Mr Edward Davey (Kingston & Surbiton, Liberal Democrat)

I beg to move amendment No. 50, in

clause 7, page 3, line 22 at end insert—

'(c) the transaction is related to a 'private finance initiative' or a 'public-private partnership.'.

Mr Derek Conway (Old Bexley & Sidcup, Conservative)

With this it will be convenient to discuss amendment No. 32, in

clause 7, page 3, line 36, at end add—

'( ) The Secretary of State shall lay regulations before Parliament within 30 days of the coming into force of this section providing for liabilities under Private Finance Initiative contracts to be apportioned so that, where appropriate, a part of those liabilities are to be treated as a credit arrangement.'.

Mr Edward Davey (Kingston & Surbiton, Liberal Democrat)

Amendment No. 50 would ensure that, when the Government set the rules for credit arrangements for local authorities, PFIs and PPPs are on a level playing field with other credit arrangements. Having re-read the amendment, I can see that it may have one or two technical defects, which I am sure that the Minister will bring to the

Committee's attention and for which I apologise. If there are technical defects, perhaps he will explain how we can get the amendment right. The intention behind it was certainly to try to ensure a level playing field for local authorities as they consider the different options.

In the past, there has not been a level playing field. Many local authorities have been forced down the PFI route, in two main ways. First, PFI credits have been given special revenue support. The Government have encouraged local authorities to go down the PFI route by making extra money available on the revenue grant side. In addition, before the regime that is being put in place by the Bill, PFI borrowing was the only game in town for many authorities. They had no other option. In the past, therefore, PFI has been given special treatment.

As I have implied and the Minister will say, the Bill goes some way towards levelling the playing field. The prudential capital regime will give local authorities an alternative, but we do not yet know whether there will be a real level playing field. As far as we know, even under the Bill there may well still be some special treatment for PFI borrowing. Let me explain exactly what I mean.

First, as the hon. Member for New Forest, West said earlier, repeating a point made during our first sitting, we do not yet know what the revenue support regime for capital borrowings will be. The Minister said that we would know later this year, but my guess is that, when we receive that information, we will see that PFI borrowing will still receive special revenue support. He may want to take this opportunity to say that that will not be the case and that there will be a level playing field in respect of revenue support for all types of capital borrowing. If so, that will be news indeed, but I suspect that the discrimination in favour of PFI borrowing as opposed to other routes will remain.

Unless we make some reference to PFI and PPP in clause 7, there is a clear danger that PFI will benefit, because its arrangements apply not only to the purchase of capital assets, but to the related management services. There is a danger that PFI will again receive beneficial treatment.

The Liberal Democrats are not the only people suggesting that that is the wrong way to do things. The Government, in talking about capital investment and PPPs in chapter 4 of the White Paper, say:

''The capital finance system itself should be neutral as to the form of procurement adopted and should ensure that authorities' purchasing strategies are based solely on considerations of best value.''

Of course, the next paragraph contains a ''however''. It says that the Government still want to give special treatment to PFI, although they set out the principle that, in theory, there should be no difference in the way that capital and revenue regimes treat different forms of capital finance in respect of procurement.

The Audit Commission backed that up in a report that was published only last week. It considered the history of PFI in local authorities, particularly in respect of schools, and showed that PFI did not merit the special treatment that it was being given. Indeed,

the report recommended that we should move away from that system. It is particularly relevant to the debate because PFI in schools represents the largest proportion of PFI in local authorities. The report states:

''In England, schools account by value for one-third of the total local government PFI commitment and are the single biggest component.''

We should take the experience of PFI in schools and local authorities extremely seriously. Having looked at the history of PFI in schools and local authorities, the Audit Commission suggests that the PFI approach should be changed. It does not say that PFI should be abandoned. That is not the position of the Liberal Democrats either. The report says, however, that all procurement options should be treated in the same way by the financial regime.

Paragraph 66 of the report says:

''Although all procurement options are technically open to LEAs, the practical barrier is the lack of an even financial playing field. It is time to review this lack of parity, particularly in light of the imminent introduction of prudential borrowing guidelines for local authorities and the concerted efforts being made to introduce new forms of PPP.''

The report talks about opening up the option so that there is no discrimination. There we have it. The prime audit body for local authorities, as the Minister reminded us earlier, recommends that we should level up the playing field. While amendment No. 50 may not do that exactly, that is its intention.

