Contact: Jon Pittam, ext 7400

1. Summary

1.1 The report summarises the new draft prudential code for capital finance and the proposed response to the consultation.

1.2 The following decision is sought:

· to approve the consultation response to the draft prudential code for capital finance.

2. Reason

2.1 The Council needs to make sure that the new prudential code for capital finance is sensible and practical in meeting both its capital programme and budget requirements.

3. Other options considered and rejected

3.1 None.

4. Conflicts of interest declared by the decision maker or a member or officer consulted

4.1 Not applicable.

5. Dispensation granted by the Standards Committee

5.1 Not applicable.

6. Reason for the matter being dealt with if urgent

6.1 Not applicable.

Approved by: Date:

Councillor T K Thornber

Contact: David Wilson, ext 7407

1. Introduction

1.1 The current system of capital controls was introduced by the Local Government and Housing Act 1989 and took effect in April 1990. The Government has sought to control local authority spending by placing annual limits on the use of borrowing and other credit arrangements (for example property leases and finance leases for equipment). The system has proved to be inherently inflexible, and a mass of regulations have been issued under the 1989 Act to deal with changing circumstances. As a result the system has become complex and increasingly difficult to understand. It also restricts local authorities' local accountability and distorts decision-making, placing too much of a direct disincentive on borrowing for capital purposes.

1.2 The Local Government Bill proposes that the current controls on local authority borrowing should be abolished. Instead, authorities will be required to make sure their capital spending plans are affordable, prudent and sustainable by complying with a Prudential Code being prepared by the Chartered Institute of Public Finance and Accountancy (CIPFA).

1.3 CIPFA published a draft of the new Prudential Code in March 2003 for consultation, and invited comments from local authorities to be submitted by 15 May 2003. This report summarises the draft Code and how it could be implemented, and then suggests some comments for submission to CIPFA.

1.4 The Government aims to introduce the new system with effect from 1 April 2004.

2. The Draft Prudential Code

2.1 The objectives of the draft Code are to:

· ensure that local authority capital programmes are affordable

· keep local authority borrowing and credit within prudent and sustainable levels

· take treasury management decisions in accordance with professional good practice

2.2 In taking decisions about these three key objectives local authorities must make sure that they are accountable by providing a clear and transparent framework. That framework must be consistent with and support

· local strategic planning

· local asset management planning

· proper option appraisal

2.3 The Code aims to do this by requiring local authorities to prepare reports setting out a series of "prudential indicators" for submission to their budget-making body, normally the full Council. Such reports could be presented for approval as an extra report both to the Cabinet and the full Council at their budget-setting meetings, and be reviewed and updated when the final accounts are approved.

2.4 The indicators required are listed in Appendix 1. Authorities are free to devise their own additional indicators if they wish.

2.5 When setting or revising their prudential indicators, local authorities must demonstrate that they have taken into account:

· affordability - for example implications for the council tax

· prudence and sustainability - for example implications for borrowing and financing costs

· value for money

· the need to provide for the cost of looking after its assets

· its objectives

· practicality

2.6 Prudential indicators based on estimates should be set over rolling three-year periods ie the budget year and two following years. Those indicators based on actuals should be determined when the accounts have been finalised. They should also be monitored throughout the year, and significant actual or expected breaches reported to the Council. Remedial action can then be taken or, if appropriate, indicators can be revised by the Council.

3. The consultation

3.1 CIPFA have asked for comments on specific aspects of their proposals:

· the extent to which they provide a proper local control framework for capital expenditure financed by borrowing

· the split of responsibilities between the Council (responsible for approving and revising the prudential indicators) and the County Treasurer (responsible for calculating and monitoring them)

· the emphasis on the importance of projected council tax levels as a measure of the affordability of capital plans

· whether the Council is happy to publish estimates of council tax levels in the future ie for two additional years beyond the forward budget year

· whether the definition of the `capital financing requirement' is clear. The paper defines it in terms of capital balance sheet items: fixed assets plus deferred charges; less the fixed asset reinstatement reserve, the capital financing reserve, deferred contributions and Government grants.

General comments

3.2 The principle of replacing statutory borrowing limits with a prudential code of practice should be welcomed. However, some of the detailed proposed prudential indicators could be better focussed.

3.3 The Government will continue to support local authorities' capital expenditure. It plans to consult shortly on whether this should be through the revenue support grant system as now or by capital grants. The primary purpose of prudential indicators is to demonstrate that capital plans are affordable. The capital financing requirement in itself does not measure this. Total external debt is also a very indirect measure, as it neither takes account of the extent to which the servicing of debt is supported by Government grant nor of the degree to which temporary sources of internal funding are available to offset the need to borrow, for example from school reserves or developers' contributions.

