Alison Ring discusses the absence of professional analysts in the local government financial reporting system and suggests that this could be a role for the proposed Office for Local Government.
Professional investors know that the annual report and financial statements are only the first document that they look at when deciding whether to invest in a listed company. The second stop on their investment journey would usually be to read the analyst or “broker” reports that provide an independent assessment of a company’s strategy, finances, governance and management.
While the buy/sell recommendations and a target share price that are typically included need to be treated with a degree of scepticism, analyst reports provide an in-depth investigation of the listed company concerned that is often critical to how investors decide on where to put their or their clients’ money.
For preparers, the existence of analysts is a key part of the financial reporting environment. Not only is there a group of people who read your reports and financial statements, they read them with an expert eye.
Accounting experts
For financially literate investors who are not accounting experts (and even for those who are), analyst reports are invaluable. Not only do they summarise the things investors need to know if they had time to read everything produced by the company concerned, they benefit from accounting experts who are able to understand what is going on in the nether regions of the notes to the financial statements.
Analysts attend investor days at which management teams set out their business strategy, participate in results presentations where the CEO and CFO explain business performance and talk about the financial position, opportunities and risks.
When there is something that doesn’t look quite right, they ask a question. When there is something that looks wrong, they tell people. All things investors might like to do themselves if they could, but which they don’t have time to do in practice.
For preparers, the existence of analysts is a key part of the financial reporting environment. Not only is there a group of people who read your reports and financial statements, they read them with an expert eye.
This provides a hugely valuable feedback loop for preparers. If you haven’t explained your strategy and how that links to your financial performance in your narrative report, the analysts will request a better explanation. Likewise, they will ask questions if you haven’t described what you are doing to manage your balance sheet, or your financial instruments’ note doesn’t adequately explain your exposure to changes in interest rates.
Analysts complement the other parts of the financial reporting environment for listed companies as their primary focus is on understanding the organisation and its strengths and weaknesses.
Although, in theory, regulators and external auditors are also interested in making sure annual reports provide a comprehensive picture of your organisation, they inevitably focus on accuracy, truthfulness, disclosure rules and accounting standards. All of these are critical to ensuring trust in financial reporting, but they do not automatically ensure that financial reports are as understandable as they can be.
Unfortunately, there is no equivalent community of professional analysts in the local government sector who read your authority’s annual accounts and question you about them. This is a real gap in the system.
Asking the right questions
Despite the long-running assertion that no one reads local authority reports and accounts, there are plenty of people who do look at the financial statements in addition to the finance teams that prepare them and the external auditors that audit them.
However, relatively few councillors, MPs or other stakeholders have the financial expertise to ask the right questions, let alone the time to do so. Commercial lenders do, as do the Public Works Loans Board and the Department for Levelling Up, Communities and Housing, but they don’t publish their research and analysis for others to use.
Unfortunately, there is no equivalent community of professional analysts in the local government sector who read your authority’s annual accounts and question you about them. This is a real gap in the system of local government financial reporting, as key stakeholders, such as councillors and MPs, are not able to benefit from the type of strategic and financial analysis available to listed company investors.
Of course, many local authorities see the annual report and financial statements as a key opportunity to communicate their strategy, finances, governance and performance, and will put a lot of effort into making sure these are understandable. However, that does not mean you would not benefit from a dialogue with readers who are interested in your numbers and disclosures and in making sure they understand your strategy and how you are performing in achieving your objectives.
In the private sector, analyst reports are also a key part of the “early warning” system that alerts investors, regulators and other stakeholders to financial or governance problems in the organisations concerned. While a strong recommendation to sell is not an option generally available to councillors, central government or other stakeholders, there are strong arguments that these sorts of warnings might have helped flag potential financial and governance failures at a much earlier stage. This might have headed off some of the s114 notices and commissioner appointments that we are currently seeing in increasing numbers.
The absence of a corps of analysts also means that local authority finance teams do not have the benefit of a dialogue with expert readers of their accounts in the same way as exists in the private sector. This is a key driver for improving the quality of financial reports and – most importantly – their understandability – that local government in England is missing out on.
Commissioning analyst reports would aid the Office for Local Government in promoting improvements in local public services and in strengthening the financial health and resilience of councils.
A role for the Office for Local Government?
In the private sector, demand for analyst reports has been driven by professional investors with millions or billions of pounds at stake, while supply has been provided by a financial sector keen to serve those investors. In the public sector, there also millions or billions of pounds at stake. But without demand from stakeholders to provide such analysis, nor a financial mechanism to pay for the supply, no equivalent has arisen.
This has meant that local government is missing one of the key elements of a strong financial reporting system – a corps of professional readers of accounts who have an interest in understanding what is reported in them.
Filling this gap is something that the proposed Office for Local Government (OfLoG) in England could do to strengthen the accountability of local government in England.
Councillors, audit committees and other stakeholders in local authorities would really benefit from the independent expert analysis that broker reports provide, while management teams would benefit from explaining their performance to professional analysts.
Commissioning analyst reports, perhaps on a rotational basis, would also aid OfLoG in its role in promoting improvements in local public services and in strengthening the financial health and resilience of councils. Not only by strengthening the early warning system available beyond the current system of monitoring external public interest reports, but also by providing in-depth analysis that expert readers of financial statements can provide.
Alison Ring is director of public sector and taxation at the Institute of Chartered Accountants in England and Wales.
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