Memorandum by Howard Knight following
Evidence Session 19 January 2009 (LAI 32)
Following the Session on 19 January, Lynda
McMullan of Kent County Council has `expressed concern that the
evidence I gave—with specific reference to Kent County Council—is
incorrect and misleading.
I certainly had no intention of either misleading
the Committee or of misrepresenting the evidence relating to Kent
CC and I have no hesitation in apologising if my evidence appeared
to so do.
Ms McMullan has raised concerns about two aspects
of my evidence, as follows:
(1) SPECIALIST
TREASURY MANAGEMENT
STAFF
EVIDENCE
GIVEN:
Q7 Sir Paul Beresford: Have you had any indication
of whether the officers have had any training in this area?
Mr Knight: It is clear that in some authorities
they do have specialist treasury management officers. Certainly
when I was chair of finance of a metropolitan authority we did
have specialist staff. If you read the PriceWaterhouseCoopers'
report on Kent, for instance, at the moment, it actually says
that that authority which has one of largest investment portfolios,
does not have any of its own specialist treasury management staff—have
to say I was pretty astonished by that.
Ms McMullan advises:
KCC have an Investment and Treasury team of circ
five people. These people are very experienced but clearly we
do not employ them to do the specialist role that external advisers
were contracted to do. In addition a professionally qualified
manager supervises this team and met regularly with the external
advisers to discuss the operation.
Elsewhere in his evidence Mr Knight talks about
councils working together to ensure specialist skills are available
collectively—this in effect was exactly the role such advisers
took. The issue is whether councils had arrangements in place
to provide specialist market advice, not how it was procured.
We believe this statement misrepresents or reflects a misunderstanding
of the situation based upon second hand information.
Howard Knight's response:
I have no hesitation in accepting Ms McMullan's
statement that KCC has an Investment and Treasury Team of five
people with a professionally qualified supervisor.
However, it will be for Kent CC's own investigations,
through its Overview and Scrutiny Committee and otherwise, to
determine whether Kent CC had in place a team with the specialist
knowledge, capacity and skills, and with the right attitude, understanding
and responsibilities towards being efficient, effective and pro-active
client's representatives on behalf of the ultimate client—Kent
CC and its elected members, on behalf of the people of Kent.
Members of the CLG SC will have the opportunity
to read the PWC report for themselves and draw their own conclusions.
My evidence reflected a summary of the PWC review as reported
in The Independent on 19 January 2009 (the day of the
Evidence Session) "PWC said Kent did not employ specialist
treasury staff and relied on the expertise of Butlers."
A key issue for all local authorities to consider
is whether they do have the capacity to be an effective client
or whether, de facto, they have in effect outsourced important
aspects of their client role and responsibilities to their specialist
advisers. This is an issue which relates to all functions, not
just treasury management.
Academic research suggests that, within three
years of "outsourcing a function" (and it doesn't matter
whether this is in the private or public sectors or whether the
function is engineering or financial services or ….),
the outsourcer will have lost the skills, knowledge and capacity
to be a good and effective client.
It is for this reason—as well as to address
the development of cartels and oligopolies—that, in the
USA, the consistent advice of the Managers of Towns and Cities
has been that, whatever the function, the authority itself should
retain a significant portion of that function under direct management.
It is clear from the statements of a large number
of local authorities with funds at risk that they had placed enormous
reliance on their treasury management advisers—and this
is reinforced by statements made by leading elected members in
response to my survey—to the extent to suggest that, whilst
authorities had retained the client's administrative treasury
management functions, they had effectively ceded their highly
informed, high-skilled, strategic client adviser functions to
their treasury management advisers. Of course, this may not be
reflected in the actual contractual relationship between local
authorities and their treasury management advisers.
Further, I simply do not accept Ms McMullan's
proposition that, in response to my comments about the need for
local authorities to work together to be sufficiently knowledgeable—both
about the market and about particular financial instruments—"this
in effect was exactly the role such advisers took." The proposition
is itself an indication that, because treasury management advisers
are themselves knowledgeable, it doesn't require the local authority
itself to have that capacity. For the reasons I have set out above,
I disagree.
In addition, the evidence given by Butlers (Kent
CC's treasury management advisers) to the CLG SC on 26 January
2009 simply does not support Ms MacMullan's perception about
the extent and nature of the role and responsibilities of treasury
management advisers generally and Butlers specifically. It is,
of course, possible that these differences of perception—and
conditioned by the exact nature of their contractual relationship—will
be tested in litigation. For the moment, I am content to point
to those clearly stated differences as a further indication that
local authorities need to assure themselves that they have sufficient
capacity and knowledge in their own treasury management team to
be an effective client.
(2) Reliance on Credit Ratings
Evidence given:
Q23 Mr Betts: Let us move on to the issue of
market information, if you like, and what might be available.
Clearly there is information from the credit ratings agencies,
and some information to us is that some of the "advisers"
who have been external advisers to authorities have done little
more that pass credit rating agency information to councils and
do not seem to have done very much more than that. Is there anything
more that could be done to get appropriate and up-to-date information
to both council officers, whether they are specialists or generalists,
and to members?
Mr Knight: "… However, I think it
is fair to say that there was a huge over-reliance on the information
provided by credit rating agencies in a market that was rapidly
changing. If you compare authorities—this maybe unfair but
I'll do it—if you looked at say Kent, it was relying on
info only from one CRA, whereas if you look at Essex, which doesn't
have funds at risk, it was very clear about having information
from three credit rating agencies and only relying on the lowest
or worst scenario from each of those agencies when taking information
into account in terms of the way it moved forward."
Ms McMullan advises:
This is simply factually untrue. KCC uses all
three credit ratings agencies. We cannot understand how Mr Knight
came to this conclusion as there is nothing to even suggest this
to be the case in any of our documentation.
Howard Knight's response:
I accept that my statement was factually inaccurate—Kent
CC did use all three credit rating agencies—and, therefore,
as I indicated, it was unfair. I apologise to the CLG SC and Kent
CC for this. I am happy for this to be corrected.
My evidence inaccurately conflated three issues.
It is, therefore, important to set them out here:
— If you contrast the investment policies
and criteria of Essex CC and Kent CC, you will find that Essex's
policies and criteria did not allow investment in Icelandic Banks
because they did not meet Essex CC's stringent treasury management
standards, whereas Kent CC's policies and criteria did allow such
investments
— Certain financial instruments and investments
being offered in the market are only rated by one Credit Rating
Agency. [It needs to be remembered that the banks themselves commission,
and pay fees to, the credit rating agencies to provide that rating.
In defending their decisions to assign AAA ratings to collateralised
debt obligations and other securities which, subsequently, were
found to be unjustified, the agencies have argued that "they
did their best with the information available".]
— My reading of Essex CC's policies and
criteria is that it did not allow investment in such securities,
but that Kent CC's policies and criteria did allow such investment.
27 January 2009
Supplementary memorandum by Howard Knight (LAI
32A)
At the Select Committee meeting on 19 January
2009, I was asked to provide:
— additional information from the survey
I had conducted with elected members holding particular positions
of special responsibility (Leader, Cabinet Member for Resources,
Chair of Audit Committee, Chair of Resources Overview and Scrutiny
Committee) in c 50 local authorities of all types (Shire
County and District, Metropolitan and Unitary, London Borough)
in England, and
— any additional comments on local authority
treasury management issues generally.
My written evidence has already included:
— Treasure your assets—a guide to
local authority financial investments, published by The Centre
for Public Scrutiny, December 2008
— A preliminary note on responses to my
survey
— A response to concerns expressed by Kent
CC about my reference to that authority in my oral evidence on
19 January 2009.
This submission contains:
— conclusions from the survey
Question | Nature of Response
|
Finance background and training |
|
| Do the leading elected members (councillors—Leader, Cabinet Member for Resources, Chair of the Audit Committee, Chair of Overview & Scrutiny Committee) with key responsibilities for Treasury Management
| |
| (1) have an economic or finance academic or professional background?
| A minority have; the majority don't have any relevant academic or professional background.
|
| (2) receive any specialist training in local government finance generally, and treasury management specifically?
| (1) Every councillor has had access to some basic training on local government finance.
(2) Many councils also offer in-house workshops on eg budgeting, performance management etc.
