Broke Woking
Reports of interest to governance practitioners are coming out in waves. Paul Feild looks at some lessons from the latest, covering Woking Borough Council.
Recently we saw a report on Woking Borough Council, which was described as ‘Thurrock on Speed’[1].
The Woking Report
The background being, in January 2023 the Department of Levelling Up, Housing and Communities commissioned an External Assurance Review Team (the Team) to examine Woking Borough Council’s Governance, Finance and Commercial Issues, following the Secretary of State’s concerns about his contact with the council.
The Team’s Report published in May 2023 is titled “Governance, Financial and Commercial Review of Woking Borough Council”. The review was carried out by Jim Taylor, Carol Culley OBE and Mervyn Greer. Their fieldwork took place over spring 2023. The Secretary of State asked the Review Team to provide an external assessment of the council’s capacity and capability to manage governance, finance, and commercial issues in the immediate and longer-term. The picture that emerged was that the council was in difficulties within their commercial and finance arrangements.
Woking Borough Council is said to be the most debt-laden local authority relative to its size in the UK, with borrowing of £1.9 billion that on current trends is predicted to be even 25% higher in the mid 2020’s. The substantial proportion of the debt is due to the funding of two commercial schemes in the council’s portfolio being the company Victoria Square Woking Limited (VSWL) in the town centre, and the regeneration of Sheerwater housing stock and public realm facilities, through the ThamesWey Group. Unfortunately for Woking the net value of these assets is significantly less than the outstanding debt.
After receiving the report and reflecting upon the Secretary of State’s engagement with Woking Council, on 25 May he determined that Commissioners should be appointed under his power in the Local Government Act 1999. Unusually he appointed the Review team to the role.
The Teams terms of reference were to examine:
- financial governance and decision making, commercial decision making and management of commercial projects, regeneration and property;
- to make changes as a result of these failures – functions associated with the Council’s operating model and service redesign to achieve value for money and financial sustainability; and
- to ensure the Council has the right skills and structures to make ongoing improvements across the entire organisation – governance and scrutiny of strategic decisions; and the appointment, dismissal and performance management for senior and statutory officer positions.
One is struck by the language used which is orthodox theory management theory rooted in the basics of asking do you have the competency, capability, and capacity to execute the organisation’s requirements to carry out its obligations?
Do note the similarity with Robin Hood Energy Ltd (RHE). In RHE Nottingham City Council tried to establish a not-for-profit power company to provide value in terms of energy costs to tackle fuel poverty. It went terribly wrong losing the council a reported £34.4m. The Report in the Public Interest under section 24 and Schedule 7 of the Local Audit and Accountability Act 2014 on RHE by Grant Thornton was published 2020. Interestingly one of the flaws of RHE was the absence of a shareholder’s agreement. An obvious omission, yet the Team tell us it was not till July 2022 it was introduced for Woking. Why did no one look at Robin Hood[2]?
This is the key challenge, in that the officer cadre will likely not have the experience to fully grasp the risks of operating in a commercial environment, nor be able to identify earlier enough when things are not right.
The Team observed:
"Despite recent best efforts of the new leadership team, the council does not have the commercial skills or capacity to identify the longer-term strategy to resolve its commercial arrangements. From the historic base, the sheer scale and complexity of the investment and commercial activity of the council, means that the council will never have the capacity to effectively manage all the commercial and economic considerations which would only be enacted properly by expert investors" Review P.6
A key point is the lure of a margin to be made on borrowing:
"the council embarked on an ambitious regeneration programme, funded by money borrowed from Public Works Loan Board at lower than commercial interest rates. This was used to fund a number of commercial properties within the borough and, more significantly, to support the regeneration of the Town Centre via a joint venture and through its wholly owned Thameswey group of companies for sustainable energy and housing, most notably, the plans for the regeneration of Sheerwater. The council then loaned money to the joint venture and the companies to develop the schemes. The council received a margin on some of these loan transactions. This margin, along with the rental income from the commercial priorities, contributed to the council’s budget to fund services. This process was used by the council to generate funds for its regeneration schemes over several years. The council is effectively self-funding the borrowing costs through additional borrowing, which is deferring risk." Review p.9
So, the principle is a local authority borrows from the PWLB which offers a lower interest because it is to the public sector which ought to be a lessor risk. If the local authority, then passing that loan onto their development company at the same rate (with an administration mark-up) it would create the all too real risk of ‘State Aid’, so the loan is set at a commercial rate. The problem with this arrangement is authorities can get hooked on enjoying the margin between the PWLB and their follow-on loan, it encourages borrowing. The painful truth is that it was just too easy to borrow and discount the risk of default and a potential devaluation of the collateral i.e. the underlying assets of the companies. In fact, the Review tells us: “With VSWL the current value of the assets has been estimated to be £300m to £350m against the outstanding debt of c£700m.”. That means a loss (not debt) on the books of at least £350m.
The Report observes:
"It is difficult to conclude the council has complied with accounting best practice and the prudential framework. The scale of borrowing was disproportionate to the council’s assets and ability to manage complex commercial activity. There was insufficient regard to the level of risk the council was being exposed to, particularly as the borrowing for VSWL and Thameswey Development covered development costs and the working capital to repay the loans for the majority of the financing period. The decisions to invest were made in line with the constitution, assessed against the Prudential Framework, the 2018/19 and earlier accounts had unqualified VfM opinions.