This is an important debate, coming so soon after the Audit Commission's report, which referred directly to the clause. We have the chance to implement what it recommends for local authorities. I hope that the Under-Secretary will take the debate seriously. If he is not willing to accept the amendment because of its technical weaknesses, I hope that he can give us an assurance that, having considered the report and the debate, the Government will table amendments to ensure that the discrimination in the system in favour of the PFI is removed. Local authorities could then have the whole range of procurement options open to them in an even way and would not be forced down a particular route, which, as the report says, often may not be the best value for money.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

Amendments No. 32 and 50 amendments seek to address the PFI exemption, if we can call it that, from the limits. Amendment No. 50 seeks to include all PFIs as credit arrangements. We have approached the issue in a slightly different way, but the intention is clearly the same. Amendment No. 32 is linked to amendment No. 36, to which we will come later. Amendment No. 36 would remove the power that the Secretary of State has under clause 8(4), which has been used to lay draft regulation 7(3)—the regulation that effectively exempts PFI contracts from this process.

We have sought to analyse what a PFI contract is and to identify the fact that often one part of it will effectively be the procurement of a capital asset and another will be the provision of a service. If we are to

see through the structures that are put in place and look at the fundamental transaction, we must see a PFI arrangement as being a credit arrangement for the provision of an asset and then a services contract on top of that. Amendment No. 32 seeks to identify the part of the liability that is akin to a credit arrangement for a capital asset, and to treat it as being on a level playing field with other credit arrangements in terms of borrowing limits. However, it would allow the part of the PFI contract that represents the fee for the provision of services to be treated as a separate matter outside the constraints of the capital borrowing regime.

The problem with the approach proposed by the Liberal Democrats is that, by including the whole of the PFI arrangement within the areas to be taken into account in calculating the use of borrowing limits, there would be a danger of catching something that should not be caught—the provision of a service. For example, in a PFI contract for a building, the capital cost of the building element should properly be caught, but the provision of maintenance and support and security services should not. That latter element should be treated as more akin to revenue expenditure.

We accept, as the hon. Member for Kingston and Surbiton suggested, that it is wrong for local authorities to be pushed into particular forms of transactions because of the arbitrary exclusion of PFI liabilities from the calculation, but we believe that the solution is to divide the PFI liabilities into two separate component parts and to take into account the part that is similar in nature to a capital transaction. Draft regulation 7(3) would exempt PFI from the restriction on the use of credit for the provision of services, but would not address the capital element that might exist in a PFI contract.

A further concern that should be addressed in considering the clause is the apparent assumption that all leases are equivalent to liabilities. On the face of it, a lease is a liability, but it is possible that the asset has an offsetting value. An example would be a local authority that has a 20-year lease on a building that it partly occupies itself, but partly rents to a major supermarket chain. The whole cost to the authority of that lease over time should not be treated as a net liability. It is a gross liability, but it is offset by a net asset, in terms of the rolled-up stream of income that will be generated from the part of the building that is sub-let. I am not sure that the arrangements proposed by the Under-Secretary cover that, because they seem to me to treat the lease of all assets, including buildings, as a future liability to be rolled up and capitalised at the outset.

I would also like the hon. Gentleman to address the way in which the Bill proposes to treat PFI deals. The proposal would not only mean that PFI deals would be excluded from the capital controls but also, in practice, allow the hypothecation of a revenue stream in preference to the general creditors of the local authority for the provision of that capital asset.

Great play has been made elsewhere of the continuation of the arrangements whereby all local authority debt ranks pari passu. However, by financing an asset such as a building through PFI,

and thus making payments for the use of that building—not repayment of debt as would be the case if the money had been borrowed, but the payment of a service fee under a PFI contract—that obligation is ranked ahead of payments to other unsecured creditors of the local authority. That is important because, as the hon. Member for Kingston and Surbiton pointed out in another context, it is driving local authorities towards entering into certain forms of transaction rather than others. We believe that the Government should be neutral about the form that the transactions take.

I look forward to hearing the Under-Secretary's detailed analysis of why the clause is necessary. Everyone recognises the significance of PFI transactions and the use to which local authorities can put them, but the Committee is concerned about local authorities being steered in the direction of one type of transaction rather than another that would possibly not be in their best interest, if it were not for an artificial incentive provided by the clause.

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

Amendments Nos. 32 and 50 would amend clause 7, which deals with the definition of credit arrangements. It should not be forgotten that there is also the context of the affordability test for the prudential borrowing regime. In both cases, the concern is with the treatment of contracts under the private finance initiative.