(3) Basic Treasury Management is likely to be covered in those sessions.
(4) Only a minority of the leading members have undertaken additional training and development on Treasury Management. Occasionally, this has involved input from the authority's external "treasury management advisers".
(5) The Improvement and Development Agency's (IDeA) Leadership Programme, for existing and aspiring Leaders, used to include a Finance Module, but that was dropped from the core programme. Discussions are now taking place about its re-instatement.
|
| Should these leading members be required to undertake specialist training in Treasury Management?
| Overwhelmingly, respondents believed that there should be an expectation that elected members with particular responsibilities in this area should have the opportunity to secure development and training. Only a minority thought this should be compulsory. A majority thought that the authority should have a responsibility to provide the opportunity if requested.
Comment:
(1) To the best of my knowledge, there is no research evidence that easily demonstrates a clear correlation between elected member development and authority outcomes. However, there is considerable evidence to demonstrate that elected members who have undertaken development and training feel better equipped to be effective leaders and scrutineers.
(2) All authorities have some elected member development programme. It is still only a minority that have an accredited programme (eg Charter for Elected Member Development)
(3) Although there is a clear logic to support the view that, as with any job, elected members should undertake appropriate development and training to enable them to best undertake their responsibilities, there are many reasons why such training might not be offered or taken up.
|
| (4) However, it is worth noting that Councillors are now required to undertake specialist training before they can be members of Planning and Licensing Committees.
(5) In my experience of member development on local government finance, in-authority programmes can be very good for developing an understanding of the issues. However, the most valuable sessions in giving elected members the confidence, knowledge and skills to ask the awkward and challenging questions have been those provided by an external agent eg by CIPFA or Local Government Futures
(6) I would have reservations about making development and training in local government finance generally, or treasury management specifically, a legal requirement even for those members with special responsibilities.
I think it would be better to incorporate the expectation of appropriate member development and training into CIPFA's Treasury Management Code Of Practice to which all local authorities have to have regard and allow monitoring of that performance by each authority's Audit Committee.
|
| Treasury management policies |
|
| Is there any evidence to suggest that councillors have pressed officers to adopt "more risky" treasury management policies?
| I have found little evidence, from tracking through from officer reports on recommendations on TM strategy and policy to the minutes of the decisions of Council Cabinets, to suggest that councillors have pressed officers to adopt "more risky" TM policies. However, such tracking will not reflect any informal influences that may have been brought to bear by elected members in the formulation of those officer reports.
|
| Responses to my survey also provide little evidence to suggest that councillor pressure has led to riskier investment policies than being recommended by officers. Only one authority admitted that members had pressed for riskier policies—referring to the returns being achieved by others—but had quickly adopted a more cautious policy early in 2007 with the first real indications of concern.
I also have clear evidence from one authority where it was the Cabinet Member for Resources (with professional banking experience) who initiated changes to adopt more cautious investment policies at an early date.
In the vast majority of authorities, the decisions taken by elected members on TM strategy and policy directly reflected the recommendations of the officers.
|
| Is there any evidence to suggest that councillors have undertaken detailed scrutiny of Treasury Management policies proposed by officers or of TM performance?
| I have found little evidence of TM policies and performance being subjected to the same degree of scrutiny as other council services or functions.
In most authorities, TM strategy and policy papers have received what I would describe as relatively perfunctory scrutiny. That was one of the reasons for producing Treasure your assets.
In most councils (and the Audit Commission) it appears that TM was treated rather mundanely, with the legislative requirement to approve the TM strategy and policy seen as a necessary hurdle to be leaped rather than an opportunity for significant challenge. The perception is that this approach was also reflected in the "3-stage routine" followed by officers:
(1) qualify institutions and investment vehicles as "acceptable" by reference to their credit ratings
(2) identify the opportunities for investment in those qualified institutions by reference to the size and term requirements
(3) choose the investment that maximises the return.
Although most reports on TM strategy and policy included reference to the wider market and economic conditions and prospects, there is little reference to the market being dynamic with the potential for significant change (although the recent experience is unprecedented) nor to the potential for using other relevant market data, such as credit spreads, to inform investment decisions during the period that the policies apply.
At a time when all the market information suggested that investors should become more risk averse—and when at least one treasury management adviser was strongly advising against investments in institutions in particular sovereign states—it appears that many authorities simply ploughed on regardless. There is little evidence to suggest that the changing market triggered a renewal of either adopted policy or scrutiny.
With many councils having investments at risk, there is certainly now an incentive for councils to undertake more detailed scrutiny—either about historic performance or future policies. Treasure your assets gives detailed advice about how they might undertake such scrutiny.
|
| So, what does distinguish those authorities who now have investments at risk from those which don't?
| It isn't political control.
It isn't size.
It is:
(1) the minimum credit rating and approved institution criteria which were agreed in their TM policies and used to determine which counter-parties were included on their lending lists.
(2) the speed with which council's responded to both formal and informal changes in market intelligence in changing their investment strategies. It is clear that in a number of authorities, and in the light of market intelligence, the Section 151 Officer applied more strict investment policies—in relation to minimum lending criteria, the size of any particular investment, and approved institutions—than the officially agreed policies required. This was usually done in consultation with the Cabinet Member for Resources, but was not necessarily formally reported to the Council at the time.
(3) The scale, timing and period of particular investments. Some authorities seem to have made some of their riskier investments for longer-terms at the time when market intelligence would have suggested otherwise.
|
| (4) The specific relationship—including the roles, responsibilities and information/advice provided by the authority's external treasury management advisers (see below).
(5) It now appears that none of the authorities whose external treasury management advisers state that they provided advice as well as specialist information have funds at risk in Icelandic Banks and that all of the authorities which do have funds at risk had external treasury management advisers who state that their service is limited to the provision of specialist and tailored information. (CLG SC 26 January 2009.)
Comment:
On the face of it, some authorities also seem to have contravened one or more of three basic rules:
(1) never put all your eggs in one basket
(2) if an offer looks too good to be true, it probably is
(3) always be very suspicious of financial institutions that consistently offer or report better terms or returns than the rest of the market.
|
| The role of TMAdvisers? | |
| Do you have any comments on the roles of TMAs?
| (1) Most local authorities have appointed external treasury management advisers.
(2) The survey responses suggest that most elected members with some form of special responsibility for TM have never met their treasury management advisers.
(3) Only rarely had a representative from an authority's treasury management advisers been present at any relevant meeting (Cabinet, Audit, Scrutiny) when TM strategy, policy or performance was under consideration.
|
| (4) All members believed that their authority had appointed external treasury management advisers to provide specialist advice as well as information.
(5) Elected members in all authorities with investments at risk made particular reference to their belief that their authority had been paying for and receiving specialist treasury management advice. This view has certainly been re-inforced by officer reports, even since October 2008, which imply that all treasury management advisers have actually been providing advice as well as information.
In both my initial written submission and oral evidence on 19 January 2009, I drew attention to what, at the least, might be described as the discontinuity between the perceptions of some authorities (members and officers) and some treasury management advisers on the issue of whether external advisers had been contracted to provide advice and/or information.
|
| This issue—and the implications for authorities in assessing whether they have the capacity to be a good client for treasury management, as well as the historic decision-making and outcomes for particular authorities—was well explored at the CLG SC on 26 January 2009. Suffice it to say that the evidence given by Sector and Butlers as to the limited contractual nature and obligations of the TM service they provided to authorities came as a considerable surprise to the vast majority of elected members in those authorities to whom they provided a service.
|
| Comment:
(1) I am not in any position to make any comment about the particular contractual relationships between authorities and their external treasury management advisers.
(2) It is clear that the vast majority of elected members with special responsibilities for TM believed that their authorities had appointed external treasury management advisers who would provide advice as well as information. The extent to which officers have, unwittingly or otherwise, mislead their members—and perhaps themselves—is an issue for individual authorities to explore.
|
| The role of Credit Rating Agencies? |
|
| Do you have any comments on the roles of CRAs?
| The survey responses show that elected members—as well as officers, TMAs and Brokers—have historically placed enormous reliance on the published ratings of Fitch, Moody's and S&P and, in particular, on any changes in those ratings.
CRAs' actual performance over the last three years is, quite properly, the subject of some questioning. Even though it is clear that the banks themselves didn't understand the nature and scale of the risk associated with particular securitisation and OCDs, there was clearly on over-reliance by potential investors on the expectation that the CRAs would understand them.
