Part 4: Financial strategies

Matters arising from our audits of the 2018-28 long-term plans.

In this Part, we outline the legal requirement for councils to prepare a financial strategy. We also comment on how effective the financial strategies were in meeting the requirements.

Financial strategies are a critical part of the LTP. For the readers of the LTP to meaningfully assess the prudence of councils' financial management, the financial strategy must be clear about its goals and trade-offs and presented in a concise way.

Financial strategies have been required for the last three LTPs. However, we have seen little improvement in how they are presented during this time. We encourage councils to put more effort into their future financial strategies. We suggest that councils could usefully focus on presenting clear and succinct information that is truly strategic.

As noted in Part 1, we consider that it would be useful for the Department of Internal Affairs and the sector to consider the effects and effectiveness of the current disclosure requirements. The disclosures required by section 101A of the Act and the Local Government (Financial Reporting and Prudence) Regulations 2014, in particular, could usefully be considered to ensure that they remain fit for purpose.

There is a risk that these disclosures are not helping readers to understand how councils manage their finances and evaluate their council's performance.

Legislative requirements for financial strategies

The Act sets out the purpose and required content of the financial strategy. The financial strategy must cover the period of the LTP, which is at least 10 years, and must be updated for each LTP.

The purpose of the financial strategy is to:20

  • facilitate prudent financial management by the council by providing a guide for the council to consider proposals for funding and expenditure against; and
  • provide a context for consultation on the council's proposals for funding and expenditure by making transparent the overall effects of those proposals on the council's services, rates, debt, and investments.21

The financial strategy is a mix of forecast information about what could have a significant financial effect on the council, such as changes in population or land use, expected capital expenditure in significant areas, and disclosures about financial parameters in which the council will operate (limits on rates, rates increases, borrowing, and targeted returns for financial investments).

The requirement for a financial strategy fits with the purposes of the LTP, particularly those related to integrated decision-making, long-term planning, and accountability.

Are financial strategies meeting the legislative intentions?

Financial strategies were introduced into the Act in 2010 and were first required to be included in the 2012-22 LTPs. We have previously said that we were pleased to see the financial strategy included as a compulsory disclosure. This is because it improved the information contained in the LTPs and helped communities to assess the implications of the decisions they were consulted on.

After reviewing the financial strategies in the 2012-22 LTPs, we noted that the most useful strategies were those that discussed the implications of the chosen strategy in a broad way, rather than including only what is required by the Act. Councils needed to remain focused on the intent of the financial strategy and balance the broader purpose against the specific disclosure requirements.

We cautioned against any further prescription of disclosure requirements for the financial strategy, which could lead the sector to address the requirements in a mechanistic way.22

After considering the 2018-28 financial strategies, we consider that there remains room for improvement.

The Act's requirements were included in most of the 2018-28 financial strategies. However, this did not mean we found the financial strategies as effective as they should be.

In our view, for a financial strategy to be effective, it needs to clearly explain the end goal – and the decisions and trade-offs the council has to consider to reach that goal – in a way that is relevant to readers. In effect, councils should be clear about the implications arising from their financial strategy. In our view, the implications arising from the financial strategy was still not strongly presented in many cases.

Kāpiti Coast District Council was one of the few exceptions. The Council presented a financial strategy that, in our view, effectively presented the Council's goal and how the Council plans to achieve that goal. It also presents an effective description of how the combined use of rates, capital expenditure, and debt influences the level of service provided to the community.

Our challenge for 2021

The main target actions are to improve our financial position and give ourselves more room to manoeuvre within the fiscally constrained environment, and to invest only in infrastructure that supports resilience and agreed growth. This will be done by undertaking a reduced capital expenditure programme that will enable us to start paying down our debt earlier than is currently forecast. In the short term, this could lead to an improved credit rating. In the longer term, this means that the Council will be in a better position to manage a substantial renewals programme for our three waters infrastructure.

Adapted from Kāpiti Coast District Council, Long-term plan 2018-28, page 18.

We are confident that most councils have a thorough understanding of their financial strategy. Our challenge to councils for the next LTPs is to present a financial strategy in a clear and concise way, in no more than five pages. This will help better meet the strategy's purpose by clearly explaining to the community how the council is managing its finances and why it has chosen to do it that way.

In working towards this challenge, we also encourage councils to have councillors and members of the community consider draft versions of the strategy. This will test how easy it is to understand.

We acknowledge that the Act requires several disclosures that increase the length of financial strategies. In our view, presenting a clear and concise strategy and then adding (where not already covered) any other required disclosures will produce a more effective financial strategy.