… Given the scale of the borrowing and the fact that future risks of refinancing were not considered it cannot be argued that the approach was prudent." Report P.23
The PWLB has tightened up their loan regime, and with CIPFA’s revised Prudential Code, it probably cannot happen now.
But that is of little solace to Woking council taxpayers who will in due course feel the impact of the perhaps inevitable section 114 Local Government Finance Act 1988 Notice and consequential cuts in services and likely extra hike in Council tax as happened in Thurrock and Croydon.
The challenge for local authorities when they act as lenders is it that they can be just too relaxed about risk. This is because it is lending to its own company and all the accountability of shareholders agreements and scrutiny functions will be balanced on the scales against politics and reputational management. The Review says:
"This has created an extremely high debt profile which is not backed by assets in any way matching that debt. Some companies are making operational losses but still extending their borrowing to cover principal and interest repayment costs." Review P.9
So why do companies making a loss continue to function? Because they have the backing of the council. It means that companies which will never make a return are allowed to continue when there is no realistic foreseeable reversal of fortune. Inevitably if there is a social purpose to a company such as not-for-profit then the need for the collateral social responsibility benefits can be used to excuse the long-term loss-maker that the company is. In RHE Grant Thornton observed:
"Overall, the governance arrangements were overshadowed by the Council’s determination that the Company should be a success, and this led to institutional blindness within the Council as whole to the escalating risks involved" Report in the Public Interest RHE Ltd Grant Thornton P.3
Sound familiar? Well, it is the similarity with Croydon’s Corporate Collective Blindness[3] that’s why. Here is where the competency and capability of the officer cadre matters. They need to be commercially literate, understand the principles of running a limited company, and have actual hands-on experience. But it is quite unrealistic to expect a local authority Chief Executive or a Monitoring Officer to really understand the structures and risks that these regeneration schemes carry with. These are full time jobs in themselves. As a result, much of the burden will lie on the Chief Finance Officer’s shoulders. Furthermore, as an onlooker I do think that the finance profession is making the effort to tackle these issues.
However, as I have recently pointed out in Local Government Lawyer, the powerful ally to the CFO namely the Local Auditor system, which can bring some objectivity, has effectively collapsed[4]. I know of councils who are literally at least three financial years of Audit behind.
What needs to happen is to have effective independent non-executive directors. That will not do in itself because the director’s duty is to the company. They could become conflicted. So there needs also to be a right for a shareholder’s representative to have full attendance at board meetings and access to all documentation with a direct reporting line to the Chief Officers Management Team.
The implication of Woking is to get the calibre of leadership will require a completely different set of competencies and capabilities. I doubt that without a stratospherically renumeration hike the people are readily available and certainly not for every local authority that needs it. A better solution is to procure specialist investment management advisors, as is the practice in pensions for example.
Last week the new leader of Woking criticised the PWLB for lending Woking the money in the first place. She is right, but the previous political and officer leadership were also to blame in not developing a robust business plan and risk balancing before commissioning the project.
Conclusion
The stark reality is that Woking’s companies’ assets are significantly worth less than the liability. With a property deflationary spiral and with significant rising construction cost, the situation if anything will look worse by the time the Commissioners report back on progress later this year to the Secretary of State.
The lesson from Woking is not dissimilar to that of Robin Hood Energy. A local authority has a well-meaning ambition to want to be a catalyst for regeneration change. But it has a flawed business model that fails to properly assess and minimise the risk. It is making a margin on the quasi-merchant banking (ie the mark-up between PWLB repayment rate and the loan rate to the companies). It goes wrong and then provides a living example of the ‘fallacy of sunk costs’, in that rather than face up to the reality, more public money is poured in until what would have been evident to a functioning local auditor (if that safeguard worked!) becomes clear to all.
Getting in more business savvy officers at this stage won’t address the underlying truth that the schemes were not viable, I struggle to see what viable partnership or strategic alliance could be set up as there is hardly a track record of delivery at Woking.
Reluctantly a picture is emerging that no matter that there is legislation such as section 4 Localism Act 2011 requirement for a company, mandatory accounting practices, the Prudential Code, Local Audit and Reports in the Public Interest, it is just not right that the council taxpayer and the public purse should be bailing out failed local government speculative adventures in trade. For example, how would readers like it if their council tax went up by 15% without a ballot as happened in Croydon this March? I’d be furious.
Finally, much that has happened creates a sense of Deja Vu. After RHE any local authority running a company ought to have ensured the senior management team were satisfied that the lessons from other local authority failures were learnt and that structures and practices were reviewed and revised to ensure that the failures were not replicated in their organisation.
Dr Paul Feild is the Principal Standards & Governance Solicitor working in Barking & Dagenham Legal Services. His 2015 Doctor of Business Administration thesis was ‘How does Localism for Standards Work in Practice? The Practitioner’s View of Local Standards Post Localism Act 2011’. He researches and writes on finance and governance issues and can be contacted by email.
References
Non-Statutory Review Nottingham City Council - Max Caller OBE November 2020
Report in the Public Interest concerning the Council’s governance arrangements for Robin Hood Energy Ltd – Grant Thornton 2020
Jim Taylor, Carol Culley OBE & Mervyn Greer - Governance, Financial and Commercial Review of Woking Borough Council for the Secretary of State for Levelling Up Housing and Communities May 2023
[1] by sources to the Municipal Journal 23 May 2023
[2] Or my article Max Power 23 December 2020
[3] Croydon Council Report in the Public Interest on 23 October 2020 Grant Thornton
[4] The failure of local audit (localgovernmentlawyer.co.uk) 22 December 2022