Comment:
I have not found any evidence that authorities went beyond reliance on published ratings—and changes in those ratings—in assessing the risks of particular investments.
Given the market intelligence and speculation from early 2006 onwards about the security of some institutions and institutions based in certain sovereign states, it is perhaps a little surprising that some councils made large and lengthy investments relying totally on published CRAs and without having commissioned more research eg commissioning inter-active credit ratings.
|
| The role of Government | |
| Should the Government guarantee council investments in the same way as it does for individual investors?
| Unsurprisingly, a majority of survey respondents from authorities with investments at risk did think that there ought to be a government guarantee on those investments! Only a minority of respondents from authorities without funds at risk supported that view.
|
| Comment:
It seems to me to be counter-intuitive for councils, on the one hand, to be arguing for increased local discretion and flexibility and, on the other hand, to suggest that the Government should guarantee whatever decisions they then make.
Obviously, both the legislative framework and CIPFA's TM Code should be continually kept under review and updated where appropriate.
|
| |
Additional Comments:
The existing CIPFA TM Code of Practice (CIPFA 2001 Section
4) sets out 4 key recommendations for the adoption of policies
and practices to secure best value in treasury management by public
bodies.
Implicitly, by addressing those recommendations and requirements,
a public body should be addressing explicitly the issue of whether
it has in place the ability and capacity to be an efficient, effective
and responsive client for treasury management.
There are many ways of building sufficient and appropriate
capacity. It is clear that many authorities looked to their treasury
management advisers to "fill the gap" in relation to
the lack of specialist, continually updated, knowledge and intelligence
about the market which are pre-conditions for fulfilling the requirement
to successfully identify, monitor and control risk and to secure
optimum performance consistent with those risks.
However, evidence given by some treasury management advisers
to the CLG SC made it abundantly clear that those advisers neither
saw nor believed they were contractually committed to undertake
that role.
In that context, it is difficult to believe that many authorities
actually had in place sufficient or appropriate capacity to properly
fulfil their effective client role. [I addressed this in more
detail in my supplementary submission in relation to Kent CC.]
In reviewing the CIPFA TM Code of Practice, I do think there
is merit in considering explicit guidance—including bench-marks
and checklists—in relation to the necessity of securing
sufficient client capacity.
Further, I believe that such explicit guidance would inevitably
question the ability of some bodies—even with the commission
of external advice and other resources—to efficiently provide
the capacity to offer a comprehensive "professional and officer
client role" to their elected members or boards.
Therefore, in parallel with the review of the Code, I believe
that the LGA, CIPFA and the Audit Commission should investigate
the merits or otherwise of the "professional and officer
client role" being provided on a county, regional or even
national basis. Such a role could be played under the auspices
of a lead authority (eg a county council for all public bodies
in the county) or a joint authority (eg some metropolitan areas
already have a joint authority which has responsibility for pension
funds and investments, which has many common skills and knowledge
requirements.)
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.
17 February 2009
Memorandum by Martin Hickman, Consumer Affairs Correspondent,
The Independent (LAI 34)
UK LOCAL AUTHORITY INVESTMENTS IN ICELAND*
*Collapsed Icelandic banks Kaupthing, Glitnir, Landsbanki
and their UK subsidiaries
Total number of UK councils: 468
Total UK council investments in Icelandic banks: £885.3 million
The Independent's figures include UK district, borough, metropolitan,
unitary and county councils. They exclude fire, police, and transport
authorities
Butlers | Claims to advise 144 UK councils: 31% of total
Number with investments in Icelandic banks: 51
Proportion of total UK council exposure to Iceland: 53%
Scotland £22.5 million, Wales £0, England £447 million
| TOTAL:
£469.5m |
| Sector Treasury Services | Claims to advise 250 UK councils: 53% of total
Number with investments in Icelandic banks: 46
Percentage of total UK council exposure to Iceland: 35%
Scotland £23 million, Wales £49.7 million, England £240.4 million
| TOTAL
£313.5m |
| Sterling Consultancy Services | Will not disclose number of UK councils it advises
Number with investments in Icelandic banks: 3
Percentage of total UK council exposure to Iceland: 2%
Scotland £3.7 million, Wales £0, England £13.5 million
| TOTAL:
£17.2m |
| No external advisor | Number of UK councils without advisors: at least 16
Number with investments in Icelandic banks: 16
Percentage of total UK council exposure to Iceland: 1%
Scotland £0, Wales £0, England £13 million
| TOTAL:
£13m |
| Arlingclose | Claims to advise 40 (now 50 after Icelandic collapse) UK councils: 9%
Percentage of total UK council exposure to Iceland: 0
Number with investments in Icelandic banks: 0**
| TOTAL:
£0 |
Notes:
**Arlingclose has taken on several local authorities with Icelandic investments; none of these investments was made while it was advisor
Rhondda Cynon Taff (£3) and Doncaster (£3 million) failed to respond
| | |
Top 10 Council Investors in Icelandic Banks
Council (Political control) | Investments
| Advisor | Broker(s) |
1. Kent (Con) | £50.3m
| Butlers | ICAP, Martins, Tullett Prebon, Garban
|
| 2. Nottingham (Lab) | £41.6m
| Butlers | City Deposit, Martins, Sterling
|
| 3. Haringey (Lab) | £37m
| Sector | Martins, Tullett Prebon, Sterling
|
| 4. Norfolk (Con) | £32.5m
| Butlers | ICAP, Sterling |
| 5. Dorset (Con) | £28.1m
| Butlers | ICAP, Tullett Prebon, Tradition
|
| 6. Hertfordshire (Con) | £28m
| Butlers | ICAP, Martins, Tullett Prebon, Sterling, Tradition
|
| 7. Barnet (Con) | £27.4m
| Butlers | ICAP |
8. Somerset
(No overall control) | £25m
| No advisor | ICAP, Sterling, Tradition, Tullett Prebon
|
9. Northumberland
(No overall control)
| £23m | Sector | ICAP, Martins, Tullett Prebon
|
| 10 Surrey (Con) | £20m
| Butlers | Martins, Stirling, Tradition, Tullett Prebon
|
| |
| |
List of Councils (51) Advised by Butlers
Council | Investments
| Advisor | Brokers |
1. Barnet | £27.4m
| Butlers | ICAP |
| 2. Bassetlaw | £8m |
Butlers | Fidelity, Sterling, Tullett Prebon
|
| 3. Bolsover | £3m |
Butlers | Sterling |
| 4. Bolton | £6m | Butlers
| Martins, Tradition, Sterling |
| 5. Bracknell Forest | £5m
| Butlers | ICAP |
| 6. Braintree | £5m |
Butlers | Sterling, Tullett Prebon
|
| 7. Breckland | £12m |
Butlers | ICAP, Tradition, Tullett Prebon,
|
| 8. Brent | £15m | Butlers
| Declined to disclose |
| 9. Bristol | £8m | Butlers
| Declined to disclose |
| 10. Bromley | £5m |
Butlers | Declined to disclose |
| 11. Cambridge | £9m |
Butlers | Martins, Tullett Prebon
|
| 12. Cherwell | £6.5m |
Butlers | ICAP |
| 13. Derwentside | £7m |
Butlers | Tradition, Tullett Prebon
|
| 14. Dorset | £28.1 |
Butlers | ICAP, Tradition, Tullett Prebon
|
| 15. East Ayrshire | £5m
| Butlers | Declined to disclose
|
| 16. Epping Forest | £2.5m
| Butlers | ICAP |
| 17. Gloucester | £2m |
Butlers | Martins |
| 18. Great Yarmouth | £2m
| Butlers | Tradition |
| 19. Hertfordshire | £28m
| Butlers | ICAP, Martins, Tradition, Tullett Prebon, Sterling
|
| 20. High Peak | £2m |
Butlers | Martins |
| 21. Ipswich | £5m |
Butlers | No brokers used |
| 22. Kent | £50.3m |
Butlers | ICAP, Martins, Tullett Prebon, Garban
|
| 23. Lancaster | £6m |
Butlers | Prebon Yamane |
| 24. Newcastle-under-Lyme | £2.5m
| Butlers | Tradition |
| 25. Norfolk | £32.5 |
Butlers | ICAP, Sterling |
| 26. North East Lincolnshire | £7m
| Butlers | ICAP, Sterling |
| 27. Nottingham | £41.6m
| Butlers | City Deposit, Martins, Sterling
|
| 28. Oxford | £4.5m |
Butlers | Martins, Sterling, Tradition
|
| 29. Purbeck | £2m |
Butlers | Prebon |
| 30. Reigate & Banstead | £15.5m
| Butlers | LCB, Tradition |
| 31. Rotherham | £4m |
Butlers | Prebon |
| 32. Rugby | £3m | Butlers
| Martins, Prebon |
| 33. Rushmoor | £2m |
Butlers | Prebon |
| 34. Rutland | £1m |
Butlers | Martins, Tradition |
| 35. Scottish Borders | £10m
| Butlers | Declined to disclose
|
| 36. Solihull | £3m |
Butlers | Martins, Tullett Prebon
|
| 37. South Lanarkshire | £7.5 m
| Butlers | Declined to disclose
|
