Memorandum by Plymouth City Council (LAI
25)
Plymouth City Council wishes to take this opportunity
to respond to the specific questions in relation to the Select
Committee enquiry into Local Authority Investments. In making
this response Plymouth would stress that the past few months have
seen unprecedented financial and economic turmoil. Whilst the
enquiry is welcomed, no authority can be complacent that it has
eliminated all risks associated with the investment of public
funds.
Any resulting actions should not be reactive
to the Icelandic situation but must look at the wider implications
of treasury management. Recommendations must recognise the success
that local authorities have generated from their treasury management
strategies whilst ensuring, as far as possible, the protection
of public monies. In addition to the review of investment strategies,
the Committee should have regard to the current local authority
borrowing regime and the implications that recent changes to PWLB
borrowing may have on future budgets.
Our response to the specific questions posed
is as follows:
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?
Response
1.1 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 organisation of their treasury management functions.
1.2 The Treasury Management Code is given
legislative weight by the 2003 Local Government Act. This
is supplemented by guidance on investments issued by the Office
of the Deputy Prime Minister in March 2004.
1.3 With regard to Investments, the Prudential
Code states that Local Authorities should bear in mind that prime
policy objectives of their investment activities are to encourage
safety and liquidity, and to avoid exposing public funds to unnecessary
or un-quantified risk. The pursuit of optimum performance from
the investment of legitimate surplus funds, as a secondary policy
objective, is a best practice approach to treasury management
and is to be encouraged. Authorities must not borrow more than,
or in advance of their needs, purely in order to profit from the
investment of the extra sums borrowed—a practice referred
to as "round-tripping". Freedoms afforded to local authorities
to invest longer-term or in investment instruments should therefore
be used always with these principles in mind.
1.4 Each year Full Council is required to
approve the investment strategy for the year. This is part of
the authority's financial framework and can only be varied by
further resolution of Full Council. In drawing up its strategy,
the Council supplements it's in house expertise by taking advice
from employed Treasury Management advisors, currently Sector Treasury
Services. Monitoring of the strategy is undertaken during the
year as part of normal budget monitoring reports, regularly reported
to Cabinet and Scrutiny Overview Committees. At the end of the
year a final Treasury Management report is taken to Cabinet as
part of the Council's budget outturn for the year.
1.5 At the heart of the Council's investment
strategy is a set of approved counterparties and counterparty
limits. 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, and advice and discussion with our Treasury advisors.
The credit rating agencies give short and long-term ratings for
financial institutions, some agencies give further information—for
example about countries. Our investment strategy sets out the
minimum acceptable rating that an institution must achieve to
be included on the counterparty list. Not all financial institutions
are rated by rating agencies, smaller UK building societies are
typically not rated. The Council does include some of these based
on asset values but often with a lower counterparty limit or shorter
maximum investment period than the rated banks.
1.6 Our treasury advisors, (Sector), provide
us with regular updates and/or changes to credit ratings for individual
organisations. Day to day responsibility for management of the
Counter party list is delegated to our Director of Corporate Resources
(the Section 151 Officer) and the list is updated immediately
we are notified of any credit rating changes for individual organisations.
In the event of an organisation having its rating downgraded,
the Council either suspends further trading or adjusts the maximum
amount or duration for investment on the Counterparty listing.
On occasions, existing investments might exceed the revised maximum
limits brought about through credit-rating downgrades and in these
circumstances the Council manages risk through:
(a) Regularly monitoring investments above revised
limits.
(b) Regular senior officer meetings discussing
the investment portfolio.
(c) Not undertaking any further transactions
with organisations that have been downgraded.
(d) At the earliest opportunity re-investing
in companies with higher credit ratings or using maturing investments
to repay debt.
1.7 In June 2008 in response to concerns
in the money market through developments with Northern Rock and
Bradford and Bingley, the Council commissioned Sector to undertake
a review of the Council's investment strategy. The resulting report
raised no specific concerns, and contained several reassuring
messages such as:
"The Council has an approved Investment
strategy which complies with best practice as defined by the CIPFA
code".
