73.The current local audit regime was established by the Local Audit and Accountability Act 2014. The Act abolished the Audit Commission and replaced it with a regime that permitted local authorities to procure their own private audit services locally. The Government believed the commission had become overly bureaucratic and expensive.
74.In June 2019, following criticisms of the operation of the new regime, including from the PAC, and delays to the completion of 200 of the 487 local public body accounts in 2018–19, MHCLG commissioned Sir Tony Redmond to undertake an independent review of the effectiveness of local audit and the transparency of local authority financial reporting. Redmond, whose final report was published on 8 September 2020, found that the local audit market was “very fragile”. In particular, he found that oversight of local audit was fragmented as “none of the six entities with responsibility for the different elements of the framework has a statutory responsibility, either to act as a system leader or to make sure that the framework operates in a joined-up and coherent manner.” To remedy this, he recommended the creation of “a new regulatory body responsible for procurement, contract management, regulation, and oversight of local audit.” He also proposed that this new “system leader” produce annual reports on the state of local audit, with a view to joining up audit findings and identifying trends and problems across local government. In its response, the Government said it was “not currently persuaded that a new arms-length body is required”.
75.In March 2021, following completion of the evidence-gathering stage of our inquiry, the NAO published its report, Timeliness of local auditor reporting on local government in England, 2020, in which it outlined the persistence of serious weaknesses in the local audit regime. In particular, it raised concerns about the late delivery of many audit opinions and the consequent impact on financial planning and about the lack of qualified local authority auditors.
76.These findings were supported by the evidence we had already taken for our inquiry. Richard Watts from the LGA, describing the audit market as “beyond fragile” and “broken”, said the “elephant in the room” was that “there are simply not enough auditors”. Rob Whiteman , CEO of CIPFA, and Sarah Ironmonger, director of audit at Grant Thornton, agreed there was a skills shortage. The latter thought it was “fair to say that the pool of people with the experience and skills to do local government audit is fairly limited”. Researchers from Nottingham Business School, describing the audit regime as “no longer fit for purpose”, said that “understanding about local authority performance and value for money” had “significantly deteriorated” since the abolition of the Audit Commission. Rob Whiteman, whilst not wishing to see the commission restored entirely, thought that in abolishing it the Government had “thrown the baby out with the bathwater”, particularly the role of an independent local auditor. He added that “public bodies should not appoint their own auditors.” In contrast, Richard Watts from the LGA told us local government did not “mourn the loss of the Audit Commission”, which was “very expensive and bureaucratic” and “had overstepped its reach”.
77.Croydon Council told us that the Audit Commission, though not perfect, had performed an important function that was now missing from local audit. Chris Buss, the interim Chief Finance Officer, whilst “not suggesting that we recreate the Audit Commission as it finished up”, said it had at first served a useful purpose in providing an “overview” and “guidance to auditors”. Katherine Kerswell, interim CEO, added:
As a young chief executive, I knew that if I got a phone call from the chief executive of what was then the Audit Commission you sat up straight and you took that call. It mattered. Their oversight and view really mattered. All of that is lost to us now. We do not want what we had back, but we need something. We have a vacuum at the moment, and it is really dangerous for us as a sector.
78.The Minister agreed that “a robust local audit system and transparent financial reporting” was “absolutely key for delivering value for money for taxpayers and supporting sound investment”. On the question of a new regulator, however, he said the Government was “looking at the full range of options that might be available to ensure long-term stability of the audit market” but that it did “not want an overcentralised, overly bureaucratic system” and wanted “to explore potential alternatives that may not require a slot for primary legislation and that potentially do not necessitate a new body”.
79.In March 2021 the Government published a White Paper setting out its plans to reform corporate audit, reporting and governance. The White Paper set out details of how the Government proposed to establish a new regulator, the Audit, Reporting and Governance Authority (ARGA), to replace the Financial Reporting Council (FRC). In May 2021, shortly before the publication of our report, the Department announced its proposals for establishing a local authority audit system leader. It agreed that “a clearly accountable system leader with overarching responsibility is needed to make sure the local audit framework operates in a coherent and joined up manner” but said it still did “not believe the creation of a new arm’s length body is needed to achieve this.” Instead, it said it would establish a standalone unit within ARGA to oversee local audit, including the Code of Local Audit Practice, which is currently the responsibility of the NAO. Responsibility for contract and procurement management would remain with PSAA (Public Sector Audit Appointments), however, as the Government believes that combining the regulatory and procurement functions could result in a conflict of interest. In recent evidence to the PAC, the Department also accepted the recommendation in the Redmond Review that the system leader produce annual reports on the state of audit across local government and said it wanted to build this into the new system.
