House of Commons - Local authority investments - Communities and Local Government Committee

Local authority investments - Communities and Local Government Committee Contents

2 An overview of the current practice of treasury management

Relevant primary and secondary legislation

5. As any individual investor should know, no investment is without risk. As Guildford Borough Council remarked in its written evidence to this inquiry, "What has happened in Iceland has been, if nothing else, a sharp reminder about the relationship between risk and return."[8]

6. The responsibility to manage local authority investments is part of what is known as "treasury management", which CIPFA defines as:

the management of the organisation's cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks.[9]

7. The framework of treasury management within which local authorities must operate is made up of various pieces of legislation, guidance and best practice. Until 2004, local authorities had to invest in a Government-approved list of banks and other bodies (known as 'counterparties'), a system described by Rt Hon John Healey, Minister for Local Government, as "inflexible, […] unwelcome, and ultimately […] ineffective."[10] Despite the fact that the list was 'government approved', it was still possible for councils to lose money: most memorably in the case of the Western Isles Council, when one bank on the approved list—the Bank of Credit and Commerce International (BCCI)—collapsed in 1991. The collapse of BCCI prompted the then Treasury and Civil Service Select Committee to publish a Report which highlighted the essential principle which should guide local authority treasury management: "In balancing risk against return, local authorities should be more concerned to avoid risks than to maximise returns."[11]

8. The Government decided that a more flexible system with less detailed regulation was required. From 2004, therefore, a new system of local government capital control was introduced, including new arrangements that allowed councils greater freedom to make their own decisions about where to lend money. That system has its statutory basis in the Local Government Act 2003. This Act gives local authorities a clear power to invest "(a) for any purpose relevant to its functions under any enactment, or (b) for the purposes of the prudent management of its financial affairs"[12], requiring local authorities to self-regulate their capital finance, borrowing and investment activities. Statutory Instrument (SI) 3146/2003—the Local Authorities (Capital Finance and Accounting) (England) Regulations 2003—develops the controls and powers in the Act and requires local authorities to have regard to the CIPFA Prudential Code for Capital Finance.

9. The Office of the Deputy Prime Minister's informal commentary on its formal statutory guidance under Section 15(1)(a) of the Local Government Act 2003 states that:

the general policy objective is that local authorities should invest prudently the surplus funds held on behalf of their communities. The [formal statutory] guidance recommends that priority should be given to security and liquidity. However, that does not mean that authorities should ignore yield. It will be appropriate to seek the highest rate of return consistent with the proper levels of security and liquidity.[13]

10. The commentary notes that local authority investments are split into two types: specified and non-specified. Specified investments are those that are invested in institutions that offer high security and high liquidity. Such investments must be in sterling, must mature within one year and must be made in high credit-rated financial institutions, as measured by the three credit rating agencies: Fitch, Standard & Poor's and Moody's. Non-specified investments are riskier investments that mature after any period longer than 365 days. The reason for splitting the two types of investments is to manage risk, the first type being deemed to be safer than the second. The informal commentary on the Government guidance does not itself impose limits, but states that local authorities should define the limits to be held in such investments at any time of the year.[14]

11. According to the Government guidance, the core principles that local authorities should follow when investing money are:

to make the deposits secure,
to ensure they have sufficient liquidity for their daily demands,
finally, to produce the highest available yield, once the first two considerations have been met.

The security of investments is ascertained by the assessment and management of the risk involved. The guidance also stipulates that local authorities must have regard to the Treasury Management (TM) Code of Practice, published by the Chartered Institute of Public Finance and Accountancy (CIPFA).

The Chartered Institute of Public Finance and Accountancy (CIPFA) Codes

12. The Chartered Institute of Public Finance and Accountancy (CIPFA) is one of the leading professional accountancy bodies in the UK and the only one that specialises in the public services.[15] It publishes the Treasury Management (TM) Code of Practice, which is given legislative weight by the 2003 Act. Subsequent to the Act, CIPFA published a Prudential Code for Capital Finance in Local Authorities and also updated and revised the guidance notes that complement the TM Code of Practice. The section below describes the requirements of the CIPFA Codes; their effectiveness is examined in more detail in Chapter 9.

THE TREASURY MANAGEMENT CODE OF PRACTICE

13. The Treasury Management Code of Practice is described by CIPFA in its written evidence as follows:

The Code sets out the procedure and policies local authorities should follow in the organization and operation of their treasury management functions.[16]

The Code makes three recommendations for the adoption of policies and practices to secure local authorities' best practice in treasury management:

To put in place formal and comprehensive objectives, policies and practices, strategies and reporting arrangements to ensure the effective management and control of TM activities.
To demonstrate thorough policies and practices that effective management and control of risk are prime objectives of TM activities.
To acknowledge that the pursuit of best value in TM, and the use of suitable performance measures, are important in order to secure business and service objectives, and that within the context of effective risk management, TM policies and practices should reflect this.

