Part 3: Is a council-controlled organisation the right option?

Governance and accountability of council-controlled organisations.

In this Part, we look at what a local authority should consider when deciding to set up a CCO. We discuss:

Considerations before deciding to set up a council-controlled organisation

Before deciding to set up a CCO, a local authority needs to comply with the requirements and principles in Part 6 of the Act that apply to decisions. This will include considering the costs and benefits of setting up a CCO as opposed to other options, and identifying who might be affected by the decision and how to consider their views.

Is a CCO the best option?

In setting up a CCO, a local authority needs to:

  • determine what it is trying to achieve;
  • consider whether a CCO is the best means to achieve that objective;
  • consider whether a CCO is a cost-effective and sustainable way of achieving the objective;
  • decide whether the entity will be a CCO or a CCTO;
  • if the CCO is a CCTO, consider whether it will be a viable business in terms of size and capability; and
  • ensure that it has the capability and capacity to manage a relationship with the CCO and to monitor its performance.

Capability to govern and monitor

The local authority's own ongoing capacity and capability to oversee the subsidiary – both at Council and management levels – is an important question when setting up a CCO. This is particularly so for a local authority setting up a CCO for the first time. The oversight needed includes:

  • appointing directors for the new entity;
  • managing an effective relationship with the CCO;
  • setting an appropriate monitoring framework;
  • engaging with accountability and reporting documents prepared by the CCO; and
  • meeting the local authority's own accountability and reporting requirements in the Act.

Managing all of these successfully is fundamental to setting up and maintaining a good relationship with the CCO. We discuss each further in Parts 5 to 7.

Benefits and disadvantages of council-controlled organisations

The benefits a CCO may bring

In 2009, the Royal Commission on Auckland Governance and the Auckland Transition Agency considered how about 40 council organisations associated with the former Auckland local authorities would fit in to the new Auckland Council structure. The Royal Commission noted that local authorities give the following reasons for placing activities in separate entities:13

  • improved commercial focus – that is, operating a company with a professional board of directors with the objective of achieving greater operating efficiency;
  • ring-fencing financial risk, by using an incorporated structure to insulate a local authority from financial liability for an activity or venture involving other parties (such as a joint venture);
  • empowering local communities – that is, creating a trust with a set budget funded by a local authority but managed by members of the community for a specific purpose such as maintaining a community centre; and
  • tax-effectiveness – local authorities can derive tax credits from commercial subsidiaries that pay dividends.

Other reviews and stakeholders identified some further benefits of CCOs:14

  • independence – separation from political direction;
  • streamlining bureaucracy, enabling nimbleness and agility – CCOs have less "process" to follow in making decisions than local authorities;
  • economies of scale, where shared services CCOs combine several local authorities' similar activities;
  • the ability to recruit and retain high-quality board members and staff who might not be available to be members or employees of a local authority; and
  • access to a wider range of funding sources – a trust or similar entity with community representatives can get donations and contributions for significant community projects and may be eligible for funding that local authorities are not.

Possible disadvantages of CCOs

Some possible disadvantages of CCOs include:

  • the local authority's lack of direct accountability to the community for the services the CCO delivers;
  • tensions between the objectives of pursuing profit and delivering community outcomes;
  • additional ongoing costs – the costs incurred by the local authority in monitoring the performance of the CCO, and the CCO's own costs, can increase overall service delivery costs; and
  • reduced ability to manage risk – arm's-length delivery can make managing risks to the reputation of the local authority more difficult.15

Figure 1 gives an example of a local authority that has tried a range of alternative arrangements for service delivery.

Figure 1
Delivering regulatory services through a council-controlled organisation – Queenstown Lakes District Council

Queenstown Lakes District Council has tried a range of options for delivering its services since the mid- to late 1990s. These include contracting out to the private sector, the CCO model, and then bringing most activities back in-house. In 1998, the Council took the novel step of contracting out its regulatory services to a private company as part of a general move at the time to contract out many of its core services.* Nine years later, in 2007, the Council decided to end the arrangement with the private company and bring regulatory services one step closer to the Council by buying the private company and forming a new CCO to deliver regulatory services.**Again, this was an unusual arrangement for regulatory services.

In late 2012, the Council commissioned a review of two of its CCOs as part of a wider organisational review of all Council activities. † The review assessed the cost, efficiency, and effectiveness of the CCO model against 13 criteria. †† Other councils reviewing their CCOs might find these criteria useful.

The review recommended that it would be more appropriate for the Council to provide regulatory and recreation and leisure activities than the two CCOs. The primary reasons were to reduce cost, both to the Council and to customers; to reduce fragmentation of activities; to improve integration of policy development and regulatory functions; and to improve management of the tension between commercial and community outcomes.

The Council agreed with the recommendation. In March 2013, it decided to disestablish the two CCOs and to bring their activities back in-house.

* We reported on how Queenstown Lakes District Council went about this decision, and considerations for other local authorities considering contracting out, in a 1999 report, Contracting Out Local Authority Regulatory Functions.

** We inquired into the Council's consultation and decision-making process and reported to the Council in a letter that we published on our website in September 2007, Queenstown Lakes District Council – regulatory and resource management services.