80.As highlighted in Sir Tony Redmond’s independent review of local authority audit, the local audit market is deeply flawed. We are particularly concerned about the shortage of specialist local auditors, about the principle of allowing local councils to choose their own auditor and about the lack of a co-ordinating body responsible for monitoring the performance of auditors and joining up auditor findings across the country. We are pleased the Government has now announced its plans for instituting a new audit system leader, and we can see the argument for separating regulation and procurement. We are also pleased that the Department has accepted the recommendation in the Redmond Review that the new system leader produce annual reports on the state of local audit, although it is not clear to what extent it will be able to join up individual auditor findings with a view to identifying systemic issues across local government. We also note that the new Audit, Reporting and Governance Authority, in which the standalone unit will sit, is being set up primarily to audit the private sector. Given that local authority audit is different from private sector audit, in that it must consider such additional matters as public interest and value for money, it remains to be seen if a standalone unit within ARGA can provide the necessary specialism that local authority audit requires. We have concerns that the Government has not established a regulator along the lines suggested in Sir Tony Redmond’s independent review, rather than as a standalone unit within another regulator.
81.We recommend the Government remove the ability of local authorities to choose their own auditors. The risk is that auditors will be reluctant to flag up potential problems for fear of losing their contract. The Government should consider who will be best placed to appoint local authority auditors, given that it should not be local authorities themselves, and ARGA doing so could lead to a conflict of interest. We also ask the Government to confirm that the new system leader will be able to join up individual auditor findings with a view to identifying systemic issues across local government. Without a central body responsible for oversight of the sector, we see no way of ensuring a robust and transparent regime of local audit.
82.As already noted, under section 114 of the Local Government Finance Act 1988, a Chief Finance Officer is required to make a report, known as a section 114 notice, if it appears to them that the expenditure of the authority in a financial year is “likely to exceed the resources (including sums borrowed) available to it to meet that expenditure.” Once a council has issued a notice, spending on all but essential services must immediately cease. It is a statement that a council is in deep financial distress and requires assistance from central government. In the last few years, three councils have issued section 114 notices: Northamptonshire in 2018, Croydon in 2020 and Slough in July 2021, shortly before publication of our report. Before that, Hackney, in 2000, was the last council to issue a section 114 notice.
83.A section 114 notice is not itself a cause of financial instability but rather a “late distress signal” and “an outward and public manifestation” of longstanding financial weakness. That said, the consequences of issuing a notice can be extremely serious for a council. Richard Watts said it was “a very difficult step for a council to take” and that the “consequences and ramifications of that are very bad.” He pointed out that Northamptonshire had been scrapped as a single council. According to Watts, the message this sent—that section 114 notices were “best avoided at all costs”—has ensured “very significant engagement by local authorities under real financial pressure to effectively take the kinds of measures you would undertake in a section 114 process, but without formal issuing of the notice.” He said that notices were “rare” and that this was evidence that the regime was “broadly” effective.
84.We were told, however, that fear of issuing a notice should not prevent councils from issuing one sooner rather than later. Rob Whiteman from CIPFA told us that, whilst everyone wanted to avoid notices, “if they cannot be avoided, they should be served as quickly as possible” and that, if they are served quickly, it should be viewed not “as a failure”, but as “a council taking control of what it wants to do.” He highlighted the cases of Camden and Hackney, both of which were able to turn themselves around because they issued notices in time. Conversely, the best value inspection report on Northamptonshire Council had “wondered whether, had the notice been served two years earlier, Northants might have avoided going down the road it did.”
85.Speaking about Croydon Council’s recent experience, Hamida Ali, the council leader, told us that issuing a section 114 notice had been “a really important step in taking back control of a financial position that had become unsustainable.” She called it “a very important moment, because it was a signal of our recognition of the situation” and “extremely necessary at the point at which it was issued.” She expressed concern, however, about the lack of clarity around the process arising from its rarity. In particular, the council had been unclear on whether it needed to issue a second notice after 21 days. In the end, it did, although, as Rob Whiteman explained, it is not necessary for a council to issue more than one in the same financial year.
