Memorandum by the Local Government Association
(LAI 23)
Thank you for your call for evidence in respect
of local authority investments, the LGA is pleased to respond
to your request. We are also grateful, in the light of recent
Government announcements in this area, for your extended deadline
of Friday 5 December.
We contend the principles underpinning local
authority Treasury Management are sound, having been carefully
developed over a number of years. No authority reports that it
faces immediate financial difficulties and there is no evidence
of recklessness by authorities in their management of this area.
Local authority deposits at risk with Icelandic banks represent
3.7% of total funds they had placed in the market at 31 March
2007.
We do not support the proposal that local authority
funds should be invested in Government stock, not least as the
interest losses would be substantial. Authorities may however
wish to invest some of their surplus cash with the Government
as part of a balanced risk strategy, as they do now
The recent government announcement to defer
the impact of impairments for a year is very welcome, and will
help authorities plan ahead. However it is not a permanent solution
and we believe the Government should support local authorities
so they can in turn maximize the support they can provide for
local people and communities in these difficult times. Such a
package would not be costly and would include:
— A guarantee that local authorities can
spread any losses from deposits with the four Icelandic banks
over a period of up to 20 years.
— Targeted support for authorities that
depend heavily on interest income to fund current budgets, in
the same way that the Government already compensation exceptional
costs such as those related to flooding.
We would be delighted to explore the issues
in our submission in more detail with the Committee.
1. The Local Government Association (LGA)
represents 466 authorities in England and Wales, together
these councils speak for over 50 million people and spend
£113 billion a year delivering services on their behalf.
Context
2. The past six months have seen a period
of substantial turmoil in global financial markets. The origins
of this crisis are likely to be debated for some time, but the
impact on major international banking institutions has been severe.
3. At 31 March 2007 English Local
Councils and related authorities had some £24.7 billion
of funds on deposit.[4]
On 9 October 2008 £926 million (or 3.7% of
the March 2007 holdings) was held with affected Icelandic
banks as below:
Table 1
TOTAL DEPOSITS WITH ICELANDIC BANKS
|
| English Councils | £788m
|
| Plus Fire, Park, Police, Passenger and Waste Authorities
| £138m |
| Equals Total English council and related authority deposits
| £926m |
| Plus Welsh and Scottish Authorities | £111m
|
| Equals Total deposits | £1,037m
|
|
Source: LGA
|
|
4. Since 9 October the LGA has been working with:
a. All affected councils to ensure the extent of liabilities
is understood and recovery of money is pursued in an efficient
and well co-ordinated manner.
b. Administrators (in the case of Heritable and Kaupthing
Singer Friedlander) and Resolution Committees (in the case of
Landsbanki and Glitnir banks) to ensure maximum sums are recovered.
c. The Improvement and Development Agency (IDEA) and Communities
and Local Government (CLG) to ensure individual authorities were
properly supported.
d. HM Treasury to ensure UK creditors' interests are appropriately
represented.
Key Messages
5. In spite of the unprecedented financial turmoil, no
council is reporting that it faces immediate financial difficulties
and there is no evidence of recklessness by authorities in their
management of this area. The LGA contends the principles underpinning
the approach to Treasury Management are sound, having been carefully
developed over a number of years. In the months since the Icelandic
bank failures affected authorities have:
a. Continued to make payments to creditors in good time,
b. Been developing contingency plans in case some of the deposits
are not recovered.
c. Been open in setting out their deposits in Icelandic institutions.
d. Established active creditors' committees to press their
case for recovery.
Select Committee Question 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?
Background to Treasury Management
6. Local authorities follow the Chartered Institute of
Public Finance and Accountancy (CIPFA) Treasury Management Code.
This code sets out the procedures local authorities should follow
in the organization of their treasury management functions.
7. The Treasury Management code is given legislative
weight by the 2003 Local Government Act. This is supplemented
by guidance on investments issued the Office of the Deputy Prime
Minister in March 2004.
