Consultation outcome

The future of the IFRS 9 statutory override: government response

Updated 6 April 2023

Part One: Introduction

The local authority accounting framework

The Department for Levelling Up, Housing and Communities has policy responsibility for local authority accounting. Section 21(1) of the Local Government Act 2003 (“the 2003 Act”) provides that the Secretary of State may make provision about the accounting practices (“proper practices”) to be followed by local authorities. Section 21(2) provides that ‘proper practices’ includes both enactments and codes of practice specified by the Secretary of State.

In practice, under Regulation 31(a) of the Local Authorities (Capital Finance and Accounting) (England) Regulations 2003 (”the 2003 Regulations”) local authorities must follow the Chartered Institute for Public Finance and Accountancy (CIPFA) Code of Practice on Local Authority Accounting in the United Kingdom (“the Code”) as containing proper accounting practices. This Code is typically reissued in every financial year and applies only to principal authorities. Since 2010/11, the Code has been based on International Financial Reporting Standards (IFRS), as adapted or interpreted for local government.

The Secretary of State has a broad power under the Local Government Act 2003 to make provisions about accounting practices, which local authorities are required to follow, including where these may conflict with the Code. Such provisions are typically referred to as “statutory accounting overrides”. Statutory provisions on accounting practices are an important component of the current local government accounting framework. However, new overrides are normally only introduced by the government in strictly limited circumstances.

The government supports high-quality reporting. There is a process through which new accounting standards are reviewed and adopted by the Code, and approved by the CIPFA LASAAC Board (“CIPFA LASAAC”). The process allows for the adaptation and interpretation of accounting standards for principal authorities. Where the government considers the necessity of introducing, amending or extending a statutory override, it will consider the balance of risk between introducing a divergence from normal accounting practices and the risks that need to be addressed. The government will also consider whether legislation is the appropriate mechanism.

History and context of IFRS 9 pooled investment funds override

From April 2018, local authorities were required to comply with the new standard IFRS 9: Financial Instruments, following its adoption, in full, by the Code. IFRS 9 replaced the International Accounting Standard 39 (IAS 39) and introduced a number of changes. Of particular relevance to local authorities, changes brought by IFRS 9 meant that more financial assets would be required to have any annual changes in value (known as “fair value movements”) recognised as profit or loss, whereas before movements for such instruments may have been held in a reserve with any movement in value only affecting general fund balances when sold.

Adoption of IFRS 9 by the Code was approved in November 2017, by CIPFA LASAAC. At that time, the Board released a statement setting out that it had considered the relevance of IFRS 9 to local authority investments and concluded that full adoption of the standard was appropriate, and that implementation would help to drive improved transparency and decision-making. CIPFA LASAAC acknowledged that the adoption of IFRS 9 would mean that the gains and losses arising from the changes in the fair value of some categories of investment would consequently impact the general fund (referred to herein as “the revenue account”). Consequently, authorities would be required to consider these fair value movements as part of their statutory duty of setting an annual balanced budget.

Local authorities raised concerns with the government, particularly with respect to collective investment vehicles (“pooled investment funds”) that would fall within the new requirements of IFRS 9. Many authorities use pooled investment funds for treasury management and, prior to the introduction of IFRS 9, had built up positions in these assets. Authorities argued that where gains and losses would need to be recognised in revenue accounts this could have a detrimental effect on their financial position and ability to deliver services, as losses would reduce available resources while gains would not represent genuine resource increases that could be spent. Local authorities have a statutory duty to annually set a balanced budget, which necessarily must take into account income and expenditure recognised in the revenue account. The impact, it was also argued, would be particularly acute on transition from IAS 39 to IFRS 9.

To address concerns, the government consulted (PDF, 384 KB) in July 2018, publishing its response in November 2018, and consequently introduced a statutory override (“the Override”). To fully understand the Override, it is important to note the unique characteristics of local authority accounts. In producing the annual accounts, authorities follow accounting practices as set out in the Code. However, there are differences between the expenditure and income recognised under the Code and those charged to the revenue account (on which the council tax requirement and balanced budget is based). For example, depreciation (a cost to recognise the economic consumption of assets) is a charge to the Comprehensive Income and Expenditure Statement under the Code, but not to the revenue account. There are a number of other adjustments that are made. Local authority accounts contain additional statements and supporting notes to show the adjustments from the financial statements produced under the Code and the revenue account.

