Going public: The implications of college reclassification

Following an extended, formal, review the Office for National Statistics (ONS) has reclassified further education colleges and their subsidiaries into the public sector. 

What may at first seem to be a technical accounting change will have substantial implications for the way in which colleges are governed, financed, and operate.

The change will for example mean that college debts become part of the national debt; and that colleges will go to the Department, not the banks, to borrow money.

It will also mean that colleges need to seek formal approval from the Department before they, for example, further use their overdrafts or engage in ‘novel’ transactions.

The net risk is that changes sparked by reclassification substantially constrain college freedom to operate – and undermine the sector’s access to capital.

Colleagues will need to take some strategically significant decisions quickly, though we should expect it to take several months before the full implications are clear.

All of the above, in a uniquely challenging fiscal context in which colleges’ energy costs have rocketed, and the pressure – and desire – to increase staff pay is huge.

Government makes lots of proactive policy announcements about the further education sector.  Some have spending commitments attached to them.  But most don’t really matter.  Whether the Department is talking about learning and skills councils or education and skills funding agencies, national skills academies or institutes of technology, local enterprise partnership oversight or local skills improvement plans, the fundamental goals and challenges tend to endure. 

Only the dance moves change.  Fashion, not fundamentals. 

A handful of measures stand above others in their materiality.  The quantum of funding that is available, and the rate of funding per learner.  The agency’s funding and compliance rules.  The substance of the latest version of Ofsted’s inspection framework.  These are measures which always bite.  Which are worth reading.  Which drive behaviour… and outcomes. 

This week, the Office for National Statistics (ONS) may well have sparked change in further education more profound than any we have seen since the Further and Higher Education Act 1992.  They did it without the customary ministerial visit, chef’s whites or hard hat. 

They did it without comment on spending implications.  But, like a new Beyonce album from the blue, they dropped a banger… 

They reclassified English further education colleges into the public sector.

Why did they do it, and why now? 

In truth, colleges have long lived close to the borderline.  Incorporation in 1992 pushed them out of local Government, with new freedom to operate in whatever manner they saw fit to fulfil their charitable objectives.  But their heavy reliance on public funding, and the controls that have always come with it, have kept them close. 

Indeed, in October 2010 they were fleetingly reclassified to the public sector – and back out again in April 2012.  They were classified into the public sector on the basis of the control which Government exercised over colleges’ corporate policies – including the fact that colleges needed consent to borrow.  The Education Act 2011 had the aggregate effect of removing enough of that Government control for ONS to push colleges out again.

This most recent ONS review was sparked by the passage of the Skills and Post-16 Education Act – which received Royal Assent in April.  Amongst other things, the bill granted the Secretary of State additional reasons to remove college boards, most notably if the college was, in the eyes of the Secretary of State, failing to meet local need.

It appears that this addition, together with changes to international guidance, has tipped the balance in the expert eyes of the ONS – creating a level of Government control over colleges which requires that they be considered part of the public sector, with all that entails. 

The full implications are not all yet wholly clear, but the sum of them will likely be substantial – impacting how colleges are funded, governed, and led…  And therefore how they deliver for the communities they serve. 

There are some things we can assume with a level of confidence, given extant, general, guidance and the examples of academy trusts, and colleges in Scotland – which were reclassified into the public sector in 2014.

Colleges’ debts will consolidate into the national debt…

One of the most important, and problematic, implications of reclassification is that colleges’ assets, and liabilities, will consolidate up into the national balance sheet.  Put simply, college debts will become national debts. 

And there are quite a lot of them.  According to the Department’s most recent data drop, in July 2021 England’s colleges owed c£1.1bn between them.  190 of 231 colleges have some level of debt; 31 have borrowings greater than £10m, seven have more than £20m. 

Lots of the other implications of reclassification, as they emerge, will have their origins in this one.  Government cannot leave colleges free to manage their financial affairs however they want when their position aggregates up into the Department’s own.  The finance function’s inevitable desire for governance and control will not sit comfortably alongside a strategic policy position predicated (albeit conditionally) on the value of local freedom and flexibility.

Colleges’ accounts will need to be consolidated into the Department’s

The reporting corollary of the above is that colleges’ annual accounts will need to be consolidated into the Department’s – from 2024, it has confirmed.  Given the amount of financial information which colleges already provide to the ESFA, it would be easy to imagine that this will be quite a small and straightforward change… but it won’t, particularly if year-end dates change, which in and of itself would be fifty shades of carnage.

The Department will need to work through exactly what it wants and needs to do on this.  They have confirmed that they will produce a College Financial Handbook – likely taking the Academy Trust Handbook as their starting point.  Creating and implementing a standard chart of accounts for colleges will be more complex than for schools given the complexity and diversity of college business models – including commercial subsidiaries, etc. 

Will colleges be able to continue borrowing money on the commercial market?

Reclassification will almost certainly mean that colleges cannot borrow from commercial lenders; Treasury orthodoxy (resurgent such as it is) dictates that public bodies should not borrow on the commercial market because Government can borrow at much lower rates. 