8. The original CIPFA Treasury Management code was developed
in the light of the BCCI collapse in July 1991 and CIPFA
have just updated their guidance in this area.
9. The heart of the treasury management code is that
authorities should adopt a diversified investment strategy spreading
deposits across different institutions in order to ensure that:
a. Their deposits are secure.
b. They have sufficient liquidity to meet day to day demands.
c. They achieve the highest available yield commensurate with
the first two factors.
Implication of having diversified deposits
10. The benefit of a diversified investment strategy
is that, in the event of an unexpected institutional failure,
an authority is unlikely to lose all of its deposits. However
a further consequence of the same approach is that at a time of
substantial financial turmoil at least some authorities may find
some of their funds have been deposited with an institution that
finds itself in difficulties.
11. The available evidence is that authorities have adopted
diversified treasury strategies. Councils have placed surplus
cash[5] deposits in banks
and financial instruments that have had high financial ratings.
Table 2
SUMMARY OF ENGLISH INVESTMENTS[6]
AT 31 MARCH 2007
|
| Institution | Amount on deposit at
31 March 2007
|
|
| Banks | £14.9bn |
| Building Societies | £6.8bn
|
| Other | £3.0bn |
| Total | £24.7bn |
|
Source: CIPFA Capital Expenditure and Treasury Management Statistics 2006-07 Table 9.
Annual investment strategies
| |
12. Local authority investment strategies are key documents
and should be adopted by a meeting of full Council. They become
part of an authority's financial framework, and can only be varied
by further resolution of full council. This sends a signal that
the strategy is a key document to be considered carefully before
being adopted.
Credit ratings and counterparty lists
13. The heart of a council's investment strategy is the
decision about which institutions an authority will deposit money
with. Authorities should only deposit funds with financial institutions
that are of a sufficient financial strength to be included on
a "counterparty list".
14. Counterparty lists are informed by an independent
assessment of the financial stability of the institutions, the
normal source of which is the rating given by one or more of the
three main rating agencies. The agencies all give short and long-term
ratings for financial institutions. Some give further information—for
example about countries. The investment strategy sets out the
minimum acceptable rating that an institution must achieve to
be included on the counterparty list. The LGA has carried out
research, this shows that whilst there are minor variations between
individual counterparty lists—the general principle of placing
deposits with highly rated institutions is a common feature.
15. Counterparty lists will vary:
a. Not all financial institutions are rated by rating agencies,
smaller UK building societies are typically not rated. Some authorities
will still include these, recognising the extent of FSA regulation
of this sector, but will lend them less money and only for shorter
periods (eg 180 days).
b. Authorities that have larger cash holdings will have higher
amounts they will deposit with individual institutions.
c. Some authorities will have money that is not needed in
the near future, and they may decide to deposit some of that for
longer periods, meaning they may place a greater emphasis on long
as well as short-term ratings.
d. Some authorities may choose to have slightly wider range
of institutions to place deposits with, others may choose to only
list institutions that have the very highest ratings.
e. The number of institutions available is reducing as a result
of mergers and takeovers of banks.
16. Authorities can sometimes face practical difficulties
in placing deposits. Not all counterparties will want to accept
local authority deposits at a time that they are available.
17. Treasury strategies and counterparty lists are normally
agreed at about the same time as the council budget. The budget
will also make an assumption of income generated from interest
on deposits. The counterparty list will be regularly updated as
individual institutions' ratings change. Authorities can and do
also update their strategies in the year in response to changes
in the economy.
Local authority budgets
18. Local authorities face a challenging 2009-10 budget:
a. The three-year settlement means finding savings is a key
to delivering a balanced budget.
b. In 2006-07 Councils generated £11.5 billion
of income from fees and charges (in comparison with £22.5 billion
from council tax.[7] The
economic slowdown is affecting authorities as they face sharply
lower income from fees and charges, creating unexpected pressures
in the current year—as well as the coming one.
c. In 2006-07 English Authorities generated £1.4 billion
interest on their deposits representing a return in that year
of about 4.8%. The recent falls in interest rates mean the percentage
return on deposits will be very substantially lower in the 2009-10 financial
year.
