, having to be more self sufficient (this is behind the government’s move to 100% business rates retention). Third, local leaders’ desire to help shape communities, whether through economic regeneration or resident wellbeing. 

Councils being more “commercial” is seen as key to addressing these, for example by raising income. However, like many fashionable concepts, it is not, alas, an instant panacea that will secure financial balance and sustainability while dodging painful cuts – just as shared services or better procurement were never, in isolation, going to achieve that either.

Being commercial is not new to councils. Our forefathers built much of municipal government – its sewers, schools, trains, trams and lighting – largely on the back of borrowing. More recently, councils have been focusing on economic regeneration. Economic development schemes that rely on commercial rental streams are not new and neither is assembling and procuring land to increase development value. All these carry commercial risk. 

The new, more intense commercial focus is revealing itself in two ways. First, buying offices and other buildings primarily for their income-yielding capacity is more widespread and involving higher values. Second, councils are making larger economic regeneration investments, partly to grow the business rates base. All this is reflected in a surge in borrowing. It almost begs the question “why wouldn’t you?” – especially if it helps the community and avoids more painful service cuts.

So, yes, councils should be more commercial – but the more commercial the venture, the more savvy the due diligence needs to be. This means: having the skills to evaluate, communicate and manage the commercial risk; judging affordability on the basis of what could go wrong, not just on the cost of borrowing; and ensuring the level and type of governance appropriate to the risk. 

Inevitably, some ventures will fail. Yields can go down as well as up and are notoriously sensitive to economic cycles. For local government, the reputational damage that follows failure is much greater than in the private sector. So councils should take a commercial decision only after rehearsing how they would defend it, especially if it were to go wrong. 

This is all enshrined in the principles underpinning CIPFA’s prudential code, which supports councils in borrowing and making investment decisions. While councils pay low interest rates because of their high credit scores, low rates are never a reason to borrow – it’s about what you borrow for. 

Chief finance officers know all this and how important the code is as a permissive framework for local government but, in the current climate, there are risks with that framework. First is the concern that councils are not carrying out adequate due diligence and ongoing governance around their commercial risks. Second is the sense that some councils are taking on disproportionate levels of debt and aggregate levels of risk, especially when buying commercial property primarily for yield purposes. These perceptions are often fuelled by the actions of a small minority of councils but the perception can attach to all. CIPFA will undoubtedly have to look at how the code may need to change because of this. 

So, while context is everything, so is acting proportionately – particularly in relation to the level of debt being put on the books, especially to buy yield. 

Sean Nolan is director of local government at CIPFA

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