If colleges can’t readily borrow from commercial lenders, the question becomes whether they will be able to borrow at all?  Without access to borrowing, colleges will need to build up the reserves necessary to fund such projects before they can commence. 

The Department has announced £300m of funding for the current year, to eliminate the ‘current deficit in funding’ and ‘move to a profile of funding which better matches need’ – whatever those two things mean, exactly; and £150m for 2023/24 to support capital spending.  As ever, whether this is additional funding – and exactly how it will be used – will be crucial.

The other thing the Department has said, already, is that further use of existing overdraft and revolving credit facilities will be subject to a ‘consent process’ – and that they expect colleges to phase out existing overdrafts and revolving credit facilities by August 2024.  How the Department will handle the likely volume of requests for consent in a timely manner, we are not sure; and how it expects colleges to not need liquidity facilities in 21 months’ time, we have no idea.

And the more strategic question remains; will college be able to access capital – in future from the Department – as readily, and at the level, they have been able to from commercial lenders to date?  Given the overall fiscal context, it seems unlikely.  The risk is that Departmental lending is necessarily constrained and focussed on averting failure – rather than strategic investment.

Notwithstanding the level of funding to be made available, mobilising and operating a proper lending facility from the Department will be very difficult.  To lend at scale, you need a banking licence, banking software, a credit committee, lending agreements, and a robust debt management regime.  That is to say… you need bankers, and you need lots of money. 

If colleges won’t be allowed to borrow, how will their existing lending be managed out?

Perhaps the most pressing question for colleagues in Sanctuary Buildings is what to do about colleges’ existing borrowings, including particularly that which needs paying back, in full, soon. 

The Department has said that colleges’ existing debt commitments do not need to change, and should be repaid to maturity.  Where loans have lump sums to be paid, i.e. so-called ‘bullet debt’, the Department will step in to provide funding that will enable colleges to repay the debt – and will recover funds over an agreed timeline. 

It will be very interesting to see the detail of the Department’s approach to such cases – and to understand the level of funding that is required to address them.  There is a risk that stepping in to service bullet debt repayment requirements drains the Department’s ability to invest or lend more strategically and with other institutions.

Will colleges retain their current freedom to engage in commercial activities?

In the spring of 2015, I (MH) took over a college that had diversified into everything imaginable, and some things unimaginable.  I inherited a founding stake in the Gazelle Colleges Group, three colleges in Saudi Arabia, a gym franchise, and a communications agency – as well as a schools trust and a bunch of buildings we didn’t need.

The prospect of over 200 institutions diversifying into whatever they want, and taking whatever commercial risks they want, will likely cause indigestion in the Department’s finance function post reclassification.  Colleagues will need to consider whether and how they might constrain, or govern, college commercial activity. 

In its response to the ONS announcement, the Department says two important things on this.  First, it confirms that colleges will retain the ability to operate subsidiaries – including those which deliver commercial activities.  Second, though, it notes that ‘novel, contentious or repercussive’ transactions must be referred to them for prior approval – which, note, is another substantial seam of case work for the Department to service.

This includes transactions which fall outside colleges’ normal range of business; so, we wonder, will this call-in mechanism be how the Department intends to subtly govern college’s commercial activities and diversification?

Will pushing commercial activity into separate or subsidiary companies keep them out?

On this question the position is clear.  The ONS has reclassified colleges and their subsidiaries. 

Several colleges have already taken steps to push commercial activities ‘further away’ from the corporation, in the hope that they might be able to continue operating – and do so in the private sector.  They will now need to take advice on whether the changes they have made mean that entities are in fact still outside of the public sector.

Will colleges be able to retain surpluses and capital receipts?

When colleges were reclassified in Scotland, the decision was that surpluses should be swept into the centre; and that colleges must seek approval from the funding council to retain capital receipts worth more than £500k. 

Ahead of the announcement, there was concern that colleges would not be allowed to retain cash surpluses, or cash balances they have been able to build up over time, post-reclassification in England. This was, no doubt, the spark for many English colleges’ pre-emptive efforts to push commercial entities away from the corporation.

The Department has though confirmed that colleges will be able to retain surpluses, recognising that they help smooth good years and bad years financially. It has also confirmed that receipts from asset disposals must be ring-fenced for capital expenditure. 

That is both sound strategic finance advice – and not what happens in a great many institutions at present.  It will be interesting to see how many colleges fall into difficulty managing their current account without access to capital-generated reserves.

Will colleges be able to reclaim VAT in the same way that academy trusts do?

Colleagues have long argued that colleges should be able to reclaim VAT in the same way that academy trusts do.  The Department has said that colleges’ ability to recover VAT is not related to their ONS classification; this will be disappointing to those who hoped that reclassification would tip the scales and deliver a welcome windfall.

Will colleges’ pension liabilities be guaranteed in the same way that schools’ are?