Impact of deposits and income on council budgets
19. Individual councils can face quite different financial
circumstances. Some councils have substantial borrowings whilst
others are debt free, some authorities have significant cash holdings
that they hold on deposit—whilst others have much less money
to lend.
20. The impact of lending also varies. Unitary Authorities
and County Councils may also have large cash holdings. Their reasons
for holding cash will vary, they may be holding funds on behalf
of schools or social services clients, they may be planning a
major redevelopment project and their holdings are needed to finance
that project. As authorities with substantial budgets they will
need to maintain a higher minimum level of reserves as part of
prudent financial management. The value of individual and groups
of deposits is often a relatively small proportion of larger authorities'
budgets. Having adopted diversified investment strategies the
extent of loss is to some extent manageable.
21. In contrast district councils typically have smaller
budgets but may also have significant cash holdings because:
a. They have built up capital receipts, either from years
of sales of individual council houses or a one-off disposal of
housing stock or other assets. Under current rules, right to buy
receipts can't be used to finance new spending.
b. They have collected business rates and council tax for
upper tier authorities that they subsequently pass on in line
with an agreed payment schedule. This may mean some small authorities
may temporarily hold significant funds from major business ratepayers
in their area—eg airports and power-stations.
22. Local authorities can be highly geared entities.
This means the income they raise from council tax is a comparatively
small percentage of their total spending, and small changes in
budgets are amplified into larger differences in amount to be
raised by local tax. Authorities already facing significant budget
pressures, will find the impact of any losses particularly hard
to manage. They will have to plan for significant impairment pressures
whilst retaining adequate levels of reserves—as required
by their external auditors.
Short-term impact
23. The LGA has been in contact with a series of authorities
that have deposits with Icelandic banks. None of the authorities
we contacted face short-term financial difficulties.
24. The evidence is authorities had been drawing up contingency
plans for the coming 2009-10 budget. These plans varied between
authorities but in individual severely affected authorities included
slowing or stopping all but the most essential spending.
25. We may not know the percentage of deposits that are
eventually recovered for several years, because recoveries may
come in part from realisation of long term assets of the various
banks. In managing the recovery of creditors' money, Administrators
may decide that it is in the best interests of creditors to continue
to run operations that are performing well, rather than to attempt
an immediate sale of these businesses.
Information from Administrators and Icelandic 'Resolution Committees'
26. The LGA has been in contact with the Heritable and
Kaputhing Singer & Friedlander (KSF) UK administrators. KSF
administrators have not been able to provide an estimate of what
percentage of deposits will be recovered or over what timetable
they may be paid. Heritable Administrators have indicated that
there will be a material dividend payable to unsecured creditors
in due course, but that it is too early to provide a realistic
estimate of quantum or timing.
27. Heritable creditors appear to have the benefit of
a parent company guarantee from Landsbanki in Iceland, although
the terms and effect of this are presently uncertain.
28. The Icelandic creditor arrangement for Landsbanki
and Glitnir is also complex, and is being managed by 'Resolution
Committees'. The Resolution Committees are not insolvency practitioners
but are groups of individuals who now have the responsibility
for the management of the non-domestic businesses of the Icelandic
banks. The local domestic businesses have been transferred to
new banks and this separation has been made under Icelandic law.
The arrangements for communication by the Resolution Committees
are, therefore, not backed by insolvency law and it is not clear
when they will be able to give an estimate of what amounts might
be recovered.
29. Glitnir is the subject of a moratorium, further restricting
the actions which may be taken by creditors.
30. The LGA is seeking clarification on a number of important
matters concerning Landsbanki and Glitnir including: whether local
government deposits have been transferred to the new, state-owned
banks and, if so, the effect this has on those deposits; how local
government deposits rank in the order of payment to creditors.
