Local authority investment in commercial property Contents

2Oversight and intervention

19.The Department has overall responsibility for the effectiveness of the prudential framework. It takes assurance on the system’s effectiveness from data provided by local authorities on their borrowing and investment activities, the work of external auditors, and the operation of a range of statutory roles and responsibilities designed to support good governance within local authorities.54

Shortcomings with data

20.In 2016 this Committee recommended that the Department review its data on capital expenditure and financing in the light of new behaviours in the sector. We stated specifically that the Department should ensure that the purpose and geographical location of capital spending can be ascertained from their data.55 The Department did take steps to improve the data it collects and also acquired some proprietary data. However, the NAO concluded that the changes to Departmental data did “…not add much clarity”, while the proprietary data it acquired appeared to “…understate the overall scale of the acquisition of commercial property by local authorities, particularly property acquired out of area”. The NAO concluded that this data and the associated analysis undertaken by the Department were “outdated”. The NAO also highlighted that the Department’s data, “…do not demonstrate whether commercial property investments are delivering planned returns or how significant these returns are to local service provision”. Finally, the NAO identified that the Department did not undertake analysis on the borrowing data it holds to make any assessment of the extent to which authorities may have been borrowing for yield.56 We recognise that this cannot be determined categorically, but we would have expected the Department to have undertaken work to produce indicative figures at the very least.

21.The Department has effectively been flying blind over this period and it needs to get a grip on this in the future. The fact that the NAO had to purchase data in order to complete its review is evidence of a significant shortcoming by the Department.57 We welcome the Department’s recognition that it needs to improve the data it collects and its commitment to “…undertake a serious data review”. However, we are concerned by the implication by the Department that the proposed changes to the PWLB will stop out-of-area investments and therefore make data on the location of investments less relevant.58 This may be the case, but the Department’s data review needs to be aimed at capturing data on emerging and future commercial investment activities rather than solely on current ones. In this respect we were not reassured that the Department has a sense of urgency in relation to acquiring data and properly understanding the new commercial strategies local authorities are now pursuing beyond the acquisition of commercial property.59

Realistic expectations of external audit

22.Local authority external auditors may examine issues relating to commercial property purchases or borrowing where they see these as a significant risk. Twice in the last two years, auditors have qualified their conclusions on a local authority’s value for money arrangements due to concerns relating to commercial property acquisitions.60 However, in a survey carried out for the local audit appointing body, almost 40% of finance directors and 30% of audit committee chairs were not able to agree that the audit service provided during 2019–20 met expectations.61

23.The Department’s Post Implementation Review of Changes to the Local Authority Capital Finance Framework demonstrated that the direct role of external audit in relation to commercial property purchases is currently limited: audit work does not always examine capital investment and borrowing strategies, where it does the approach is ‘light touch’ and does not involve challenging the assumptions. In addition, there needs to be very clear evidence of risks or issues with a commercial property acquisition before the auditor would examine it, which would generally be after the investment had already been made. Accordingly audit “should not be viewed as a strategy for mitigating risk within the system”.62 In the Department’s view, external audit cannot be relied on to prevent authorities from incurring excessive risk through commercial property acquisitions: it is not a substitute for scrutinising something that is happening in real time. The Department does however see external audit as providing assurance about council governance and transparency.63

24.The Department has commissioned Sir Tony Redmond to carry out an independent review of the operation of external audit arrangements, including the implications for audit of the growth in commercial investment activity. The Department will consider whether the external audit framework could deliver more specific assurance in relation to compliance with the prudential framework once that review has been received.64 The Department told us that their aim is for the Redmond review to be completed in September 2020.65 The Centre for Public Scrutiny argued against creating a situation where external bodies “begin to second-guess the decision-making of councils” as this could lead to diffuse, less effective accountability; instead the Centre recommended bolstering local governance.66 External audit reforms are not the only game in town. This Committee previously recommended taking concrete actions to improve local governance and accountability more widely.67 The Department will consider strengthening local authority audit committees and CIPFA has suggested further specific options such as ensuring that the statutory chief financial officer role is held by a suitably senior officer.68

