Appendix 1: Government response
This memorandum, prepared by the Department for Communities
and Local Government (CLG) and agreed with the HM Treasury, sets
out the Government's response to the Committee's report.
The Government was grateful for the opportunity to
participate in the Committee's inquiry and now welcomes the thorough
analysis and constructive recommendations in the Committee's report.
During the financial events of the last year, important lessons
have been learnt by all with an interest in local government treasury
management. The report highlights and consolidates the key messages
and provides a resource to inform discussions of the subject for
the foreseeable future.
The contents of this response have been discussed
with the Audit Commission and the Chartered Institute of Public
Finance and Accountancy (CIPFA). Both of those bodies are responding
separately to the Committee, as is the Financial Services Authority.
This memorandum therefore concentrates on the recommendations
directed specifically to central Government. It confirms, in particular,
that CLG has already begun the review of its investments guidance
proposed by the Committee. In finalising the content of the revised
guidance, CLG will take full account of the views of local government
practitioners (see paragraph 9 below).
The responses below appear under the headings used
in the Conclusions and recommendations section of
the report (pages 66 to 70). The relevant recommendation of the
report with its paragraph number is quoted in bold italics in
each case.
Local authorities' investments and reserves
1. We conclude that it would
be inappropriate to seek to restrict local authorities' investment
options. Although interest rates are now at historically low levels,
returns on investments are usually an important source of local
authorities' revenues and investment by local authorities an element
in the health of the UK financial sector. The primary consideration
of local authority investment, as emphasised by CIPFA, should
remain security and liquidity; but yield should not be neglected.
The risk involved in seeking yield should be mitigated by robust
and responsive Codes, guidelines and best practice. (Paragraph
37)
The Government is in full agreement. It would be
a mistake to return to anything like the restrictive regime of
"approved investments" which predated the present guidance-based
arrangements. Ineffective even a decade ago, such an inflexible
system could prove disastrous in today's more volatile investment
circumstances. The CLG and CIPFA guidance codes by contrast encourage
authorities to take responsibility for investment decisions and
to react rapidly to market developments.
Both guidance codes should continue to emphasise
the priority to be accorded to security and liquidity over yield.
As the Committee has recognised, however, it would be unrealistic
to urge authorities to ignore yield completely. The report (paragraph
168) acknowledges that the CLG guidance in this respect strikes
the right balance. But in reviewing the guidance (see paragraph
9 below), CLG will consider whether that message should be expressed
even more clearly.
Local authorities' financial teams
2. We recommend that the Government,
CIPFA and the LGA study ways in which local authorities, particularly
smaller ones, could join together to share expertise and pool
treasury management resources. The sharing of information and
expertise, such as identifying banks that are in the same financial
group, might have lessened the failures that occurred during the
Icelandic crisis. (Paragraph 56)
The Government fully supports the sharing of information
and expertise and knows that many authorities already engage in
such initiatives. Both CIPFA and the LGA actively promote these
exchanges of knowledge, through, for example, conferences, advisory
services and networking websites. CLG will discuss with CIPFA
and the LGA the scope for further developing such mechanisms specifically
in relation to treasury management and investment practice. CIPFA's
proposed Treasury Management Forum will be relevant here;
it is intended to be a national forum for the discussion of major
treasury management issues and to provide a local network for
the dissemination of good practice.
Credit rating agencies
3. […] We recommend that
the Government revise the informal commentary on its statutory
guidance, to include information about the appropriate use of
credit ratings. We also recommend that the CIPFA Codes include
guidance to local authorities on the nature of credit ratings,
highlighting the risks of over-reliance on them. Credit ratings
should not be used in isolation as a justification for the soundness
of an investment and local authorities should be made aware of
the fact that credit ratings should be viewed within the context
of wider financial and economic information and advice."
(Paragraph 81)
In reviewing its investments guidance, CLG is considering,
in particular, how it should deal with credit ratings and to what
extent this issue should be covered in the statutory guidance
itself or in the informal commentary, or both. The commentary
at present simply states (paragraph 23) that "it is not implied
that credit ratings are the only means of assessing creditworthiness".
The Government recognises that the warning about undue reliance
on credit ratings should be strengthened.
The Government's provisional view is that the CLG
guidance should not include specific recommendations of alternative
methods of risk assessment. Any such prescriptive approach could
(like the former discredited "approved investments"
regime) create a potentially false sense of security and discourage
authorities from taking full responsibility for their investment
procedures. The treatment of credit ratings is an issue on which
CLG will wish in particular to seek views when consulting local
government on the revised guidance (see paragraph 9 below).
Treasury management advisers
4. We recommend that the Audit
Commission carry out a value for money study of the services that
local authorities have received from treasury management advisers,
with a view to advising local government on the value that they
offer in the differing circumstances applying to individual authorities.
(Paragraph 101)
5. The Financial Services Authority
(FSA) should take a more active role in the regulation of treasury
management advisers […] There is a strong case for a full
investigation by the FSA of the services provided by local authority
treasury management advisers. We recommend that such an investigation
be carried out as soon as possible. (Paragraph 120)
6. […] The Audit Commission,
CIPFA and the FSA must all re-examine the role and reliability
of treasury management advisors and their discharge of duties
of care for local authorities in managing this aspect of treasury
management.
(Paragraph 121)
The Audit Commission, CIPFA and the FSA are responding
separately to the Committee. As the limitations of credit ratings
become more widely appreciated, authorities will explore supplementary
means of assessing credit risk and may increasingly rely upon
the treasury management firms for assistance with these often
complex techniques. The Government recognises therefore that it
is vital for such consultants to provide an efficient and transparent
service.