| 38. South Oxfordshire | £2.5m
| Butlers | Tradition |
| 39. South Ribble | £5m
| Butlers | Martins |
| 40. Surrey | £20m |
Butlers | Martins, Sterling, Tradition,Tullett Prebon
|
| 41. Surrey Heath | £4m
| Butlers | Declined to disclose
|
| 42. Tamworth | £7.5m |
Butlers | ICAP, Prebon, Tradition
|
| 43. Uttlesford | £2.2m
| Butlers | ICAP, Sterling, Tullett Prebon
|
| 44. Vale of White Horse | £1m
| Butlers | Tradition |
| 45. Wakefield | £9m |
Butlers | Declined to disclose |
| 46. West Oxfordshire | £9m
| Butlers | Tradition, Tullett Prebon
|
| 47. West Sussex | £12.9m
| Butlers | ICAP, Martins, Sterling, Tullett Prebon, Tradition
|
| 48. Winchester | £1m |
Butlers | ICAP, Sterling, Tradition, Tullett Prebon
|
| 49. Wokingham | £5m |
Butlers | Tradition, Tullett Prebon
|
| 50. Wynchavon | £2.5m |
Butlers | Tradition |
| 51. Wyre Forest | £9m |
Butlers | ICAP |
January 2009
|
| | |
Supplementary Memorandum submitted by Martin Hickman, Consumer
Affairs Correspondent, The Independent (LAI 34A)
Local Authority Treasury Management
I am a reporter at The Independent newspaper. A story I wrote
comparing the differing records of local authority investment
advisers regarding Icelandic banks appeared on the front page
of the Independent on Monday 19 January.
Following publication of the story, I was contacted by an
individual claiming to work at a senior level in the City of London
who indicated he had information about the behaviour of local
authority advisers and brokers.
After agreeing to respect their anonymity, I met this individual
in the City of London in January. We discussed local authority
investments in general, rather than specifically investments in
Iceland. During our meeting, this individual made a series of
claims about the conduct of local authority finance officers,
advisers and brokers.
This individual claimed:
That local authority investment officers placing tens of millions
of pounds of investments in banks were poorly trained and motivated.
That some local authority officers placing investments had
enjoyed extensive hospitality provided by companies profiting
directly from those investments.
That brokers actively touted for business, dealing directly
with local authority finance officers to discuss the placement
of funds.
That brokers received from banks substantial commission (sometimes
running into hundreds of thousands of pounds) for placing local
authority funds with those banks.
That brokers share this commission with advisers; unbeknownst
to local authority clients.
That advisers actively advise local authority clients to place
funds with particular institutions in order that they would receive
a share of this broking commission.
That together advisers and brokers hold conference calls with
local authority finance officers in which they (advisers and brokers)
act in concert to give such advice.
During our conversation, this individual named specific companies,
individuals within those companies and individual transactions.
I have not passed on these details because I feel it would be
a breach of natural justice to those organisations and individuals
to do so.
For professional reasons, I have not sought to investigate
these claims. I must stress that as such I consider them to be
unsubstantiated. However I was satisfied that this individual
was employed at a senior level in a financial company in the City
of London. It was also my belief that their views were sincerely-held
and honestly expressed.
I hope this information is of use to the Committee.
April 2009
Memorandum by the Audit Commission (Revised LAI 37)
The Commission's core statutory function in relation to audit
is to appoint auditors to approximately 900 principal local
government and NHS bodies. The Commission also undertakes national
studies on a wide range of topics to examine the economy, efficiency
and effectiveness of local public services. We carry out research
and provide independent analysis to give insight into complex
social problems and best practice in tackling them. We make practical
recommendations for policymakers and for people delivering public
services. This often includes recommendations to central government
relating to its interaction with the bodies that provide local
public services. This memorandum draws on evidence and information
from the work of appointed auditors and from our ongoing research
into local authority treasury management.
Summary
1. The Audit Commission is pleased to submit evidence
to the Communities and Local Government Select Committee investigation
into local authority investments.
2. This memorandum summarises the information we have
obtained from appointed auditors and the early stages of a research
project we are undertaking into treasury management in local public
bodies.
3. Although we have not finalised our conclusions, we
have identified a number of themes:
(a) we have identified 124 local government bodies with
potential losses of deposits in Icelandic banks totalling £950.1 million.
District councils have experienced proportionately greater losses
than other authorities;
(b) treasury management has generated a useful revenue stream
for local authorities;
(c) there is evidence of variability in how local authorities
use information before making deposits, with some authorities
using only information from ratings agencies and others using
a wide range of information sources;
(d) the quality of governance and scrutiny of the treasury
function is variable but there are some authorities in which scrutiny
has been limited with little effective challenge; and
(e) public bodies are not always clear about the risks they
are prepared to take with their financial assets and there may
be an inconsistency between their appetite for risk and the way
their treasury function operates.
4. We expect to publish our report in March 2009.
Introduction
5. Since the default of the Icelandic banks, the Commission
has been working to ensure that the extent of the exposure of
local public bodies is understood and that the lessons that can
be learnt from the situation are captured. The Commission currently
has two main streams of work.
6. First, through its appointed auditors, the Commission
has collected information from public bodies identifying those
that had deposits in Icelandic banks and their subsidiaries and
the value of deposits held. Individual auditors have also reviewed
their assessments of the financial standing of those authorities
with Icelandic deposits as part of the use of resources judgements.
7. Secondly, the Commission has also started a major
research project to examine local authorities' arrangements for
handling their cash reserves held on deposit. This project has
three elements:
(a) the collection of data from a wide range of local public
bodies on their deposits on 7 October 2008 in all institutions
and any deposits in Icelandic banks since November 2007;
(b) more detailed work, including site visits, to a sample
of some 40 local authorities to examine treasury management.
The sample has been selected to include a range of bodies including:
those that had deposits in Icelandic banks on 7 October 2008,
those that had never held Icelandic deposits and those that had
previously held Icelandic deposits; and
(c) a review of the nationally available guidance.
8. The Commission intends to publish its final report
in March 2009.
9. We have completed our collection of data from the
vast majority of local public bodies. We have also carried out
the first set of detailed visits to local authorities and examined
national guidance. It is, however, too early to come to authoritative
conclusions. Nevertheless, we hope it will be helpful to the Committee
if we identify some of the emerging themes. It is, of course,
possible that some of these will not be fully substantiated by
further research.
10. This submission draws on some of the early findings
of the research and of our appointed auditors.
Exposure
11. In October 2008 the Commission asked its appointed
auditors to identify which public bodies held deposits with Icelandic
banks that were at risk. This exercise identified 124 bodies
that were exposed, including local councils, police authorities,
passenger transport authorities and fire and rescue authorities.
The total exposure reported was £950.1 million. In cash
terms, the largest single exposure was £50.35 million.
However, the Commission has compared the potential loss to the
gross revenue expenditure (GRE)—a broad measure of spending—of
the bodies to adjust for the different sizes of the organisations
with potential losses. In one case, the potential loss represented
over 25% of GRE and in 13 cases over 10%. Of the 30 authorities
where potential loss exceeds 5% of GRE, 27 are district councils,
1 is a police authority and 2 are transport bodies.
