LAI0028

Written evidence submitted by Arlingclose Limited

1. Introduction

1.1              By way of introduction, Arlingclose Ltd is a private company providing independent treasury management and capital finance advisory services to UK local authorities. Arlingclose is authorised and regulated by the Financial Conduct Authority.

1.2              At the end of April 2020, Arlingclose had 170 UK local authority clients representing approximately 40% of the local authority market.

1.3              Our clients embrace a wide range of circumstances and regulatory guidance throughout the UK. They have all adopted what has become known as commercialisation in different ways as part of their response to severely reduced central government grant at a time of increased statutory and demographic demands on services. Some, though not all, have interpreted it to include commercial investment.

1.4              The recent report by the National Audit Office (NAO): Local authority investment in commercial property (February 2020)[1] provides a comprehensive background to the extent of activity.

1.5              This submission looks at the specific area of the various official guidance issued to UK local authorities only. Officials at the Ministry of Housing, Communities and Local Government (MHCLG) and the Chartered Institute of Public Finance and Accountancy (CIPFA) seem frustrated that local authorities are not following their guidance. We believe this is because the various official guidance documents are confusing and sometimes contradictory.

1.6              Detailed official guidance references are provided in the attached Appendix.

2.              Background

2.1              Since the relaxation of capital controls on local authorities in 2004, the CIPFA Prudential Code[2] has stated 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 terms “borrow”, “investment” and “needs” were generally well understood. In particular “investment” was defined as treasury investments such as bank deposits and bonds, not property, while “need” was defined in terms of the capital financing requirement which includes all types of property. Borrowing to buy investment property was therefore thought to be permitted.

2.2              In December 2017, CIPFA changed the definition of an investment in its Treasury Management Code[3] to include “non-financial assets which the organisation holds primarily for financial returns, such as investment property portfolios”. However, the definition of an investment in the Prudential Code[4] published in the same month still excluded all types of property.

2.3              MHCLG revised its Investment Guidance[5] in February 2018 to include the phrase from the Prudential Code 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”. It adopted an even wider definition of an investment, to include “non-financial assets that the organisation holds primarily or partially to generate a profit – for example, investment property portfolios”. Taken at face value, this would prevent borrowing to buy a property used principally for delivering services but rented out when not being used, such as at weekends. However, with no definition of “needs” in the guidance, many local authorities continue to adopt the capital financing requirement so that the need to borrow increases with the purchase of any property irrespective of the purpose to which it will be put.

2.4              The Investment Guidance also, very unusually in our experience, provides guidance on what local authorities should do when not following the guidance.  They “should explain why the local authority has decided not to have regard to this Guidance” even though having regard to the guidance is a legal duty.

2.5              MHCLG’s Minimum Revenue Provision Guidance[6] (how capital expenditure is financed) was issued at the same time and also gives guidance on setting aside revenue for investment properties that have been funded by borrowing, implying it is a normal activity of local authorities.

2.6              CIPFA published Guidance Notes for Local Authorities to accompany its Treasury Management Code[7] in July 2018. Adding to the confusion, these have adopted MHCLG’s “primarily or partially” definition of an investment rather than the Treasury Management Code’s own “primarily” definition. It also permits borrowing in advance of need “where there is a clear business case for doing so … for the current capital programme”. All property purchases form part of the capital programme.

2.7              Most recently, CIPFA’s non-statutory guidance Prudential Property Investment[8] published in November 2019 attempts to use “on-lending” to describe borrowing to buy investment property. Most readers would understand on-lending to mean borrowing money to then lend that money on, not to buy a property. It also notes that “it is uncertain whether a commercial or an investment property would meet the statutory definition of an investment”.

3.0              Devolved Administrations

3.1              While borrowing for commercial property is currently only an issue in England, it is important that the solution is nationwide. Unfortunately, the devolved administrations have each adopted different approaches.

3.2              The Welsh Government’s 2019 Investment Guidance is similar MHCLG’s, save that property is only an investment if it has been bought using the legal power to invest, rather than separate powers to acquire land and buildings. It is therefore unlikely to apply to property that is mainly used for local public services.

3.3              Statutory guidance in Northern Ireland has remained unchanged since 2011 and contains no prohibition on borrowing in advance of need, it merely requires councils to state their policy on it. No property counts as an investment.

3.4              As is often the case, Scottish guidance is the clearest of the four nations. It is the only government publication to define borrowing in advance, and uses a rolling 12-month in advance capital financing requirement. Property only counts as an investment if it would be accounted for as an investment property – i.e. if it is held solely for financial purposes.

4.0              Conclusion

4.1              We would conclude that the official guidance is confusing and that it is understandable why elected representatives and officers of local authorities adopt differing interpretations to the place of commercial property investment in their specific authority’s activities.

May 2020

LAI0028

Appendix: Official guidance on borrowing for investment property