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Across the local government sector there continues to be extensive use of prudential borrowing to fund new and existing investments, including regeneration, levelling up and net zero investments.
However, one of the issues that led to the update of the Prudential Code was local authorities using their prudential borrowing powers to buy capital assets purely for a commercial return.
Sometimes, these capital assets were sited a long way away from the authority’s area and sometimes local authorities were able to undercut private sector investors as a result of access to lower-cost borrowing.
The updated Code and guidance notes aim to stop this.
However, the update to the Code does not mean that local authorities cannot use their prudential borrowing powers to buy capital assets that provide a commercial income.
The question is one of primacy. Any such activity must be done primarily for the socio-economic benefits to those in the authority’s area.
Socio-economic benefits are best understood by referring to the Treasury’s Green Book guidance.
This makes socio-economic benefits to people in the local authority’s area difficult to justify when the investment activity is a long way away.
The Levelling Up and Regeneration bill currently at committee stage in the House of Lords includes a new capital risk monitoring regime.
This regime is part of the response to the criticism that central government does not have a strong understanding of the overall level of prudential borrowing.
The monitoring regime, which should benefit local authorities and central government, has a focus on four risk categories:
The total of a local authority’s debt (including credit arrangements) compared to the financial resources at the disposal of the authority
The proportion of the total of a local authority’s capital assets which are investments made, or held, wholly or mainly in order to generate financial return
The proportion of a local authority’s debt (including credit arrangements) where the counterparty is not central government or a local authority.
The amount of minimum revenue provision charged by a local authority to a revenue account for a financial year.
Prudential borrowing requires capacity and capability in areas such as business cases, the Green Book and financial management, including some investment theory.
“There is no one-size-fits-all approach”
It’s important to draw a distinction between funding and financing, where funding is your income, grants and reserves, while financing is money that you borrow and will need to repay (from funding).
Also, there is a distinction between corporate finance and project finance, where corporate finance is borrowing against an organisation’s balance sheet, while project finance is linked to a specific project and its future cash flows.
Finally, we need to acknowledge the difference between the primary and secondary market when looking at investments.
A primary investment results in newly created assets, property or infrastructure which can create new socio-economic benefits, while a secondary investment sees existing assets only change hands.
As a result, it is difficult to see how a secondary investment can generate any new socio-economic benefits for the communities served when the assets already exist and should, in theory, already be providing benefits, unless it is genuinely the case that without the investment the asset would become redundant.
We acknowledge that this is a complex area.
Programmes, projects and investment proposals need to be looked at on a case-by-case basis.
Therefore, care will be needed in any future update to the prudential borrowing arrangements and in applying the capital risk monitoring regimes.
A local authority can also be economically complex. It can be a borrower and an investor. It can be a procurer and supplier of goods and services and an asset owner.
Generally, prudential borrowing is a straightforward process through the Public Works Loan Board, but that doesn’t mean investing is as simple or straightforward.
Based on recent experience of local authorities as investors, there is a real need to build capacity and capabilities and refresh decision-making approaches.
Local authorities might be able to learn from looking at how private sector equity investors and debt providers (e.g. banks) consider a public private partnership investment.
They would probably look for a series of protections, including seeking a balanced portfolio (meaning not all their eggs are in one basket), while extensive due diligence is undertaken before any investment is made, likely over a period of months.
Then there would be very regular monitoring against the original business case and financial projections. Significant work would have been undertaken on a range of “downside scenarios”.
Local authorities are allowed to borrow for commercial return under the Prudential Code, however it must be for the benefit of people in the local authorities’ area and within their means.
It is a complex and difficult process to evaluate and oversee, which is why a case-by-case process should be adopted. There is no one-size-fits-all approach.
CIPFA advises that local authorities use the HMT Better Business Case approach, the Five Case model and the Green Book for their economic decision-making framework and as a way of documenting their decisions.
This will provide vital guidance, accountability and transparency and will give local authorities the assurance they need.
