Memorandum by Leeds City Council (LAI
20)
Summary
The main points are:
Question 1:
— The operation of Treasury management
works well within the provisions set out under the local government
act 2003 with regard to CIPFA prudential code for capital
finance.
— The framework ensures that treasury management
policy and investment is considered and approved by Council.
— The Council ensures that there are sound
monitoring and frequent reporting of progress against treasury
management strategy.
— Whilst the Council did not have any exposure
to the Icelandic banks it has revised its investment criteria
as the crisis in the money markets has unfolded.
— Treasury management activity has enabled
savings to be delivered that have been used to assist in the delivery
of front line services and to limit council tax increases.
— Local Authorities can reduce their investment
risk by repaying debt but this has not been economically viable
since the DMO changed the rules over premature repayment of debts
on 1 November 2007.
Question 2:
— Under the 2003 Local Government
Act, the Council's Statutory Financial Officer is required to
make a statement to Council on the adequacy of reserves. In addition,
the Comprehensive Performance Assessment framework requires the
authority to have a policy on the level and nature of its reserves
and ensure these are monitored and maintained within the range
determined by its agreed policy.
— The Council has set its level of reserves
in accordance with current guidance. If it were to raise this
level to reflect heightened concern in the money markets there
will be an impact upon the level of council tax or front line
services.
Question 3
— If Councils collectively deposited greater
sums with the Government the market would be further drained of
essential liquidity, making it more likely that the interbank
cost of borrowing would increase and in turn the banks would become
more reliant on Government help.
— The repayment of debt without incurring
a premium, has become more difficult since the PWLB introduced
differential rates on 1 November 2007. This is an issue that if
resolved could allow local authorities to repay debt and thereby
reduce the level of investments.
Question 4
— The framework for treasury management
has been set for a number of years and is generally clearly understood
by local authorities. It is Leeds' view that the framework does
provide adequate scope within which to undertake effective treasury
management.
— 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
advisors. Issues are also regularly discussed with the broking
community and various banks.
Question 5
— The criteria for investments including
the amount, length and selection of the counterparty to invest
in is determined by each local authority and detailed in its treasury
management investment strategy that is approved by full council.
This strategy incorporates the financial and capital aims of the
individual local authorities. Leeds believes that this process
has worked well for a number of years, but the current systemic
unique problems facing the money markets at present may be aided
by some temporary Government protection.
Main Details
1. 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?
1.1 The operation of the Treasury Management
function is governed by provisions set out under part 1 of
the Local Government Act 2003 whereby the Council is required
to have regard to the Chartered Institute of Public Finance and
Accountancy (CIPFA) Prudential Code for Capital Finance in Local
Authorities.
1.2 The Prudential Code requires that full
Council set certain limits on the level and type of borrowing
before the start of the financial year together with a number
of Prudential indicators. Any in year revision of these limits
must similarly be set by Council.
1.3 The Code of Practice requires that policy
statements are prepared for approval by the Council at least twice
a year. Strategy statements are produced in February for the year
ahead, reviewed half yearly and at the end of the year. The strategy
formally outlines the borrowing and investment strategy and progress
to date. These strategies are reviewed further in quarterly strategy
meetings with the Director of Resources and the Council's treasury
advisors. Monitoring reports are also produced on a monthly basis
for consideration the finance management team. The day to day
implementation of strategy is delegated to the Treasury Management
Section.
1.4 Leeds regularly invests surplus cash
reserves in other local authorities, banks and building societies
as part of its normal cashflow management. These investments can
range from overnight deposits to investments of over twelve months.
By investing funds in this way the Council is able to earn interest
which it can use to offset the cost of its services. The Prudential
Code also allows local authorities to borrow in advance of need
and invest surplus funds until they are required. The Council
has borrowed funds in advance of need when borrowing rates have
been low and have invested these funds until required earning
interest for the Council which again supports the Council's revenue
budget (see 1.10).
1.5 The criteria used by the Council in
relation to the creditworthiness of financial institutions is
provided by the Council's treasury advisers, Sector Treasury Services.
The financial institutions with excellent credit ratings are coded
"red" whilst those with good credit ratings are coded
"green". Each of these classifications attracts limits
in terms of how much the Council will invest with them and for
how long as shown below:
|
| Limit
£m | Period Limit
|
|
| Red | 15 | Up to 365 days or more
|
| Green | 5 | Up to 3 months
|
|
There is also a group party limit of £30 million
| | |
1.6 The counterparty list is prepared from the credit
ratings. These credit rating are updated as and when changes occur
The Council does not just rely upon the credit rating provided
but also seeks additional information by closely following the
financial press, Reuters, credit default swaps, share-market price
volatility, seeking advice from the Councils advisors, talking
to the money brokers, discussion of the issues within the Council,
engagement with other local authorities, attending seminars and
also considering the rate of return on an investment in relation
to the market average. It is through this analysis that the decision
was taken in February of this year to not deal with the Icelandic
banks. A similar approach was adopted when Leeds withdrew from
investing in the Northern Rock, Alliance and Leicester, Bradford
and Bingley and the Japanese banks last year. This was also extended
to the Irish banks but has been subsequently relaxed due to the
Irish Government guarantee on commercial deposits.
