The new Prudential Code for Capital Finance in Local Authorities will not include an explicit ban on borrowing for profit-making investment, as had previously been proposed. However, LGC understands the removal of the ban is unlikely to have an impact on government moves to prevent councils using loans to fund out-of-area property investments.
The Chartered Institute for Public Finance & Accountancy consulted over the summer on plans to update the code to reflect the increasingly commercial approach being taken by many councils. The move is reported to have followed growing concern in Treasury about the scale of council borrowing to fund commercial investments.
A recent LGC investigation found more than a third of councils had invested in commercial property specifically to generate an income since 2010. A third of these owned property outside their area, worth a total of £619m. However, not all of this has been purchased since 2010.
A consultation on the revised Prudential Code proposed including the statement that councils “must not borrow more than or in advance of their needs purely in order to profit from the investment of the extra sums borrowed”.
Borrowing in advance of need has typically been understood to refer to playing the money markets with cash borrowed for capital investment purposes, before it is required. However, when taken in conjunction with proposed revisions to the government’s Local Authority Investment Code that stipulate borrowing to generate rental yield should be considered borrowing in advance of need, finance experts have warned it would amount to a ban on borrowing to invest in property solely to generate an income.
Cipfa confirmed to LGC that the proposed wording would not be in the final updated Prudential Code, which is due to be published in January, but stressed it is the Local Government Act 2003 and associated regulations that determine what a council can and cannot do with money it borrows.
A source close to Cipfa told LGC councils would still be prevented from borrowing to fund investment in property where the only motivation was to generate an income. This will mean investments outside of a council’s area are likely to be particularly hard hit. However, there is no expectation that the government will seek to apply the new code retrospectively as some councils had feared.
The updated Prudential Code will still include new requirements around governance and transparency in relation to the new generation of commercial investments which the source said had helped to head off major concern in the Treasury about some councils’ investments.
“Because they are comfortable with the way we are improving governance, transparency and requirements around independent advice that has limited the amount of regulation that they felt they needed to move,” the source said.
John Rice, director of commercial services at Runnymede BC which has invested £160m in property since 2010, told LGC this move would effectively remove the option for councils in less affluent areas to use income generated from property investment to support services.
Mr Rice, who is also a member of the Local Government Association’s advanced commercial group, said: “If you’re one of the northern authorities with low land values the only way you can realistically have investments that make sense if to have out-of-borough investments. The government are actually restricting the ability of those northern authorities to balance their budgets.”
Cipfa’s revised prudential code is due to be published in January. Consultation on the Department for Communities & Local Government’s Local Authority Investment Code closes on Friday.
The department issued a Q&A clarifying some of its intentions in relation to rules on council borrowing late last month.
It said: “We do not want to restrict opportunities for local authorities to use commercial structures to kick start local economic regeneration to deliver services more effectively. However, the prime duty of a local authority is to provide services to local residents, not to take on disproportionate levels of financial risk by undertaking speculative investments, especially where that is funded by additional borrowing… Local authorities will be able to borrow to fund investments that have multiple objectives, including generating yield.”