What financial impact will reclassification have on colleges and what changes need to be made to ensure success?

On the 29th November 2022 the Office for National Statistics (ONS) reclassified all colleges and their subsidiaries as public sector bodies. It is important to note that despite the reclassification, colleges will continue to be self-governing, retaining responsibility for their educational character, courses, contracts, and employee relationships.

So what does this change mean for colleges?

Reclassification has and will have a wide ranging impact on the financial management of colleges, the Department for Education (DfE) has announced they are working on a new College Finance Handbook but this is not expected to be published until March 2024. Below are some of the changes that the DfE has already confirmed along with the financial considerations stemming from them.

Following reclassification, colleges are now subject to the framework for financial management as set out in the publication Manging Public Money (MPM). The MPM sets out requirements that all resources must be managed and used responsibly in the public interest. This changes how colleges will report to, and interact with, government and requires they ensure their financial control systems support public sector standards of accountability. The framework also includes guidance on senior pay which will apply to colleges. Whilst this sounds like a significant change, some MPM requirements and obligations are already included in many colleges' funding agreements.

For most colleges, the most important changes will relate to borrowing requirements, going forward DfE permission will be required for any new private sector borrowing in line with MPM requirements. Specifically colleges "may only borrow from private sector sources if the transaction delivers value for money for the Exchequer;" as such it is extremely unlikely that colleges will be able to satisfy this condition, given the higher financing costs associated with private sector funding. According to the Association of Colleges (AOC), there have already been 55 loan applications made to the DfE, of which 22 were refused, 10 are pending and the 23 applications approved were all for short-term loans.

The DfE has already confirmed that there will be no change to colleges' existing debt. The Government has stated that refinancing any debt commercially is unlikely to be possible as it will not fit within the MPM criteria. For colleges who have loans which require a lump sum paid at the end and are unable to pay, the DfE will provide additional funding and recover the payment by withholding an agreed amount of future funding. Additionally, the use of existing overdrafts and credit measures will be subject to DfE consent, with current expectations for such arrangements to be phased out by August 2024.

There is potential that the new borrowing requirements could limit the freedom of college spending, also there are concerns over the speed with which the Education and Skills Funding Agency (ESFA) will issue approvals. This, combined with a system which does not seem ready to facilitate the financing requirements of colleges and a banking sector which has been sent a message by the Government that there will be a lack of borrowing by colleges, will cause a range of issues for the sector and colleges, which will have to be dealt with in time.

To help colleges manage their cashflow and "address the historical issue of uneven monthly payments" the DfE confirmed an investment of £300 million before the end of the current financial year and each college will get further additional funding with the aim of reducing the need for borrowing.

Importantly, colleges will not need to get prior approval for capital transactions and normal commercial activity, they will also retain their own reserves, any surpluses made, and any proceeds from their sold assets. The DfE has reassured colleges that they will retain freedom and flexibility over their financial long-term planning.

At the time of writing there will be no change to colleges' inability to recover VAT despite the University and College Union stating that "every single financial benefit available to state schools needs to be extended to colleges." It is estimated that the ability to reclaim VAT would save the further education sector a total of £200m a year.

There has been concern by some over the inclusion of the following line in the DfE guidance "if a transaction could reasonably be considered to be novel, contentious or repercussive, then it must be treated as such." Given the vague and subjective nature of this statement, colleges must ensure they are able to demonstrate robust, well-documented processes and procedures to avoid falling foul of this requirement.

The ONS have indicated that it will be reconsidering the classification of UK universities in Q4 2023, and in light of the recent decision to reclassify colleges it is unlikely that there will be a reduction in control. Far more likely is the possibility of similar controls being imposed on universities. If applied, the "non-contentious transaction" requirement would place a significant constraint on universities limiting growth, development, and innovation.

The AOC have criticised reclassification as introducing unnecessary red-tape and limiting the ability of colleges to meet the needs of their students, employers, and communities in a timely manner. Gerry McDonald, the principal and chief executive of New City College, who have an annual turnover of more than £100m, criticised the decision stating "more layers of approval and a slow bureaucratic timetable gives us less freedom and will not help us serve the skills agenda that our students need." Delays mean additional costs for colleges and uncertainty around funding will dissuade them from starting new projects crucial for skills and development.

The AOC has given five recommendations that the DfE could implement which would ease the worries of many in the sector:

1. Implement VAT changes for colleges akin to those for schools.

2. Issue a Local Government Pension Scheme guarantee letter as they do for schools.

3. Support teacher recruitment, as they do for schools.

4. Add colleges to its centralised buying schemes like business rates, licenses, insurance etc. which are all funded for schools.

5. Provide capital funding to compensate for borrowing restrictions and help colleges save energy by winter 2023.

The AOC have also stated that they will be pushing ministers and officials to help colleges deal with rising costs and the differences in funding between colleges and academies which can no longer be justified following reclassification. There was hope that the change in classification would increase funding for colleges but, as is evident, this is not always the case. It will be important to monitor future DfE announcements as there are still many unknowns which need working out within the DfE, ESFA, and colleges themselves.