A new direction for regulation

In the past, the Housing Corporation/HCA has supported RPs that may otherwise be stricken, primarily by increasing grant rates. But with the government only part-way towards its debt-reduction target and highly likely to bear down further on the sector in future spending reviews, the HCA (either in its regulatory or funding role) is in a position to continue to rescue RPs that get themselves into trouble. Suffice to say, from hereon it will be down to the sector to save itself, with the Regulator as facilitator.

The most public of 2013’s viability cases was Cosmopolitan Housing Group’s rescue by Sanctuary Housing Group, brokered by the Regulator, but there have been other, less public, interventions. Individually and collectively, these take up a huge amount of the Regulator’s (already squeezed) resources. It is no wonder that the recent HCA consultation paper on the introduction of fees does not promise any increase in HCA resources in return for a new source of income from the sector. Moreover, it seems clear from Cosmopolitan that even a medium-sized RP now risks being "too big to rescue" should it come to it, and the list of RPs that, realistically, could step in quickly to take on a distressed RP is uncomfortably short.

The Regulator, therefore, sees a clear rationale for strengthening significantly its expectations of RPs to protect more effectively the (estimated by the Regulator) £45 billion of public funds currently invested in social housing to reduce the risk of RPs getting into difficulties in the first place, and make any necessary rescues much easier to deliver. It has suggested it intends to do this principally by:

1. strengthening the Governance Standard of the Regulatory Framework; and

2. enhancing emphasis on risk management and contingency planning in a new/expanded Regulatory Standard.

Interestingly, the Regulator will not impose additional ring-fences around social housing assets (as had been proposed), citing the insurmountable challenges of devising a mechanism that would actually prove watertight, particularly in a climate of increasing diversification by RPs and cross-collateralization within group structures. The proposed ring-fence will be introduced for "for-profit" RPs and RPs that are headed by a non-registered parent.

Evolution in governance

Weak governance and RP failure go hand in hand, according to the Regulator, which will, in future, be much more explicit in its expectations of the performance of RP boards and executive teams. We can expect a restructured Governance Standard around the themes of boards:

• displaying a proper and in-depth understanding of all aspects of the business that their organisation carries out;
• possessing appropriate skills and expertise at board level to manage that business;
• demonstrating appropriate financial governance, which means understanding and ownership by the whole board of fundamental financial concepts including liquidity, covenant compliance and risk exposure;
• understanding the true nature of cross-subsidy and its ability to distort the actual cost of activities – particularly commercial ones - and how this operates in practice across all of the RP’s / group’s activities and the risks this creates; and
• prioritising the long-term financial stability (50+ years) of the organisation, demonstrating long-sightedness in business planning and avoiding short termism.

The expectation is that boards will "own" the governance strength (or lack thereof) of their own organisation based on the risks that they see. For RPs finding their board structure hidebound to a model they cannot change (for example, LSVTs with nominees on their boards), the Regulator is unlikely to do much to make their lives easier. Suggestions from that direction are that an inflexible board composition will not be any excuse for weak governance, and RPs finding themselves in that position could be subjected to a governance downgrade. A more focussed Governance Standard with clearer expectations and consistently applied sanctions for breach should, the Regulator has suggested, assist RPs in their negotiations with intransigent councils (although it is hard to see how).

New focus on risk management

RP boards are financial custodians of the long term financial stability of their organisation which means the long view they should be taking is closer to 50 years than 10. The regulatory expectation for the future will be that RPs run their businesses with an eye to how they will weather the inevitable storms over the long term. This means being proactive in identifying what these risks are and being creative in working out how they can be managed. Whilst the Regulator is unlikely to offer much by way of prescription, there are several constituent elements to prudent risk management that it has indicated it will expect RPs to put in place:

(a) Asset registers

All RPs should have an asset register, but the quality of these across the sector is mixed, with many RPs confessing to a paucity of information about their assets. This can impact on their ability to devise and implement a serious asset management strategy under which to optimise the use of their stock, and also on their ability to rescue – or be rescued – where good data is needed at short notice either to enable funds to be raised by rescuer or rescuee. RPs will be required to have comprehensive asset registers including core information on the properties they own, their title (including defects), rents charged/ property value (yield), and whether the properties are charged, if so to whom and on what terms. We consider asset registers should go further in being used to model future maintenance costs of properties against income stream to help assessments of whether properties should be disposed of or retained. We consider this will be a key tool for RPs to evidence embedding value for money in their future activities, as has recently been in the trade press.

(b) Robust risk assessment

RPs must be absolutely clear about their risk exposure, particularly where these could fall on social housing assets. RPs embarking on new activities need to judge additional risks and exposure cumulatively with the organisation’s existing risks and exposure to make a sensible decision about whether to commit to these activities. It has been suggested that the Regulator’s view is that normal sensitivity testing carried out by RPs is often not robust enough to counter the types of risks it sees for the sector and that it will require RPs to carry out much more significant stress-testing of their business plans.