We have not yet seen a financial strategy that we consider to be an overall good example. However, Hamilton City Council, which presented its financial strategy in five pages, is heading in the right direction. The Council's financial strategy had good opening contextual information, most of its information was in reasonably non-technical language, and included a helpful mix of text and diagrams.

Disclosures required in the financial strategy

As noted above, the Act requires several disclosures in the financial strategy. The most significant components are:

  • information about factors that are expected to have a significant impact on the council; and
  • rates and debt limits set by the council.

For the first component, we consider that councils could focus on improving their explanations about the effects of changes in land use23 on their finances. This is often missing or poorly described.

For the second component, presenting rates and debt limits set by the council is more complicated to summarise. We discuss the presentation of limits below.

Rates and debt limits – how are they set and how effective are they?

The Act requires councils to present quantified limits on rates, rate increases, and borrowing.

We considered the limits set by all councils in detail as part of our reporting on the 2015-25 LTPs.24 Although we have not repeated this detailed analysis for the 2018-28 LTPs, the review work we have done has not indicated any change to the nature, range, or types of limits councils apply.

Previously, we encouraged councils to be clear about what limits they have set and, more importantly, to explain why using that specific limit to assess the financial health or prudence is relevant.25 We have seen no change in councils clearly explaining the selection of limits in the 2018-28 LTPs, although, as in the past, councils generally explain debt limits better than rates limits.

Where councils have attempted to explain the rationale for the limits they have set, this is often linked to a view about what is affordable for the community. Councils are generally weak at explaining what affordability means or how it has been assessed.

Ashburton District Council’s financial strategy talks about the effects of Ashburton’s changing economy (the ongoing transition from arable farming to dairy and specialised cropping) and discusses the increased facility and service needs resulting from this change. It also notes that the economic growth leading to population growth is accompanied by increased wealth, making the proposed increased rates affordable for most of the community. It also acknowledges that there will be an effect on owners of lower-value properties, particularly with increasing uniform annual general charges.

Ashburton District Council presents the rates and debt limits in simple terms. This is complemented by a good discussion about the economic context the Council is operating in, which enables a more understandable explanation of affordability for its ratepayers.

Councils generally approach the development of their rates and debt limits in one of two ways:

  • Councils set limits based on a strategy established before the forecasts are prepared – using them as true strategic limits that underpin the development of the forecast spending and drive the council's activity decisions.
  • Limits are set to fit around the financial forecasts – and so do not really function as a true limit. When the strategy is less effective, the limits are often set unrealistically low and are readily breached in the LTP forecasts.

Council debt limits are influenced by the limits imposed by the New Zealand Local Government Funding Agency or mirror those of the Agency and reflect financial market views of prudence. Although the disclosure of debt limits is useful information for the reader of the LTP, they reflect an industry requirement rather than a purely self-imposed financial prudence control. This shows that the legislative prescription is not the main influence on behaviour.

The rates increase limits continue to be problematic. It remains difficult for most councils to express an effective limit related to rate increases. We have seen rates increase limits that:

  • exclude growth in the rating base;
  • exclude both rating units and valuation movement impacts; or
  • are restricted to reflecting increases in general rates rather than all rates.

Although, in most instances, councils stick to the limits they set, many ratepayers cannot relate the increases in their rates invoice from one year to the next to the rate increase limits set by their council. The challenge remains for councils to identify a more effective way to communicate with ratepayers about value for money from rates and to more effectively justify annual rate movements.

Financial prudence benchmark disclosures

The Local Government (Financial Reporting and Prudence) Regulations 2014 require councils to outline their planned performance against defined benchmarks. The regulations were intended to improve the ability of ratepayers and stakeholders to assess the council's financial health and compare performance with other councils.

The multiple benchmarks provide much information on a financial component basis, but are technical in nature. We recommend that the Department of Internal Affairs and the sector consider the effects and effectiveness of the regulations to ensure that they remain fit for purpose.

20: Local Government Act 2002, section 101A.

21: This occurs when consulting on the proposed content of the LTP. The consultation document must set out the public interest matters relating to the proposed content of the financial strategy.

22: Controller and Auditor-General (2012), Matters arising from the 2012-22 local authority long-term plans.

23: Section 101A(3)(a)(i) of the Act requires councils to explain changes in land use.

24: Controller and Auditor-General (2015), Matters arising from the 2015-25 local authority long-term plans.

25: Controller and Auditor-General (2015), Matters arising from the 2015-25 local authority long-term plans, Part 2.