Part 8: Operating in the local government environment

Governance and accountability of council-controlled organisations.

8.1
In this Part, we focus on matters that directors (and managers) of a CCO will encounter as part of a public entity but are unlikely to meet in the private sector. These matters include:

operating in the political environment of local government;
accountability in that environment;
requirements for releasing information; and
managing conflicts of interest.

8.2
These add to factors we discussed in earlier Parts of the report:

the statutory requirements for accountability and monitoring (Part 6); and
the features of an effective relationship between a local authority and its CCOs (Part 7).

8.3
Although it is easy to identify differences between public and private sectors, the essential requirements for good governance are the same.

Operating in a political environment

8.4
A CCO operates in a complex environment. Although a CCO may be an arm's-length commercial operation, unlike a privately owned entity, it operates in a political environment. It must meet the expectations of both shareholder and community. A CCO is the steward of community assets or uses ratepayer funds. It is accountable to the community for their use. At the same time, the parent local authority is accountable to the community for the performance of the CCO.

8.5
CCOs are publicly owned entities. As elected representatives of the community, councillors have a legitimate interest in a CCO's activities. As a consequence, CCOs are subject to scrutiny from members of the public and from elected members that a business in the private sector is unlikely to experience. Private sector businesses are used to operating in private. Public sector entities must be prepared to operate in public.

8.6
Public scrutiny is often apparent in the expectation that information will be readily available or in allegations that a director's personal interests conflict with those of the CCO. These matters are discussed later in this Part.

8.7
Further, elected members have a direct accountability to the community that elected them. They are also likely to have many connections in the community. Directors of CCOs may be less connected to the community, so members of the public may turn to councillors when they perceive problems with a CCO.

8.8
A decision of a CCO justified on commercial or other grounds and consistent with the agreed objectives set out in its statement of intent might nevertheless be unpopular with the community. The community might expect councillors to bring pressure on the CCO to review its decision. An example could be land that a CCO owns but does not currently use. The CCO might seek a commercial return on the land, whereas the community might prefer that the land be used as a park or playground.

Political accountability

8.9
The formal statutory requirements are unlikely to address all of the accountability issues with CCOs that might arise. Problems in accounting for the performance of a CCO generally arise from the complexity of the relationships between a subsidiary entity, its shareholding local authority, and the community.

8.10
We discussed the question of political accountability with the people we interviewed – whether elected members, CCO directors, or officials. Drawing on those discussions, and on our other work in the local government sector, we believe that addressing the following matters can help.

CCOs must understand the political environment they operate in

8.11
A CCO must understand the political environment it operates in. Directors and managers of a CCO need to acknowledge that councillors often engage with the community and will, from time to time, also want to engage on matters to do with the CCO.

8.12
CCOs can perceive that, when the CCO is running smoothly, the local authority receives the credit but that, when things go wrong, the subsidiary gets the blame. CCOs need to understand that, as owner, the local authority will want to publicise "good news stories" about its subsidiaries.

8.13
However, the parent local authority also needs to understand that its adoption of the CCO's successes can send a conflicting message to the community, who may then assume that the local authority is responsible for the delivery of service or stewardship of assets.

Handling complaints about CCOs

8.14
It is simple to say that responsibility for handling complaints about a CCO should sit with the Council when the issue concerns the Council's strategy for the CCO, and with the CCO when the complaint concerns the CCO's delivery of service or performance more generally.

8.15
As Figure 7 shows, in practice, complaints will be made directly to councillors or the local authority, who are likely to want to try to resolve the matter rather than referring it to the CCO.

8.16
We suggest that the local authority and the CCO agree a protocol on handling complaints to avoid confusion about the accountability of the CCO.

Figure 7
Handling complaints – Wellington City Council

Wellington City Council faced criticism from community groups after it merged Wellington's major events venues, including the Wellington Town Hall and the Michael Fowler Centre, into a CCO called Positively Wellington Venues Limited. The merger followed concerns that the venues were costing too much to manage in-house. The Council's terms of reference for the CCO required it to break even but also to achieve greater community access to the facilities. However, elected members began to receive complaints from community groups used to getting discounted rates under the previous structure, who believed that the rates were too high. The CCO then faced political pressure to review its fees, which had been set at a level to ensure that the subsidiary covered its costs. In spite of the political pressure, the fees remained unchanged.

CCOs must have effective engagement with the community

8.17
A CCO needs to engage with the community, especially if it is delivering a service on behalf of the Council. The nature of the engagement will depend on the business of the CCO. For example, if the CCO delivers a service, the relationship with the community will be that of supplier and customer.

8.18
CCOs need to think about what information they make available to the community, because the community is ultimately the CCO's owner. We discuss the statutory requirements for the release of information in paragraphs 8.21-8.29.

Local authorities should say what they want

8.19
We discussed in Part 7 the importance of an effective relationship and clear expectations between the local authority and the CCO. Expectations may be communicated by any or all of the statement of intent, a letter of expectations, and a policy drafted by the subsidiary and agreed to by the local authority.

8.20
These expectations can include the level and means of the CCO's community engagement. It is an opportunity for the local authority to identify issues it wishes to deal with itself or on which it wants to be consulted before there is public communication. Such issues might concern, for example, the tension between dividend to the local authority and subsidy of service to the community or between dividend and investment in the CCO's business. The local authority and the CCO should try to anticipate the issues that might arise and agree in advance how they should be handled.

Releasing information

8.21
A CCO is subject to the requirements of the Local Government Official Information and Meetings Act 1987 about releasing information. The presumption is that information will be released unless one of the specified grounds for withholding information applies – for example, to enable the carrying out commercial activities or to protect legal professional privilege.