3.4 More relevant is how changes in the capital financing requirement compare with changes in the amount of new borrowing being supported by Government capital grant or revenue grant towards capital financing costs, if the Government continue to support borrowing rather than paying capital grants. A more appropriate indicator would be `capital expenditure funded by unsupported borrowing'. This Council could include this as an extra indicator in its own reports, should CIPFA not accept this point. For comparison purposes an indicator of unsupported debt per head of population might be helpful.

The responsibilities of the Council and the County Treasurer

3.5 In general CIPFA proposes that the Council, as budget-making body, should consider all reports on prudential indicators. The calculation, monitoring and reporting responsibilities would fall to the County Treasurer.

3.6 This seems reasonable. All current budget and final accounts reports are presented initially to the Cabinet, but they are formally approved by the Council, and it seems logical that prudential indicators should be subject to the same process. The County Treasurer would initially report to the Cabinet as and when any action is required.

Use of projected council tax levels as a prudential indicator

3.7 Projected council tax levels are already reported to the Council and published on the basis of the continuation of the current budget strategy. However, CIPFA's proposals overestimate its potential importance as an indicator, particularly beyond the second year.

3.8 Just as with external borrowing, it is an unreliable guide to the affordability of capital financing plans. For a County Council, a council tax projection has little meaning other than in the context of central Government plans for local authority spending and financing. The Government currently publishes three-year spending plans every two years, so every other year councils do not have any information on the Government's proposals for the third year. The County Council's current practice is not to attempt to guess the Government's plans for that third year. There is further uncertainty at present because of the absence of pre-announced floors which limit the loss of Government grant over a transitional period. Further uncertainty in longer term forecasting is still created by changes in specific grants and functions.

Definition of the capital financing requirement

3.9 Generally the definition given in CIPFA's paper is clear and has the benefit of being derived directly from the Council's balance sheet, but there is one significant caveat, which is also relevant to the indicators for external debt. This is the treatment of property leases, where the Government are proposing not to follow accounting principles. Under the current accounting rules, finance leases have to be included in the balance sheet but operating leases are regarded as purely revenue items and do not. The Council may wish to take the view that the same rules should be applied to property leases ie that, providing the terms meet the criteria for treatment as an operating lease, they should not be regarded as credit liabilities and not form part of the capital financing requirement.

4. Conclusions

4.1 The increased local flexibility and accountability provided by the proposed arrangements are to be welcomed. It is hoped that the Government will not feel the need to use the reserve power in the Local Government Bill to impose borrowing limits.

4.2 The prudential limits in the draft Code of Practice provide a framework for setting capital spending plans, but they do not determine those plans. The County Council will need to draw up a policy framework, within which the indicators will be set. A key element in determining the framework will be the basis on which the Government provides support for future local authority capital spending, on which consultation is due to be undertaken this spring. Future reports will be brought to the Cabinet on this further consultation and on the County Council's prudential policy framework against the final published code adopted.

Recommendations

That the Cabinet approves the consultation response to the draft prudential code for capital finance and that the County Treasurer be given delegated authority to respond to CIPFA on behalf of the Council on the basis of the comments set out in sections 3 and 4 of this report, subject to any other comments Cabinet may have.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

1. Published works.

2. Documents which disclose exempt or confidential information as defined in the Act.

TITLE FILE

None

Appendix

List of prudential indicators

Indicators based on estimates must be prepared for the forthcoming financial year and the following two years. Those based on actuals will be calculated after each year end using the Council's accounts.

Key indicators of affordability

Estimates of the ratio of financing costs to net revenue stream

Actual ratio of financing costs to net revenue stream

Estimates of the impact of capital investment decisions on the council tax

Indicators for prudence

Net borrowing and capital financing requirement ie over the medium term net external borrowing must not exceed the capital financing requirement (see below)

Indicators for capital expenditure

Estimates of total capital expenditure

Actual total capital expenditure

Estimates of the capital financing requirement at the year end (similar to the current credit ceiling)

Actual capital financing requirement

Indicators for external debt

Authorised limit for external debt (ie borrowing plus other long-term liabilities)

Operational boundary for external debt (ie borrowing plus other long-term liabilities)

Note: the operational boundary should be the Council's estimate of the most likely and prudent scenario, whereas the authorised limit should provide headroom for unexpected or unusual cash movements.

Actual external debt

Treasury management

Adoption of the CIPFA Code of Practice for Treasury Management in the Public Services

Upper limits on fixed rate exposures, either in terms of interest payable or principal outstanding

Upper limits on variable rate exposures

Upper and lower limits on the maturity structure of fixed rate borrowing (ie borrowing maturing during each stipulated period as a percentage of total fixed rate borrowing at the start of the period).

(Note: stipulated periods are: under 12 months; between 12 and 24 months; between 24 months and 5 years; between 5 and 10 years; and 10 years and above).

Upper limit on total principal sums invested for periods longer than 364 days