† The Council's airport company, Queenstown Airport Corporation Limited, and a forestry joint venture with Central Otago District Council were excluded from the review.

†† Queenstown Lakes District Council (2013), Organisational Review Assessment of the council-controlled organisation model, page 3.

Considering costs and benefits

Although setting up a CCO to manage a local authority service may have cost efficiencies, there will be additional overhead costs associated with establishing and continuing to oversee a CCO. The CCO will have its own overhead costs. It will have a management and administration structure separate from the local authority. It will incur costs in preparing a statement of intent and in reporting against it, and will also incur audit fees. It may have additional accountability requirements under legislation other than the Act, such as the Companies Act 1993 or the Charities Act 2005.

Local authorities should be aware of these costs and take them into account when deciding whether a CCO is the most appropriate model. In short, the scale of a CCO's undertaking should be large enough to justify the additional costs.

The Act was amended in 2014 to require local authorities to review the cost-effectiveness of their service delivery arrangements.16

This new requirement requires local authorities to actively consider the place of CCOs in service delivery. A review must consider options for governance, funding and delivery of infrastructure services, and regulatory functions.

The Act lists the options that local authorities must consider when reviewing arrangements. The local authority can:

  • retain responsibility for all aspects of service delivery;
  • delegate responsibility for governance and funding to a joint committee or other shared governance arrangement; or
  • retain responsibility for governance and funding but give responsibility for delivery to a CCO, other person or agency, or another local authority.

Considering risk

Considering risk, and whether the perceived benefits outweigh any inherent risks, is an important step in deciding whether to set up a CCO.

Councillors need to be comfortable with devolving authority to others, because directors of CCOs will effectively be making decisions on their behalf. A local authority must make clear to its CCOs how much risk it will tolerate. Then, when the CCO is operating, it should be able to give the local authority assurance about how it manages risk.

Local authorities need to consider risk management

Local authorities are required to consider and express their views on risk management from time to time in their investment policy.17 Local authorities with CCOs need to have an effective governance regime for managing the risks associated with CCOs, including through the statement of intent process. This is part of a council's responsibility for prudent financial management.

In addition, amendments to the Act in 2010 added new requirements to consider the risks of commercial activities. Local authorities must now periodically determine whether the expected returns from any investments or commercial activities are likely to outweigh the risks inherent in the investment or activities.18

There is also a requirement to address risk management in contracts between local authorities and CCOs where the CCO is responsible for delivering infrastructure, services, or regulatory functions for the local authority.19

Can a local authority transfer risk to its CCO?

A reason for setting up a separate entity such as a CCO can be to insulate the local authority from financial liability for an activity or venture involving other parties (such as a joint venture). However, when there are concerns or problems, the parent local authority is likely to find that it retains accountability for outcomes – in a reputational sense at least.

When transferring authority and responsibility to the governing body of a CCO, the local authority needs to be clear about its appetite for risk. The local authority also needs to make this clear to CCO directors.

Our inquiry into property investments by Delta Utility Services Limited (Delta) at Jacks Point and Luggate illustrates these points (see Figure 2).20

Figure 2
Losses associated with property investments by a council-controlled trading organisation – Delta Utility Services Limited

In mid-2008, Delta, a CCTO of Dunedin City Council, entered into a joint venture for a residential sub-division at Luggate, near Wanaka. The property development was not successful, and Delta lost about $4.4 million from the Luggate joint venture (after tax). Delta also lost about $2 million on another property investment at Jacks Point, Queenstown. Although the Dunedin City Council had no legal liability for the investments or the losses, the Council's net worth decreased by about $6.4 million because of Delta's investments. Ratepayers with concerns about the investments directed their criticism at the Council as well as at Delta.

In our inquiry report, we considered that the Council bore some responsibility for the investments even though Delta did not give the Council much information about the investments. This was because the Council's governance regime at that time failed to provide any guidance or oversight to Delta about investment, and the Council had not specified its risk appetite for the activities of its trading organisations. The Council's main interest seemed to have been on returns from its CCTOs and not so much on what they were actually doing.

In 2011, the Council changed the governance arrangements for its CCOs. We outline those changes in Example 3 in Appendix 1. Delta has subsequently ceased its property development activities.

13: Royal Commission on Auckland Governance (March 2009), Volume 1, chapter 21, paragraph 21.14, pages 459-460.

14: Auckland Transition Agency (March 2010), Auckland in Transition: Report of the Auckland Transition Agency, "Volume 2 Attachments: Council Controlled Organisations", Part 1, pages 8-9; Queenstown Lakes District Council (2013), Organisational Review Assessment of the council-controlled organisation model, page 8.

15: This paragraph includes points made in Queenstown Lakes District Council (2013), Organisational Review Assessment of the council-controlled organisation model, page 8.

16: Section 17A of the Act.

17: Section 105(e) of the Act. CCTOs are usually regarded as a form of investment.

18: Section 14(1)(fa) of the Act.

19: Section 17A(5) of the Act.

20: Controller and Auditor-General (2014), Inquiry into property investments by Delta Utility Services Limited at Luggate and Jacks Point.