Sensitive information

8.22
The request for commercially sensitive information may come from the parent local authority. A CCO is not required to include information in its statement of intent, its half-yearly report, or its annual report that it could properly withhold under the Local Government Official Information and Meetings Act.⁵¹

8.23
However, as the owner, the local authority will expect to receive important commercial information from its subsidiary, including sensitive information that may not be public. This can be particularly challenging if the subsidiary is a listed company.

8.24
The local authority is entitled to receive information it needs to hold its subsidiary to account, including sensitive information. Local authorities need strategic commercial information to act as diligent shareholders. They need to understand the board's strategy for the CCO, business cases for major investments, the financial outlook for the business, and expected turnover.

8.25
However, the local authority should ensure that it has effective processes to manage the exchange of sensitive information and minimise the risk of confidentiality breaches. Concerns about the risks of sensitive information being publicly disclosed can impede the flow of information and affect the relationship if the concerns are not proactively managed and the risks minimised.

8.26
Setting procedures for handling sensitive information, having a common understanding of respective interests, and having clear expectations about how such information will be protected will support a relationship of trust and confidence.

8.27
There was a general acknowledgement among the CCOs we spoke to that a higher level of transparency is required because a subsidiary entity is publicly owned. However, they also observed that this requirement can have a negative effect on operations if the subsidiary cannot maintain a competitive edge.

8.28
One subsidiary told us that it is often a challenge to strike a balance between meeting obligations for transparency in the accountability documents while maintaining commercial sensitivity. Although the subsidiary complies with its obligations to include specific information in its statement of intent, it is always mindful that competitors use the documents because they signal proposed or actual commercial activity. This affects what information is included. See also Example 4 in Appendix 1.

8.29
Some local authority subsidiaries are companies listed on the New Zealand Stock Exchange and subject to its rules about information flows. This can affect what information can be shared with the shareholder. In addition, listed companies are exempted from the requirement to prepare a statement of intent, a half-yearly report, and an annual report.⁵² As a result, the local authority may not receive as much information as it wants.

Confidentiality breaches

8.30
Sometimes, information can be misused. Many of the CCO directors and managers we spoke with mentioned the risk that not all elected members were prepared to keep sensitive information about the CCO's activities confidential.

8.31
Such confidentiality breaches can inhibit the exchange of information and have a detrimental effect on the relationship between a local authority and its CCO. They can also create risk for the commercial position of the CCO.

8.32
We mentioned in our 2014 report into investments by Delta Utility Services Limited that there can be a tension between open communication and commercial sensitivity for CCOs:

7.33 For council-controlled trading organisations, there can be a tension between open communication and commercial sensitivity. There will often be a good reason for a council-controlled organisation to protect or withhold information during commercial negotiations [under the Local Government Official Information and Meetings Act 1987], including when the council- controlled organisation considers that there is a risk of leaking confidential information that might affect those negotiations.

7.34 However, when decisions have been made, confidentiality considerations should become less important, and council-controlled organisations need to decide then how best to communicate with their shareholding councils. Private sector entities dealing with council-controlled organisations should be aware of this, and that the situation is more complex when dealing with a public entity.⁵³

8.33
CCHL told us that it has not experienced significant issues with breaches of confidentiality. There is a clear understanding between the holding company and its subsidiaries that all reports are treated as confidential, because competitors could use information made public. As a result, the subsidiaries provide more detailed information in their reports to CCHL than they otherwise might.

8.34
However, sensitive information is excluded from reports that go to the Council to minimise the risk of information being leaked to the public.

8.35
CCHL's guidelines for the conduct of directors require directors to observe the confidentiality of non-public information acquired by them as directors.

Conflicts of interest

8.36
CCOs are public entities and stewards of public assets. In that context, the perception that a director of a CCO is acting in their own interest is serious. Given the public scrutiny of public entities, allegations of conflicts of interest seem to arise readily. It is important to handle such allegations carefully. In the mind of the public, the perception of a conflict of interest can be as damaging as an actual conflict.

8.37
Actual conflicts of interest will often arise. New Zealand has a small population, and CCO directors are likely to have other interests in the business and local communities. Conflicts of interest, potential or actual, should be identified, declared, and carefully managed.

8.38
For CCO companies, the provisions of the Companies Act 1993 about conflicts of interest apply to board members. That Act defines an interest in a transaction to be when a director is a party to, or will or may derive a material financial benefit from, the transaction, or if they are a director, officer, or trustee of a party to the transaction.

8.39
When such a situation arises, a director must disclose their interest to the board and add it to the interests register. If there is a likelihood of an interest causing a future conflict, a director can include a general notice in the interests register. This is then regarded as enough disclosure of interest for that transaction.

8.40
Failing to disclose interests in keeping with the requirements of the Companies Act is an offence.

8.41
Councillor-directors are also subject to these requirements. In addition, they must be mindful of the conflict of interest rules contained in the Local Authorities (Members' Interests) Act 1968 when they are participating in matters before the local authority that they may have a pecuniary interest in.

8.42
Even if there is no pecuniary interest, a councillor can create legal risk to a decision before a local authority if their participation raises:

a conflict between their duty as a member of the local authority and any duty to act in the interests of the subsidiary; or
a risk of predetermination, if the councillor has taken part in earlier discussions on the matter at the subsidiary board table and then takes part in discussions on the same matter at the council table.⁵⁴

51: Section 71 of the Act.

52: Section 71A of the Act.

53: Controller and Auditor-General (2014), Inquiry into property investments by Delta Utility Services Limited at Luggate and Jacks Point, page 126.

54: See our 2007 good practice guide, Managing conflicts of interest: Guidance for public entities.