On entering government, Labour announced that it would refocus the Office for Students’ role to “prioritise the financial stability of the higher education sector.”
We’ve since seen the regulator put out an updated evaluation of the sector’s financial health, expand its capacity for financial analysis through new appointments and procurement, and most recently (and controversially) pause other aspects of its regulatory responsibilities to concentrate on working with institutions under pressure.
Along with additional effort, it would seem sensible in any refocusing to think through of possible changes to the regulatory framework – system-level reform, rather than simply additional man-hours from a clearly overstretched team.
The backdrop
Now, the OfS’ latest analysis of sector financial performance is undoubtedly bleak and somber reading. This report for the first time connects official financial data with updated information on recruitment trends and shows that previous analysis of the sector’s financial position (based on the time-lagged official data) was inaccurate.
We therefore agree with the conclusion drawn by David Kernohan on Wonkhe that “if OfS genuinely wants to be a responsive and risk-led regulator, it needs timely data. It does not even currently have data that allows it to regulate based on the experiences of students enrolled on courses at providers this year.” Without this, regulatory decisions and advice to the sector is problematic.
There’s another issue too, which OfS itself has identified: optimism bias, and in particular overly optimistic predictions of student recruitment.
However, OfS does not (publicly) ask itself the secondary question as to why that is. As David Kernohan put it, “providers feel compelled to make submissions as optimistic as possible… if you made a submission to OfS that suggested your underlying financial position was perilous you would be at risk of a breach of condition of registration D.”
One important question here is to what extent the OfS D conditions influence provider behaviour in planning and forecasting.
Condition D
The key definitions in this condition are financial viability and financial sustainability.
Here “financially viable” means that “the OfS judges that there is no reason to suppose the provider is at material risk of insolvency within a period of three years from the date on which the judgement is made” – and the condition then goes on to refer to broadly accepted technical definitions of insolvency. I would argue that this is non-contentious.
But the definition of financial sustainability is necessarily more judgement-based and refers to the ability to keep investing and making surpluses, the ability to fulfil all requirements related to delivering advertised courses, and the resources needed to fulfil all other conditions of registration. The horizon given for the judgement is five years – which feels a long time in the current context!
It is here that Condition D also interacts with the requirements under “reportable events”. Three of the examples given of “matters relating to a provider’s financial viability or sustainability” directly relate to financial performance against planned positions:
- a material change in actual or forecast financial performance and/or position
- a material change in student numbers that was not included in the provider’s financial forecasts
- significant redundancy programmes.
The regulatory regime does in part drive behaviour in relation to Condition D and “reportable events”. Albeit unintentionally, institutions are heavily incentivised to produce forecasts in the Annual Finance Return (AFR) that show growth, and viable positions, especially where the starting point from actual results is poor or even negative in, for example, a reported deficit. Such forecasts can on paper be signed off by governing bodies on the basis that:
- conditions of going concern are met for external audit purposes
- the second part of condition D of registration (financial sustainability) is satisfied
- any necessity to report an “event” to OfS is avoided.
Improving the framework
How can the current regulatory and reporting framework be improved with regard to finance? In short – by removing the second part of condition D, referring to “financial sustainability”.
As this is an issue of judgement, rather than fact as with “financial viability”, the framework needs to treat this in a way that is non-binary. If judgements on financial sustainability were removed as a condition of registration, a requirement to nevertheless report negative outlooks could be retained in a more realistic and conducive way for a better dialogue between providers and the OfS (the term “reportable event” is also unhelpful, as “event” suggests a point in time, rather than looking at this as a scenario based risk with an associated probability).
A reframing of the reporting of financial sustainability issues to OfS would be helpful not only to the regulator, but also to governing bodies themselves, who could be encouraged to take a more robust approach to scenario modelling and planning.
Such an approach could encourage more realistic planning in terms of the likely achievability of financial change by way of recovery (restructures, discontinuation of loss making activities, and more conservative estimates of growth), “soft” collaboration (sharing resources, joint ventures) and “hard” collaboration (mergers and group structures).
Changing the stakes
While we would not want to increase the regulatory burden on institutions, given the issues around current financial uncertainties and the gap between the 2023 AFR student numbers projections vs. actual numbers in 2024, it would seem that a temporary mid-year finance return ask might be justified.
The last time a mid-year return was used was in 2020 during the pandemic. The current situation facing institutions is arguably much more serious and uncertain than even at that time.
The Annual Financial Return is a key document not only for the regulator, but also for stakeholders such as lenders. It is a set of forecasts that the governing body of an institution needs to have understood, tested, and be able to stand by as realistic and achievable based on reasonably conservative assumptions.
Condition D, as it stands with its five-year horizon on a fairly global definition of financial sustainability, has arguably contributed to the use of variable degrees of ambitious projected growth in student numbers to mop up the fall in real value if resources and unavoidable cost increases that are beyond the institution’s direct control (such as national insurance and pensions).
Reducing the stakes on condition D to “viability” rather than “sustainability”, which is actually difficult to define anyway, would open the door to more open mechanisms for dialogue and support with the aim of finding routes through to resilience – a much better word in the current financial context than “sustainability”.
I’m not convinced more regular reporting is the solution to optimism bias. One thing I pushed for at OfS was the introduction of stress tests or scenario based forecasts asking providers to assess what their financial outlook might be if certain scenarios happened such as a 25% reduction in overseas student numbers or no growth in home students. The idea never got traction despite being the approach used for banks in the wake of the 2008 crash. To my mind the regulator proposing a set of scenarios that providers had to plan for would at least flush out a lot of the optimism and tell them how resilient providers are.
A very good idea, but the follow-up question as a regulator would be: If a long established provider significantly failed the stress test, what would the regulatory intervention be?
If we move past a position of optimism bias, into a position of realism, how should and would that change both the actions of the regulator and governing boards and if behaviour does change how would we know that it’s in the interest of students?
These are knotty questions which neither the regulator nor their regulated parties necessarily have a good answer to currently.
It would be interesting to explore why this optimism bias on student numbers actually occurs. As one of the commenters suggests, the regulator isnt realistically going to intervene in any meaningful way if an institution showed a deteriorating position. So one might suggest that the optimism bias is a management response to challenging environments – easier to predict the instutituion will somehow grab extra volume to grow income than actually face into the more difficult challenges of creating sustainable operating models. In other words “grow yourself out of trouble” is more palatable for executive and governing body to adopt… hence these unrealistic forecasts. If this a viable theory then the remedy lies in examining the decision making and accountability of the governing bodies who have approved these submissions to the OfS.