This is another area in which colleagues may have been hoping for some good news, given parallels and precedents from elsewhere.  In 2013, the Department put in place a guarantee to provide an assurance to LGPS pension fund managers that academies should not be treated as ‘high-risk’ employers.  The guarantee means that if an academy trust closes, outstanding LGPS liabilities are met by the Department – not the pension fund. 

A similar guarantee for colleges would mean smaller deficit reduction payments being imposed on colleges by their LGPS providers.  But – bad news – the Department’s line today is that reclassification ‘does not require any action from colleges’ with respect to LGPS.

Will the intervention regime continue in its current form?

Put simply, what will happen when a given college runs into financial difficulty?  As above, this could be because they have maturing debts which they cannot refinance, or it could be for the raft of reasons colleges currently run into financial difficulty. 

The Department will need to consider whether and how the current regime continues, either as a mechanism by which it manages the implications of reclassification for colleges’ financial wellbeing – and / or alongside arrangements for managing those implications.

Since the wave of mergers which followed the area review process, and the introduction of the college insolvency regime in 2019, a great deal of progress has been made on colleges’ financial sustainability. 

Their accounts show that in the year to July 2021, the ESFA issued only £13m in loans (i.e. emergency financial support) to colleges, compared to £35m the previous year, and £60m the year before that.  It also received £21m in repayments from colleges in 2020/21; £9m in 2019/20.

The Department will need to think about how it sustains that momentum, whilst dealing with the implications of reclassification.  Some evolution of the oversight and intervention regime seems inevitable in the medium-term.  And we (MA) know how complex that work is, having run the Department’s oversight regime for six years until the summer just gone.

Will college governance arrangements change?

As a general rule in public administration, if the money rolls up, so should the decision-making.  That’s tricky – because that isn’t how the further education sector has worked for thirty years, or how the Department has – by implication of successive policy changes, including most importantly the 2022 Act – said it wants the sector to work in the future. 

It is therefore particularly difficult to predict the general extent, and specific ways in which, governance and control arrangements may change.  Post-reclassification in Scotland, colleges: require funding council consent to retain the proceeds from capital asset disposals over £500k; must obtain funding council consent to enter into consulting contracts worth more than £100k; and must seek approval for severance payments over £1k.

Similar controls in England would grind the ESFA, and colleges, to a complete standstill. 

Will this mean that colleges get more money?

Some in the sector – we might call them the ‘optimists who do not watch the news’ – hope that reclassification will mean that Government feels compelled to provide colleges with more money e.g. by increasing the unit of funding.  Anyone who thinks this should ask colleagues in local government or the NHS how being part of the public sector is working out for them.

If anything, we expect that reclassification will make the sector’s outlook more challenging; we presume that the funding announced today is not in any meaningful sense ‘new money’.  In the current fiscal context, it is extremely unlikely that HM Treasury will agree to spend more money on further education.  And to the unlikely extent that they are drawn out, they will want and need to focus on solving the problem of college borrowing before – and therefore instead of – having a conversation about the unit of funding.

What about the learner?

It is hard to imagine a relevant decision that could be further away from the learner experience.  As ever, policy rolls down hill and the learner will enjoy, or suffer, the implications.  Given all of the other challenges our communities face right now, it is vital that learners’ interests guide colleagues’ thinking and decisions.

What now?

The decisions that the Department and others take – and the detailed guidance they issue – on the series of questions outlined above, and several others besides, will determine how big a change reclassification transpires to be for colleges. 

Our hope is twofold.  First, that decisions are taken quickly.  Kwasi Kwarteng will tell you that markets do not like uncertainty.  Second, that decisions are taken strategically.  For colleges to succeed in what may be a new era, they need a clear, coherent, and enabling strategic framework – not the aggregation of a set of technical decisions.

There is a slight risk that the Department reverts to the 2012 playbook, i.e. tactical, legislative tweaks which, they hope, nudge colleges back out into the private sector.  Given the ink is barely dry on the most recent, relevant, Act, that would seem unlikely.  Colleagues will have known that this was coming – and could have tweaked their way onto a different path through that Act.

We should expect that further information, and formal guidance, will emerge in the days, weeks, and months to come.  Some points will need to be resolved quickly.  Others can probably wait.

The effect will likely be that colleges, including particularly their directors of finance and governance, have more questions than answers for a little while yet.  We hope that this piece has helped colleagues frame the issue and start thinking about where, and how, they may need to act.  We will be tracking Government’s response closely – and look forward to working with colleagues to make a success of whatever hand we are, ultimately, dealt.

By Professor Matt Hamnett, Founder of MH&A, and Matt Atkinson, MH&A

Professor Matt Hamnett spent eight years in what is now DfE – where he led work on strategy, policy, and spending in the sector – before working PwC’s strategy practice, Capita’s major deals team and as a CEO in the further education sector before founding MH&A in 2018.

Matt Atkinson spent the six years to August 2022 leading DfE’s provider market oversight function, fostering financial sustainability and compliance in the sector.  Before that, he spent 12 years in PwC’s deals team.  He is a qualified insolvency practitioner.