The Override does not affect the element of the accounts produced under the Code, but does introduce a further adjustment in arriving at the revenue account position by requiring local authorities to reverse out all unrealised fair value movements resulting from pooled investment funds to a reserve. This removes any impact or risks to budgets that authorities had raised as concerns. Statutory overrides such as this are described as deviations from normal accounting practices (i.e. those set out the Code and which are largely consistent with the standards applied by other public bodies), as they remove or change the consequences of accounting treatments for the revenue account and add additional complexity to an authority’s statement of accounts.

The Override was limited to a period of 5 years, to expire 31 March 2023, to reflect the duration pooled investment funds are typically held, and provide authorities sufficient time to review their investment strategies. As set out in the consultation response, the government did not see a case for a permanent deviation from normal accounting practices and there was no indication that this measure would be made permanent in the future, although the government undertook to keep the Override under review.

The future of the override and the government response

To inform the future of the Override post March 2023, the government conducted a consultation asking for views on the options to: make the override permanent; extend it for a limited period; or allow it to elapse as at 31 March 2023. The consultation also requested data to better understand the financial position of the sector and the consequences of the different options. The consultation ran from 11 August to 7 October 2022. Within that period, there were 104 respondents who took part in the consultation. The government is grateful for the responses received and all responses have been taken into consideration. Further detail is set out in Parts 2 and 3.

Having considered the consultation responses, the government intends to extend the Override for an additional two-year period until 31 March 2025. Other than extending the period to which the Override applies, no other changes will be made to the Override.

The government recognises that due to economic issues arising from the COVID-19 pandemic, this may have limited authorities’ options to divest from investments. Further, that financial pressures on local government due to the pandemic and current wider economic issues, including interest rate and inflation increases, mean that allowing Override to end now could put additional pressure on local authorities’ finances. This could undermine other efforts to support financial stability.

As a pragmatic approach, the government will put in place a temporary extension to extend the existing override for a further two years, until 31 March 2025. The government expects authorities to carefully consider their current and future investments, including whether volatility and risk can be managed without detriment to service delivery and sustainability, while complying with proper accounting practices.

Part Two: Overview of the consultation

This part sets out a high-level summary of the engagement with consultation and the number and categories of respondents. A summary of the responses by question and the government’s response on specific matters raised is in provided in Part 3.

The consultation ran from 11 August to 7 October 2022. Within that period, there were 104 respondents, including 96 local authorities. Responses were also received from CIPFA and the Institute of Chartered Accountants in England and Wales (ICAEW), the Local Government Association and local government advisors.

Table 1A: Breakdown of respondents by type

A total of 104 respondents too part in the consultation. The majority of these were from local authorities.

Category of respondent	Number of respondents	Percentage of total
Local authority	96	92%
Organisations representing local government	3	3%
Local government advisors	3	3%
Other organisations	2	2%
Total	104	100

Table 1B: Breakdown of local authority respondents by class

Segmentation of the 96 local authority responses to the consultation. Shire Districts account for almost half of respondents followed by Shire Counties and Unitary Authorities. Police and Fire & Rescue authorities are included as ‘Other’

Class of authority	Number of respondents	Percentage of total
Shire District	45	47%
Unitary Authority	14	15%
Shire County	12	13%
Metropolitan District	11	11%
London Borough	9	9%
Other	4	4%
Combined Authority	1	1%
Total	96	100

Notes: the tables show the breakdown of individual respondents. Where organisations submitted a joint response, each organisation is counted separately to accurately reflect the number of participants. There were 100 individual responses.

The consultation asked a total of 11 questions (13, including 2 sub-questions). These can be considered, at high-level, to have collected evidence on:

• views on the future of the Override. Specifically, whether it should be allowed to elapse, extended or made permanent, and the rationale for stakeholder views.
• the risks and benefits of the Override, including the financial risks to local authorities of the different options and consideration of the impact to financial reporting and risk management.
• the impact of the timing of any decision with respect to the Override.
• the financial position of local authorities with respect to pooled investment funds.

