Housing Treasury – Financing Risk Plenary three: Regulating social housing providers Speakers:Jonathan Walters Deputy Director, Strategy and Performance Homes and Communities Agency Gareth Hall Partner, Banking, Governance and Corporate Devonshires

Successful places with homes and jobs A NATIONAL AGENCY WORKING LOCALLY The Regulator’s Perspective Jonathan Walters, Deputy Director Strategy and Performance 23 October 2013

The SHR’s objectives, duties and general approach  The economic regulation objective  The consumer regulation objective  Ensuring that social housing assets are not put at risk  Protecting the public value in the assets  Helping to ensure that the social housing sector can continue to attract the necessary finance to build new homes  Minimise interference  Proportionate, consistent, transparent and accountable  Co-regulatory principles underpin the regulatory approach

Diversification in the sector  Involvement in a greater range of activities  More complex financing arrangements and organisational structures  Wider range of business models involved in social housing  Different business models emerging  What is the function of a social housing business?

Diversification – the case for  A rational response to changes in the operating environment  Cross-subsidisation (ish) of social housing activities  Facilitates development of new homes  Contributes to wider economic and social benefits

Diversification – the issues  Legal ability to undertake an activity  The full range of implications and legal obligations  The links between social and non-social activities and within groups  Cross-subsidisation of non-social housing activities?  Impact of capital outlays on cash balances

Current regulatory approach to diversification  In line with the Regulatory Framework and Regulating the Standards  Boards sighted on risks and have effective strategic planning and control frameworks in place  Understanding the links between social and non-social activities and within groups  Understanding the mechanisms for ensuring that social housing assets are not put at risk  Using the same sources of assurance that Boards use where possible

What is the regulator looking for?  Liquidity  Interest cover  Gearing  Security  Headroom against covenants and stress tested, for example: –Delay in sales / drop in values –Increases in interest rates –Reduction in rental income (e.g. owing to welfare reform)  Board engagement and quality of advice  Fit with business plan

Some more challenging issues  Non-social housing: level of recourse to the social housing assets? –On balance sheet –On-lending –Guarantees  Technical covenants – e.g. around on-lending  Complexity and byzantine structures  Manage future exposures – e.g. index-linked finance; derivatives  How do the new finance structures play out in an insolvency? –Capital markets – public bonds / non-UK private placements –Sale/lease and leaseback –Unsecured creditors (including retail investors)

Diversification  Where are we? –Responses to the discussion document are due to be published this week –Series of external stakeholder events in the autumn –Working towards publication of discussion document early next year

What was in the discussion document responses?  Recognition that there was a problem that needed addressing  Many providers concerned about ring fencing, although many lenders were keen on the concept  General support for resolution and recovery planning, but concerns over practical implementation  Jury divided on the disposal of properties to for profit entities

What will be in the consultation document?  Revisions to G&V standard  Disposal of Assets  Registrations Guidance  Rents – following direction from DCLG

Protecting the social housing assets  The regulator is looking for a 5 pronged approach: –Understand you assets and liabilities –Understand your contingent liabilities – not just on a legal basis –Understand how they perform through an economic cycle –Understand what combination of factors can derail the business and what mitigations can be put in place –Have a plan for protecting the social housing assets in the event of a business failure  This will be set out in the revised G&V standard and the associated code of practice

Issues to be resolved  The regulator’s thinking is still developing, but issues to be dealt with include: –What is the role of boards and executives? –Is there a place for third party assurance? –How does the regulator judge a good plan? –What happens if the regulator has concerns?  This will be a step change for many providers and there will be greater scrutiny of the business models of providers  The fundamental issue remains – how do we protect social housing assets, whilst funding new development, in a more challenging operating environment

Regulating Social Housing Providers Gareth Hall Partner Devonshires Solicitors 23 October 2013

What I will be talking about What’s it like out there for RPs? Conclusions from consultation paper HCA: investment and regulatory roles Permitted activities: legal constraints New business, new ways of doing business Risks and how to manage them Recovery planning

What’s it like out there for RPs? Rising delivery targets, falling grant Need to cross subsidise: diversification Diversification brings risks – need to accept and manage them RPs need freedom to deliver their development programmes There’s no going back

Conclusions from Consultation Paper Full ring fencing not achievable Some trade-off risk and reward is inevitable “One size doesn’t fit all”  capacity; capability; size; history; geography; appetite for risk Regulatory focus on outcome: maximise output, manage risk …and robust measures to prevent business failure

HCA: investment and regulation Investment arm: more than social housing: objects relate to, in England (H&RA, s2)  Improve supply and quality of housing; regeneration and development of land and infrastructure; creation, regeneration, development and wellbeing of communities; sustainable development and good design. Initiatives have included Help to buy; Build to Rent; Get Britain Building; PRSI Regulatory focus: protect social housing and associated funding (section 92K)

RPs’ permitted activities Provider of (at least some) social housing: low cost rent, LCHO (s80, 112) Registered (or small) charity or (s115): Non profit; purposes are provision or management of housing, and matters connected with or incidental to provision of housing Complies with regulation: financial, constitution (governance) and management (s112)

Charity law Primary purpose activities: low income (affordability), elderly, disabled On-balance sheet non-primary purpose trade: “no significant risk” Financial investment: market rent; loans/equity for subsidiaries Investment policy: issues similar to HCA’s i.e. identify and manage types of risk and return Mixed motive investment Tax/gift aid

Diversification: non-social housing business Sale Market rent Key worker, student? Care (stand-alone)

Commercialisation: how you do business Could be social, non-social or mixed Group structures Joint ventures and consortia Cost share groups Buying businesses and companies Agency and Franchising Leasebacks Bond issues? Use of proceeds

Legal risks to core business Equity/loan investment Who contracts for mixed developments Guarantees, indemnities, step-in Cross collateral Comfort letters Leasebacks: forfeiture risk Loan covenants: repricing, intra group cross default

Legal protection It’s all about risk; so manage it Identify your limits: mission-creep, support-creep Play the vires and regulation card RPs are not banks Internal processes; training

Recovery planning Stress test business plans to ensure they can withstand most serious challenges Can social housing assets be protected? Not just the usual sensitivity analysis Will the HCA sign them off? Capacity/expertise External validation? What if things change? Monitoring/review Tendency to down play risks? Implications for rating agencies

Where should the focus be? Effective risk management and monitoring Exit strategy/risk management plan Vires may prevent bringing activity on balance sheet Board composition– capacity to understand and manage risk Don’t lose sight of core social housing business Value for money