Accounting for losses
31. Several factors will determine the medium term effect
on authorities:
a. The proportion of deposits that are not recovered.
b. The length of time over which councils eventually have
to make up lost deposits.
32. CIPFA is the professional institute for public sector
accounting, they recently published their technical guidance on
this issue. CIPFA concluded that potential losses on deposits
in affected banks are revenue "impairments" and as such
councils should budget to write them off in their income and expenditure
accounts. In practice this would have meant that estimated losses
would have to be financed in the 2009-10 financial year.
33. CIPFA further noted that this was not just an issue
of self regulation. The 2003 Local Government Act does not
allow impairments to be regarded as capital and therefore they
cannot be financed by capital receipts.
Secretary of State announcement
34. On 26 November 2008 the Minister of State
announced he intends to make a regulation under section 21(1)
of the Local Government Act 2003 which will have the effect
of deferring the impact of impairments for local authorities'
Icelandic banks investments ("relevant investments")
until the 2010-11 financial year.
35. Local Authorities will still have to make an estimate
of impairments as part of the 2009-10 budget process, but
they will then be able to charge a credit to their accounts to
equal the impairment.
Preparing 2009-10 budgets
36. Local Authority Treasurers must draw up robust and
prudent budgets, with final decisions made by mid February 2009.
a. A prudent budget means that the assumptions in it must
be justifiable. A budget must take account of potential losses.
In the absence of information from Administrators, a reasonable
estimate of impairments must be made.
b. The budget must ensure the authority still maintains a
reasonable level of reserves, particularly given the uncertainties
in the coming 12 months.
c. A robust budget means the savings proposals should be deliverable,
this means ensuring there are plans to deliver all savings in
the budget.
37. In practice decisions will have to be made some time
in advance of the February deadline. Authorities have to consult
on budgets with business ratepayers, and many authorities now
consult widely on their budget proposals.
38. Specific consultation is needed where significant
service changes are proposed, particularly if they involve changes
to an agreed three year budget or business plan. Such consultation
will typically include:
a. Service users where it is proposed to close or mothball
an activity eg a leisure centre.
b. Staff who might be made redundant or redeployed under such
a proposal.
c. Businesses or service users—where it was proposed
to raise fees and charges.
39. The Secretary of State's announcement is welcome
as it helps Local Authorities plan their budgets and gives everyone
more time to make a reasonable estimate of eventual impairments.
Authorities can decide, in the absence of any other support, if
they need to apply for capitalisation in 2009.
Capitalisation
40. The 2003 Local Government Act allows for revenue
spending to be treated as capital if a capitalisation direction
has been received.
41. Capitalisation would allow local authorities to either:
a. Charge estimated losses against capital reserves—for
example capital receipts.
b. Fund the loss over up to 20 years. In effect making
a payment each year from the revenue to pay off the capitalised
sum.
Delivering the 2009-10 and 2010-11 budgets
42. Planning and consulting on budgets is only the first
step. Delivering a resulting budget that includes significant
service changes will require significant elected Member and senior
management focus. The Secretary of State's announcement allows
for better forward planning.
43. The more affected authorities face a considerable
medium-term budget challenge. They must resolve this issue over
the coming 12 months without losing the capacity to manage
other important agendas.
44. In order to plan ahead local authorities need an
early decision about any capitalisation requests—ideally
as soon as a clearer picture emerges about likely levels of losses,
probably in spring 2009.
In summary
45. The effects on local authorities will vary significantly:
a. 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. However these authorities still face other pressures
because of the economic slowdown.
b. Some authorities with more substantial deposits at risk
will face significant difficulties. They will need to plan and
consult on potentially significant service changes. Users and
employees may be directly affected. Early indication of capitalisation
will allow those authorities to plan three-year budgets effectively
and reduce disruption in their local economies.
Select Committee Question 2
In the light of recent events, are any changes needed to the framework
for the scale, spread and risk of local government reserves?
