Memorandum by Reading Council (LAI 17)
In connection with your Committee's enquiry
I submit some comments in response to each of the questions raised,
together with some wider comments, as the questions raised seemed
to be mainly about the investment side of treasury management
(TM), but an understanding of the borrowing side is important,
as TM has to be looked at as a whole.
Reading BC did not have investments with Icelandic
banks, nor have we ever had such investments, and indeed those
banks have not appeared on our list as eligible counterparties,
and it is from this perspective that I submit comments.
What are the present arrangements for local authorities'
Treasury Management—and in particular the requirement to
produce Annual Investment Strategies—and how have these
affected the performance of local authorities, both as service
providers and employers, given recent potential losses experienced
by many local authorities?
1. The present arrangements have become fairly
well established and at a strategic level involve approving a
Treasury Management Strategy Statement (TMSS) and Annual Investment
Strategy (AIS) before the start of each year, and reporting the
outturn in a Treasury Outturn Report (TOR). Like many authorities
we fulfil the first of these requirements by including the TMSS
& AIS as part of the Council's budget package, and the TOR
is reported to Council in parallel with the final accounts. The
relevant documents are available on our website for public inspection
(by following budget ore statement of accounts links at
http://www.reading.gov.uk/councilanddemocracy/councilfinances/).
2. In practice, in Reading, as in many authorities,
these documents are prepared based on templates provided by our
treasury advisor. Anyone looking at a large number of statements
would find some similarity of style according to advisor. This
carries some risks that authorities don't sufficiently "personalise"
the template and own their strategy, placing too much reliance
on the advisor. We have always taken the view that whilst it is
the role of advisors to guide and help, ultimately the authority
must control and own the process. Ultimately treasury activity
is carried out by a small team within the finance function with
the staff handling day to day transactions having clear guidance
on what can be done on a day to day basis. More senior officers
in the team take responsibility for long term borrowing decisions
(mainly from the Public Works Loans Board (PWLB)), and medium
term (one month—three to five year lending).
3. In recent years treasury management has made
a positive contribution to many authorities financial position;
it had until about a year ago been possible to restructure debt
on favourable terms with the PWLB, and it has been recognised
that since the advent of the Prudential System it is acceptable
to borrow ahead of need, if interest rates appear advantageous.
In this context in recent years with an inverse yield curve it
has been possible to borrow long term at attractive interest rates,
lending out the money until it is needed usually at a higher rate.
We, like most unitary authorities had a substantial underspend
on our treasury budget in 2007-08, and indeed an underspend is
forecast in the current year. We would suggest active treasury
management has contributed positively to local authorities financial
position, and indirectly to improved service delivery.
In the light of recent events, are any changes
needed to the framework for the scale, spread and risk of local
government reserves?
4. Our view is that whilst the broad structure
of the guidance does the correct things, recent events have emphasised
the need to consider the risks, both financial and reputational
of treasury activity. Historically, in the pre prudential controlled
system we had modest sums to invest and could usually place them
with a range of high street banks and building societies. Money
was often needed within a relatively short period, so investments
were short term. More recently when we began to have larger sums
to invest (in some cases borrowed to help fund the Council's ambitious
capital programme), initially we were placing larger sums with
the same small group of banks, usually revising our lending limits
upwards to do so. In discussion with our advisor and broker we
developed a more substantial lending list, based on credit ratings,
but not using them as the only criteria. We included some higher
rated foreign banks, though with lower limits than equivalent
rated UK banks, and a greater range of building societies (top
10, rather than top 2-3). During 2007, in March we arranged a
loan with the Northern Rock for one year from September 2007.
Whilst one of the lower rated institutions on our list, part of
our judgment for including them was that as a significant "high
street" institution it was unlikely the government and banking
community as a whole would allow total failure. The subsequent
difficulties faced by Northern Rock were a salutary lesson, and
caused us to review, tighten and affirm a more strict adherence
to our lending list. We suggest that all authorities should have
re-evaluated risk in the autumn of 2007, given CIPFA guidance
that capital preservation should be seen more significantly than
pursuing enhanced returns.