Problems with local governance

25.The Department has said that transparency is important.69 Good governance in local authorities is critically important given the pressure local authorities are under.70 The previous Committee commented on weak arrangements for the management of risk in local authorities’ commercial investments in May 2019.71 Shortfalls in transparency are not confined to local authorities: we recently concluded that commercial sensitivity was not an adequate excuse for a lack of transparency by civil servants about the risks to the High Speed 2 programme.72

26.There is clear evidence about governance problems relating to local authority commercial investments. Based on its recent research, the Centre for Public Scrutiny reported that “In some councils member governance has not caught up with commercial activity”; the need for culture change is the greatest challenge to effective and safe commercial activity.73 CIPFA’s Chief Executive expressed some concerns about Chief Financial Officers (Section 151 Officers) at a minority of councils feeling inhibited about speaking truth to power. He stressed it is important that the Section 151 Officer is a senior director and therefore can give proper but unwelcome advice about financial strategies dependent on commercial income. Alternatively the Section 151 Officer may fear that, if they give such advice, they may see their roles demoted.74 External auditors have expressed a range of concerns, including insufficient reporting to members, limited internal challenge to decisions, over-reliance on external expertise, and limited capacity and skills.75 Current practices can cause concern locally: we received a striking range of written evidence alleging apparent problems with governance or transparency of commercial investments. For example: decision-making by very small sub-sets of the ruling group; cabinet papers or other information supporting purchase decisions that contain limited analysis or are kept confidential well after the purchase has completed; poorly formulated objectives for purchases; not allowing potential purchases to be called in for scrutiny; and placing reliance on advisors with an apparent risk of a conflict of interest.76

27.The Department told us it had strengthened the prudential framework to support transparency by requiring publication of capital and investment strategies that should include details of the significant investments that authorities are making.77 However, the Department’s Post Implementation Review found that there is still significant progress to be made in terms of transparency and that good practice is not currently wide ranging.78 The National Audit Office also found examples of information missing from strategies, including risk indicators and the scale of contingency arrangements.79 The Department’s Review also found examples of policies where deviations from statutory guidance were not presented transparently to members.80

54 C&AG’s Report para 4.13

55 HC Committee of Public Accounts, Financial sustainability of local authorities, Twenty-Sixth Report of Session 2016–17, HC 708, 18 November 2016, recommendation 5, page 7

56 C&AG’s Report, paras 4.4–4.6, 4.14

57 Qq 137, 143; C&AG’s Report, p67

58 Qq 109, 137

59 Q 113

60 C&AG’s Report, Figure 1, para 3.35; Department’s Post Implementation Review, para 5.12

61 Local Government Association, PSAA Quality of Audit Service feedback survey, December 2019, pages 2 and 35–37

62 The Department’s Post Implementation Review, paras 5.11–5.13; C&AG’s report, para 4.13

63 Qq 133–135; Department’s Post Implementation Review, para 19

64 Ministry of Housing, Communities & Local Government, Review of local authority financial reporting and external audit: terms of reference, 10 July 2019; the Department’s Post Implementation Review, paras 26 and 2.13

65 Q 142

66 LAI0011

67 HC Committee of Public Accounts, Local Government Governance and Accountability, Ninety-Seventh Report of Session 2017–19, HC 2077, 15 May 2019

68 Q 35; LAI0011; the Department’s Post Implementation Review, para 26

69 Q 110. See also HC Committee of Public Accounts, Local Government Governance and Accountability, Ninety-Seventh Report of Session 2017–19, HC 2077, 15 May 2019, para 16.

70 HC Committee of Public Accounts, Local Government Governance and Accountability, Ninety-Seventh Report of Session 2017–19, HC 2077, 15 May 2019, p. 3.

71 HC Committee of Public Accounts, Local Government Governance and Accountability, Ninety-Seventh Report of Session 2017–19, HC 2077, 15 May 2019

72 HC Committee of Public Accounts, High Speed 2: Spring 2020 update, Third Report of Session 2019–21, HC 84, 17 May 2020

73 LAI0011

74 Qq 33–34

75 C&AG’s Report, para 3.33

76 LAI0010, LAI0012, LAI0015, LAI0016, LAI0024, LAI0025, LAI0034, LAI0035

77 Q 110; C&AG’s Report, Figure 21

78 The Department’s Post Implementation Review, paras 1.10, 1.12

79 C&AG’s Report, para 4.28

80 The Department’s Post Implementation Review, para 3.25

Published: 13 July 2020