Part Three: Summary of responses

This section summarises the responses to the consultation and provides further detail on the government’s response to specific matters raised. As this is a summary, it does not attempt to capture all views that were shared as part of the response to the consultation. All views, however, have been carefully considered.

Q1) In your view, what should the future of the IFRS 9 override be post March 2023 [elapse/extend/make permanent]?

Of the 99 responses from local authorities and bodies representing local authorities, the vast majority were in favour making the Override permanent (91 responses), while only 8 expressed the view that the Override should not be made permanent. Of the non-local authority respondents, only 1 expressed the view the Override should be made permanent, while 5 stated that it should be allowed to elapse or be extended only on a limited basis with a clear end date.

The arguments for making the Override permanent remain similar to the responses received to the 2018 consultation. In summary, these were:

• that without the Override, the fair movements of pooled investment funds will need to be reflected in the general fund. This will introduce volatility to budgets giving losses that would need to be managed, potentially through increasing council tax or cutting service expenditure, while gains do not represent usable resources. That pooled investment assets are low risk over the long-term, and that it is therefore inappropriate to introduce annual volatility.
• that there are a number of other statutory overrides in place, and so a permanent override would not be without precedent. A number of respondents stated that authorities do have to comply IFRS 9 in full when producing the accounts in compliance with the Code (see paras 1.8 to 1.9), thus facilitating transparency for the user of the accounts.
• that there are local processes to monitor investment risk and a duty to comply with statutory codes of best practice, suggesting that risk is sufficiently transparent and taken into account without the requirement of fair value movements to be taken to the revenue account.

Many reponses stated that the underlying reasons for the Override have not changed since 2018, and there would always be some degree of volatility and economic uncertainty associated with pooled investment funds, therefore the Override should be made permanent.

Of the respondents that stated the Override should be allowed to elapse, the main arguments were that local authorities are exposed to same levels of risks from pooled investment funds as other entities are, and it was therefore appropriate for IFRS 9 requirements to apply on the same basis. It was acknowledged that the Override does not affect the valuation on balance sheets (produced in compliance with the Code), but that removal of fair value movements from the revenue account results in a loss of transparency by removing any impact to the general fund position and reserves, and defers risk to when the assets are sold.

There was general consensus amongst the majority of respondents (local authorities and others) that recent events such as the COVID-19 pandemic and wider economic conditions mean this is a particularly difficult time to change the status of the override.

Q2) Please describe any financial consequences for your authority if the statutory override is allowed to elapse from 31 March 2023?

As per responses to Q1, the majority of local authority respondents mentioned the need to recognise fair value gains and losses from inherent market volatility impacting the budget as a major consequence, and references were made to cutting services or increasing council tax to manage annual losses. Some respondents indicated that if the override elapsed, this would make pooled investment funds less attractive, potentially leading to divestment or avoiding these investments in future.

Q3) What are the advantages and disadvantages of investing in pooled investment funds for your LA (Local Authority)?

There was general consensus across the respondents that pooled investment funds offer benefits of diversifying investment portfolios, spreading financial risk and that pooled funds also give consistently better returns than other investment options available to local authorities. Some local authorities also referred to the benefits of such funds being managed by professional fund managers on their behalf.

The disadvantages given were that pooled funds are relatively illiquid so local authorities do not always have easy access to the cash if it is required. It was also recognised that the capital value could fall, though the majority of authorities expect values to increase over the medium to long-term. Other specific risks mentioned include the complexity of the underlying asset within a fund, a lack of control by the investor and that if a large number of investors chose to exit at the same time this could cause issues with the timely withdrawal of funds.

The current capital framework was also cited as a disadvantage, as having to recognise unrealised gains and losses in revenue accounts disincentivises particular investment assets. This refers to the fact that, under the capital framework, certain types of investment are required to be treated as capital expenditure (“capital investments”). This is intended to bring riskier investments under the controls of the capital system. Capital investments do not, however, directly affect the general fund through fair value movements. Pooled investment funds that fall under the scope of the Override, are not capital expenditure, reflecting that they are generally considered to be lower risk.

Q4) How would removing the statutory override change your current approach to investing in pooled investment funds?

