Written evidence submitted by CIPFA [FSS 012]

1.              Executive summary

1.1                 The financial sustainability of local government has been the subject of scrutiny for several years, but the current pandemic has understandably accelerated concerns. This document sets out CIPFA’s response to this inquiry under the following headings:

                      local authority financial sustainability

                      the Prudential Framework 

                      the Section 114 regime.

1.2              CIPFA supports the view that the sector will be more financially stable when local authorities are able to confidently produce medium term financial plans. We strongly advocate that longer-term planning and greater financial certainty improves financial sustainability and resilience in the public sector[1]. One-off grants and single-year spending reviews do not provide a foundation for confidence.

1.3                The Prudential Framework is key to local authority decision making. It allows the sector freedom to invest in areas such as regeneration and housing. If the sector is to play a central role in rebuilding post-COVID communities during the next five years, it must remain active and have the flexibility to make local decisions. CIPFA is working with government and institute stakeholders to reshape the Prudential Code to better meet future need.   

1.4                We continue to have concerns over the financial resilience of the local government sector and so to provide transparency we will produce the second Resilience Index in February 2021. Based on 2019/20 government data this model will show the resilience of local authorities as they entered the pandemic. 

1.5              Local government relies heavily on funding from council tax and business rates. COVID-19 has exposed the weaknesses of these limited funding sources and, over the long term, the funding system may need to look very different. Recognising that reform will take longer than the lifetime of this parliament, CIPFA urges the government to start to look ahead.

1.6                The issue of a Section 114 notice is inevitably undertaken against a background of severe financial challenge. This is what the legislation anticipates and consequently, the issue of a Section 114 notice is not a sign that the system is failing but that the system of financial checks is working. CIPFA remains convinced that the legislation provides sufficient flexibility for CFOs to make professional judgements. However, CIPFA has modified its guidance to encourage CFOs to enter dialogue with government to explore alternative options. This helps avoid the consequences of issuing a Section 114 notice as a result of COVID pressures. Government should support the sector with adequate funding and flexibilities delivered in a timely manner to allow CFOs the opportunity to make professional decisions.  

 

 

 

2.              Local authority financial stability

2.1              Government funding for local authorities was reduced by an estimated 49.1% in real terms from 2010/11 to 2017/18.[2] This equates to a 28.6% real-terms reduction in ‘spending power’. Therefore, when the increased demand for local government services emerged as a result of the COVID-19 pandemic, the quantum of spending power was already under strain.

2.2                 Central government has provided over £3bn of additional COVID support funding during the pandemic and through the Spending Review[3] core spending power for local authorities was estimated to increase by 4.5% in cash terms in 2021/22. Much of this was predicated on increases in council tax at 2% in 2021/22 and the adult social care precept of up to 3%.

2.3               CIPFA’s evidence from discussions with CFOs is that additional funding has provided a financial respite in 2020/21. However, there is significant concern for 2021/22 budgets as funding streams have not been guaranteed and there will be a disproportionate reliance on increased council tax.

2.4                  The 2020 Spending Review assumes that local authorities will be able to increase council tax by the maximum allowed under the legislation. This assumption is now being tested through the local political system and it is evident that some authorities such as Lincolnshire County Council feel this is not acceptable.

2.5                   The funding gap has been exacerbated by the decrease in non-grant income received by authorities. Income pressures from lost revenue through sales, fees and charges are substantial, with district councils especially losing funding from leisure and car parking. It would be wrong to assume that income and fee levels will revert quickly to previous levels (if at all) and this must be built into any forecast. We can see this causing cash-flow and funding issues that will have a significant impact on local authority finances into 2021/22.

2.6                 The government’s plan to cover 75% of income losses from fees and charges (after local government fund 25% of lost income) still leaves a significant financial gap. It does not recognise the further challenge of lost income from council tax and business rates. Deferring this over three years rather than funding the loss does not provide additional funding but is nonetheless welcome to avoid pressure on council tax calculations now.

2.7              Demand-led additional funding such as for local council tax support has been welcomed. However, the complexity of local government finance must be recognised. For example, a rise in recipients of council tax support will have an impact on the council tax base that will affect council finances. There is concern there may be unintended consequences as councils work out their council tax in 2021/22.