Amendment No. 32 seeks to ensure that such contracts are included in the definition, and amendment No. 50 would classify all public-private partnership contracts and PFIs as credit arrangements. The hon. Member for Kingston and Surbiton, in his usual modest way, did down the technical efficiency of his amendment No. 50, and it is true that terms in the amendment—PFI and PPP—would have to be defined, probably lengthening the Bill.

Putting that to one side, the amendments are unnecessary and at odds with the strategy of clause 7. The Government's intention is to rely as far as possible on current accounting practice to determine what does and does not count as a credit arrangement. In the case of PFI, that means that a contract will be treated as a credit arrangement only to the extent that it has to be shown on the local authority's balance sheet. There is a test related to that, and that in turn depends on the degree to which risk is transferred to the private sector partner. Such an approach gives authorities an incentive to achieve a significant level of risk transfer when negotiating such contracts, and it may mean that some issues relating to how PFI will be treated will have to be clarified, as under the present system, but that can be best done in regulations. There is no need to refer explicitly to PFI in the Bill.

The hon. Member for Kingston and Surbiton mentioned the Audit Commission and its study into PFI in particular schools. I understand that that survey related to 17 pathfinder projects, since when we have had a further 500 or so PFI arrangements for schools. A lot of lessons have been learned from the 17 projects and the Audit Commission report, and I am confident that the new PFI arrangements have responded to the points that were highlighted.

I also believe that the new prudential regime will not force authorities down one route or another. It will give them the opportunity to consider not only PFI but other capital financing arrangements, and I assure the Committee that the credit arrangement clauses, and the new prudential borrowing regime in general, are about giving more flexibility and choice to local authorities.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

If I understand the Under-Secretary correctly, he is saying that amendment No. 32 is unnecessary because subsection (2) provides for the apportionment of the cost of the PFI contract as an item that is a liability on the balance sheet and an item that is not. If so, will he make that explicit and, perhaps by using an example, show how that will work?

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

This is the crux of the hon. Gentleman's argument in tabling the amendment. He seeks to split every PFI contract rigidly into the service and capital components. The best way to do that is to use the current accounting practice mechanism. Certainly in some cases when the balance sheet test is applied there are opportunities to have a separable component, such as when the service elements operate independently from the asset arrangements. I may be able to find specific examples at a later date. I am sure that the hon. Gentleman can think of some.

I do not believe that it is easy as simply drawing that line down the middle of a long-term contractual arrangement. Current accounting practices look at the treatment of the whole of the contract and the extent to which risk is transferred to the private sector. Obviously, if the liability remains in the whole on the local authority, it will be classed as on balance sheet. There are plenty of circumstances where the treatment would be off balance sheet if the risk and the liability were similarly transferred to the private sector. I do not believe that a rigid approach requiring the separation in every case is necessary.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

I am trying to follow the hon. Gentleman. I think that he is saying that it is not an apportionment but an either/or, based on an assessment of where the balance of the liability of the contract lies. Is he therefore saying—if he is, I confess that I have not understood this—that where a PFI contract relates primarily to the provision of the capital asset and, on current accounting practices, is deemed to be a liability that needs to be shown on the balance sheet, the whole of it is to be treated as a credit arrangement for the purposes of the clause?

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

That may well be the case. The point about the provisions that we have set out is to give flexibility so that current accounting practices can in some circumstances see a PFI arrangement as being on balance sheet and in others as off balance sheet. Many of those variables depend on who is bearing the variation in the profits or losses related to the property concerned. For example, does the purchaser have access to be benefits of the property and, similarly, to exposure to the risks inherent in those benefits? Does the purchaser—the local authority—have liability to make payments to cover the costs of the property?

Those are the issues that are considered in the balance sheet test. I believe that those accounting practices are the best ones to follow. They certainly ensure that each contract is treated on its merits.

Mr Edward Davey (Kingston & Surbiton, Liberal Democrat)

I do not think that any member of the Committee will have problems with normal accounting practices being applied in the way that the Under-Secretary described. He will know, however, that the clause provides regulation-making powers to spell out some of the details. That may be appropriate in view of the flexibility involved. However, I want to direct him to the core of my remarks. Will those regulations be drawn in such a way that PFI approaches have no extra benefit compared with other procurement options?