(c) Living wills and recovery planning

It is very important for RPs to plan for what would happen if a series of adverse effects hit their organisation and any steps they have put in place to mitigate these risks don’t work. If a lender calls in its security, the properties will be lost to the social housing sector. Tenants of the properties will be protected, rent-wise, only until the next rent review and then rents could be increased to market rent. This would be devastating in itself but the wider implications to the sector are more concerning. It could trigger a significant loss of confidence followed by a reduction in the volume of lenders willing to lend within the sector and an increase in margins charged by the rest of them. Clearly, it is in everyone’s interests to avoid this happening at all costs.

There has been much talk about RPs being "too big to rescue" and what this tends to mean is "too big to rescue whole" – if RPs are prepared and equipped to portion themselves into component elements, this makes it much more likely that rescuers (in the plural) could be found and the risks above drastically reduced.

Therefore the Regulator will expect RPs to formulate a strong contingency plan including:

• Having an assets register listing all relevant data (as above);
• Devising a strategy for being rescued (for example, jettisoning / allowing part of the business to be rescued by someone else to ensure the continuation of the rest of it);
• Analysing their funding documentation so they can work out how to manage a rescue;
• Equipping themselves with a proper “contracts estate” (copies of all relevant documents including constitutions, transfer agreements, loan documentation, property documents, key contracts etc).

It is everyone’s hope that contingency plans will never need to be called upon, but RPs should be doing what is necessary to ensure that, should the need arise, all of the relevant information is at their (and the Regulator’s) fingertips.

Once the Regulator has settled on the wording of the changes to the Regulatory Framework, this will be put out to consultation for the statutory 3-month period. This is likely to be in Q4 of 2013/14 or Q1 of 2014/15. Thereafter, the final standards will be issued with a firm adoption date.

However these may look when they are issued, it is clear that this marks a significant step-change in the Regulator’s approach to regulation and RPs will need to accommodate this as soon as they are able. The Regulator must be prepared to be pragmatic about this – governance change takes time (as the many organisations still trying to implement the current expectations over board sizes and renewal demonstrate) and upskilling boards to meet the Regulator’s requirements around business planning and risk management will not happen overnight. We recommend that all RPs start to think about this now rather than wait and, to help with this, we will continue to monitor progress on the Regulatory Framework and will issue updates and guidance to RPs as appropriate.

Regulator to pass on the costs of regulation to RPs

The evolution of the Regulator’s approach to regulation is not all one-way and it has spent much of the past 12 months on a significant and strategic internal restructuring designed to enable it to regulate more effectively. Whereas previously, the Regulator had separated its financial analysis function from its governance function, it has now combined the two into a multi-disciplinary team structure based around financial analysis and engagement overseen by regulation managers. There is also now a separate central quality assurance team which is designed to ensure consistency via the evidence-based central grading of RPs and risks, and to ensure that lessons are learnt and shared across the Regulator where appropriate. A separate and specialist "for profit" team has been formed because the Regulator anticipates this will be a growth area in the future and it has doubled the size of its "investigation and enforcement" (ie troubleshooting) team as a response to the resourcing implications of its direct engagement with troubled RPs.

Clearly, all of this comes at a cost and, very recently, the Regulator has published a discussion paper on its proposals to invoke its statutory right to charge RPs for the privilege of being regulated. Final proposals are to be published by October, with April 2015 as the earliest date for the introduction of fees, but at this stage the Regulator is contemplating a two-stage approach (although it has not ruled out introducing new, additional, fees for other regulatory functions in the future):

First, a registration fee for new RPs (which could reflect the cost to the Regulator of registering an RP, estimated at £10,000 per applicant) and, secondly, an annual fee calculated (it has suggested) by reference to the number of units the RP has. The annual fee will be payable per group, rather than by each RP in the group (which could mean smaller RPs in groups benefit).

There are a number of immediate questions surrounding these new proposals. For example:

• To whom does the Regulator owe its obligations and how will it balance them? To tenants? To the Government? To the wider HCA? To RPs? To the sector’s funders? Or to all of the above?

• Will RPs be permitted a greater say in the Regulator’s remit if they are required to fund its existence?

• What would happen if a disgruntled RP chose not to pay? Would it receive a downgrade or some other form of penalty?

• Is it really appropriate for the Regulator to be funded by RPs while it still sits within the HCA?

As with the April 2013 discussion paper on the future of regulation, the Regulator may simply be seeking to stimulate a wider discussion on the role of the Regulator and RPs are encouraged to submit their responses to the consultation by the deadline of 21 March 2014 to help inform the debate.

For more information

For more information contact Victoria Jardine on 07811 326084 or victoria.jardine@anthonycollins.com.