Around 20% of local authority respondents advised that there would be a reduced or hesitant appetite to invest in pooled investment funds due to the need to recognise the annual gains and losses in their budgets, and some refered to divesting from existing investments should the Override end. Risks highlighted included a loss of investment income if authorities avoided or divested from these investments. Some respondents also stated that removing the override could result in a shift in authorities’ investment strategies. In terms of managing risks, respondents referred to setting aside reserves, using fair value gains where possible, to offset future fair value losses as mechanisms that would need to be used if the Override ended.

Q5) Assuming the statutory override elapses in March 2023, what impact might this change have on your audit process?

Over half of respondents believed there would be no impact to their audit processes as gains and losses in fair values of pooled funds are already reported in the accounts produced under the Code, if not recognised in the revenue account. However, around a third advised that there may be extra scrutiny from external auditors if the override is removed, due to the inherent market volatility of pooled funds impacting on setting a balanced budget.

Government response to Q1-5

The government recognises the arguments put forward, and that removal of the Override will mean that fair value movements of pooled investment funds will need to be reflected in budgets, and that this will create additional volatility. The government also agrees that unrealised gains and losses should not lead to pressures on service delivery or be reflected in council tax. The government does not want to impede sensible treasury management, however, local authorities should ensure that their investment strategies effectively manage their exposure to such volatility, and authorities should not become overly exposed such that volatility can have a material effect on their ability to set a balanced budget or deliver services.

There is robust process for interpreting and adapting accounting standards for local government through the Code, and IFRS 9 was adopted in full following due process, on the basis it should apply to local authorities as it does to other entities.

As reported in the Redmond Review, the introduction of statutory overrides lengthens accounts, increases complexity and reduces usability. Each override must be considered on a case-by-case basis, including whether divergence from consistent accounting practices itself is appropriate and whether legislation is the correct mechanism to do so.

The government notes the comments on the impact to audit.

Q6)a) Assuming that the statutory override is continued beyond March 2023, do think it should be time-limited or permanent?

b) If you think the statutory override should be time-limited, what do you consider the appropriate length of time it should be extended?

Many respondents cited answers already given for Q1 as reasons for the override to be made permanent if it does continue past March 2023. The main reason provided was that market conditions since the override was put in place in 2018 have not changed, and therefore the Override would always be needed.

Of those authorities that expressed a view on any time limit, most asked for a further 5 year extension to match the investment period such assets are held and to minimise the impact on medium term planning. Of the non-local authority respondents, durations of 2 years were put forward on the rationale that authorities have had 5 years to prepare, but recognising that allowing the Override to elapse now could exacerbate current financial challenges.

Q7)a) If applicable, has your authority taken steps to reduce its exposure to the risks associated with pooled investment funds ahead of the statutory override potentially ending 31 March 2023?

b) If your authority has not taken steps to reduce its exposure to risks from pooled investment funds, please set out the rationale for this.

Of the 85 local authorities that reported they have pooled investment fund assets, 47 local authorities indicated they had taken some form of action that would limit the risk of the Override ending, or that their position would mean there was limited impact. Actions included limiting exposure to pooled investment funds, avoiding new investments, or setting aside reserves to manage annual volatility. Most respondents believed they have appropriate risk mitigations in place and that investing in pooled funds has diversified their portfolio enough to spread the risk and reduce exposure to volatility.

A number of authorities said that the COVID pandemic had led to decreases in the value of their investments, limiting the opportunity to sell without a loss. Some authorities also mentioned that they were unwilling to change their investment strategies until they had a clear decision and guidance from government on the future of the Override – either make permanent or be clear that it will elapse from a specified date. A minority of respondents stated they assumed the override would be made permanent so have not considered changes to their investment strategy at the time of responding.

Q8) Do you agree that by not recognising the fair value movement of pooled investment funds this reduces effective risk management and potentially creates future risks?

All 99 local authorities and local authority representatives responded to this question and 82 disagreed with the statement. Of these, 43 advised that the fair values of pooled funds are already reported by being disclosed as a separate line item within the unusable reserve, so the council has sight of any movements in their financial reporting. Respondents also believed that they currently have appropriate risk mitigations in place to reduce exposure, as detailed in Q7a and Q7b above.