2.8               It should be noted that the practicalities of budget setting are made more difficult for 2021/22 because of funding announcements that do not align with the budget setting process of councils.

2.9                Work undertaken by CIPFA through its Resilience Index[4] provides clear evidence that the available pre COVID-19 funding was insufficient to cover the sector’s needs. The index looks at key indicators of resilience including reserves. Those authorities with low level of reserves will be among those at highest risk. 

2.10                Reserves are an important part of the financial resilience of an organisation and part of the CFOs responsibility[5]. The requirement for financial reserves is acknowledged in statute.[6] When setting their budget for 2021/22, councils will have to plan for rising demand and falling income and as a result will be required to have adequate reserves. While it may be counterinitiative, in some areas reserves may need to increase in the face of increased risk.

2.11               CIPFA asks the Committee to consider and acknowledge the importance of reserves within local authority finance. For example, where authorities have had to draw down on reserves to support local COVID-19 activity there must be consideration given to how these will be replaced. Replacement is unlikely to be affordable from local resources. In the absence of central government support to enable reserves to be restored to locally acceptable levels, it is likely that a number of councils will be vulnerable.

2.12              CIPFA supports the view that the sector will be more financially stable when local authorities are able to confidently produce medium term financial plans. We would ask government to consider this request in next year’s CSR.

2.13              CIPFA is concerned by the reliance on council tax built within the spending review assumptions and its impact on ongoing sustainability. There is no recognition of the link between ability to raise income and need, with those in greatest need likely to be least able to pay. We would also draw attention to the accumulative effect of council tax increases and ongoing sustainability. 

3.                 The Prudential Framework

3.1               The Prudential Framework is key to local authority decision making. It allows the sector freedom to invest in areas such as regeneration and housing. Local government will play a central role in rebuilding post-COVID communities during the next five years. The ability to have the flexibility to make local decisions is essential. CIPFA is working with government and institute stakeholders to reshape the Prudential Code to better meet future need.

3.2                The objectives of the Prudential Code are to ensure, within this clear framework, that the capital investment plans of local authorities are affordable, prudent, and sustainable.

3.3                 Over a period of five years and against the background of funding reductions, the risk appetite of local authorities has increased. This has resulted in the well-documented commercial actions of several local authorities. While CIPFA does recognise and is concerned about the significant growth of commercial activities and debt for yield investments, for most authorities the Prudential Code as a part of the Prudential Framework has worked well supporting decision making and prudent capital investment.

3.4                  It is essential that, post-COVID, local authorities remain able to support and invest in their communities with the freedom to make local decisions. CIPFA considers that the current framework supports this objective but following the outcomes of the Public Accounts Committee’s July 2020 report, Local authority investment in commercial property, CIPFA has agreed to strengthen the Prudential Code to provide increased levels of assurance. 

3.5                CIPFA is committed to reviewing both the Prudential Code and Treasury Management Code, to ensure they continue to be fit for purpose and support and protect local decision making. CIPFA’s consultation will begin on 1 February 2021.

3.6                  The consultation on the Prudential Code and Treasury Management Code will have a focus on governance to ensure decisions are transparent and accountable, backed by a greater requirement for decision makers’ knowledge and skills to demonstrate competency to manage risks at a local level with robust scrutiny.

3.7                 Following the recent and significant changes to Public Works Loan Board lending guidance CIPFA would wish to see a period of stability to enable local authorities to support economic regeneration post-COVID. Additional uncertainty will hamper longer term planning.

3.8                  The Prudential Framework has worked well for local authorities for over 15 years. While a small number of authorities have recently tested the framework, far more have benefited from its flexible approach. New developments must be focused on targeted assurance and accountability rather than broad increased restrictions.

4.                 The Section 114 regime

4.1               During summer of 2020 CIPFA updated its Section 114 guidance to CFOs. Responding to increased uncertainty caused by the pandemic, this guidance clarified the need for discussions to take place with MHCLG on possible additional COVID-19 related support. While not removing the legal requirement for a Section 114 this reflected the need for additional consideration to include possible financial aid from central government.