Use of resources
12. Auditors have a responsibility to satisfy themselves
that the audited body has put in place proper arrangements to
secure economy, efficiency and effectiveness in its use of resources,
in accordance with criteria specified by the Commission. These
arrangements are defined by the statutory Code of Audit Practice
to include the audited body's arrangements for managing its financial
and other resources, including arrangements to safeguard the financial
standing of the audited body.
13. In reviewing an audited body's arrangements for its
use of resources, it is not part of auditors' functions to question
the merit of the policies of the audited body, but auditors may
examine the arrangements by which policy decisions are reached
and consider the effects of the implementation of policy.
14. Appointed auditors consider the financial standing
of local authorities as part of the annual use of resources assessment,
which forms part of the Commission's Comprehensive Performance
Assessment of local authorities. Treasury management arrangements
are considered in the context of financial standing, which looks
at how well the council manages its spending within the available
resources. In particular, auditors have to consider the authority's
arrangements to keep its treasury management strategy under review
and to monitor performance against it, and for ensuring that the
strategy reflects the requirements of the CIPFA Code of Practice
for Treasury Management in Public Services.
15. Although appointed auditors have advised us of isolated
cases of breaches of bodies' treasury management policies, there
is not yet any evidence that these were widespread. Breaches of
which we are aware include deposits apparently being made without
appropriate authorisation and individual counterparty limits being
exceeded.
Deposits and interest receipts
16. Local public bodies hold large sums of public money
with around £29 billion of deposits in banks and building
societies. Authorities draw an income from these deposits. In
recent periods, treasury management has been a source of additional
income for local authorities. In its research on the impact of
the economic downturn on local authorities, Crunch Time? [Ref
1], the Commission noted that 40% of chief finance officers had
reported increases in interest receipts in 2007-08. Although we
have not compiled an average yield on cash deposits, using a typical
figure of 5.5% for 2007-08 would imply that councils' interest
receipts exceeded £1.5 billion.
17. Local public bodies deposit money in a very wide
range of institutions. Over 130 different counterparties
have so far been identified. Predominantly these are UK owned
financial institutions, but there are also UK subsidiaries of
foreign banks and UK branches of foreign banks. From an examination
of the returns, it is clear that there is a wide range of behaviour:
some organisations have very conservative approaches while others
have used a wider range of counterparties. Having a wide range
of counterparties typically leads to a higher rate of return,
although it potentially also increases the risk of losing the
deposit.
18. In addition to the authorities that had exposure
to Icelandic banks on the day of default, a number of authorities
had previously held Icelandic deposits.
Use of credit ratings and other information
19. We have identified a range of behaviour among bodies
in how they use information to assess the appropriateness of counterparties.
In some cases, almost the only information used before placing
a deposit is a single credit rating from a commercial ratings
agency. In other cases, they use a much wider range of information,
including reading around the subject, looking at market intelligence
from a range of sources and broker information. Additionally,
the culture of the treasury management functions vary between
local authorities, with some staff adopting a sceptical approach
to information, while others are more trusting of that which they
receive. There is some evidence from our early fieldwork that
those with Icelandic deposits were using a narrower range of information
than those that either had never deposited or had stopped depositing.
20. Most authorities have contracts with treasury management
advisers and brokers. However, in many cases the advice is fairly
limited, for example they are used only to access the latest credit
ratings. Brokers may add value but some authorities may achieve
better results by approaching counterparties directly rather than
through an intermediary.
Governance and Scrutiny
21. Given the large sums of public money involved, it
is important that local authorities have in place arrangements
for appropriate scrutiny and governance of the treasury management
function. Our early fieldwork has identified some cases where
this function is well developed, with appropriate systems in place
to enable monitoring of the function, together with active engagement
and challenge from both top management and elected members. However,
in other cases the governance and scrutiny functions are ineffective:
treasury management policies have been adopted by councils with
minimal review and there is little challenge to the way the treasury
function has been carried out.
Risk appetite and assessment
22. Effective treasury management policies require a
good understanding of the risk that the organisation is prepared
to bear. However, as yet, we have found little evidence that local
authorities have systematically assessed their risk appetite.
23. There is some evidence that, in managing their cash
deposits, authorities have not had an appropriate balance between
maintaining security and liquidity on one side, and receiving
a yield on the other. Because of the historically high returns
that were available in 2008, it may be that yield considerations
were given too much weight and that security was neglected.
24. We have identified some shortcomings in the way that
deposit limits have been set. For example, some limits do not
take account of the increased risk of default of lower rated institutions.
Limits could be expected to be lower for lower rated institutions.
Additionally, authorities have generally not considered the country
risk, where there may be an adverse economic situation that affects
more than one institution. This was highlighted by the collapse
of the Icelandic banking system. But there are other countries
where there is considerable exposure, with potential seriously
to damage a council's financial position.
Conclusion
25. At this stage it is too early to draw any firm conclusions.
However, treasury management has been a useful source of additional
income for local authorities where, over the past year, interest
receipts have exceeded budget forecasts. We have identified examples
of strong treasury management in some organisations with informed
decision making and high standards of governance, scrutiny and
accountability. However, we have also identified some weaknesses
in the way the treasury function operates in some bodies with
insufficient use of information, poor governance and a failure
to appreciate the risks in the decisions being taken.
26. Going forward, local public bodies will need to ensure
that they are managing their cash deposits appropriately. This
includes understanding their appetite for risk and an appropriate
structure for managing their deposits in line with this risk appetite.
Authorities need to ensure that they are either not taking any
risk with their deposits by leaving them with the government's
Debt Management Office (DMO) or that they have a relatively sophisticated
and well-resourced treasury management function.
Reference
Ref. 1: Crunch time? The impact of the economic downturn
on local government finances. Audit Commission, 2008
Supplementary memorandum by the Audit Commission the role of
auditors (LAI 37B)
Background
The Audit Commission submitted a memorandum of evidence to
the Select Committee in January and Steve Bundred, its Chief Executive,
and Martin Evans, its Managing Director, Audit gave oral evidence
to the Committee at its hearing on 9 February.
We have subsequently been asked to produce a short note on
the work of appointed auditors in relation to finance, as part
of the regular Corporate Assessment of local authorities, to provide
some context for what the Committee says in its report in relation
to treasury management.
Summary
1. Public audit is an essential element in the process
of accountability for public money. The Audit Commission's appointed
auditors' provide independent assurance on whether public money
has been properly safeguarded and accounted for, and how well
it has been used in the delivery of services. They are an important
safeguard where taxpayers' money is raised by compulsory levy
and the normal commercial disciplines of the market do not apply.
2. The focus of auditors' work is a local authority's
annual accounts and the financial management systems and processes
that underpin them. Their work is therefore essentially retrospective.
3. It is a fundamental principle that public auditors
should be independent of those who are responsible for the stewardship
and use of public money. The Audit Commission's primary statutory
function is to appoint auditors on behalf of the taxpayer and
preserve their independence. This is essential if taxpayers, on
whose behalf public auditors work, are to trust auditors' judgements
and conclusions.
4. Auditors cannot comment or advise on an authority's
treasury management strategy or policies, as they may subsequently
have to review the effects of their implementation. Neither can
they substitute their judgement on risk or second guess specific
investment decisions by managers, as these are properly the responsibility
of management.
5. Both appointed auditors, in planning the audit to
meet their statutory and professional responsibilities, and the
Commission, when mandating elements of the annual audit programme,
are mindful of the need to adopt a proportionate approach and
to target audit work on the areas where the risks that something
might go wrong are highest. This risk based approach also serves
to reduce the cost and burden of audit for audited bodies.
6. Following the development of the CIPFA Code of Practice
on Treasury Management (the CIPFA Code) in light of the events
surrounding the collapse of BCCI in the early 1990s, neither the
Commission nor appointed auditors perceived treasury management
to be a significant risk. Indeed the view was that this was generally
a well managed function.
7. Few experts in investment were drawing attention to
risks with Icelandic investments until the spring of 2008, and
many not until the autumn. In carrying out their audits of the
2007-08 accounts, auditors would not have had cause to draw
attention to potential risks relating to investments in Iceland,
and neither the opportunity nor the powers to intervene. They
can only intervene in extreme circumstances, primarily if they
believe unlawful acts are imminent.
