The majority party at our council is also mooting – a move into the commercial property market.
“Forthcoming CIPFA guidance on councils borrowing to invest in commercial property could clarify the definitions of “borrowing in advance of need” and “proportionality”, according to the man drawing it up.
Last month, CIPFA announced it would produce more guidance to address the failure of the government’s revised investment code to curb some instances of councils borrowing to invest in commercial property.
Speaking at the CIPFA Treasury Management and Capital Conference in London this week, Don Peebles, the institute’s head of UK policy & technical, gave more clues as to what the guidance could contain.
Speaking to delegates, he said: “It may well be that we actually specify and think about what exactly is ‘borrowing in advance of need’.
“We may set parameters of what proportionality looks like. We may give guidance on what the appropriate ratios are for commercial income associated with net service expenditure.”
When the guidance was announced last month, Peebles told Room151 that it would be likely to formally incorporate text from the commentary which was released alongside the Ministry of Housing, Communities and Local Government’s (MHCLG’s) revised investment code, which was adopted earlier this year.
On proportionality, that commentary says that each council should set its own “limits that cannot be exceeded for gross debt compared to net service expenditure, and for commercial income as a percentage of net service expenditure”.
However, Peebles’ comments were a hint that the guidance could go further by providing indications on what the appropriate ratios are.
Also speaking at the event, Duncan Whitfield, director of finance and corporate services at London Borough of Southwark, said that any definition of proportionality must take into account the needs of local authorities to properly finance services.
He said: “I am looking at my budget now and seeing how much of it is ring-fenced for social care.
“So are we talking about a proportion of our ring-fenced money in our revenue account or is it the total budget? In different parts of the country that varies wildly…”
And Richard Paver, treasurer of the Greater Manchester Combined Authority and chair of the CIPFA treasury and capital management panel, warned that the guidance should not reverse freedoms introduced under the prudential code introduced in 2004.
He said: “I can tell you it was a complete pain in the neck to run anything in the old days when you had annual limits on your capital spend, you could only spend a proportion of your capital receipts generated in any one year. You had to pool your capital receipts and pass them back. We need to remember where we are and protect that. The CIPFA guidance needs to give us the tools to do that.”
During a separate session of the conference, Peebles acknowledged the point, saying: “I am conscious that the guidance [should be] within the flexible framework we have all enjoyed and any steps to minimise that flexibility starts to take away from the 15 years of success of the prudential framework and operation of the prudential code.
“But in the current climate it seems additional guidance is certainly needed.”
Also speaking at the conference, Martin Easton, head of capital and treasury at Birmingham City Council, said that the term “borrowing in advance of need” was “unhelpful” and should be scrapped.
He said: “It originated years ago in the treasury management code in addressing treasury management investment activity which is about managing the cash flows of the authority. In that, there will be some times when the yield curve is such that you can borrow cheaply for a few years or in advance of your need for treasury purposes, and it was possible to reinvest it short term until it was needed for meeting the cash flow needs of the authority.”
He went on to say: “That expression doesn’t really work when you are investing in a community organisation, let’s say, to deliver social or service outcomes, or even when you are making an explicit decision to invest in commercial property.
“I think you could drop the ‘in advance of need’ from that phrase – the key issue is: is it right or appropriate for your authority or ever for a local authority to borrow purely or mainly to make a financial gain? Is that really the role of local authorities?”
Easton also warned that the current increase in borrowing cheaply to invest in commercial property was another “craze” sweeping the sector, and compared it to investment in Icelandic banks, LOBOs and interest rate swaps.
He said: “What fundamentally might be a sound idea – like a limited proportion of your book could be in LOBOs because it manages risk in a different way and produces a good revenue result, or managing treasury risk through interest rate swaps – is good but doing it excessively is not.
“These things get overdone. They overtake the sector and then a wheel inevitably comes off at some local authority that has gone too far… And I fear that we are in the grip of another one of those crazes, which is called commercial property at the moment.”
Giving a private sector perspective, Howard Meaney, head of real estate UK at UBS Asset Management, said that the real estate market was “quite disparaging about some of the transactions [by local authorities] that have been undertaken recently.”
He said: “I think what the market is generally seeing is local authorities are almost, in some situations, a buyer of last resort.
“They are setting new market levels with some of the transactions and they are buying assets in what to a degree is a buy and hope – hope that tenant stays in your property and continues to pay your money and your rent so you can arbitrage that to increase your revenue and pay your coupon on your debt.”
Councils need to be prepared to invest in their commercial property assets in future in order to maintain rent levels, Meaney warned.
He asked: “Looking down the line, will local authorities have that money to invest into a property to continue to receive the revenue?”