4.2                The modification to S.114 was one of the tools provided to finance professionals.  The Committee will be aware of CIPFA’s Financial Management Code which, for the first time, sets standards of financial management for local authorities. The FM Code is the most recent CIPFA code and was introduced in September 2019. CIPFA considers good financial management to be essential to financial sustainability.

4.              However, there will be those organisations who are unable to bridge the funding gap and are unable to produce a balanced budget. In these instances, the CFO will be required to issue a S.114 notice.

4.4               The S.114 notice is a statutory notice[7] issued by the CFO that prevents the local authority incurring additional expenditure while further discussion takes place regarding the financial standing of the authority.

4.5                  The CFO is required to use their professional judgement on issuing a S.114 but in 2020 CIPFA provided additional COVID related guidance to support a CFO in their decision making. This introduced a requirement to enter discussion with government to request additional support. 

4.6                The most recent S.114 notice was issued by the London Borough of Croydon in November 2020. This was not wholly as a result of COVID-related activity. While the pandemic will have impacted on Croydon’s financial position it is generally considered that it did not cause them. It is important to recognise this difference as the financial stability of an organisation experiencing COVID-related pressures will be different.

4.7                The issue of a S.114 notice is generally seen as an indicator of financial failure. While it is correct to recognise that severe financial challenges will underly this issue of the notice, it must be borne in mind that the intention of legislation itself is a statutory control which prompts further action. It is therefore a necessary and valuable instrument of government. CIPFA would caution against judging the effectiveness of S.114 against the background of a global pandemic. In practice, it will not be possible to remove the risk of a S.114 but several approaches may be taken to mitigate that risk.

4.8                  To improve financial sustainability we would support a move away from ringfenced grants to ones that allowed local authorities greater flexibility. With the understanding that there are clear outcomes required by government, local government would commit to the outcomes as described in the Spending Review.

4.9               While recognising the challenges of COVID, CIPFA would recommend several changes associated with grant allocation that would improve financial sustainability. These would include a reduction in the grants that require individual bidding and a reduction in the volume of grants with more focus on single larger grants to reduce complexity. Any system that allocates public money on the quality of a bid, diverts resources into unnecessary competition between public bodies.

4.10               Confirmation regarding the allocation of funding is often delayed and the guidance to accompany the schemes incomplete. These two factors add to the complexity of financial planning leading to increased financial instability. This could also be extended to the timing of government funding announcements that do not reflect the local authority decision-making cycle.

4.11               Accounting flexibilities could be included as part of these strategies. The exact nature of these flexibilities would need to be determined and CIPFA is clear they would not be a substitute for adequate funding but may meet a short-term objective.

4.12                 In the past where there have been specific financial challenges to individual organisations, central government has considered certain accounting flexibilities including capitalisation directions. While these do not create additional funds, they provide CFOs with short-term headroom. CIPFA does not advocate these as long-term measures as they are not consistent with strong financial management but acknowledges these as available short-term tools.

4.13                Councils are still awaiting the outcome of funding decisions especially those in negotiation with MHCLG for exceptional support. These are councils most likely to be at risk of issuing a S.114.

4.14              While there is transparency around the principles for exceptional support, these discussions will be negotiated individually. CIPFA regards these principles to be fair but asks government to recognise the legislative requirements facing local authorities when setting budgets. These are:

                      value for money

                      long-term sustainability

                      the underlying drivers of fragility

                      avoidance of moral hazard,

                      need to be legally robust

                      ensure eligibility.

4.15              CIPFA remains convinced that the current S.114 legislation provides sufficient flexibility for CFOs to make professional judgements. However, as indicated earlier, CIPFA has modified its guidance to encourage CFOs to enter dialogue with government to explore alternative options. This helps to avoid the consequences of issuing a S.114 notice because of COVID pressures. Government should support the sector with adequate funding and flexibilities delivered in a timely manner to allow CFOs the opportunity to make professional decisions.

 

January 2021

 

 


[1] Financial Management Code, CIPFA 2019

[2] Financial sustainability of local authorities 2018, National Audit Office

[3] Spending Review 2020

[4] CIPFA Resilience Index

[5] Role of the CFO in Local Authorities, CIPFA 2016

[6] Sections 31A, 3242A and 43 of the Local Government Finance Act 1992

[7] Local Government Act 1988