8. In giving their annual value for money conclusions
and use of resources assessments, auditors reviewed the treasury
management arrangements put in place by an authority. This involved
the auditor satisfying him or herself that an authority had put
in place arrangements to comply with the CIPFA Code. The CIPFA
Code was considered the appropriate standard, as it not only represents
generally accepted best practice in this area but is defined in
regulations as a "proper practice" to which authorities
should have regard. It is only the recent extraordinary events
that have exposed its limitations.
9. They are, however, now in a strong position to assess,
separately for every individual local authority, whether things
have gone wrong and, if so, why. Combined with our national report
on these issues, this will ensure that the appropriate lessons
are learned by all authorities, whether they had investments in
Iceland or not.
Introduction
10. Public audit is an essential element in the process
of accountability for public money. The Audit Commission's appointed
auditors' provide independent assurance on whether public money
has been properly safeguarded and accounted for, and how well
it has been used in the delivery of services. They are an important
safeguard where taxpayers' money is raised by compulsory levy
and the normal commercial disciplines of the market do not apply.
11. Auditors have two core responsibilities that touch
on treasury management.
a. Their primary responsibility is to give assurance (in the
form of an opinion) that the financial statements of the authority
present fairly (ie do not materially misstate) the financial performance
and position of the authority.
b. Reflecting the wider scope of audit in the public sector,
auditors have a duty, as part of their audit of the accounts,
to satisfy themselves that the audited body has put in place proper
arrangements to secure economy, efficiency and effectiveness (ie
value for money) in its use of resources.
12. In meeting these responsibilities, the focus of auditors'
work is a local authority's annual accounts and the financial
management systems and processes that underpin them. Their work
is therefore essentially retrospective.
13. In the context of their value for money responsibilities,
appointed auditors also consider the financial standing of local
authorities as part of the annual use of resources assessment,
which forms part of the Commission's Comprehensive Performance
Assessment of local authorities (and from 2009 will form
part of the new Comprehensive Area Assessment). Treasury management
arrangements are considered in this context.
14. This supplementary note focuses on auditors' responsibilities
in relation to value for money and their related use of resources
assessments. However, for completeness, it briefly outlines the
work auditors do in relation to local authority investments in
giving their opinion on the financial statements.
15. First, however, it outlines considerations relating
to auditors' independence and summarises the annual audit cycle,
both of which impact on auditors' role in relation to local authority
investments.
The Independence of Auditors
16. It is a fundamental principle that public auditors
should be independent of those who are responsible for the stewardship
and use of public money. The Audit Commission's primary statutory
function is to appoint auditors on behalf of the taxpayer and
preserve their independence. This is essential if taxpayers, on
whose behalf public auditors work, are to trust auditors' judgements
and conclusions.
17. The independence of the Commission's appointed auditors—whether
District Auditors from the Commission's own staff or private sector
accountancy firms—is enshrined in statute. They are legal
entities in their own right with separate statutory duties and
powers.
18. While the Commission can give guidance and advice
to auditors and can mandate elements of their annual work programme,
it cannot:
a. interfere with an appointed auditor's exercise of his or
her professional skill and judgement in performing his or her
statutory functions;
b. substitute its own judgements for those of an appointed
auditor in the exercise of those functions; or
c. direct an appointed auditor to act or to review his or
her decisions, as only the courts have the powers to do so.
19. The Commission's Code of Audit Practice, which is
approved by Parliament and with which auditors have a statutory
duty to comply, requires appointed auditors to exercise their
professional judgement and act independently of both the Commission
and the audited body. It also requires them to comply with the
Ethical Standards issued by the independent Auditing Practices
Board (APB).
20. Ethical Standards (ES) contain basic principles and
mandatory procedures to be followed, together with related guidance,
on the integrity, objectivity and independence of auditors. They
identify a number of potential threats to auditors' independence
and integrity, including the self review and management threats.
21. To avoid these specific threats the Code of Audit
Practice states "it is not part of auditors' functions to
question the merits of the policies of the audited body, but auditors
may examine the arrangements by which policy decisions are reached
and consider the effects of the implementation of policy. … In
making any recommendations, auditors should avoid any perception
that they have any role in the decision-making arrangements of
the audited body".
22. Therefore, appointed auditors cannot comment or advise
on an authority's treasury management strategy or policies, as
they may subsequently have to review the effects of their implementation.
Neither can they substitute their judgement on risk or second
guess specific investment decisions by managers, as these are
properly the responsibility of management.
23. Auditors can only intervene in extreme circumstances,
primarily if they believe unlawful acts are imminent.
The Audit Cycle
24. Initial planning for the audit of the 2007-08 accounts
took place in spring 2007 and these initial plans were firmed
up in the autumn. Work on the opinion audit began in earnest at
the beginning of 2008, with the bulk of the work taking place
in summer 2008 when draft accounts had been prepared and
approved by the authority.
25. Both appointed auditors, in planning the audit to
meet their statutory and professional responsibilities, and the
Commission, when mandating elements of the annual audit programme,
are mindful of the need to adopt a proportionate approach and
to target audit work on the areas where the risks that something
might go wrong are highest. This risk based approach also serves
to reduce the cost and burden of audit for audited bodies.
26. Following the development of the CIPFA Code in light
of the events surrounding the collapse of BCCI in the early 1990s,
neither the Commission nor appointed auditors perceived treasury
management to be a significant risk. Indeed the view was that
this was generally a well managed function.
27. When auditors were planning their audits in 2007,
they had no reason to consider treasury management to be a significant
risk. Only a few experts in investment were drawing attention
to the potential weakness of the Icelandic banks before the spring
of 2008, and many not until the autumn.
28. When carrying out and reporting on their audits of
the 2007-08 accounts, auditors would not have had cause to
draw attention to potential risks relating to investments in Iceland.
Whilst there were some warnings in the early summer 2008, this
is not something auditors could reasonably be expected to have
had regard to. Auditors do not monitor credit rating agencies'
or treasury management advisers' bulletins nor, given the nature
of their role, is there any reason for them to do so.
29. The vast majority of local authority audits for 2007-08 were
completed (and the reports to those charged with governance summarising
the key findings of the audit had been prepared and issued) before
the collapse of the Icelandic banks. Of the bodies with Icelandic
deposits, only nine audits were outstanding at 7 October
2008.
Value for Money Conclusion
30. It is one of the principles of public audit that
the scope of the audit is wider than in the private sector and
covers issues of probity and propriety and value for money.
31. The Commission's appointed auditors have a statutory
responsibility, as part of their audit of the accounts, to satisfy
themselves that an audited body has put in place proper arrangements
to secure economy, efficiency and effectiveness (ie value for
money) in its use of resources. Under the Code of Audit Practice
they are required to give a positive conclusion as to the adequacy
of those arrangements. In doing so, they must have regard to criteria
specified by the Audit Commission.
32. These arrangements are defined by the Code of Audit
Practice to include an audited body's arrangements for managing
its financial and other resources, including arrangements to safeguard
its financial standing.
33. The statutory focus of auditors' work in relation
to the value for money conclusion is the arrangements put in place
by an authority. In the case of treasury management, this involves
the auditor satisfying him or herself that an authority had put
in place arrangements to comply with the CIPFA Code.
34. The CIPFA Code was considered the appropriate standard,
as it not only represents generally accepted best practice in
this area but is defined in regulations as a "proper practice"
to which authorities should have regard. It is only the recent
extraordinary events that have exposed its limitations.
35. As such, auditors would not:
a. review individual investment decisions;
b. review the portfolio of investments;
c. provide assurance on the operation of the authority's treasury
management arrangements.
36. These are properly matters for an authority's management.
An authority's treasury management system is part of its wider
system of internal control. Regulation 4(2) of the Accounts and
Audit Regulations 2003, as amended by the Accounts and Audit (Amendment)
(England) Regulations 2006 requires authorities to "conduct
a review at least once in a year of the effectiveness of its system
of internal control" and to prepare a statement on internal
control. This is a basic management function and is implicit in
the CIPFA Code.
Use of resources assessments
37. In the context of their value for money responsibilities,
appointed auditors also consider the financial standing of local
authorities as part of the annual use of resources assessment,
which forms part of the Commission's Comprehensive Performance
Assessment of local authorities (and from 2009 will form
part of the new Comprehensive Area Assessment). Treasury management
arrangements are considered in this context.