1.7 As the liquidity crisis has expanded Leeds has also
taken additional measures to limit exposure by ensuring that investments
are spread amongst different countries. Currently where it is
necessary to deposit funds for cash flow purposes, these are being
placed for periods of up to one month, but no longer. It is also
the case that as the Council's expenditure accelerates in the
second half of the year (largely due to capital programme) the
levels of investments will reduce as they are timed to mature
to fund this expenditure.
1.8 Whilst it is the case that Leeds did not have any
investments with Icelandic banks it is appropriate to illustrate
the effect of investment strategy on the overall impact of the
Council's budget. Since the introduction of the prudential code
in 01/04/04 that gave the Council powers to borrow in advance
of need and invest monies until required, treasury management
have reported overall savings as shown in the table below. These
savings have occurred as a result of being able to borrow in advance
of need and invest monies until required, carry out rescheduling
of long term debt and the effect of lower borrowing rates. The
benefit of reducing the average external borrowing rate has been
passed onto the Government through reduced housing subsidy.
|
| Year | Savings | Impact on Council Tax
£ per Band D property
|
|
| 2007-08 | £13.5 million
| £58.67 |
| 2006-07 | £22.2 million
| £97.23 |
| 2005-06 | £1.75 million
| £7.73 |
| 2004-05 | £5.5 million
| £24.78 |
|
| |
|
1.9 One way of reducing the risk of investing surplus
funds is to repay debt. However, whilst this has helped the revenue
budget as illustrated above, this has become increasingly difficult
since the DMO changed the rates on premature repayment of debt.
1.10 The majority of the Council's long term debt is
funded by borrowing from the Public Works Loans Board (PWLB).
On 1 November 2007 the DMO implemented new changes to the
way local authorities can borrow and prematurely repay loans.
These changes restrict the effective management of the Council's
long term-debt portfolio and reduce the opportunities to fairly
take advantage of movements in the markets and generate discounts
and interest savings for the Council and, through Housing subsidy,
the Government. It also limits the ability to come out of high
rate loans.
1.11 The management of the Council's long term debt portfolio
has to strike a balance between volatility and the interest rate
paid for a particular loan. Whilst market loans in the form of
LOBOs have always provided a cheaper alternative funding source
they have not always been chosen, as their rate can vary and result
in increased uncertainty. It is good treasury practice to have
the right balance of fixed and variable loans in a portfolio.
If the Council no longer has the practical option of rescheduling
fixed PWLB loans, as a result of the differential repayment rates,
the Council sees itself taking on more market debt. In the short
term this may provide a cheaper option, but at the expense of
future volatility and more expensive loans perhaps in the future.
1.12 The Council has a low council tax (more than £100 lower
than the average Core City in 2007-08, and 5th lowest of all 36 metropolitan
districts) and as such its scope to manoeuvre is perhaps less
than for other authorities. The Council has responded well to
the Gershon agenda and has exceeded its three year targets. The
Council's Use of Resources assessment continues to demonstrate
strong financial performance and value for money.
1.13 It is against this context that the Council has
in the past looked to making savings from treasury operations.
However, the introduction of new repayment rates has hindered
the ability to prematurely repay debt without incurring a premium.
2. In the light of recent events, are any changes needed to
the framework for the scale, spread and risk of local government
reserves?
2.1 Under the 2003 Local Government Act, the Council's
Statutory Financial Officer is required to make a statement to
Council on the adequacy of reserves. In addition, the Comprehensive
Performance Assessment framework requires the authority to have
a policy on the level and nature of its reserves and ensure these
are monitored and maintained within the range determined by its
agreed policy. The purpose of a reserves policy is:
— to maintain reserves at a level appropriate to help
ensure longer term financial stability; and
— to identify any future events or developments which
may cause financial difficulty, allowing time to mitigate for
these.
2.2 The established policy encompasses an assessment
of financial risks included in the budget based on directorate
budget risk registers. The risk registers identify areas of the
budget which may be uncertain and the at risk element of each
budget area has been quantified. This represents the scale of
any likely overspend/shortfall in income and does not necessarily
represent the whole of a particular budget heading. Each risk
area has been scored in terms of the probability and impact on
the budget.