An unprecedented event
46. Before considering any proposed changes it is important
to recognise this was an extremely unusual event. It was unlike
previous financial episodes that affected local government treasury
management. This was a case of an entire banking system of a highly
developed European country unexpectedly collapsing.
47. Local authorities find themselves in the same position
as many other "sophisticated" creditors including; international
banks and bondholders, UK banks and building societies, charities,
universities and housing associations.
48. Total English local authority deposits at 9 October
represented 3.5% of total deposits outstanding at 31 March
2007 (though in a number of cases the individual authority
exposure was significantly higher). There is not yet complete
information on this issue but the LGA has seen evidence that several
authorities were in the process of reducing their exposure to
Icelandic banks.
49. However a significant number of the deposits were
longer-term ones that could not be prematurely withdrawn without
the agreement of the Icelandic banks. These deposits were made
when the international financial environment was quite different.
Areas for change
50. The LGA believes there may be potential improvements
to the treasury management framework, but like other risk management
decisions these should be:
c. Made with a full understanding of the likely consequences
(given that the annual interest on cash deposits is equivalent
to 6.3% of council tax income overall[8]
and, for some councils very much more than that).
51. The existing arrangements are highly decentralised.
Authorities have different investment strategies and within these
make local choices on when and where to invest their funds. This
means whilst individual authorities made deposits that are now
at risk, many did not.
52. There are areas where changes might be made:
a. Clarifying the responsibilities of professional advisors
and credit referencing agencies.
b. Building country credit ratings into decision making
c. Establishing systems making it easier for authorities to
work together to get the best terms when making deposits.
d. Looking at the perverse incentives that discourage authorities
from repaying PWLB debts early.
53. Some issues for further exploration include training
for Members to help them in their oversight role and for treasury
managers—along the lines of CIPFA's new treasury qualification.
Select Committee Question 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?
54. The LGA does not agree with the proposal to require
local authorities to deposit funds in Government stock. Authorities
may however wish to invest some of their surplus cash with the
Government as part of a balanced risk spread strategy, as they
do now
55. UK banks and building societies offer higher interest
rates than those offered by central government through the Debt
Management Office. If authorities place deposits in the DMO they
will currently earn 1.6% on those balances. This compares unfavourably
with the three-month London Interbank Bid Rate which stands at
3.9%.[9]
56. With council tax currently generating £22 billion
year the additional cost of depositing only in DMO products is
equivalent to an additional 2.5% on top of existing levels council
tax—assuming rates remain at their current level.
57. In practice the effects on individual budgets will
vary. The impact on larger authorities might be less significant,
but smaller more highly geared authorities will be greater.
58. Any comparison with other countries needs to look
at to totality of local authority funding, including the extent
to which those authorities in other countries have access to other
sources of finance.
59. The LGA is concerned that the locally determined
income is already at comparatively low levels, this proposal would
reduce it further.
Effects on UK banks
60. It is difficult to draw direct comparisons between
local authority cash holdings and UK bank holdings. LGA has collected
the following data—but Information from the British bankers
association is at October 2008 and includes Northern Ireland
Table 3
UK TOTAL BANK HOLDINGS AT OCTOBER 2008
|
| Deposit type | Value at October 2008
|
|
| Personal deposits | £660bn
|
| Sole traders | £88bn |
| Other businesses (includes UK local authority bank deposits)
| £103bn |
| Building society holdings (includes UK local authority building society deposits)
| £228bn |
| Total | £1,079bn |
|
Source: British Bankers Association
| |
Table 4
GREAT BRITAIN LOCAL AUTHORITY INVESTMENTS AT 31 MARCH 2007
|
| All Authorities England | £24.6bn
|
| Plus Welsh Authorities | £1.4bn
|
| Plus Scottish Authorities | £1.8bn
|
| Equals all authorities Great Britain | £27.8bn
|
| Of which: | |
| Bank deposits | £16.6bn
|
| Building society deposits | £7.4bn
|
| Other deposits | £3.8bn
|
| Total deposits | £27.8bn
|
|
Source: CIPFA Capital Expenditure and Treasury Management Statistics 2006-07.
| |
Select Committee Question 4
What is the role of central government in providing financial
advice and guidance to local authorities? Should any other bodies
have a role?