38. Auditors are required to review a wide range of corporate
financial and performance management systems and processes, by
applying a series of Key Lines of Enquiry (KLOE), and "score"
their effectiveness against criteria specified by the Commission
on a four-point scale:
1: Below minimum requirements—inadequate performance.
2: Only at minimum requirements—adequate performance.
3: Consistently above minimum requirements—performing
well.
4: Well above minimum requirements—performing strongly.
39. KLOE 3.1 for the 2008 use of resources
assessment considers how well "the council manages its spending
within the available resources". The criteria for level 2 performance
in this area required auditors to consider the authority's arrangements
for keeping its treasury management strategy under review and
monitoring performance against it, and for ensuring that the strategy
reflects the requirements of the CIPFA Code.
40. For 2009, KLOE 1.1 asks auditors to consider
whether the authority plans its finances effectively to deliver
its strategic priorities and secure sound financial health.
41. The Commission has provided guidance to auditors
on level 2 performance in treasury management as follows:
"The council's treasury management ensures it has sufficient
cash to meet its needs, balancing achieving VFM with the security
of its investments (ie achieving a balance between liquidity,
security, and yield). Performance is monitored against its treasury
management strategy and outcomes match benchmarks set out in the
strategy. The council meets any tax and prompt payment legislation
(Late Payment of Commercial Debt (Interest) Act 1998). The council
has 'had regard to' the Code of Practice for Treasury Management
and the CIPFA Prudential Code, as per regulations issued under
the Local Government Act 2003."
Audit of the Financial Statements
42. In carrying out their audit of the financial statements,
auditors comply with the same professional auditing standards
that apply in the private sector.
43. Auditors are concerned to satisfy themselves that:
a. an authority does actually own the investments it is claiming
to have in its balance sheet; and
b. the assets have been appropriately valued in the accounts.
44. To get the assurance they need to be able to give
an opinion on a set of financial statements, auditors will carry
out third party verification tests—where the auditor writes
to those listed as holders of an entity's investments asking that
they confirm that they have these investments.
45. Normally, valuation of deposits with banks is not
problematic. Clearly, however, in the light of the Icelandic banking
crisis this will be an issue when auditors audit the 2008-09 financial
statements. Where authorities have reliable evidence about any
reduction in value, they will need to reduce (write down or impair)
the value of the investment in the balance sheet and charge the
amount of the write down to the income and expenditure account.
Where they do not have reliable information, they will have to
disclose in a note to the accounts that they may not recover the
full amount when the investment falls due for redemption.
Actions taken since 7 October 2008
46. Once the news of the collapse of the Icelandic banks
broke, the Commission immediately issued guidance to those auditors
who had yet to complete their audits of the 2007-08 accounts
on the implications for their opinion on the accounts.
47. We also asked all auditors to review their use of
resources assessments in relation to financial standing and, in
a number of cases, auditors chose to revise their assessments
on the basis of the new evidence available to them.
48. We have also asked auditors to obtain more detailed
information about authorities' treasury management arrangements
to inform our study of treasury management in local government.
49. Auditors will also be monitoring the situation locally.
Many of the authorities that have money at risk in the Icelandic
banks have already commissioned independent reviews of their practice,
which have made recommendations. Auditors will consider whether
the authorities' responses are appropriate and whether they need
to take any action themselves, for example in terms of public
reporting.
50. We will also ask all auditors to follow up the findings
from this study at the local level over the coming year, whether
an authority had investments in Iceland or not, to ensure that
the appropriate lessons are learned by all authorities. This work
will inform auditors' work on their value for money conclusions
and use of resources assessments for 2008-09, which will be issued
in September 2009.
Conclusion
51. The Audit Commission's appointed auditors' provide
independent assurance on whether public money has been properly
safeguarded and accounted for, and how well it has been used in
the delivery of services.
52. In order to maintain the independence, which is critical
to their role, auditors cannot comment or advise on an authority's
treasury management strategy or policies, as they may subsequently
have to review the effects of their implementation. Neither can
they substitute their judgement on risk or second guess specific
investment decisions by managers, as these are properly the responsibility
of management.
53. Historically, neither the Commission nor its appointed
auditors perceived treasury management to be a significant risk.
Indeed the view was that this was generally a well managed function.
In giving their annual value for money conclusions and use of
resources assessments, auditors reviewed the arrangements that
an authority had put in place to comply with the CIPFA Code, which
was considered the appropriate standard of best professional practice
in this area.
54. Few experts in investment were drawing attention
to risks with Icelandic investments until the spring of 2008,
and many not until the autumn. In planning and carrying out their
audits of the 2007-08 accounts, auditors would not have had
cause to draw attention to potential risks relating to investments
in Iceland, and had neither the opportunity nor the powers to
intervene.
55. They are, however, now in a strong position to assess,
separately for every individual local authority, whether things
have gone wrong and, if so, why. They will follow up our national
report on these issues to ensure that the appropriate lessons
are learned by all authorities, whether they had investments in
Iceland or not.
Memorandum by the Investment Management Association (IMA) (LAI
38)
Summary
— The necessary framework is in place to guide the administration
and investment of cash by local authorities.
— Good governance could be improved by the employment
of outside advisers and managers in all but the largest authorities.
— There may some merit in amending the rules on limiting
investment to say a maximum of 5% with any one entity and addressing
the length of the term of investment.
— Given the current economic climate any tightening
of the rules to limit counterparty exposure might only enhance
the liquidity problems in the money markets.
— Pooled investment vehicles offer many advantages and
are likely to be used increasingly.
Who we are
1. The IMA represents the asset management industry operating
in the UK. Our members include independent fund managers, and
the asset management subsidiaries of banks and life insurers,
as well as managers of occupational pension schemes.
2. They are responsible for the management of over £3 trillion
of assets, which are invested on behalf of clients globally. These
include authorised investment funds, institutional funds (eg pensions
and life funds), private client accounts and a wide range of pooled
investment vehicles. We estimate over £200 billion of
those assets are held for local authorities; predominantly as
pension scheme assets. This evidence does not address pension
scheme issues, but only cash management, or Treasury, operations.
3. Member firms, which are regulated by the FSA, manage
significant sterling cash portfolios for clients, including within
segregated cash portfolios for local authority clients. We would
expect any firm to have a disciplined approach to managing such
portfolios and undertake rigorous analysis of institutions and
others who offer cash instruments for investment. This includes
a consideration of rating agency opinions; though importantly
credit ratings should not be used as a replacement for adequate
credit risk management.
4. In this regard and given comments on the over-reliance
of credit ratings below and elsewhere, the Committee may wish
to note that we published in December 2008, with EFAMA and the
ESF, Guidelines on the Over-reliance of credit ratings by asset
managers. These are attached for ease of reference in case some
of the principles might assist the Committee's considerations.
Present Arrangements
5. Whilst others will no doubt give similar evidence,
as we are asked about the adequacy of the current framework we
have set out a brief summary of how we see it.
6. We understand local authorities currently to manage
their cash on a day-to-day basis. Like any organisation receiving
and disbursing money, cash flows are uneven and, therefore, it
would be prudent to invest such daily surpluses over periods of
time related to the known cash requirements of the organisation.
Furthermore, government restrictions on the use of capital receipts
from, for instance the transfer of local authority housing stock
to a housing association, generates funds that can be invested
for a considerable period of time. It is, therefore, in the interest
of the local council taxpayer to secure a market return in interest
payments; though obviously this seeking after yield should not
be at any cost. This was a lesson from a bank failure long pre-dating
the current crisis.
7. Certain constraints had been placed on the investment
of such cash by regulation following investment in BCCI, a bank
offering exceptional short term returns, which failed. Those regulations
limited the duration of investment and allow investment in certain
instruments only without losing flexibility of future use of the
cash when returned to the local authority eg certificates of deposit,
short gilts and supranational bonds.
8. The advent of the regulations saw the birth of advisers
to local authorities, now including Sector Treasury Services,
Butlers, Arlingclose and Sterling International. These advisers
help local authorities in the drawing up of an authority's Annual
Investment Strategy, recommending on how to invest cash, reviewing
the instruments in which to invest and as appropriate advising
on the selection of professional managers who are typically given
a mandate to manage the cash for a period of three years against
an appropriate benchmark. A number of our larger members have
significant cash management activities for local authorities.