86.Crucially, the representatives of Croydon Council also thought the council should have issued a notice sooner. Katherine Kerswell, the council’s interim Chief Executive, said that “having issued the notice much earlier in the year would have given the council” much more time to control the expenditure in-year and reduced the need for Government support. Hamida Ali, who was a cabinet member at the time, effectively agreed when she said it was “a legitimate question” whether the council had acted soon enough. As Katherine Kerswell also noted, the best value report into Northamptonshire had suggested that that council should also have acted earlier. She partly blamed the regime itself for making it difficult for councils to take the necessary steps and questioned whether it was still fit for purpose:
It was designed in quite a different time, and there were other mechanisms that sat alongside it to give councils, and particularly the statutory officers, the ability to ensure that councils stayed within financial balance. The world has really moved on, and it is too blunt an instrument now.
87.Chris Buss, the interim Chief Finance Officer, agreed that the regime was out of date, describing it as “an instrument of its time” and explaining that when it was first introduced, in 1988, there had been “lots of other protections around for local government”, including “specific capital controls”, “an organisation that was responsible for looking after local authority audit”, “a surcharge for councillors if they misbehaved themselves in terms of overspending” and the “protection for statutory officers”. With the exception of some “limited protections for statutory officers”, those protections have been “wiped away”, leaving local government with “a very blunt instrument”. He concluded with a helpful analogy:
I would probably describe it in footballing terms. If you are a referee, you go straight to a red card with a 114. There needs to be some form of yellow card, a warning mechanism. There is not. You go literally straight to the red card and there is no intermediate step, because there is no other control around. It needs to be looked at.
88.Katherine Kerswell then provided a compelling explanation for why the decision to issue a notice is so difficult:
Because it is so rare and because it is that red card moment, as a governance mechanism and a warning mechanism, it is really very absolute. Everything stops; all the expenditure stops. As the leader said, our staff were worried about their pensions and their pay. It was an enormous wash-over. It was not an easy mechanism to use to enable us to manage our budgets very, very effectively. There needs to be something different. People are incredibly anxious, as chief officers, thinking, “Should we move a section 114 notice?” I was interim chief executive at Nottingham City Council during last summer, and there was lots of discussion about whether this was necessary and whether it was a possibility for the council. There was real anxiety about going there, because of what it represented to the residents and to staff. We really need something better to enable us, as chief officers, to flag the warnings that need to be flagged and control expenditure in a much better way than we can at the moment when things get as tough as this.
89.The absence of section 114 notices before 2018 is adduced as evidence that the regime has been broadly successful. The consequences for a council of issuing a notice are serious, however, and we are concerned that, rather than concentrating minds, the regime might be hindering good financial management, as it lacks intermediary measures that councils can use to flag up concerns. Croydon Council delayed issuing a notice for fear of the negative publicity and the statement it would make about its financial position. Northamptonshire Council also delayed. We believe that an intermediary “yellow card” measure that could be applied by the Chief Finance Officer might have forced these councils to confront much earlier the seriousness of the problems facing them.
90.We recommend that the Government consider changing the section 114 regime to provide Chief Finance Officers with intermediary measures that can be applied at a much earlier stage to highlight concerns before a council’s finances deteriorate so far as to require a section 114 notice. We also recommend that Chief Finance Officers report to both the Executive and appropriate scrutiny committees on a quarterly basis on the state of local authority finances and, in particular, draw attention to potential serious financial problems.
145 Departmental press release, , (March 2014)
146 Public Accounts Committee, Eighty-Fifty Report of Session 2017–19, , (15 March 2019)
147 , (September 2020), p. 10
148 , p. 3
149 , p. 5
150 MHCLG, , para 68
151 National Audit Office, , (March 2021), pp. 6–7
154 Professor Peter Murphy (Professor of Public Policy and Management at Nottingham Business School); Dr Peter Eckersley (Senior Research Fellow at Nottingham Business School); Katarzyna Lakoma (Research Associate at Nottingham Business School); Bernard Kofi Dom (Associate Lecturer at Nottingham Business School) ()
159 MHCLG, , (March 2021)
160 , (19 May 2021)
162 Oral evidence taken before the Public Accounts Committee on 20 May 2021, HC (2021–22) 1292, [Catherine Frances]
164 Professor Peter Murphy (Professor of Public Policy and Management at Nottingham Business School); Dr Peter Eckersley (Senior Research Fellow at Nottingham Business School); Katarzyna Lakoma (Research Associate at Nottingham Business School); Bernard Kofi Dom (Associate Lecturer at Nottingham Business School) ()
165 Special Interest Group of Municipal Authorities ()