Budgets have been tightening year on year since the 2008 worldwide financial crash, so commercialisation of services and commercial investments have become ways of bridging the gap between income and desired (or required) expenditure.

The Local Government Association (LGA) has a map on its website¹ which shows the various themes of commercial activity across councils in England. The benefits to local bodies are as varied as the commercial projects and ventures councils are involved in. Commercial investment generates extra revenue, protects the delivery of essential services, provides a wider choice of services for the community, aids local regeneration, and retains jobs and expertise within the council.

But as with any commercial venture, it’s not without its risks. There is also the added headache of navigating legislation, which many see as limiting the freedom of councils to trade effectively.

The ‘selling’ of services to schools is one of the commercial ventures that has been around the longest, driven initially by the Education Reform Act 1988. The act paved the way for grant-maintained schools to be introduced. Funded directly by central government, they were given complete autonomy over how to distribute their budgets.

This was soon followed by foundation schools in 1998, and then finally the introduction of academies in 2010. The cumulative effect of these changes was to reduce the ability of local education authorities (LEAs) to rely on income from their schools to fund support services.

Local Education Authorities (LEAs) now have to compete with other providers for a range of non-statutory services, including school meals, grounds maintenance, cleaning, and of particular interest to ALARM members, insurance and risk management services.

While some councils have been successful in persuading schools to purchase their services, in general the overall trend is to move away from local council support.

This has led to innovative thinking by some, in an attempt to retain school business². For example, the London Borough of Sutton formed a stand-alone company (called Cognus Limited) to provide education services to mainstream schools and specialist education providers. South Gloucestershire Council established a traded services team, Integra, within which Integra Schools deliver specialist support services to schools and academies.

But what’s next for public bodies looking to commercialise their assets? 

The double impact of COVID-19 and Brexit has had significant implications for councils. While the impact of Brexit may take longer to be fully apparent, there are clear signs many councils’ commercial operations have been adversely affected by COVID-19.

To put things into context, the pandemic caused a forecast loss of £2.8 billion of income for councils in 2020-21, as a result of a reduction in their sales, fees and charges, commercial and other income streams. Across the country, councils expect to lose almost £700 million from reduced car parking income alone, and a further £500 million income from the facilities such as leisure centres, theatres and museums they run³.

Research carried out by The Guardian last summer using International Financial Statistics (IFS) data, showed more than 30 councils received at least 25% of their income from commercial investments⁴. This reliance on commercial activity could impact core service delivery.

Some councils have been hit even harder. Luton Borough Council, which owns Luton Airport, lost out on £37 million in revenues from the Airport as a result of the pandemic. The Council received £35 million in emergency support from the Government. This funding came with the requirement to undertake an assurance review to ‘examine the Council’s commercial arrangement with Luton Airport’ and aim to reduce dependency on it⁵.

One increasingly popular area of commercialisation directly affected by the pandemic was the large-scale investment in commercial property. The impact was severalfold. Firstly, many commercial premises such as shops and restaurants were closed for long periods in 2020 and into 2021. Many landlords were faced with renegotiating far lower rents to enable their tenants to continue trading. Councils have had to do the same. This has a knock-on effect on the returns budgeted for in their business plans.

Alongside this, there were failures of several high street chains. Rental income was cut at a stroke, leaving councils with empty units in shopping centres or on high streets with little likelihood of lettings. This in turn reduces their attractiveness as destination points.

It isn’t just retail and hospitality venues that have been hit, many councils invested in office buildings, often out of their local area. The jury is out on whether workers will return to working full time in office accommodation but certainly in the short to medium-term it looks like hybrid working is being adopted by many, so less office space will be required. Will public sector landlords be asked to renegotiate rents to facilitate this?

The capital value of these investments has also been hit. North Somerset Council purchased two retail properties in 2018 and their value has dropped by more than £26 million in three years. In addition, the Council had originally budgeted for £1.3 million annual net income from the two purchases, but income going forward is now forecast to be just £900,000⁶.

In November 2020, the Government effectively banned investment in commercial property purely for yield, and in February this year CIPFA launched a consultation on proposals to strengthen the Prudential Code. One of the main changes put forward in the consultation is a clear statement that borrowing for debt-for-yield investment (even outside the PWLB) would not be permitted and that it presents an unnecessary risk to public funds⁷.