9. The Chartered Institute of Public Finance and Accountancy
(CIPFA) also created a panel to examine and recommend on best
practice and publish a document (and regular updates) which makes
recommendations on treasury management practice which is, by and
large, followed by local authority treasury managers. This advocates
prudent investment and advises local authorities to diversify
their investments across a range of investments and institutions.
10. The production of the Annual Investment strategy
has had the effect of focusing on what is done each year, looking
to the future and helping local authority directors of finance
form a view of potential income to support the rate and reduce
the burden of the local council taxpayer. However, the perception
is that this has not always led to the strengthening of an authority's
treasury management team. Responsibility for such investments
is frequently undertaken as part of a wider-ranging job. The advisers
referred to above do however help to fill this gap in expertise.
Change and the Future
11. Given the regulations currently in place, sound advice
on Treasury Management promulgated by CIPFA, input from several
well-regarded investment advisers together with a number of well-established
investment managers in the field, there is a robust framework
already in place. The key is to make the structure work better.
12. We address (some themes overlap):
— external assistance in identifying the right investments;
— the ability to react to change; and
— the risk of over-reaction.
External assistance
13. Local authorities produce annual investment strategies
for their cash investments; merely to do so more frequently could
be counter productive. The strategy reviews investments and cash
flows and tries to predict income to support the rate. In normal
times, this can be quite significant depending on the cash resources
currently held by the authority. The income projections are often
calculated with help from the advisers and based on predictions
of professional cash managers if employed.
14. It has been suggested to us that less than half of
the local authorities in the UK use advisers and significantly
less than half use professional cash managers. It being said that
this figure was much higher but lack of volatility in markets
between 1997 and 2007 after the establishment of the
MPC and early warning of Base Rate changes meant that many local
authorities took managing their money back "in-house".
15. Our members' experiences are that many local authorities
have a Treasury investment policy with a stated lending list,
which for some has been quite complex, but has now become very
conservative. Without the depth of resources, experience and expertise
to use all available instruments, there is a fear that the policy
has limitations driven as much by name recognition as by quality.
16. In our view, the primary aims for local Authorities'
cash investments should be:
— Preservation of capital.
— Diversification of credit risk.
17. Local Authorities' requirement for yield and investment
income should always be secondary to the above aims. Whilst acknowledging
that yield is an important consideration, the priority of Local
Authorities' Treasury Management departments must always be the
preservation of council tax payers and pension funds' capital.
These aims are set out in CIPFA's Code.
18. The Icelandic bank failures have attracted much attention.
Despite the sums that some local authorities invested in Iceland
were large they were usually less than 10% of total cash funds
invested by that authority in the market and it could be argued
that that is not inconsistent with a reasonable diversification.
Furthermore, criticism may not always fully reflect the fact that
some of the funds had been invested for long periods eg three
years with no recourse to recall, so it was difficult to do anything
as the credit ratings of the Icelandic banks grew steadily worse.
Nevertheless there remains an issue as to more recent investment
despite warning signs. It was not unknown for Icelandic banks
to have been excluded from lists by some professionals about two
years ago.
19. Having noted the above qualifications, with over
100 Local Authorities suffering capital losses through investment
in Icelandic banks, serious questions remain about the pressure
felt by many authorities to achieve the greatest returns possible
and the extent to which external advisers can assist internal
treasury staff to balance that pressure.
20. A proposal for the future might be to limit the maximum
amount of cash placed by a local authority with any entity to,
say, 5% of the total available for investment, with the exception
of cash placed for management by professional managers or upon
external advice.
21. 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.
Reacting to change
22. The permitted investments are already controlled
by regulation so freedom of action is already limited. It is the
ability to react to changes in circumstance within these permitted
investments that may need to be reviewed. For example, should
investments be limited to a maximum of say 18 months; this
might not eliminate all losses similar to those experienced in
Iceland but it might have reduced.
23. In the absence of assistance from advisers, authorities
may be slow to pick up news on counterparties/institutions, particularly
downgrades. We are not in a position to identify the factors behind
this and the extent of cost this may bring to authorities that
do not use external consultants.
24. The framework for effective and efficient management
of local authority cash is already in place. Despite the risk
of it being seen as self-serving we do think it could be prudent
for all authorities to consider the use of advisers such as Sector,
Butlers et al and professional investment managers as a matter
of course because they are experts and spend all their working
time reviewing investments. Given the resources they deploy they
are inevitably more able to react to adverse market events. Authorities
will wish to consider having robust arrangements to consider conflicts
of interests that arise from using fee-based advisers; recent
guidance from the Pension Regulator on the use of external consultants
and conflicts may provide useful pointers for local authorities.
IMA strongly supported this more detailed and robust guidance;
and we have issued case studies on conflicts to assist pension
trustees.
The risk of over-reaction (and dealing with the Committee question
about investment in Government stock)
25. Should limitation of access to receipt of interest
cease, or be too severely limited, the effect on local authority
budgets could be critical in balancing budgets. The current febrile
state of the market will, at sometime in the future, return to
a more predictable normality. Local authorities have already adapted
and have reviewed where they are placing their money eg with DMO.
Because of the banking crisis lending is being kept very short
and risk minimised, but this action only exacerbates the current
problem. There is at present a 1% yield pick up between one week
and one year on the UK yield curve; lending very short means authorities
cannot access this.
26. If local authorities were required to invest only
with the government it would limit liquidity available to the
banks in normal times and it would increase dependence on the
government. We are not best placed to comment on the effect on
council taxes, but poor or sub-optimal returns ultimately must
have a negative impact for the council.
27. There is a risk that the losses from this crisis
will push local authorities to lower/zero risk assets, which may
allow them to confirm that the assets are safe, but is not necessarily
in their best interests. Holding Government Stock is a sensible
option for Local Authorities, and some currently invest in both
gilts and treasury bills. Unfortunately the day to day price fluctuations
in Gilts are not conducive to the valuation and reporting requirements
of Local Authorities. Member firms consider that new skills would
have to be learned to trade a gilts book. This reinforces the
need for external assistance but also leads to a consideration
of pooled vehicles below.
Central Government's Role
28. Central Government's role in providing financial
advice and guidance is achieved through the Prudential Code for
Capital Finance. We believe that this provides an appropriate
financial framework for Local Authorities.
Protection of Investments
29. It should not be necessary for the Government to
protect local authorities in the same way it protects individuals.
Local Authorities are currently classified as "Professional
Clients" under current FSA definitions. We believe that this
is appropriate, and that they should not receive further protection
from the Government. The framework is in place for local government
to protect itself. To do otherwise would risk incentivising decisions
not to seek external assistance.
Other Comments—Pooled Vehicles
30. Local authorities can now invest in Government Stock
via pooled, unitised investment vehicles providing liquidity,
appropriate yield and ease of administration whilst meeting their
reporting and valuation requirements. It is our expectation that
Local Authorities' use of such funds will grow over the coming
year, in response to a tightening up of their treasury management
practices to meet their primary capital preservation requirements,
and we understand firms to have received much direct feedback
to that effect.
31. Legislation was passed in 2002 to allow local
authorities in England and Wales to invest in money market funds
(SI 2002 No. 451 and 2002 No. 885). Similar legislation
has not been passed in Scotland (although we did understand that
it was on the agenda for 2008).
32. Whilst a matter for the Scottish office we think
this legislation should be passed. Money market funds offer the
benefit of diversification which is provided by a pooled investment
(and is a key differentiator when compared with a deposit account),
they provide professional cash management and independent credit
analysis (eg our information is that no UK-managed MMF was invested
in Icelandic banks). This should in theory be an ideal type of
vehicle which local authorities should use for short-term cash
management.
33. Consideration could be given to the establishment
of longer term pooled funds which would give a better rate of
return for local authority cash and which would minimise losses
to individual authorities if an entity were to fail.
34. Member firm's experience in relation to corporates
is that they are now much more likely to use pooled vehicles like
money market funds (either variable or constant net asset value
funds) than attempt to make these decisions themselves.
35. This range of products run along the risk/return
spectrum offering the flexibility that Local Authorities may require,
whilst offering realistic market yields. Some funds will offer
higher yields in exchange for reduced liquidity and some will
offer higher yields for increased credit risk.
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