The Audit Commission
7. […] We recommend that
the Audit Commission review its own auditing procedure and prioritisation
of the areas of local authority activity it chooses to audit,
in order to ensure that such complacency does not happen in future.
(Paragraph 135)
Although sponsored by CLG, the Audit Commission is
an independent body and will be responding separately to the Committee.
In relation to investment, local authorities' statutory duties
are to have regard both to the CLG investments guidance and to
the CIPFA Treasury Management Code. The Government considers that
auditors should give sufficient weight in the planning and execution
of the audit to reviewing compliance with those duties.
The CIPFA Codes
8. We recommend that CIPFA add
to the issues that need to be covered in a local authority's annual
investment strategy (AIS) the use, or not, of an external advisor;
schemes of delegation and the role of the Section 151 officer;
and the use of and procedures regarding credit rating agencies.
The guidance need not be prescriptive about the way in which the
AIS should address these issues, but it should ensure that proper
attention is paid to these previously under-scrutinised areas.
(Paragraph 141)
It is the CLG investments guidance which introduced
the concept of an Annual Investment Strategy (AIS) and specifies
what it should contain. However, other regular reports on treasury
management are required by the CIPFA Treasury Management Code
(TMC). CLG is reviewing its guidance and CIPFA is reviewing its
Code and associated guidance notes. The two bodies are working
together to ensure that their respective documents are complementary
and comprehensive.
CLG will wish to consult local government before
deciding on any changes to the content of the AIS. The treatment
of credit ratings is discussed in more detail in paragraph 8 above.
Central Government and local authority treasury
management
9. We welcome the Government's
willingness, as expressed by the Minister for Local Government
in evidence to us, to revise its approach to investment guidance,
and we trust that it will look closely again at that guidance
in the light of the conclusions of this Report, especially at
the issues surrounding the use of credit ratings. However, the
failures in treasury management identified by our inquiry and
by the Audit Commission's work have for the most part occurred
not because of CLG's guidance, but because of local authorities
not following the guidance properly. (Paragraph 145)
The Government recognises that the time is right
to reconsider the CLG investments guidance. Issued in 2004, the
guidance is in any case due for review. But the recent events
in the investment market and the Committee's report on them give
the task added urgency and will be fully reflected in the updating
exercise. CLG's review of its guidance has already started and
is being undertaken through the technical sub-group of the Capital
Programmes Working Party (see paragraph 11 below). The question
of what should be said about credit ratings is among the main
issues under examination in the work programme (see paragraph
3 above). It is aimed to have proposals ready for full consultation
with all local authorities in the autumn, with a view to introducing
revised guidance with effect from 1 April 2010.
The Government is grateful for confirmation that
the failures in treasury management are not attributable to deficiencies
in the CLG guidance. Local authorities are required by law to
have regard to the guidance, which recommends the submission of
an investment strategy to elected Members. While no authorities
seem to have neglected their basic legal duty, there are clearly
variations in the efficiency and enthusiasm with which strategies
have been devised and implemented. The revised guidance will seek
to encourage uniformly higher levels of performance across local
government.
10. We agree with the Government's
approach to assisting those local authorities that have funds
at risk in the failed Icelandic banks […] The Government
will have to monitor closely the amount of money that local authorities
eventually get back from Iceland to ensure that any actual losses
do not seriously disadvantage either local council tax payers
or local service uses […] (Paragraph 152)
The Government welcomes this endorsement of its general
handling of the situation. It is continuing to monitor developments
carefully and is keeping in close touch with local government
representatives, as well as CIPFA and the Audit Commission.
11. We seek reassurance that
regular meetings at an appropriately senior level are held between
the Audit Commission, the local authority associations, CIPFA
and CLG to ensure that the treasury management system is kept
under review. We also recommend that these meetings include links
with the financial regulatory bodies—the Financial Services
Authority and the Bank of England—to ensure consistent and
up-to-date information is passed onto these bodies.
(Paragraph 156)
The Government is pleased to offer the reassurance
sought by the Committee. The Capital Programmes Working Party
(CPWP) has for many years provided a forum for the discussion
of local government capital finance, treasury management, accounting
and all related issues. The members are: CLG; the Treasury; other
Government departments interested in local authority capital spending;
the Local Government Association; London Councils; CIPFA; the
Audit Commission; the National Assembly for Wales; the Scottish
Executive. Also, the Public Works Loan Board (PWLB) participates
in discussions relevant to its functions. The CPWP normally meets
at least twice a year (most recently on 15 July 2009) and is chaired
by a CLG official (grade 5 or 6). A technical sub-group
of the CPWP is convened as required to consider changes to capital
finance legislation and codes; it is now reviewing the CLG investments
guidance (see paragraph 9 above). In accordance with the Committee's
recommendation, the Government will ensure that the CPWP establishes
appropriate links with both the Financial Services Authority and
the Bank of England.
12. The majority of stakeholders
in treasury management agree that the cost of early repayment
of debt to the PWLB needs to be reviewed. We add our voice to
those recommending that the Government carry out an urgent review
of the arrangements for early repayment of debt to the PWLB. (Paragraph
166)
This issue has been under discussion in recent months
between local government representatives and the PWLB, the Treasury
and CLG. The PWLB will shortly be consulting local authorities
on proposals for change.
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