"The Councils lending list is very robust
and takes into account consideration of the rating criteria, amount
limits and also duration limits, which is exactly what Sector
recommends from authorities that are looking to place money with
any institution".
"The Council currently spreads risk duration
by investing for varied periods of time and Sector recommends
that the Council continue to do this in order to remove duration
and interest rate risk from its portfolio".
1.8 The amount available for investment
is determined by the Capital Financing Requirement, a key measure
in the Prudential Code. In recent years advantage has been taken
to undertake an element of borrowing in advance of immediate needs,
not only in order to achieve the best rates for both borrowing
and, in the shorter term, lending, but also to ensure that the
overall sums that will be needed to fund the Council's capital
programme will be available. Such activity is permitted within
the prudential code and is checked annually as part of the external
audit.
1.9 Over the last few years the Council
has been successful in achieving favourable investment returns
and the improved position on Treasury budgets has been key to
both balancing the budget and investing in essential maintenance
and service improvement. We are still forecasting an additional
£2 million investment interest above budget in 2008-09,
brought about by "locking in" investments at high interest
rates earlier in the year for periods of up to 364 days (before
the fall in interest rates). However, this does not account for
any losses in relation to Icelandic investments.
1.10 In response to the Icelandic situation
and potential loss of investment income the Council has taken
a much more risk adverse position to its treasury management investments
and implemented a short term investment strategy as follows:
"That all investments are made for a maximum
of three months in the UK only with the highest credit rating
organisations or through the Government Debt Management Office".
1.11 Whilst in the current year this is
having a "limited and manageable" impact on budget projections,
there will be a significant impact in terms of next year's revenue
budget as a result of the fall in interest rates and the decision
to invest for much shorter periods. Overall, Plymouth is forecasting
a revenue pressure, (compared to 2008-09 budget), due to
reduced treasury management activity and lower investment returns
of: £1.4 million in 2009-10, rising to in excess of
£2 million for each of the following two financial years.
Again, this does not account for any losses related to our Icelandic
investments.
1.12 When we add to this "loss"
of income other pressures on local authorities such as reduction
in other fee and charges income following the general economic
downturn, increasing demographic expenditure requirements and
increasing need to find efficiency savings in order to balance
our budgets it is clear that this will have a substantial impact
on our ability to provide essential front line services.
1.13 One key part of the Treasury Management
system available to local authorities is the Public Works Loans
Board (PWLB) run by the Debt Management Office (DMO). This makes
loans available at a government rate, and is the main source of
debt finance. A key part of the overall treasury management strategy
is the ability of authorities to restructure debt. In recent years
this has been one of the main attractions of taking PWLB long-term
debt, in that it could be done in the knowledge that if the rates
reduced in future, the council could restructure (paying a premium
over the life of the new loan), in order to reduce costs.
1.14 Approximately 1 year ago, the
PWLB changed the rates available to restructure debt, and this
has had a major adverse effect on local authority treasury management.
In particular, in the current market of reducing interest rates,
it removes the logical way to offset the impact of those rate
reductions on investments. We comment further on this issue at
the end of our submission.
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?
Response
This response has been made on the assumption
that the question relates to local government investments rather
than reserves
2.1 Before considering any proposed changes
it is important to recognise, as stated above, that 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.
2.2 Putting our investment into Iceland
into perspective, the Council had £13 million invested
in 3 Icelandic banks in October 2008. Our total investment
portfolio at the time was £284 million with investments
spanning across 41 different financial institutions.
2.3 Authorities rely not only on the advice
of treasury management advisors, but also on credit ratings. Improvements
could be made by clarifying the responsibilities of professional
advisors and credit referencing agencies and by building country
credit ratings into decision making and also by establishing systems
that make it easier for authorities to lend to each other.
