Has government attempted to ban local authorities from investing in property? Colin Marrs disentangles recent government statements to find that the real difference will be made only when the case law is built.
The day after Boxing Day, local government finance officers may have been forgiven for feeling a little worn out. But those remaining alert after a hard year and their festive excesses may have noticed an important headline in their copy of The Times.
The story, titled Ban on local investments in risky portfolios, revisited the government’s consultation on revisions to the investment code, reported by Room151 in November.
In the run up to the consultation, cross-bench peer (and director of three investment management firms) Lord Oakeshott led property investment sector voices calling on the government to stop councils borrowing cheap money to raise income from property investment.
“The government has woken up to this gross abuse of public money and cracked down on councils gambling on property at long last,” he told The Times.
But do the government proposals really amount to a ban, or could local government find a way to continue the increasingly popular practice?
Disclosures
Somewhat confusingly, DCLG’s original consultation document makes no mention whatsoever of a desire to stop councils from borrowing in order to invest in property.
However, the crucial line in the document said: “Borrowing solely to invest rather than to deliver statutory services or strategic objectives has always been considered to be borrowing in advance of need.” It did not refer to a ban, but asked respondents whether councils borrowing solely to invest should disclose additional information.
After complaints from the local government sector about confusion over the meaning of the consultation, DCLG was forced to release a clarification. However, once again, this document steered away from directly outlining the intention of the guidance, saying merely: “Local authorities will be able to borrow to fund investments that have multiple objectives, including generating yield.”
One senior sector figure says that the meaning of the DCLG consultation was uncharacteristically vague. “There is a lot about this process I haven’t come across before,” he says. “When you get a consultation, it is normally crystal clear what the government is aiming at. That wasn’t the case in this instance.” The sector was left to rely on behind-the-scenes conversations and piecing together clues to uncover the government’s real intentions.
Conjunctions
It quickly became clear that the section proposing the classification of borrowing solely to produce an investment yield as “in advance of need” was meant to be read in conjunction with CIPFA’s Prudential Code, which guides councils’ capital finance decisions.
The relevant section says: “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.” (Before Christmas, Room151 mistakenly reported that this line was due to be removed from the final version of the code. However, the document, released in early in the New Year retained it.)
It was a juxtaposition that caused alarm among some sections of local government. The Local Government Association’s response to the consultation said: “Taking these together the result is that under the guidance local authorities will not be able to borrow in order to invest in any yield bearing opportunities. The guidance needs to be clear if this interpretation is correct as this would be a significant problem.”
Restricting councils’ ability to invest in property to raise income, the LGA continued, “could have a major impact on their ability to fund and deliver services to their residents. If, it said, the change was applied retrospectively, forcing councils to divest themselves of existing investments, “the financial costs and potential losses could be disastrous for some councils.”
The LGA, and others, also point out that under the existing Prudential Code, published in 2010, it is clear that “borrowing in advance of need” relates solely to financial investments, while commercial property investments are counted as capital expenditure.
“The definition of an investment in the Prudential Code excludes investment properties,” says David Green, client director at treasury adviser Arlingclose. “So CIPFA and DCLG are talking about different things. In the Prudential Code, investing in property does not count as profiting from the investment of the funds borrowed.”
But a statement to Room151 from the DCLG is clear that the government is relying on an interpretation of the Prudential Code which extends its provisions to commercial property investment.
Although admitting that the proposed wording of the investment code does not amount to a ban, a DCLG spokesman is clear: “If a council does borrow in advance of need and purely to generate revenue, they would need to explain why they haven’t followed the guidance.”
Case law
According to local government finance expert Stephen Sheen, the argument over wording in either code is actually irrelevant in deciding whether the government is proposing to implement a “ban” on councils looking to borrow to profit from commercial property investment.
Such a prohibition is not possible to implement through guidance alone. “The problem here is that it is ultimately a matter of statute as to whether authorities can borrow to acquire investment properties,” he says.
In 2003, the Local Government Act provided specific powers for councils to borrow and to invest, while the 2011 Localism Act introduced a general power of competence. A lack of case law on the operation of these two acts means it is impossible to conclude whether councils can, or cannot, invest solely to produce a yield and borrow to do so, he says.
“The absence of precedents about the interaction of these powers explains why you won’t find either DCLG or CIPFA pronouncing the acquisition of investment properties as legal or illegal, as this would be a matter for the courts to decide,” Sheen says.
All of which means, that legally, the proposed changes to the investment guidance will change nothing, other than requiring councils to disclose the contribution that each investment makes towards their core objectives.
Sheen adds: “Investment in property with no purpose other to generate a yield will be as legal — or illegal — as it has always been, with this being a matter of conjecture unless, or until, the courts rule on the issue.”
Despite this, he says, the furore, and the strong message from government that it disapproves of borrowing solely to raise yield, might mean some councils chose to avoid such investments in future.
“Changes to the investment code won’t force authorities to do things differently,” Sheen says. “But it could make them think that it is less than straightforward and they might choose to avoid it.”
