The government has issued a single consultation paper on the Prudential Framework, proposing changes to two key documents: the statutory guidance provisions for local authority investments and for minimum revenue provision (MRP).
The investments guidance is being extended so that it covers non-financial yield bearing assets, investment properties, not just paper investments. As most authorities will already have beeen acquiring investment properties in a prudent and judicious fashion, the changes should not have fundamental effect; a little more transparency, a little more public disclosure of what the authority is up to.
By contrast, the MRP guidance is being amended because the government is concerned that the existing provisions are not being applied in the way intended and need to be more restrictive.
There is a real expectation that some authorities will change their ways and regularly set more revenue resources aside to finance capital expenditure. It is therefore vital that every authority understands the budgetary implications of these particular proposals.
Satisfaction
Dealing with the investment guidance first, it has never been its purpose to determine which investments authorities can or cannot take out. It satisfies itself with requiring authorities to have policies in place that limit the amount that is invested in instruments with credit risk. The proposals bring investment properties into the fold, but with some variations for the different security/liquidity/yield considerations that apply:
- The key principle for investment will be security through recoverable fair value, with preparedness for possible impairment.
- Authorities will need to disclose in their capital strategy:
– reasons for borrowing to invest in property and policies for managing risk;
– how the authority assesses the markets it competes in;
– the contribution that investment property returns make towards the cost of core services, the level of dependency on achieving expected yields and contingency plans for liquidating assets;
– a demonstration that any risky loans to local enterprises are proportionate and made in awareness of expected losses.
The amendments also make clear that it is expected that members and officers should have the capacity, skills and information to take decisions and negotiate deals with due awareness of the Prudential Framework.
The changes are not likely, then, to change behaviours, unless the need for more transparency would stir local political sensitivities that you would prefer to be soothed.
Clampdown
The proposals for the MRP guidance are more problematic. There is a significant issue here in that authorities have an underlying statutory duty to determine a prudent MRP for each financial year. In meeting this duty, they must have regard to the statutory guidance, but are entitled (and sometimes required) to disregard it if it might frustrate meeting the statutory duty.
The consultation usefully reaffirms that the purpose of MRP is to align the cost of an asset over the period during which their capital expenditure provides a benefit. This supports those authorities which have departed from the statutory guidance to secure a more equitable MRP charge.
However, there is a suspicion that a number of authorities have disregarded or misapplied the statutory guidance with the primary aim of minimising MRP charges, rather than rebalancing them. This could particularly be the case for investment properties where there is evidence that some authorities are using the statutory guidance to justify a questionable “no depreciation = no MRP” policy.
The proposals appear to be a clampdown on these authorities, at the expense of all. But the big risk is that making the statutory guidance more restrictive will increase the circumstances in which authorities would legitimately be able to disregard it and make it harder to police the illegitimate departures.
The two substantial proposals are for:
- Specification of maximum useful economic lives for assets over which MRP should be charged — 50 years for land; 40 years for any other class of assets.
- No MRP holidays where an authority determines that it has over-provided in the past, unless it can demonstrate that the overpayment was deliberate.
The limitation on useful economic lives will clearly be contradicted by instances at every authority that has any property acquired before 1977 and would have the real potential to make some construction and infrastructure projects unaffordable if applied.
It also ignores the impact of subsequent capital expenditure. But the limitation would only have an impact on already conservative authorities that have been hesitant to exercise their discretion to depart from the statutory guidance. Everyone else will find themselves able to pass over it.
The ban on MRP holidays also cuts across the principle that, if an authority finds that it has raised too much from council tax payers in previous years, the most effective way of trying to return the cash to them would be to make an immediate abatement, whilst the maximum number are still council tax payers, not spread the gain over future financial years. It is therefore contrary to the “who benefits, pays” principle.
We should have great faith in the Prudential Framework as currently constituted to deliver proper MRP charges, based on ensuring that authorities only carry forward an equitable amount of capital expenditure to be financed in future years. Under this approach, though, the absolute level of borrowing is unimportant, provided its consequences are affordable. There is therefore a clear contrast with government aspirations for the limitation of borrowing.
If the problem for the government is particular authorities acting imprudently, then it would be more equitable to help them in particular see the error of their ways rather than punish everybody. Government, auditors and advisers need to be chasing out bad practice in MRP minimisation to ensure that the continuing operation of the Prudential Framework is not jeopardised.
But if the problem is borrowing limitation, then it would be more effective to achieve this through the imposition of borrowing caps, within which authorities would be able to continue using everything in the Framework toolbox to satisfy “who benefits, pays”.
Make sure that you have your say by the 22 December closing date. Don’t leave it to Santa to bring Christmas cheer to DCLG.
Stephen Sheen is the managing director
of Ichabod’s Industries, a consultancy
providing technical accounting support
to local government.