This has led to many councils quickly altering or even shelving their commercial investment programmes to make good income shortfalls forecasted. Thurrock Council invested heavily in solar power in recent years and just before the ban was announced borrowed £1bn for investments, including £604m in solar energy. Although its solar and green energy investments have reportedly raised over £100m over the last four years, the government imposed changes on borrowing to raise revenue means the council isn’t investing in the same way. Instead, the Council aims to save £34m by 2024. One consequence will be the loss of 500 full time jobs, as well as the sale of 33 council owned businesses, including the Thameside Theatre Complex. https://www.bbc.co.uk/news/uk-england-essex-57763432

Shropshire Council finds itself in a similar position as it now needs £48m to balance its budget. However, it is looking at the problem in a different way. The aim is to maximise income from existing commercial ventures, including its theatre and three shopping centres purchased in 2018. It also plans to create a new housing company. https://www.bbc.co.uk/news/uk-england-57734298

Not all councils have been deterred by the rule changes. Somerset West and Taunton Council is investing in £56 million in commercial property outside its area; funded in the main by loans from other councils⁸.

While some councils have always taken a broader view of the purpose of their investments, some are now making this explicit. In February 2021, the Royal Borough of Kensington and Chelsea issued an apology for past property investments saying that the “Council did not find the right balance between financial benefits and social benefits” and it had focused on the “narrow goal of generating commercial income above the broader aim of delivering benefits to our wider community”⁹.

It seems councils do not always know how best to serve their communities. A recent LGA finance peer challenge report said that it can “come across as a tendency to assume that a council is the natural, and best, provider of services to the community. The justification for the council doing this is not always clear and leads the peer team to question whether the council routinely questions what its role is within the community and economy and how it can be an enabler as well as a provider”¹⁰.

So how do councils find the right balance? As the LGA peer challenge report highlighted, one view is that councils should move away from being seen exclusively as service providers and move towards a stewardship role in their local area. Stewardship in this context means they ensure the social, economic and environmental wellbeing of their communities. These factors should be considered in the decision-making process on commercial activities and investments.

Being clear about the objectives of commercialisation at the outset is critical, as is a regular review of the rationale: the priorities of the council or their commercial partners may have changed over time for example. Once the objectives have been agreed, the council then needs to consider the various risks (and opportunities) a commercial activity presents.

These fall into familiar categories:

• Strategic– reputational damage from trading failure, trading activity not consistent with political make up of council.
• Legal– challenge from competitors, ultra vires considerations.
• Commercial– failure of demand or supply.
• Financial– returns are unsustainable, non-payment.
• Operational– impact on core services, lack of suitable resources.
• Ethical– potential conflict of interest in investing other geographical areas.
• Environmental – climate change, damage to wildlife habitats through development.

The Association for Public Service Excellence¹¹ and the LGA¹² both have useful guidance documents on their websites looking at the risks and opportunities around commercialisation, including the need for strong governance and performance monitoring.

There is little doubt councils will continue to engage in commercial activity to support the services their communities need. The long-term consequences of the pandemic, the ongoing budget cutting in the sector and an increased focus on stewardship, social benefit and place making, make it even more important that councils understand the risks, as well as the opportunities in taking a more commercial approach to service provision.

Disclaimer

This note is not intended to give legal or financial advice, and, accordingly, it should not be relied upon for such. It should not be regarded as a comprehensive statement of the law and or market practice in this area. In preparing this note we have relied on information sourced from third parties and we make no claims as to the completeness or accuracy of the information contained herein. It reflects our understanding as at 14^th July 2021, but you will recognise that matters concerning COVID-19 are fast changing across the world. You should not act upon information in this bulletin nor determine not to act, without first seeking specific legal and/or specialist advice. Our advice to our clients is as an insurance broker and is provided subject to specific terms and conditions, the terms of which take precedence over any representations in this document. No third party to whom this is passed can rely on it. We and our officers, employees or agents shall not be responsible for any loss whatsoever arising from the recipient’s reliance upon any information we provide herein and exclude liability for the content to fullest extent permitted by law. Should you require advice about your specific insurance arrangements or specific claim circumstances, please get in touch with your usual contact at Risk Management Partners.

Risk Management Partners Limited is authorised and regulated by the Financial Conduct Authority. Registered office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company no. 2989025

Resources

¹local.gov.uk/our-support/efficiency-and-income-generation/commercialisation/commercialisation-case-study-map

²apse.org.uk/apse/assets/file/schools%20(web).pdf

³accountancydaily.co/local-government-finances-hit-pandemic-fallout

⁴theguardian.com/society/2020/jul/13/english-councils-rely-heavily-commercial-investments

⁵lgcplus.com/finance/luton-resists-possible-sale-of-airport-after-35m-bailout-24-02-2021

⁶publicfinance.co.uk/news/2021/02/value-councils-purchases-plummet-due-pandemic

⁷cipfa.org/about-cipfa/press-office/latest-press-releases/cipfa-consults-on-stronger-local-government-prudential-code

⁸publicfinance.co.uk/news/2021/06/council-borrow-peers-fund-multi-million-property-investments

⁹theguardian.com/uk-news/2021/feb/26/grenfell-tower-council-apologises-for-prioritising-profits-in-borough

¹⁰ https://www.spelthorne.gov.uk/peerreview

¹¹apse.org.uk/apse/

¹²local.gov.uk/