Strategic commercial interventions - initiating companies in public ownership: standard operating procedures - part 1

2.3. Financing Public Corporations or NDPBs and Securing Commercial Outcomes

The SPFM’s Investment in Business Framework advises that investing carries the risk of distorting the market(s) in which a business operates and also comes with an element of commercial risk to the public sector. For these reasons, a commercial outcome from any proposed business investment is essential, ensuring an acceptable risk/reward ratio supports the investment of public funds. Finance from the public purse needs to be provided on market-consistent terms which is key to maintaining a level playing field with private competitors.

Subsidy Control

From 4 January 2023, public funding became subject to a new, UK-wide subsidy control regime. The framework for this new regime is provided in the Subsidy Control Act 2022.

In general terms, and for the purposes of our international commitments, a subsidy is a measure which:

• is given by a public authority at any level – central, devolved, local government or a public body;
• makes a contribution (this could be a financial or an in-kind contribution) to an enterprise, conferring an economic advantage that is not available on market terms (examples of a contribution are grants, loans at below market rate, or a loan guarantee at below market rate or allowing a company to use publicly owned office space rent free);
• affects competition or investment within the UK (please note, a measure could have a relevant effect on competition and investment in the UK even where the market covers a small geographical area or where the amount of financial assistance is exceptionally low); and
• affects international trade (this can be trade with any World Trade Organisation (WTO) member or, more specifically, between the UK and a country with whom it has a Free Trade Agreement. Please note that you are not being asked whether the subsidy could harm trade but merely whether there could be some sort of effect).

The Subsidy Control Team acts as the Scottish interface on subsidy control and offers a range of assistance to help Scottish public bodies understand and comply with subsidy control rules.

To inform the commercial case of a business case on whether the decision to initiate a public corporation or NDPB represents long term sustainable solution, SG departments should consider the Business Investment Framework (BIF)’s guidance. It is important to consider the twin objectives of a clear policy rationale (i.e. wider impact on the public, such as job safeguarding, job creation and future growth opportunities in the sector) and an acceptable risk/reward ratio:

• Determining an optimal capital structure: An analysis of various capital structures should be performed prior to intervening where possible. SG departments should ensure they perform benchmarking activities with relevant sector companies / competitors. This is specifically relevant where a strategic objective of an intervention is to stabilise and grow to recruit and retain talent.

SG officials will need to consider the respective roles and responsibilities of the Ministers’ ownership function, SG’s sponsorship, and board management in making decisions that affect capital structure. Officials will need to consider when the focus on a public body’s capital efficiency and value creation gives way to public policy concerns or SG budgetary needs, that the public body is no longer operating on competitively neutral terms with private competitors.

Such departures from competitive neutrality can occur notably through reductions in rate-of-return requirements imposed on the public body, but also through unwarranted capital outflows (e.g. dividend pay-outs that are not justified by company performance) or excessive capital inflows (e.g. direct subsidies that confer a competitive advantage on the public body’s commercial activities).

• Establishing rate-of-return: Officials should seek to understand the rate-of-return per private sector practices and the extent to which public bodies will be held accountable for their fulfilment. Within SG, SNIB has a target rate of return which relates to repaying or investment.
• Setting dividend policy: Consider setting guidelines that direct the amount of dividends paid out by the public corporation or NDPB and the frequency with which the dividends are paid out. The following are examples of dividend policies in the public sector:
  • Within the Scottish Water group, the licensed and commercial activities are self-financing with any profits generated being retained and invested in future developments of the business. The Scottish National Investment Bank is seeking a similar framework;
  • The Royal Mint has an annual fixed dividend target; and
  • Met Office pays an annual dividend a least equal to its required rate of return on average capital employed;

In practice, guidelines would be set by way of consultations between the board, the sponsorship team, SG Finance, Ministers, and external advisors. Usually, dividend pay-out levels would be based on profitability, investment needs and cash reserve requirements. The main reporting factors should be taken into account when determining annual dividend levels for the public body along with the process on the annual negotiation of dividend levels, and the respective roles of the ownership, sponsorship function, the public body board and management in determining the dividend policy (reinvest or distribute etc.) and be reflected in the framework document.

• Providing direct state support: Officials to examine the conditions and modalities for providing direct support to public bodies, where such support is possible by way of Minimum Financial Assistance (MFA), Services of a Public Economic Interest (SPEI) in line with Subsidy Control rules.