Of the 5 non-local authority responses, only 1 disagreed. Of those that agreed, the risks highlighted included that the Override could obscure increasing fair value losses and the final impact this might have on the resources of the authority, should the underlying assets not recover their historical value, or if the investor is forced to exit in a loss position. That the Override removes the incentive for authorities to focus on the fair value movements and manage their risk, and investors may focus solely on the yield provided by the investments.

Government response to Q6-8

The government notes that many authorities stated that they have risk management processes in place to consider their investment strategies. The government expects authorities to have robust, local processes to set and monitor investment strategies and appropriately manage risk. In making investments, authorities must have regard to statutory guidance and codes produced by CIPFA and the government, and appropriately comply with the Prudential Framework*. Authorities are also required to have sound systems of internal control and have a statutory requirement to meet their Best Value Duty.

It is noted that many authorities have taken steps to reduce their exposure to volatility from pooled investment funds. The duration of the original Override was established as a reasonable timeframe for authorities to address the risks highlighted in 2018 associated with the adoption of IFRS 9. As set out, the government has decided to extend the Override a further 2 years, reflecting the current economic environment.

*The Prudential Framework refers collectively to the legislation and statutory codes under which authorities borrow and invest.

Financial data

Questions 9 to 11 of the consultation were intended to collect financial data to better understand the sector’s financial position with respect to pooled investment funds.

Q9) What is the fair value of your authority’s pooled investment fund investments as at 31 March 2022?

Of the 96 local authorities that responded, 85 authorities reported a value for pooled investment funds as at 31 March 2022. The fair values reported total £2.46 billion. This is broken down further by authority class in the table below. 11 authorities reported no assets held or did not answer.

Table 2: value of pooled investment funds as at 31 March 2022

Local authorities were asked to provide the fair value of their pooled investment funds as at 31 March 2022. This table sets out the aggregate value by class of authority.

Class	Number of responses	Total (market value) as at 31 March 2021 £’m
Shire County	11	816
Shire District	41	689
Unitary Authority	14	416
London Borough	6	325
Metropolitan District	8	142
Combined Authority	1	47
Other	4	28
Total	85	2,464

Notes: the values are taken directly from the responses provided in the consultation returns.

Q10) Please set out the value of the gains/losses from your authority’s investments in pooled investment funds for the financial years 2019/20, 2020/21, 2021/22, recognised under proper practices.

Of the 85 authorities that reported a value for pooled investment funds as at 31 March 2022, 71 authorities responded to the question, and provided values for the gains and losses in their pooled investment funds over the three-year period 2019/20, 2020/21 and 2021/22.

Class of authority	Number of respondents	Sum of 2019/20 gain/(loss) £’m	Sum of 2020/21 gain/(loss) £’m	Sum of 2021/22 gain/(loss) £’m
Shire County	10	-77.1	59.2	50.6
Shire District	36	-52.0	38.6	28.2
Unitary Authority	12	-32.1	-1.9	32.4
London Borough	4	-12.0	9.1	4.4
Metropolitan District	5	-5.7	1.2	9.4
Combined Authority	1	-2.3	1.6	1.1
Other	3	-2.3	1.6	2.3
Total	71	-183.5	109.4	128.4

Notes: the values are taken directly from the responses provided in the consultation returns. The values are for fair value gains and losses only, and do not include dividend income.

Q11) What is the balance on the unusable reserve as created by the statutory override as at 31 March 2022?

Of the 85 authorities that reported a value for pooled investment funds as at 31 March 2022, 80 authorities responded to this question. The net total was an overall fair value gain of £79 million held in unusable reserves. Of these 80 respondents, 64 authorities held a gain in their unusable reserve (totalling £89 million), while 16 authorities held an overall deficit (totalling -£11 million). Some authorities stated that more recent valuations indicate asset values have fallen over 2022/23.

Government response to Q9-11

The government notes the information provided and the overall decline in asset values in 2019/20 and that a number of authorities indicated that the value of the investments is likely to have fallen over 2022/23. In recognition of the challenging economic environment and financial challenges authorities are exposed to, the Override will be extended a further 2 years.