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

Because we will not have the credit approval system under the new prudential borrowing regime, I do not believe that the current level of restriction will apply in future. We are in the process of drawing up the regulations in respect of the revenue provisions of capital. Those announcements will have to be made in due course. There are particularly good reasons in many cases to give an incentive for authorities to consider and look at PFI as a way of transferring risk, but also ensuring swifter delivery of a result that may be desirable for that area. In designing the arrangements, we do not want to exclude the possibility that we will want to look more favourably at supporting PFI arrangements.

Mr Edward Davey (Kingston & Surbiton, Liberal Democrat)

The Minister gave the clarification that I was about to seek. Is he therefore confirming that the Government are minded to give special treatment to PFI for local authorities in future?

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

That is not necessarily the case. As far as possible we want to leave it to local authorities to take decisions on the contracts that they wish to enter into. The purpose of the set of clauses is to let go of the central controlling arrangement and to allow local authorities wider choices and more options in borrowing to benefit local people. PFI is one option in achieving that aim. The Government may highlight the benefits and virtues of a particular route, but the route that the local authorities choose to take is a matter for them.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

The Minister talks about choice for local authorities. Could a local authority that was at its borrowing limit and therefore could not borrow to finance a project execute that same project by means of PFI? That is the litmus test of whether the system that the Government propose is biased in favour of PFI.

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

I understand the hon. Gentleman's point. The clause will ensure that where the liabilities rest on the local authority through a PFI contract, they should be treated as credit arrangements and in turn be subjected to the affordability test in terms of their financing, just as ordinary borrowing would be. If a PFI arrangement is to be regarded as on balance sheet it will have to come within the local authority's affordability envelope. However, there may be circumstances in which a PFI arrangement transfers risk and liability to the private sector and thus it may

be outwith the definition of a credit arrangement. In that situation the limit would not apply. I hope that is helpful.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

The Minister is trying to be helpful and I am genuinely trying to understand him. Is he saying that in accordance with good accounting practice there is never a circumstance in which it would be appropriate to treat a single transaction as being made up of more than one component, one part of which might be treated as a liability carried on the balance sheet, for example, and another part treated in another way? The assumption that that might sometimes be the case was the reason for tabling amendment No. 32.

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

No, I am not saying that. In some contracts there may be separable components in respect of service elements operating independently from the asset arrangements. I draw the hon. Gentleman's attention to accounting practice FRS 5, application note F, which has a section about the circumstances in which contracts might be regarded as separable.

The hon. Gentleman made two points about leases and asked whether a lease's sub-lease could offset the liability. I am not entirely clear about that, although I suspect that the balance sheet test would also apply, and in some circumstances they too could be separable. If I am wrong, I shall write to the hon. Gentleman about it.

As to the hypothecation of a revenue stream with preference for a particular creditor, I would regard those as unusual circumstances where the council had more, rather than less, liability under that arrangement. The issue would rest on the level of risk transfer that was undertaken in respect of the person providing the contract. It would depend on what would happen if there were a default and on who would first bear the cost of remedying that default. If the hon. Gentleman wishes to pursue the issue, I will write to him.

I hope that the hon. Gentleman will accept my reassurances about the clause and withdraw the amendment.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

I have listened carefully to the Minister and think that perhaps a little light is being shed on the matter. I liked the fact that the Minister appeared to be saying that what is proposed follows good accounting practice, and if a liability has to be carried on the balance sheet under good accounting practice it should be treated as a credit arrangement for the purposes of looking at compliance with borrowing limits. That seems to be sensible. However, I am not sure why the provisions are in the Bill; I thought that its general architecture supported the idea that accounting practices will prevail unless it is specified to the contrary. If we are all so keen to follow good accounting practices, I wonder why the Secretary of State needs powers to define something in subsection (2)(b), for example, rather than leaving it to accounting practice to ensure that things are treated as they should be.

The Minister has persuaded me that amendment No. 32 is probably unnecessary. I shall leave it to the

hon. Member for Kingston and Surbiton to talk about amendment No. 50. The Minister has not persuaded me that clause 7 is necessary. In demolishing the argument for amendment No. 32 he also demolished the argument for clause 7, as he made a good case for relying on standard accounting practice.

