Revision to the Prudential Code – A method of Capital Control? Mark Swallow

It is nearly 17 years since the Prudential Code was introduced and last week CIPFA published consultation on its latest proposed changes (Prudential Code Consultation | CIPFA) which would see the sixth amendment since the introduction of the Code back in 2004 (2009,2011,2012,2017 and 2019 saw previous changes).

Those of you with long memories will remember the pre-prudential system of controls on borrowing that were governed by the credit ceiling and various credit approvals that were issued by Central Government but controls on borrowing go back even further than the 1980’s.  

Between the mid-nineteenth century and 1972, local authorities needed a sanction to use a loan to fund a capital scheme, firstly giving approval for the project itself and secondly authorising the use of a loan.

Some major changes in legislation took place during the 20th Century namely:

  • 1933 Local Government Act consolidated the legislation of the previous 50 years. Set out the type of expenditure which could be financed by borrowing (effectively anything a Minister considered “proper”) and detailed types of borrowing open to local authorities.
  • 1972 The Local Government Act consolidated all previous legislation into one act and loan sanctions were replaced by borrowing approvals.
  • 1980 Local Government, Planning and Land Act provided a definition of capital expenditure and controlled this through annual capital expenditure allocations. Limits on capital expenditure were set partly by reference to a prescribed proportion of an authority’s capital receipts.
  • 1989 Local Government and Housing Act the main effect was to control capital expenditure funded by borrowing through the issue of credit approvals. The spending of capital receipts was regulated by the requirement for authorities to set aside part of their receipts as provision for credit liabilities.
  • 2003 The Local Government Act put in place the broad legislative framework for the prudential regime for borrowing by local authorities and the introduction of the Prudential Code.

From the 1st  April 2004 local authorities under the new Act and the CIPFA Prudential Code were free to fund capital spending from self-financed borrowing without the need to have government approval if it was considered affordable, prudent and sustainable to do so.

In its most recent consultation CIPFA is proposing to strengthen the provisions within the code by:

  • Further strengthen provisions of the Prudential Code to state clearly, that borrowing for debt-for-yield investment is not permissible under the Prudential Code.
  • Any commercial investment undertaken should be consistent with statutory provisions, proportionate to service and revenue budgets and consistent with effective treasury management practice.
  • Further strengthening the requirements to assess the affordability of commercial activity within local authorities’ capital strategies. CIPFA will also publish, early this year, further guidance on good practice for development of capital strategies.
  • The addition of sustainability and ensuring that the capital expenditure is consistent with a local authority’s corporate objectives (such as diversity and innovation) to the objectives in the Prudential Code.
  • Introduction of new prudential indicators on affordability. External debt to net service expenditure (NSE) ratio, and commercial income to net service expenditure.
  • The introduction of the Liability Benchmark to promote good practice and understanding of local authority’s debt management in relation to capital investment.

Whilst these proposals will see changes to the Code of Practice which local authorities follow when making capital expenditure and borrowing decisions the tone of the first bullet point above, combined with recent changes in PWLB lending criteria, would suggest that a return to controls on borrowing are back on the political agenda and if local authorities do not comply with what is effectively a method of self-governance then a legislative framework may be used as it was before 2004.