5. Inasmuch as so many authorities have had
investments in Icelandic Banks, clearly a wide range of authorities,
and indeed the Audit Commission, have come to a different risk
judgment to ourselves. Clearly market have undergone substantial
stress in 2008 with the government now having to support a range
of UK financial institutions. At the current time these are the
only non public sector organisations we are placing money with
(other than our own bank (Co-Operative)).
Should local authority money be invested in Government
stock, with lower risk, but with a low return? What effect would
this have on UK banks and on council taxes?
6. We do not take the view that the purchase
of Government Stock should be the only investment permitted for
local authorities. Such investments are not really suitable for
"cash flow" investments (ie the largest amounts of money
come into the authority on 1st (local tax) 15th (DWP HB grant)
but expenditure occurs daily, with the largest regular item being
salaries, towards the end of the month; authorities that have
covered their long term borrowing requirements need to make short
term investments between the two. As a general principle AAA money
market funds and call accounts with reputable banks provide the
most suitable investment vehicle for this purpose, in normal times.
7. It does however appear to us that some authorities
may have relied excessively on credit ratings or their advisors
interpretation of them and given insufficient thought to the possibility
and consequences of investments in foreign banks being unlikely
to get the same sort of support in severely stressed times, and
in particular to the risks associated with the banks in a relatively
small island economy.
What is the role of central government in providing
financial advice and guidance to local authorities? Should any
other bodies have a role?
8. It is the role of central government through
legislation, and high level guidance to set the broad framework
within which authorities operate. That framework specifically,
and appropriately recognises guidance issued by CIPFA. Central
government should not have a role in advising authorities should
or should not invest with particular institutions, save the strategic
level one, and the basic advice that lending should be done with
capital preservation as the key objective.
Should the Government protect local authorities'
investments in the same way that it is protecting personal assets?
What consequence does this have for the relationship between local
and central government?
9. Local authorities are generally regarded
as professional counterparties in the market place, and employ
professionally trained and qualified staff in senior finance roles,
and in most cases purchase professional advice about their treasury
activities from professionally qualified advisors with substantial
market experience. The position of authorities is very different
from that of individuals, and therefore an unconditional government
guarantee of LA investments would not be appropriate.
10. Having said this it should be recognised
that local authorities are removed from the London centred market
and have to rely on advisors and brokers to keep them up to date
of market developments. Recent years have seen the emergence of
lending products from banks, often at interest rates below those
offered by PWLB, in some cases with a low starting interest rate
(LOBO loans). Some authorities have made significant use of these
LOBO products, though it does not seem to have been recognised
that the lenders option would be most likely to be exercised at
a time when borrowing rates were disadvantageous. In the light
of events there is a need for guidance to re-emphasise the need
for risk management in relation to treasury activity.
11. In addition, as indicated above the government
(DMO) run PWLB substantially worsened its lending terms about
a year ago. Until 1 November 2007 changes the PWLB had permitted
the repayment of most loans, with any discount or premium calculated
at the present interest rate for a loan of the remaining period
of the loan being repaid. At that time a set of repayment rates
25-46bps less were introduced for repayments, although at some
points on the yield curve the rate at which authorities could
borrow was marginally improved. For authorities that had borrowed
ahead, and in the changed economic circumstances now faced, one
response would be to prematurely repay some of the borrowing,
to reduce treasury risk. The action of the PWLB last year has
(until very recently) made this almost unaffordable, and in some
ways has increased treasury risk faced by authorities. Whilst
we understand (having visited them) that the PWLB no longer wished
to be considered the sole or main lender to local government,
and we can accept the need for some margin between borrowing and
repayment rates we think those introduced by the PWLB were excessive,
and a 10-20bps margin would have been equally as effective in
normal times. Assuming the committee intends to consider local
authority treasury management as a whole, we think there is a
case for an exploration of this issue in its work.
We would be happy to clarify, or provide more
detail about any of the issues raised in this letter if it would
assist the committee in its deliberations.
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