Local authority investments - Communities and Local Government Committee Contents


4  Local authorities' financial teams

38. We now consider the capacity and competence of local authorities to handle the large sums of public money which are at their disposal for investment.

Audit Commission's report Risk and Return

39. The Audit Commission published a report in March 2009, Risk and Return: English local authorities and the Icelandic banks, which addressed treasury management practice in English local authorities, in the context of the specific circumstances surrounding the Icelandic banking collapse. It collected data from appointed auditors of English local authorities, visited 37 English local authorities to examine treasury management practices and studied 30 sets of treasury management documentation and 179 counterparty lists. It found variations in the standards of local treasury management arrangements, from the best local authorities, which "explicitly balance risk and reward; review and scrutinise policies and procedures regularly; have well trained staff and engaged elected members; and use a wide variety of information"[47] to those less satisfactory local authorities, which "have weak governance; depend exclusively on credit ratings; and have staff who are inadequately trained."[48]

40. The Audit Commission specifically considered the actions of those local authorities which have funds at risk in Icelandic banks. The Commission's report sets out the timeline of the downgrading of the Icelandic banks. On 30 September, credit rating agency Fitch downgraded all three of the banks concerned to adequate grade, and Moody's downgraded Glitnir to adequate grade. Also on this date, Glitnir was partially nationalised.[49] The Commission highlighted and severely censured seven local authorities, which had deposited money into the Icelandic banks after 30 September and, in some instances, had breached their local treasury management policies:

Local Authority Amount Deposited Date
London Borough of Havering £2 million1/10/2008
Kent County Council £3.3 million

£5 million

1/10/2008

2/10/2008

Redcar and Cleveland Borough Council £4 million1/10/2008
Restormel Borough Council £3 million1/10/2008
Bridgnorth District Council £1 million2/10/2008
South Yorkshire Pensions Authority £10 million2/10/2008
North East Lincolnshire Council £3 million

£1.5 million

2/10/2008

3/10/2008

Source: Audit Commission "Risk and Return", table 3

41. The table shows a total of £32.8 million invested by seven local authorities from 1 to 3 October 2008 at a time when the Icelandic banks' credit ratings had been downgraded.[50] It shows that two local authorities—Kent County Council and North East Lincolnshire Council—placed separate investments on two consecutive days, amounting to £12.5 million. The report highlights explanations given by local authorities for these breaches:

Not opening an e-mail from the treasury advisor that warned of the rating change; using a different approved lending or counterparty list to that used by the treasury adviser; and an officer placing a deposit that exceeded the local authority's investment limit for a single transaction.[51]

42. We endorse the Audit Commission's censure of these rudimentary mistakes in organisations responsible for investing large amounts of public money. However, as the Commission's research has found, those seven authorities were not necessarily the only local authorities at fault. The Commission found:

[…] differences in the behaviours displayed by local authorities that were non-investors in the Icelandic banks, those whose deposits matured between 1 November 2007 and 7 October 2008, and those that have funds at risk. Non-investors generally had more effective governance and scrutiny arrangements and took more measured approaches to managing risk than either local authorities whose deposits matured between 1 November 2007 and 7 October 2008 or those that have funds at risk.[52]

43. It is important to note that three-quarters of councils were not exposed to Icelandic banks at all. However, the Commission suggested that some authorities that avoided potential losses in the Icelandic banks "were lucky"[53] and, given the fact that the Audit Commission itself did not place the auditing of treasury management as a high priority,[54] there is no reason to suppose that lapses in treasury management practice were confined only to those local authorities with money at risk.

The investment capabilities of local authorities

44. In its written evidence, the Local Government Association defends local authorities, noting that:

Most authorities had no exposure to Icelandic banks at the point of their collapse, and the evidence is a number of authorities were reducing their exposure to Icelandic banks as deposits matured over summer 2008.[55]

The Audit Commission's report to some extent upholds this view, acknowledging that the best local authorities:

[…] explicitly balance risk and reward; review and scrutinise policies and procedures regularly; have well trained staff and engaged elected members; and use a wide variety of information.[56]

However, it also concludes that the less effective authorities "have weak governance; depend exclusively on credit ratings; and have staff who are inadequately trained."[57]