2.4 Our view is that whilst the broad structure
of the guidance does the correct things, recent events have emphasised
the need to revisit 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, (borrowed to help fund the Council's ambitious capital
programme), we have had to expand our lending list considerably
in order to invest the sums, as a key risk issue is ensuring that
the proportion of investments with any one institution is limited.
2.5 The current, unprecedented market position
means that authorities have to review their risk assessments and
many have taken a much more risk adverse approach to investments.
Our view therefore is that the framework is a reasonable one,
with authorities acting and responding to circumstances as required.
However one of the key issues for our authority is the extent
to which a bank can be expected to be supported if it gets into
difficulty. Our investments are now only made in institutions
where support is strongly expected, or guaranteed. If the Irish
or British Governments were unable to support the banks whose
investments have now been guaranteed, then the framework would
need to be changed (as would many other things).
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?
Response
3.1 Plymouth partially agrees with this
comment but believes this should be one of the options, not the
only option. For instance, we are currently investing in the Government
DMO, balancing this with investments in the markets to balance
risk and returns. As stated in response to question 1, the Council
has substantial sums to invest and relies on its investment income
to balance the budget and maintain services. Focussing solely
on low risk, low return investments would have a major impact
on services or taxpayers.
3.2 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. The largest amounts of money
come into the authority monthly at the start of the month, (eg
local tax), and mid month (Government grants) 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 rated money market
funds and call accounts with reputable banks provide the most
suitable investment vehicle for this purpose.
3.3 Government stock is not "liquid"
enough for the daily dealing that is required, particularly if,
as is now the case for many, the Authority's own bank does not
have a high enough credit rating to justify leaving sums in its
accounts.
3.4 Local Authorities as a whole are significant
investors in the wholesale bank markets, and withdrawing their
funding will have an impact on the funds available to banks at
a difficult time. 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%. With regard to the impact on Council tax payers
we have answered this point in paragraph 1.11.
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?
Response
4.1 Central government has established the
framework for local authority capital accounting and investment
management. Within this framework CIPFA provide more detailed
technical advice, drawing on advice from expert practitioners
from within local government when doing this. We consider this
appropriate.
4.2 We believe that Central government should
not have a role in advising what authorities should or should
not invest with particular institutions.
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?
Response
5.1 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.
5.2 In response to your question, we do
not believe that a blanket unconditional guarantee is appropriate
especially if this comes with increased regulation. However we
do believe that protecting Local Government investments should
be considered carefully in the context of particular circumstances.
5.3 With regard to the Icelandic bank crisis
for instance, we have already stated that this crisis has arisen
as a result of unprecedented turmoil both in economic and financial
markets and therefore in this instance believe that this is a
situation that should be supported. Whilst authorities are hopeful
that they will get some of their money back, it is too early to
identify the resulting shortfall or impact and thus what support
each authority may look towards the Government to provide. However
the consequences of not providing any support will lead to local
authorities progressively withdrawing funds from the international
banking system and thus progressively worsening the current financial
and economic climate.
5.4 With regard to the relationship between
central and local government, one key aspect in treasury management
terms is, as noted above, the relationship between the government
(DMO) run PWLB and local authorities. The PWLB substantially worsened
its lending terms on 1 November 2007. Until then, 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.
5.5 For authorities who have borrowed ahead,
one response to the current market conditions would be to repay
a part of the borrowing, to reduce treasury risk. The action of
the PWLB last year has made this unaffordable for an authority
like Plymouth, and has therefore increased the treasury risk for
the Council. Given that the Committee's enquiry is into the general
principles involved in local authorities' Treasury Management,
and that the Committee wishes to explore the relationship between
central and local government in relation to this, this should
also be a key issue for the Committee to consider.
Thank you for allowing us the opportunity to
respond to the committee questions. We are an authority that has
potentially lost money in Iceland and are responding on an individual
basis. We are also acting as the Society of Unitary Treasurers
representative on the Local Authority Icelandic bank steering
committee.
Sandra Wilson
For Plymouth City Council
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