61. Central government has established the framework
for local authority capital accounting and investment management.
Within this framework CIPFA then provide more detailed technical
advice, drawing on advice from expert practitioners from within
local government when doing this.
62. Elected Members in each authority are responsible
for setting the local investment strategies on advice from the
Finance Director, who is also responsible for ensuring the day
to day management of treasury services follows the agreed strategy.
63. Authorities draw on professional advice from specialist
advisors, but the responsibility for final decisions lies with
the local authorities themselves. The advantages of the system
are that it is flexible, and able to accommodate the quite different
financial circumstances in different authorities. It also provides
a very clear incentive for high quality financial management,
because full responsibility rests locally and skilful management
can make a significant difference to the authority's performance.
64. If central Government were to take a more prescriptive
role in providing financial advice and/or guidance some fundamental
issues would need to be considered:
a. As any advice would necessarily be public, that might have
a significant effect on the financial markets.
b. The Government would expose itself to liability if its
guidance proved incorrect.
c. The Government would be placed in the position of having
to defend its advice against the judgements of market professionals
and others.
d. If the Government required prescriptive advice to be followed,
it would need to accept consequential liability if its advice
failed to warn about a subsequent event leading to loss.
65. The LGA believes it is not likely to be practical
for Government to provide advice or guidance in this area, beyond
the existing approach of establishing a framework within which
authorities operate.
Select Committee Question 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?
66. Local and central government have a series of shared
objectives in these uncertain times:
a. The stability of the UK financial system.
b. The economic prosperity of local areas and the UK as a
whole.
c. Ensuring appropriate action is in place to support struggling
communities and businesses.
d. Providing high quality services at minimum cost to the
taxpayer.
67. The LGA proposes timely, but targeted support for
those authorities facing an unprecedented financial challenge.
The key is that any support is identified and in place in time
for authorities to prudently plan for the 2010-11 budget.
68. The alternative is that, because of the capping regime
in place, more highly geared councils will be obliged to make
budget reductions affecting local businesses and services and
undercutting those shared objectives.
69. The key features of LGA proposals are:
a. To allow authorities to capitalise significant losses,
so the sums are paid off over a number of years.
b. To fund some of the interest losses where the loss is above
a given threshold, perhaps set as a percentage of the council
budget. The benefit of this is the sums are comparatively small—perhaps
around £45 million or less than 0.04% of the annual
local authority budget.
70. The approach is similar to the Bellwin scheme that
was used to provide assistance with recovery from last year's
floods—providing targeted help at a time of unprecedented
financial turmoil.
71. Local Government is not looking for substantial financial
assistance. The key in our proposal in local government should
finance the bulk of any losses in a way that minimises the short-term
financial impact on local communities at a time of great economic
uncertainty.
4
This information is drawn from CIPFA Capital Expenditure and Treasury
Management Statistics 2006-07 Table 9. The £24.9 billion
includes joint passenger transport, fire and civil defence, waste
disposal and police authorities. Back
5
These figures represent surplus cash, not useable revenue reserves.
Part of the cash surplus will relate to revenue reserves, part
will be capital reserves, but much of it will be temporarily surplus
cashflows or the proceeds of borrowing raised in advance of capital
spending, which has been invested until needed. Back
6
Investments include joint passenger transport, joint fire and
civil defence joint waste disposal and joint police authorities. Back
7
Source CLG Local Government Finance Statistics No 18 (2008)
Table 2.5a Back
8
Interest on balances = £1.46 billion in 2006-07, council
tax income was £22.9 billion in the same year. Back
9
At 27 November 2008. Back
| 