45. We have not, of course, been in a position to carry out a thorough review of local authority treasury management function along the lines of the Audit Commission's inquiry. We have nevertheless received evidence which backs up the Commission's conclusions. Not surprisingly, perhaps, we did not receive many written submissions from those local authorities that have money at risk in Iceland. We did, however, receive evidence from two councillors at Westminster City Council, for example, which gives an overview of changes that occurred in that council's treasury management policy in March 2008. Those changes included creating new rules for handling medium term funds, including removing the limit of no more than 10% of total reserves in a single institution in 'specified investments'.[58] The evidence goes on to describe Westminster City Council's investments in Iceland, which started at the end of 2006 and continued to 2008, with a total of £9.85 million being invested in Iceland up until 29 August 2008. This was at a time when many investors and non-investors alike were aware of the fact that Iceland was not a safe place in which to invest.[59]

46. After the collapse of the Icelandic banks, Westminster City Council commissioned KPMG to carry out an independent review of its treasury management practices. The review's findings identified inconsistencies or omissions in the investment strategy, ambiguities within the in-house treasury team and a counterparty breach (where the council had exceeded its own counterparty limit with a building society in September 2008).[60] Other local authorities with investments in Icelandic banks have carried out similar reviews, with similar findings.[61]

47. CIPFA Scotland describes how local authorities as investors are classified:

[…] under the Market in Financial Instruments Directive (MiFID), local authorities are generally categorised as Professional Clients not as Retail Clients. This is indicative of the greater level of understanding of the money markets which local authorities should have, and their greater resources to retain the services of professional advisers where appropriate. Local Authorities should therefore be in a position to make value judgements on the risk incurred in their investments.[62]

48. The Iceland affair has shown clearly that a number of local authorities fell short of the competence expected of professional clients. As the Audit Commission points out in "Risk and Return":

During 2008, confidence in the creditworthiness of some of the Icelandic banks changed relatively rapidly and between January and September 2008, a number of credit rating downgrades were announced, which should have prompted treasury managers to review the creditworthiness of the Icelandic banks.[63]

Had all local authorities stopped placing deposits in the Icelandic banks in April 2008, the total amount of funds at risk when the banks collapsed in October would have been £389 million instead of £954 million.[64]

49. It is obvious from our written evidence, and from the research carried out by the Audit Commission, that there are some local authorities with excellent treasury management services, but there are also local authorities with a less effective service. One of the objectives of the CIPFA Codes and Codes of Practice should be to ensure that all local authorities are aware of the level of expertise which is necessary to run a successful treasury management operation, and have all the checks and balances in place to ensure adequate monitoring, on an ongoing basis, of both the framework within which its treasury management team operates and the individual decisions which are made on a day-to-day basis. We welcome CIPFA's review of its codes, prompted by the events of last autumn, and recommend that it bear these principles in mind as it undertakes that review. We make some specific suggestions about how the Codes could be improved later in this Report.[65]

District councils and the pooling of resources

50. The question arose during our inquiry of whether there was a particular issue for district councils. Mr Antill, representing the Society of District Council Treasurers as a member of its Executive Committee, told us that district councils are smaller than other local authorities, and that this can have an effect on treasury management:

In district councils we do not have an awful lot of expertise. It is often relying on a very small team, so external advice is fundamental, particularly that of the credit agencies.[66]

He went on to note that potential losses in a district council's investments have a larger effect on its budget:

I can see the Government having difficulty protecting the investment…but I do think this is unprecedented, certainly in my limited experience, and I think it will be difficult for local authorities. If impairment means that we have to suffer the losses to our revenue accounts, ie over one year, that is going to be extremely difficult for any authority to manage, but for a district council to write its losses off over one year will be exceptionally difficult. I think we need help on that front.[67]

51. The Iceland affair seems to suggest that it is this latter point—the effect on district councils' budgets if something does go wrong, rather than the likelihood of something going wrong in the first place—which is more significant. As the Audit Commission's report points out, 44% of county councils had deposits with Icelandic banks, compared with just 24% of district councils. Written evidence from the District Councils Chief Executive Network defends district councils, stating:

Often the first comment made in almost any situation is that smaller authorities (districts) have a particular problem due to 'capacity'. I fear that sentiment has also circulated around the issue of Icelandic banks. The evidence shows that the smaller authorities (districts) far from having a question over capacity would seem to have proven themselves to be the type of authority least likely to have been caught out.[68]

52. However, the Audit Commission's report highlights that 30 authorities have investments in Iceland that exceed 5% of their gross revenue expenditure: district councils make up 27 of those 30. Although there are fewer district councils than county councils with investments at risk in Iceland, those district councils that do have investments at risk have large investments compared to their gross revenue expenditure. This substantiates Mr Antill's argument that those district councils with Icelandic investments face a harder prospect in writing off any losses than do the larger councils with their larger revenue budgets.