Mr Edward Davey (Kingston & Surbiton, Liberal Democrat)

I agree with the hon. Gentleman that this has been a useful debate and that the Under-Secretary has been helpful in explaining some of the Government's thinking on the matter. However, I am disturbed by some of his remarks, as it seems to be the Government's intention to retain bias towards PFI in the system. The Under-Secretary was not explicit, but he said that when the Government eventually publish their thinking on revenue support for capital finance in local authorities they may decide to give extra support for PFI borrowing. Many people outside the House will be concerned that the Government are taking that route, despite the evidence from the Audit Commission and others.

The Under-Secretary referred to the first 17 schools, but the report, which is very authoritative, considers the matter in detail. It looks at the PFI experiments and new school buildings across the piece, comparing PFI with more traditional options. Although the conclusion omits the fact that as the experience of using PFI in schools continues, lessons will be learned and the practice will improve, its recommendations are clear: it wants barriers and restrictions to other forms of borrowing removed so that there is a level playing field. The thrust of the Minister's remarks was that the Government would not adopt that proposal. While the hon. Member for Runnymede and Weybridge was speaking, I read the notes on regulation 7, which state that

''the Government still wishes to encourage the use of Private Finance Initiative contracts, where they represent best value. PFI contracts are credit arrangements which provide the authority not only with a capital asset but also with associated services.''

That suggests that the Government are keen to give PFI special treatment. I accept that amendment No. 50 would not get rid of that special treatment, but this has been a useful debate to tease out the latest Government thinking on the matter. I will not divide the Committee on the amendment, as we will return to the issue. It worries many people, especially when the Government are not following the Audit Commission's recommendations. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the clause stand part of the Bill.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

Two issues remain outstanding. While the hon. Member for Kingston and Surbiton was speaking, I was looking at the notes to regulation 3, which slightly undermine the Minister's remarks. It is disappointing, Mr. Conway, that the Minister does not have the explanatory notes to his own regulations. I will be happy to give him a copy when I have finished referring to them. The thrust of what he was saying is that standard accounting practice should determine how the capital controls

provisions are implemented. The notes to regulation 3 specify that all property leases will be included

''within the definition of 'credit arrangements' ''.

They continue:

''although many leases would be caught automatically by''

the test of proper accounting practices,

''not all have to be shown in the balance sheet. The regulation therefore ensures that leases of any kind are taken into account for the purposes of the authority's prudential limit [clause 3] and any limits that might be imposed by the Government [clause 4]''.

Given that the general thrust is to go with the flow of proper accounting practices, the Minister will have to explain why in his draft regulation he proposes to include all property leases within the scope of credit arrangements. That only highlights the issue we have been debating, because it will create a perverse incentive to organise the supply of operational buildings by way of PFI contracts that may not otherwise be in the local authority's best interests.

Bear in mind, Mr. Conway, that typically an operational building will have a long life, and even a prudent authority might question whether it wants a lease of 20 or 25 years chewing up a chunk of its borrowing limit. If it were to enter a PFI-type transaction, as I understand the Minister, that might not fall to be counted against that borrowing limit. We need an explanation from the Minister as to why property liabilities have been determined by the draft regulation to be counted always as a credit arrangement.

Mr Edward Davey (Kingston & Surbiton, Liberal Democrat)

The hon. Gentleman may have a point, if I have understood him correctly. Is he saying that with the new regulations the leases to which he refers will be treated differently from the way they were treated previously and therefore the incentive to use PFI for the provision of buildings will increase?

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

That must be the import of the notes. They say:

''although many leases would be caught automatically . . . not all have to be shown in the balance sheet''.

It is for the Minister to tell us how this proposed treatment relates to the current treatment. It would be useful to the Committee if he could clarify that. My interpretation is that this is a decision by the Government to ensure that all property leases are included as credit arrangements.

I raise the second issue in the spirit of a Committee scrutinising the fine detail of a Bill. Local authorities unhappy about the controls imposed on them might not thank me for raising the question whether a loophole is inadvertently being created, but it is our duty as Committee members to look for anything that may have slipped past the Minister's eagle eyes.

If the Government's intention through the clause and the inclusion of credit arrangements is to avoid creating an alternative to borrowing against the prudential limit, is the Minister sure that he has not inadvertently created a loophole in subsection (3)(b)? It excludes from the definition of a qualifying liability

''a liability in respect of which the date for performance is less than 12 months after the date on which the transaction giving rise to the liability is entered into''.

