Appendix 4: Response from the Audit Commission
The Audit Commission welcomes the Communities and
Local Government Select Committee report on Local Authority Investments.
We are pleased that the Committee was able to rely
on the evidence in the Commission's own report Risk and Return:
English Local Authorities and the Icelandic Banks, and that
the Committee's conclusions about local authorities are very much
in line with our own. The Commission notes the Committee's endorsement
of its criticism of the seven local authorities that made deposits
with Icelandic Banks after the banks' credit ratings had been
downgraded.
We have been asked to respond to the Committee's
report and have the following comments on those of the Committee's
conclusions and recommendations that relate to the Commission.
1. 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)
2. Our examination of the role
of treasury management advisers in the Icelandic debacle has raised
wider questions about their influence on local authorities' treasury
management practice. First, there is confusion, and perhaps some
deliberate ambiguity, about what services they offer. It is clear
to us that some local authorities believed that they could place
reliance on their treasury management advisers in a way that some
of the treasury management advisers themselves now seek to argue
was misguided. Second, there is concern about the independence
of treasury management advisers that may be part of companies
that will benefit from the investment decisions of the local authorities
that they advise. Third, there is a lack of clarity about the
extent to which local authorities can assume that treasury management
advisers are properly regulated. While local authorities must
ultimately take responsibility for their investment decisions,
a range of regulatory and advisory bodies appear to us to have
been complacent in their approach to the role of treasury management
advisers. 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 Commission agrees that local authorities could
benefit from a greater understanding of the role of external treasury
management advisers and Risk and Return included a recommendation
reflecting this view. However, there may be a more immediate way
of producing advice for local authorities than undertaking a study.
We therefore propose to discuss with CIPFA and representatives
of local authorities how best to meet the need for appropriate
advice on the use of external treasury management advisers.
3. The Audit Commission took
it for granted that treasury management was a well managed function,
and, consequently, was not an area of concern for auditors. Even
if it could not reasonably have been expected to foresee the collapse
of a country's entire banking system, the Audit Commission should
have been aware of the greater risk to treasury management as
a result of the prevailing financial climate and should have adjusted
its practice accordingly. The Audit Commission failed to realise
that treasury management was becoming an increasingly risky area
and, in that respect, it must share some of the blame for the
potential loss of funds in the Icelandic banks. If it had viewed
treasury management within the increasingly volatile economic
context, it would have put treasury management higher in its auditing
procedures, and if it had done that, it is possible that less
public money would now be at risk. 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)
We agree that, with the benefit of hindsight, we
could have highlighted to auditors the emerging risks to treasury
management and asked them to do more work in this area or draw
them to councils' attention.
However, we do not accept the Committee's suggestion
that the Commission is culpable for the potential loss of funds
deposited by local authorities in Icelandic banks. This confuses
the responsibility of the Commission and its appointed auditors
with that of managers and those charged with the governance in
local authorities.
Audit is an expensive and finite resource and the
Commission is always mindful of the need to minimise the cost
of audit to bodies within its remit. Audits are conducted on an
annual cycle, planned in advanced and targeted on risks, on the
basis of the evidence available at the time. When the audits were
being planned, the Commission took the view that the evidence
showed that most councils were effective at managing their deposits.
On a balance of risk and cost, it was not appropriate to ask all
auditors to do specific work on treasury management beyond that
required for the Use of Resources assessment. The Commission remains
of the view that this was the correct judgement.
It is not the role of auditors to provide assurance
to councils on the effectiveness of their systems. The Statement
of Responsibilities of Auditors and of Audited Bodies (Statement
of Responsibilities) is issued to all audited bodies and referred
to in all audit reports. It makes these matters clear:
Auditors evaluate significant financial systems,
and the associated internal financial controls, for the purpose
of giving their opinion on the financial statements. Where auditors
identify any weaknesses in such systems and controls, they will
draw them to the attention of the audited body, but they cannot
be expected to identify all weaknesses that may exist (paragraph
17);
While auditors may review audited bodies' arrangements
for securing economy, efficiency and effectiveness in the use
of resources, they cannot be relied on to have identified every
weakness or every opportunity for improvement (paragraph 28).
Treasury management is part of an authority's wider
system of internal control and should be included in the authority's
annual statutory review of the effectiveness of its system of
internal control. The results of this review are reported in
an annual governance statement, which is normally signed by both
the leader and chief executive.
Although auditors are required to review whether
the statement on internal control has been presented in accordance
with the relevant requirements, the Statement of Responsibilities
is clear that auditors are
not required to consider whether the statement on
internal control covers all risks and controls, nor are auditors
required to form an opinion on the effectiveness of the audited
body's corporate governance procedures or risk and control procedures
(paragraph 18).
Councils, therefore, must not rely on external auditors
to find out whether treasury management, or any other aspect of
their management arrangements, is working effectively. That is
a function of managers and those charged with governance, and
is not a matter for auditors or the Commission.
The Committee recommended that we review our own
auditing procedure and prioritisation of the areas of local authority
activity that we choose to audit, in order to ensure that such
complacency does not happen in future. The Commission can confirm
that it keeps all of its processes under review, including those
for identifying risks to be considered as part of the annual audit.
4. 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 Audit Commission is an active participant in
CIPFA's treasury management panel, which meets regularly to discuss
the functioning of treasury management. Other participants include
representatives of local authorities, the FSA and central government.
The Capital Programmes Working Party also provides
a forum for discussion of treasury management issues.
Next Steps
In Risk and Return the Commission said it
would ask auditors of all local authorities, police and fire and
rescue authorities to follow up the lessons learned. Such central
direction is now clearly justifiable on the balance of risk and
cost, and we have developed a short mandatory work programme for
auditors.
The work programme is supported by a technical briefing
on treasury management commissioned from the expert advisers involved
in Risk and Return, which has been made available to all
auditors. This summarises the characteristics of good and poor
treasury management, as identified during the study research.
The Commission is also contracting for more technical
support and advice to auditors on treasury management. Finally,
it is identifying staff from within its own audit practice to
take the new specialist treasury management qualification launched
this month by CIPFA and the Association of Corporate Treasurers
(ACT).
For its own treasury management activity, the Commission
acknowledges the criticisms made by the Committee, which reflect
the Commission's own reviews. The Commission's treasury management
is now compliant with the best practice identified during the
research for Risk and Return.
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