We’ll need a regulatory overhaul to bring the early years childcare market in line

The childcare system is undergoing a period of rapid consolidation as investors – often backed by private equity financing - are drawn in by the prospect of high returns, but these changes are exposing substantial gaps in the regulatory framework. This follows in the footsteps of adult and children’s social care, where for-profit chains have already undergone a rapid expansion, and their experiences suggest that the spread of these chains will exacerbate existing problems and create new ones.

There’s a growing body of evidence indicating that for-profit firms operating in care can have a negative impact on staff, financial resilience, and the quality of care, often because their primary focus is on profitability and expansion. A study of for-profit nursery chains found that their staff costs (as a percentage of sales) were as much as 14% lower than comparable not-for-profits, likely to be in part due to poorer pay and working conditions. Profit shifting and high debt levels have been found in nurseries, and adult and children’s care homes. These practices increase the chance of a business failure occurring, often with little warning due to the companies’ complexity. Finally, recent research on adult care homes that had experienced a change in ownership (to an investment firm) found that the quality of care was often negatively impacted.

The right regulation?

Currently the primary regulator of the childcare market is Ofsted, which has a legal duty to monitor the quality and standards of care, and it aims to inspect existing daycare providers at least once every six years. This exposes one of the current regulatory gaps: an infrequent inspections regime. Given the rapid consolidation that is occurring this frequency could easily miss out on multiple ownership changes. This matters because the businesses’ finances and priorities can affect the quality of care.

There is no regulator with a duty to monitor childcare’s financial resilience, but bodies such as the Competition and Markets Authority (CMA) are increasingly concerned about resilience across numerous critical industries. This second, and more significant, regulatory gap is dangerous because as the childcare system consolidates into the hands of less financially resilient chains, the risk of a disruptive exit increases, as well as the associated impact on the availability of childcare in a local area.

Following on from the collapse of the adult care home chain, Southern Cross, there is a greater emphasis on monitoring financial risks in adult social care, with the Care Quality Commission (CQC) given duties to assess the financial sustainability of large providers. In its interim report on the children’s social care market, the CMA expressed concern over how high debt levels could trigger the sudden exit of firms and negatively impact children. It pointed out that stakeholders suggested limiting for-profit provision and that it was considering an oversight regime with clear limits on debt levels. However, by its final report it had moved away from debt moderation even though it admitted this would “have the benefit of tackling the root cause of concerns”. This was motivated by a fear of deterring investment away from children’s social care, but contrasts with its findings that firms were currently making large levels of excessive profits per child.

This highlights one of the CMA’s fundamental limitations. Despite its wide-ranging powers to study and intervene in markets, its mandate is limited to predominately focus on consumers, prices, and the efficiency of corporations. This focus minimises the importance of issues affecting workers, other stakeholders, and concerns around financial resilience, and economic power.
 

Should we fill regulatory gaps or ban difficult-to-regulate practices altogether?

To address the first gap, it would be wise for Ofsted to re-inspect daycare providers after a change in ownership, particularly if they’ve become part of a for-profit chain.

The second gap has a number of solutions available - with some more bold than others. At a minimum a financial oversight regime should be put in place for the childcare system. This could operate in a similar way to adult social care, and Ofsted would be the best placed regulator to take on this role because of its deep sectoral knowledge, but it would need to be supported with additional resources and expertise.

However, it’s questionable whether such oversight is effective. Firstly, the expanding chains tend to have highly complicated corporate structures making it hard to assess the risk of collapse holistically. It’s helpful to look at the example of adult social care here. Market oversight functions do not appear to have been able to predict the failure of adult care chain, Four Seasons. This is not a surprise given numerous accounts of auditors missing financial difficulties across a number of industries, despite having access to a wider range of management information. Secondly, even if advanced warning is given it may not be possible to find spare places nearby due to shortages in supply, particularly if a large provider is in distress. Thirdly, the current regime does not resource the CQC to rescue or prevent a business failure, but only to provide a warning to local authorities, but not necessarily to residents and their families. Finally, there can be a fear of damaging a home’s ability to recover if it’s deemed likely to fail, along with issues of regulatory capture. Clearly there is further to go in care sectors beyond childcare.

Another solution

A bolder solution would be to simply not allow practices that are too complicated to effectively regulate. This solution starts from the observation that high debt levels and other financialised practices (for example, operating companies with low levels of assets, excessive payments to shareholders) are not essential to the provision of childcare, and most organisations are able to operate without them. Limiting these through methods such as caps on the amount of debt leverage (something most banks have in place with businesses they lend to), cuts out many of the financial risks without preventing a provider from running a viable business.

This would require an adequately resourced regulator with a legal duty to monitor and assess the market (as with an oversight regime) but also require enforcement powers. Utility regulators, such as Ofwat and Ofgem, already have a similar oversight duty. For example Ofwat can mandate that water firms reduce their indebtedness, and ask them to explain how their dividend (profits paid out to shareholders) policy is compatible with their longer-term sustainability. As with oversight, this requires either in-house or external expertise (for example, credit ratings agencies).

When considering this measure for the children’s social care sector the CMA expressed concern that it would deter investment. Whilst there are reasons to argue that their worries were overblown, it’s worth noting that in the nurseries sector increased debt levels and mergers have not led to a rise in the number of places. So the current wave of consolidation doesn’t appear to be adding much value, which suggests that if some firms did leave, it would simply redistribute the places to (more resilient) new or existing providers. The impact of these reforms could be cushioned with a grace period, providing firms time to adjust their finances or sell their interests.

Conclusion

A better childcare system needs to be sustainable, and therefore able to meet the needs of children and workers. Adequate regulation is a necessary part of this, and we can learn from other care sectors which have gone further in monitoring the financial health of key firms. Given the changing nature of childcare providers, the current regulatory framework should be re-evaluated and updated to reflect the system’s direction.