I invite the Under-Secretary to consider the transaction for the leasing of an asset such as a motor vehicle over three years. If I understand subsection (3)(b) correctly, the liability for borrowing purposes will be taken to be only the second and third years' payments under the credit arrangement, not the first year's payments. Let us say that the vehicle is a refuse collection vehicle and the authority borrowed to buy it—if there are any local authorities that still collect their own refuse. The whole of the borrowing cost would fall to be counted against the borrowing limit.

I believe that a creative local authority treasurer might be able to use the exclusion—I understand the reason for it—of the portion of the liability that falls due in the current period. That would generally be treated differently on the balance sheet, but it potentially opens up a loophole, and I should be grateful for the Under-Secretary's observations.

Mr Edward Davey (Kingston & Surbiton, Liberal Democrat)

The great thing about a clause stand part debate is that it is a process and we can catch up on ourselves. Since I last spoke, I have been studying more carefully some of the regulations that apply to the clause, and I have noticed—perhaps I should have noticed earlier—that regulation 7(3), which is in draft form, clearly specifies that private finance initiatives will be treated differently. Although the explanatory notes say that the exemption is currently in operation, regulation 7(3) continues it, which confirms the fear that I expressed earlier that the clause and the regulations created by it will embed the bias towards PFIs.

Many of us share that concern. We openly agree that flexible credit arrangements and a range of options for local authorities are needed. Those freedoms are needed, but if they involve a residual control or a residual direction where there is a clear financial benefit as between one option and another, the Government are not giving local authorities real, meaningful freedoms and they are going against the experience and analysis of bodies such as the Audit Commission.

I hope that the Under-Secretary will say that the Government will go away and reconsider that point. I hope that they will admit that the prudential capital regime that they are establishing is not sufficient to level the playing field and that they are indeed deliberately retaining the discretion to benefit PFI.

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

The hon. Member for Runnymede and Weybridge raised a number of specific points. He smiled at the fact that there was no notice of them and that that was an interesting way of putting the Minister on his mettle. As I try to answer those points, he may well be proved right, but I will try my best to give him answers.

First, however, let me put the clause in context. As I have said, it deals with credit arrangements, a term that has been used since 1990. It may be helpful if I say something about the history. Before 1990, more basic capital finance controls were in force. These regulated capital expenditure financed by borrowing, but

authorities found other ways to access capital assets, and many authorities obtained buildings and other property by leasing. Another popular device was the so-called deferred purchase agreement, a sort of hire-purchase scheme for buildings. At that time, those transactions were outside the capital controls. Therefore, when the present capital finance system was introduced in 1990, one of the main aims was to place borrowing and other sorts of credit on an equal footing, and that was done effectively, although in a highly complex way.

Leasing and all other forms of long-term credit are now covered by the term ''credit agreement'', and any authority entering into a credit agreement must work out the total amount that it will pay throughout the whole contract. The lump sum is then treated notionally as if it were being borrowed now and so, as with actual borrowing, the credit arrangement is controlled by the number of credit approvals issued to the authority by the Government.

The experience of the 1980s shows that we cannot regulate borrowing alone. Authorities' financial performance is generally far more responsible and professional than in those days, and it is that achievement that makes it right for us to offer them the new freedoms contained in the Bill. However, if we focus only on borrowing, we will undermine the safeguards provided for in clauses 3 and 4. The references in those clauses to borrowing limits must therefore be extended to cover credit as well.

Clause 7 sets the scene for that, by preserving the idea of a credit arrangement, but greatly simplifies the definition. We have taken that simplification still further since the Bill was first issued for consultation. That was possible because the local government accounting framework has itself become more robust since 1990, and any transaction with the same effect as borrowing will generally be treated in the accounts as if it were borrowing. That means that we can safely dispense with the cumbersome definitions contained in the 1990 legislation and instead can rely mainly on accounting concepts.

A credit arrangement is therefore defined in clause 7(2) and 7(3) as a transaction giving rise to a long-term liability in accordance with proper practices. ''Long term'' means 12 months or more, and the expression ''proper practices'' has the meaning given in clause 21(2).

