Issues

Follow the money – financing the future of local government services

Keyboard_01It’s certainly not the best of times and it’s probably not the worst, but times are tough in city halls and council offices across the UK.

Financial tensions are testing service delivery and the relationship between central government, local government and its rate-paying stakeholders.

And, with nine out of ten local authority chief executives forecasting that some local authorities will get into serious financial difficulties inside the next five years, the outlook for local authority finances is challenging, to say the least.

It’s fair to say that the pressures on local government in Northern Ireland have been less severe than on their counterparts in GB, where some have experienced up to a 50 per cent reduction in funding over recent times. In addition, the pressures appear to have been greater on revenue than on capital spending.

Prolonged austerity and more recently the push for financial devolution and responsibility to the regions and away from Westminster are both driving an important shift in local government. Back in 2011, our first PwC report into local authority financing, The Local State We’re In, characterised the early years of austerity as authorities taking action to reduce costs through a range of traditional ‘supply side’ cost reduction measures. Even then, only 37 per cent of chief executives were confident that they could maintain service delivery standards over the following 12 months.

In 2016, things are looking up – at least in the short-term – with our latest The Local State We’re In report reflecting 65 per cent of chief executives as confident around short-term service delivery. However, the medium-term outlook remains bleak. Chief executives in local authorities across the UK – including in Northern Ireland – foresee some local authorities facing serious financial crises inside five years (87 per cent); unable to deliver essential services (77 per cent); and only 13 per cent believe their own council can make necessary financial savings over the next five years without seriously impacting service delivery.

Equally worrying, ratepayers and council taxpayers agree. In a poll included in our 2016 The Local State We’re In report, virtually every service, from road repairs, street cleaning and refuse collection to playgrounds, parks and recycling services, the public said the services in their particular council area had deteriorated compared to service provision in 2011.

Given that austerity in public finances will last beyond 2020 and the traditional local authority funding model moves ever faster away from a central grant based system to one of increased self-reliance under devolution, local government needs to raise its sights and shift beyond traditional cost reduction approaches.

It’s clear from The Local State We’re In that authorities are already reaching a tipping point where it is no longer possible to undertake even the same activities as before. That means local councils now have to fundamentally redefine their role and purpose, where local public services need to be viewed in a much more holistic way, with a focus on how multiple organisations, and citizens themselves, can contribute to securing desired outcomes.

So, while doing nothing is not an option, this new landscape will require fundamentally different organisational cultures, behaviours and skills to make it successful, along with an intense focus on delivering local economic growth, digital innovation and intelligent and insightful data collection and management.

In this new normal of austerity, the role of local authorities will be redefined to facilitate outcomes, but not necessarily deliver them. That means building partnerships with citizens, public, private and third-sector stakeholders and where required, adopting commercial structures and funding sources not historically utilised by local councils. While that can create structures and funding models sufficiently nimble and flexible to help alleviate chief executives’ medium-term fears, it presents fresh challenges surrounding the understanding of risk and the creation of robust models of governance. Such a shift in the local authority funding dynamic and the requirement to look to new ways of delivering outcomes means councils across the UK will move firmly into the ‘risk business’.

But, the local council use of alternative commercial models or funding sources requires a robust approach to understanding and managing risk and an appropriate governance structure and that infers some key issues.

Turning to real structures and funding options, the establishment of wholly owned special purpose vehicle (SPVs) or trading companies to deliver on local needs can offer opportunities to create long-term council revenue streams and depending on the nature of the project, an appreciating asset. We are working with local authorities across the UK on the establishment and structuring of council owned trading companies, funded by a mix of debt and equity raised through the Public Works Loan Board (PWLB), with the objective of undertaking activities to deliver against defined economic needs. These include the development of infrastructure and housing, energy generation and trading, commercial and leisure use assets.

A second, albeit more complex, approach to alleviating financial pressures and delivering against local economic needs is through the use of joint ventures (JV). Often used in GB for development, regeneration or asset management led projects, JVs tend to be 50:50, with the partner providing a mix of private sector debt and equity finance and the local authority contributing cash and, in many cases, property or land assets for development. Potentially one of the more attractive ways of generating new revenues without incurring excessive levels of risk is to put non-core, potential development property into JVs with private sector partners, where there is the likelihood of getting future planning approvals.

It is also worth noting that there is an increasing appetite amongst investors (like pension funds) and institutions, for investments that can deliver long-terms annuity returns and there are already several GB models where councils are delivering or refinancing their own projects, by selling stakes in SPVs or JVs at investment yields. These are particularly applicable in housing and commercial developments but could be equally credible in other index-linked, revenue-generating sectors. However, attractive as these schemes may be, investors will typically seek to back off key, long-term project risks to the Council in most cases.

Whilst the two broad structures outlined above present local authorities opportunities to deliver on local needs and to potentially share in the ‘upside’ of local growth and financial returns, this is not without risk. Fundamental to exploring the creation of any trading company, JV or similar structure is an understanding firstly of the local authorities objectives in doing so, but also firmly defining its own appetite for financial risk and then ensuring the structures ultimately put in place align with that risk appetite. The structures outlined above also require a robust approach to project management, governance and long-term stewardship to protect the taxpayers’ investment.

A number of councils have looked further afield for finance, specifically to the EU for funding for strategic projects. Only the EU could call it JESSICA, but the Joint European Support for Sustainable Investment in City Areas, was developed in co-operation with the European Investment Bank (EIB) and the Council of Europe Development Bank (CEB) to support sustainable urban development and regeneration.

Through Peace IV, the EU can also support social infrastructure investments aimed at reducing segregation, while ERDF/ESF can be brought to bear (via SFP) on transport, education, innovation and research, low carbon energy and a number of other areas. Closer to home, the Northern Ireland Investment Fund is looking to support urban regeneration, particularly around the development of commercial/ office property that will encourage foreign direct investment (FDI).

The notion of accepting and managing risk – rather than shifting it – will not sit easily with many councils, neither will the need to focus on improving governance and avoiding conflicts of interest. But the chief executives in 2016 The Local State We’re In report are adamant – austerity will continue, the ability to make further short-term savings is virtually gone and the medium-term points towards significantly reducing service provision and potential financial crises across local government. If they are right, councils will have to embrace new structures and funding methods as doing nothing will not be an option.

Glynn Johnston

Tel: 028 9041 5219

Email: glynn.johnston@uk.pwc.com

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