2.3 The results of this exercise for 2008-09 indicate
a minimum level of reserves of around £12 million is
required. This assessment has not in the past considered the risk
of default on investments. However, if the level of reserves was
raised to say Leeds' Counterparty limit of £15 million there
will be an impact upon the level of council tax or front line
services.
3. 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?
3.1 When placing funds in the market the Council has
to have due regard from security of capital, liquidity and finally
the return offered. The current alternative for the Council to
placing surplus funds in the markets is to keep the funds with
the councils own bank that is currently paying a margin above
the bank rate. There is a further alternative that includes investing
the money with the Government's Debt Management Account Deposit
Facility. The best rate that this account currently offers sub
2% and it is perhaps more appropriate to repay debt rather than
invest at the rate offered. However, the repayment of debt without
incurring a premium, has become more difficult since the PWLB
introduced differential rates on 1 November 2007. This is an issue
that if resolved could allow local authorities to repay debt and
thereby reduce the level of investments.
3.2 It is also the case that if Councils collectively
deposited greater sums with the Government the market would be
further drained of essential liquidity, making it more likely
that the interbank cost of borrowing would increase and in turn
the banks would become more reliant on Government help.
3.3 The council has also recently noted that where it
has required funds these have been supplied by other local authorities
to a greater extent.
3.4 The Council has investments which are expected to
diminish towards the end of the financial year, as the Council's
expenditure accelerates in the second half of the year (largely
due to capital programme) these investments are timed to mature
to fund this expenditure. As such it is unlikely that any of these
returned long term investments will be re-invested.
3.5 It is important to recognise that whatever risk measures
are put in place to protect the Council's investments, there is
no 100% guarantee that an investment will be risk free. (Please
see the points raised in section 5.) Leeds's current strategy
on investments is to consider:
— The rate that can be secured on the borrowing given
interest rate forecasts.
— Security of counter parties to ensure that we get
the money back, to include:
— Evidence so far that the UK Government appears to
be keen to support the UK banking sector—through recent
acquisitions and shareholdings.
— Evidence that some non-UK Governments are also backing
their banks, for example, Ireland.
— Whether there is scope within the lending list to
lend further funds to "red" rated institutions both
within the UK and outside the UK.
— Review of the Investment guidelines for Councils by
CIPFA and this review of the local government treasury management
code.
4. What is the role of central government in providing financial
advice and guidance to local authorities? Should any other bodies
have a role?
4.1 The operation of the Treasury Management function
is governed by provisions set out under part 1 of the Local
Government Act 2003 whereby the Council is required to have
regard to the Chartered Institute of Public Finance and Accountancy
(CIPFA) Prudential Code for Capital Finance in Local Authorities.
4.2 The framework for treasury management has been set
for a number of years and is generally clearly understood by local
authorities. It is Leeds' view that the framework does provide
adequate scope within which to undertake effective treasury management.
4.3 Throughout the year there are seminars held by CIPFA,
the local government association, banks and treasury advisors
which allow for detailed discussion around the current issues
faced in treasury management. It is also the case that some of
the topics are delivered by Government advisors/Civil servants.
4.4 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 advisors.
Issues are also regularly discussed with the broking community
and various banks. These various forums provide the Council with
an up to date view of the issues affecting treasury management.
5. 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?
5.1 Treasury management relies on engaging in the money
markets and it is the responsibility of the local authority to
investment monies with regard to the provisions set out under
part 1 of the local Government Act 2003. Local authorities
themselves are classified as professional investors under MIFID.
5.2 The criteria for the amount, length and selection
of the counterparty to invest in is determined by each local authority
and detailed in its treasury management investment strategy that
is approved by full council. This strategy incorporates the financial
and capital aims of the individual local authorities. Leeds believes
that this process has worked well for a number of years, but the
current systemic unique problems facing the monies markets at
present may be aided by some temporary Government protection.
5.3 If the Government were to guarantee all local authority
deposits there are a number of questions that would need to be
debated including:
— What would be the impact on local authorities setting
their own prudential indicators and their investment strategies?
— Would the Government want to cap the exposure in any
one counter-party to limit their own exposure?
— Would local authorities become more liberal in their
lending attitudes through the pursuit of greater returns safe
in the knowledge that the deposit would be guaranteed by the Government.
— Would the Government insist that investments are limited
to UK banks?
— How would other nations react to this, given we are
facing an international problem?
— What will be the cost of protection and where will
it fall?
— How would a blanket guarantee on local authority investments
affect the overall standing of the Government? Would guilt issuance
have to rise and the rate at which investment in gilts lower the
price, thereby raising the yield and making it more expensive
for local authorities to borrow debt?
5.4 If an authority loses monies through a failed investment
the cost of this will inevitably fall upon the council tax payer
through increased council tax or reduced services. If the Government
protected these investments the immediate burden would fall upon
central government. However in the longer term would this mean
that local government settlements would be tighter?
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