In order to achieve these three recommendations there are, according to CIPFA, specific practices that local authorities should adopt, including the creation of a TM policy statement; the setting up of reporting procedures, including an annual strategy; the delegation of responsibility for execution of decisions to a responsible officer; and the delegation of responsibility for the monitoring of its TM policies and practices to a relevant committee of the authority.[17]

THE PRUDENTIAL CODE FOR CAPITAL FINANCE

14. The Prudential Code sets out the framework within which local authorities manage their investment requirements, as established by the Local Government Act 2003. Its key objectives are

To ensure, within a clear framework, that the capital investment plans of local authorities are affordable, prudent and sustainable—or, in exceptional cases, to demonstrate that there is a danger of not ensuring this, so that the local authority concerned can take timely remedial action.[18]

15. The Prudential Code requires the full Council to set certain limits on the level and type of borrowing before the start of the financial year and gives directions for the setting up of "prudential indicators", against which local authorities can monitor and measure their performance. The first such indicator in the Prudential Code is the adoption of the CIPFA Treasury Management Code of Practice.[19] According to CIPFA's written memorandum, if these prudential indicators are implemented, local authorities' treasury management decisions should be "affordable, prudent and sustainable".[20]

Annual Investment Strategy (AIS)

16. The CIPFA TM Code of Practice recommends that the local authority receive reports on its treasury management policies and activities, including, as a minimum, an annual strategy.[21] The updated guidance notes to the TM Code, "Treasury Management in the Public Services: Guidance Notes for Local Authorities including Police Authorities and Fire Authorities", place greater emphasis on the Annual Investment Strategy, which is central to the ODPM guidance on the 2003 Act. The CIPFA guidance notes stress that the AIS should state the local authority's policy on the use of credit ratings, the procedures for determining and limiting the use of riskier (non-specified) investments and the liquidity of investments. The AIS must be approved and, if necessary, amended by the full council, and should be publicly available.[22]

Local authority officials' roles and responsibilities

17. Local authorities are required under Section 151 of the Local Government Act 1972 to appoint an officer who is responsible for the proper administration of their financial affairs. He or she is often referred to as the Section 151 Officer and is responsible for, amongst other things, treasury management.[23] Local authority financial teams are discussed in Chapter 4.

Scrutiny of treasury management by elected officials

18. The Section 151 Officer must report to the Audit Committee on the council's Treasury Management Performance for the previous year, and on its Treasury Management Strategy and Policy, including the annual investment strategy, for the following year. The Treasury Management Code of Practice recommends in Treasury Management Practice (TMP) 6 that local authorities adopt the following statement:

This organisation will ensure that regular reports are prepared and considered on the implementation of its treasury management polices; on the effects of decisions taken and transactions executed in pursuit of those policies; on the implications of changes, particularly budgetary, resulting from regulatory, economic, market or other facts affecting its treasury management activities; and on the performance of the treasury management team.[24]

TMP6 goes on to state that the council should expect to receive, as a minimum: an annual report on the strategy and plan for the coming year; and an annual report on the previous year, citing "the effects of the decisions taken and the transactions executed in the past year, and on any circumstances of non-compliance with the organisation's treasury management policy statement and TMPs."[25]

19. The guidance notes to the TM Code of Practice describe the role of councillors in scrutinising treasury management in greater detail. Noting that the detail included in the annual reports at the start and at the end of the year will vary according to an organisation's circumstances,[26] it explains:

Whatever form the reports take, they should ensure, as a minimum, that those with ultimate responsibility for the treasury management function appreciate fully the responsibility for the treasury management policies and activities, and that those implementing policies and executing transactions have properly fulfilled their responsibilities with regard to delegation and reporting.[27]

20. The effectiveness of councillors' scrutiny of treasury management is assessed in Chapter 5.

External service providers

21. Most local authorities do not carry out their treasury management duties completely in-house, but employ private sector external service providers to supply expert assistance. These include treasury management (TM) advisers, external fund managers and brokers. Many employ treasury management advisers who aid them, to a lesser or greater degree, in their treasury management activities. The four main treasury management advisers for local authorities are Arlingclose, Butlers, Sector and Sterling, all of whom gave written evidence to our inquiry and three of whom gave oral evidence.[28] External fund managers may also be retained to manage local authorities' investments directly, observing the limits set out in the council's Annual Investment Strategy. Additionally, while some local authorities will deal directly with counterparties in setting up investments, others employ treasury management brokers to carry out the transactions on behalf of the local authorities. Brokers cannot and do not offer treasury management or investment advice, but simply act as an intermediary. The CIPFA guidance notes gives the following advice about external service providers:

These relationships need to be managed proactively in order to secure the optimum benefit for an authority. They should be subjected to regular review and, in accordance with standing orders, to formal invitations to tender for services, if best value is to be obtained.[29]

22. Issues surrounding external service providers, in particular treasury management advisers, are explored in Chapter 7.

8 Ev 51 Back

9 CIPFA, Treasury Management in the Public Services: Code of Practice and Cross-Sectoral Guidance Notes, April 2001, p 1. Back

10 Q 317 Back

11 Ev 68 Back

12 Ev 112 Back

13 Local Government Investments, Guidance under section 15(1)(a) of the Local Government Act 2003, paragraphs 14 and 15. Back

14 Ibid, para 22. Back

15 Ev 61 Back

16 Ev 63 Back

17 CIPFA, Treasury Management in the Public Services: Code of Practice and Cross-Sectoral Guidance Notes, April 2001, section 4 and 5. Back

18 CIPFA, The Prudential Code for capital finance in local authorities, 2003, p 3. Back