When the Prudential Code of Capital Finance was introduced in 2004, it heralded a new and modern era for local government financial management.
It was designed to allow local authorities, which had become sophisticated public service delivery organisations, to be able to take their own local investment decisions in accordance with their local strategic needs.
It was of course part of the wider prudential framework for capital finance which was introduced by the Local Government Act 2003, based on a system of risk based, self-management.
More fundamentally, it finally ended a centrally controlled and complex system of borrowing restrictions, which limited local authorities’ ability to take effective capital investment decisions.
The intervening years since the code’s introduction have seen reduced financial resources and long-term austerity.
Local authorities have had to make difficult service decisions and more commercial-based decisions to ensure that they make the most of their limited resources to support service delivery and economic generation.
‘The unintended combination of flexibility and austerity has however set an environment where some local authorities have moved towards investments in commercial properties financed by borrowing.’
The unintended combination of flexibility and austerity has however set an environment where some local authorities have moved towards investments in commercial properties financed by borrowing.
For some local authorities the scale of their commercial investments has been disproportionate to their resources.
The Prudential Code takes the same position as the statutory guidance and is clear 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.
The code sets out that local 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.
Both prudence and affordability have to be analysed and managed from a risk.
These types of investments require local authorities to understand the impact of an undiversified investment portfolio, the impact from potential failure or a downturn of the property market and potential distortion of the local property investment market.
This prompts questions about the extent to which our valued local services are being exposed to reliance on commercial income.
It is now a modern day problem that local services, much of them delivered to vulnerable people are becoming reliant on property prices rather than on a stable financial base.
But while the Prudential Code is designed for local delivery and local decision-making, it is still a national Code.
Local activity can therefore have national implications and can prompt action by CIPFA.
The intention of the statement issued last week was to make it clear that borrowing in advance of need purely for profit is inconsistent with the Code.
Updated statutory investment guidance from the Ministry of Housing, Communities and Local Government earlier this year also made it clear that local authorities should not become too dependent on commercial income or in taking out too much debt relative to net service expenditure.
The current guidance in support of the Prudential Code will be augmented and strengthened to ensure that assistance is provided to local authorities.
It is expected that the new guidance will remind local authorities and their elected members of the substantial risks associated with the current practices.
The Prudential framework and the code continues to represent a positive development in modern public financial management.
Local authorities will be guided in every way possible to ensure that these valued flexibilities are protected.