The hon. Member for Runnymede and Weybridge raised several specific points. With regard to leases, he highlighted concerns about the notes on regulation 3. It is true that there are specific regulations covering leases, but those should be put in the context of the other regulations. The hon. Member for Kingston and Surbiton, on closer scrutiny, discovered that paragraph (3) of regulation 7 provides for specific accounting arrangements with regard to PFI, and I believe that those go some way towards answering the point made by the hon. Member for Runnymede and Weybridge. He might regard those arrangements as PFI, but we view them as leasing.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

Paragraph (3) of regulation 7 deals specifically with the prohibition on borrowing to

finance revenue expenditure on service provision, and allows a PFI contract even if it might otherwise be treated as borrowing for those purposes. That regulation does not address the need to include a specific provision in regulation 3 stating that a lease of a property should always be treated as a liability, regardless of whether good accounting practice would require it to be treated as such. That cross cuts to the earlier question that I put to the Minister for Local Government and the Regions and to which he replied, about a situation in which a local authority had a liability under a lease, but also had an offsetting income stream, if, for example, part of the property was sub-let. It appears to me that regulation 3 automatically requires that the liability be treated against the authority's capital borrowing limits. That would not necessarily accord with good accounting practice.

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

No. I endeavoured to explain earlier that that was not the case. Some property leases may not necessarily score as on the balance sheet, but we do wish the system to cover all leases, as it does now, to avoid any perverse incentives that might arise and lead a local authority to think that leasing was a worthwhile activity over and above the other areas that were proper for it to undertake. The only test that we want to see is the value-for-money test, which is included. That is why we have covered all leases in the regulations.

The hon. Gentleman also asked whether a loophole might exist in regulation 7(3)(b) about, for example, the purchasing of a vehicle juxtaposed with the borrowing of a vehicle. Regulations will ensure that short leases that are expected to be renewed will be treated as long-term leases. Indeed, parallel provisions in regulation 6, which concerns options, work to close down loopholes and the treatment of various undertakings that might try to circumvent issues in another way.

Mr Philip Hammond (Runnymede & Weybridge, Conservative)

I can see how the Under-Secretary might want to use the options provisions to deal with bogus short leases that are in fact longer leases, but I ask him to consider the situation of a genuinely short lease on an asset with a three-year life. My understanding is that if it is borrowed for, 100 per cent. of its costs would be treated against the borrowing limit. If it is obtained under a credit arrangement, only two thirds of its cost will be treated against the borrowing limit. Is that correct?

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

The hon. Gentleman needs to see the provisions in the context of their purpose, which relates to the prudential borrowing regime and the affordability limits and tests as set out in clauses 3 and 4. It would be wrong to calculate the consumption of credit in that way. The calculations under the code, perhaps because of affordability or for national economic management reasons, will pick up all the revenue consequences of the arrangement. The fact that all the revenue consequences will be covered in the calculation of the affordability limit provides a safeguard and ensures that the affordability test and arrangements in clauses 3 and 4 will operate properly.

The hon. Member for Kingston and Surbiton asked why the PFI provisions under draft regulation 7(3) are needed. They are included to ensure that the accounting practices and balance sheet tests can be regarded properly. When we come to clause 16 on capital expenditure, we will debate the various ways in which generally accepted accounting practice may vary from local authority accounting practices. That will help elaborate on some of the issues for the hon. Gentleman. The regulations are needed for a common-sense treatment of private finance initiative arrangements under the normal accounting practices test in the Bill.

Mr Edward Davey (Kingston & Surbiton, Liberal Democrat)

I am sorry to press the Under-Secretary, but the impact of regulation 7(3) is that PFI services for schools can be paid for through a credit arrangement while services from a normal procurement route cannot. There is a clear financial differentiation and benefit given to PFI. The hon. Gentleman has not admitted or justified that.

Mr Christopher Leslie (Parliamentary Secretary, Cabinet Office; Shipley, Labour)

The hon. Gentleman should take a step back from looking at the details of one particular contract. Ordinary borrowing arrangements would simply provide the asset for the authority and would be accounted for in the normal way, but the PFI mechanism, depending on its components and balance of risk, has a reflection on whether it accounts on or off the balance sheet. The regulations ensure restrictions on the nature of the credit arrangements that can be entered into by ensuring proper boundaries and limits. That also encapsulates some forms of PFI arrangements and classes them fairly in circumstances in which they are defined as credit arrangements and count towards the affordability limit. Those are set out, and there will be opportunities in debating a later clause to consider the definitions of accounting practice. If the hon. Gentleman has any specific points, I undertake to find answers then.

I hope that the Committee will regard the clause as robust and necessary in ensuring that credit arrangements are part of the prudential borrowing regime. I commend clause 7 to the Committee.

Question put and agreed to.

Clause 7 ordered to stand part of the Bill.