53. District councils in particular might therefore wish to consider ways in which they can mitigate the risks inherent in investing relatively large amounts proportionate to their gross revenue expenditure. The Audit Commission's report, highlighting the difficulties faced by some smaller local authorities, accentuates the need for properly resourced treasury management teams:

Some smaller local authorities have been unable to allocate sufficient resource to treasury management functions, with a consequent failure to understand the markets and counterparties properly. Local authorities are now recognising that safeguarding invested cash requires an adequate level of resource; and many have either allocated extra resource, or are now considering how best to allocate extra resource to this function.[69]

54. One way of allocating such extra resources is by the pooling of resources with other local authorities. We received evidence from various local authorities about the benefits of sharing expertise between different public bodies. Leeds City Council describes the following arrangement:

Leeds is also able to consider issues affecting investment and treasury management by engaging and debating issues in various forums including West Yorkshire Treasury Managers meetings, Core Cities treasury management meetings, SIGOMA meetings and quarterly strategy meetings held with the Councils own treasury advisers. Issues are also regularly discussed with the broking community and various banks.[70]

55. Failures that occurred during the Icelandic crisis might have been lessened, had the expertise of local authorities been shared. The Investment Management Association, for example, commented on the fact that many bodies, not only local authorities, did not realise who owned the banks in which they invested:

Aside from Icelandic banks still being on lists seen by firms last year, other comments have highlighted the prevalence of errors in identifying the ultimate ownership of banks. This is an issue not limited to local authorities; evidence given to the Treasury Select Committee on deposit protection has noted the difficulty of identifying even which banks are in the same group. Work could be done here to assist local authorities.[71]

56. Speaking on behalf of district councils, Mr Antill told us that he welcomed the chance for local authorities joining together in order to pool resources:

We would welcome any extra advice or help they can give and I think it is a fair point about districts working together and perhaps sharing expertise more. I think it has drawn our attention perhaps to the need to do that.[72]

Such an arrangement would still enable each individual authority or other public body to remain responsible and accountable for the adoption of its own strategy and policy and for performance. 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.


47   Audit Commission, Risk and return: English local authorities and Icelandic banks, Cross-cutting national report, March 2009, p 4. Back

48   Ibid, p 4. Back

49   ibid, p 28. Back

50   Audit Commission, Risk and return: English local authorities and Icelandic banks, Cross-cutting national report, March 2009, p 28. Back

51   Ibid, p 29. Back

52   Audit Commission, Risk and return: English local authorities and Icelandic banks, Cross-cutting national report, March 2009, p 45. Back

53   Audit Commission, Risk and return: English local authorities and Icelandic banks, Cross-cutting national report, March 2009, p 46. Back

54   Q 302 Back

55   Ev 99 Back

56   Audit Commission, Risk and return: English local authorities and Icelandic banks, Cross-cutting national report, March 2009, p 4. Back

57   Ibid Back

58   Ev 58 Back

59   The details of warnings about Icelandic banks will be discussed in detail in Chapter 7. Back

60   KPMG, Westminster City Council: Review of Investment Strategy and Internal Control, 9 December 2008, p 3. Back

61   Examples include: Price Waterhouse Coopers (PWC),'Kent County Council: Review of Treasury Management procedures', December 2008 (www.kent.gov.uk); PWC,'Hertfordshire County Council: Review of Treasury Management procedures', February 2009 (www.hertsdirect.org). Back

62   Ev 94 Back

63   Audit Commission, Risk and return: English local authorities and Icelandic banks, Cross-cutting national report, March 2009, p 21. Back

64   ibid, p 27. Back

65   See Chapter 9 Back

66   Q78 Back

67   Q119 Back

68   EV 151 Back

69   Audit Commission, Risk and return: English local authorities and Icelandic banks, Cross-cutting national report, March 2009, p 43. Back

70   Ev 88 Back

71   Ev 141 Back

72   Q 114 Back


 
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