Examination of Witnesses (Questions 260-277)
MR JEREMY
PALMER, MR
GUY SEARS
AND MR
RICHARD WARNE
9 FEBRUARY 2009
Q260 Chair: As I understand it, your
members manage funds for a variety of different public bodies
including local authorities?
Mr Warne: That is correct.
Mr Sears: Yes.
Q261 Chair: Do you think local authorities
are less or better qualified, or have less or better qualified
persons within them, than some of the other public bodies for
whom your members are managing funds?
Mr Warne: It is always a difficult
question to answer in relation to a wide body. Experience shows
that there are some local authorities who have very experienced
individuals working in them and other local authorities who, either
through scale or size, have much less experience. I think it is
a very tall order personally to expect people in local authorities
to have intimate knowledge of all the financial instruments, markets
and day-by-day movements within those markets and credit ratings,
et cetera.
Chair: How much would you expect such
a person to be paid to get the quality of person you would need?
Q262 Mr Hands: At the moment not
very much.
Mr Warne: From previous evidence
it is apparent that people are paid salaries that you would anticipate
for the roles they pursue in local authorities.
Q263 Chair: We know how much they
are paid in local authorities but when they attract in, apart
from maybe Mr Hands, we do not work in the financial markets so
we do not know. I am asking an open question. The sort of person
not working for a local authority but out there looking for a
job that would have the level of knowledge and experience that
would enable them to take these sorts of decisions, how much would
you expect them to be paid roughly?
Mr Warne: I think in aggregate
an experienced credit analyst, or someone who is used to analysing
credit, would be paid more than what was typically mentioned,
£40,000.
Q264 Chair: Twice as much?
Mr Warne: Potentially twice as
much. It is not going to be an order of magnitude of more than
that. A very experienced fund manager that has a long track record
in managing large amounts of money would expect to be paid more
than that.
Chair: More than £80,000.
Q265 Mr Hands: Can I come back to
the small local building societies argument? Do you think there
is a strong counter-argument that if a local authority is encouraged
to put more investments in place with a local building society
that you are effectively concentrating the risk of the local area?
If a local building society gets into financial difficulties or
goes under that is going to have a knock-on effect on the finances
of the local authority albeit indirectly. Should there not be
a counter-argument that local authorities should divest away from
their local institutions?
Mr Palmer: Perhaps the answer
is that in all investment of this kind there should be sensible
counterparty limits. We would not advocate any local authority
putting massive investment proportionate to its total cash deposits
with one individual building society. We think local authorities
would perhaps be interested to note that by putting money in building
societies they are helping to support the provision of housing
finance and in some cases that would be in their local or regional
markets and helping to support the local and regional economies.
If those considerations weigh at all with them, then we would
encourage them to go with the flow. Exposure limit is the key
question.
Q266 Mr Hands: I have a question
to the IMA in terms of diversification. You talked about credit
limits and diversifying credit, which sounds a very sensible thing
to do, but is there also an argument for having a credit limit
by sector or indeed by country? There is obviously no coincidence
that the three major Icelandic banks all became insolvent at precisely
the same time. Is there not an argument for having a country limit
as well as perhaps a sector limit on the basis that say UK builders
might have peculiar problems facing them at any one time? Are
these sensible things for local authorities to be considering?
Mr Sears: Richard may want to
speak as a practitioner but the analogy I draw is with the pension
schemes. The Local Government Pension Scheme Regulations do have
hard limits in various areas to do with instrument coverage and
it would be entirely possible to have geographic and other coverages.
The difficulty you may say in why occupational pension schemes
do not take this model from Europe and they used a prudent person
approach is that any proxy you get is always going to be weak
at some point. It may be historically weak. It may well be that
new processes have occurred, for instance when some of the building
societies and banks changed what they were doing as business models
inside and these things fall out. What we probably feel much more,
and what we were trying to say in this, is this is about a service.
When you say how much people should be paid, there is also the
cost of the process. The process of credit assessment and assessment
of investment risk is a very large investment at many of the firms
and that is something that, with the best will in the world, local
authorities perhaps should not be expected to do. But their qualified
people should be like hawks on people like our members and others
testing what they are saying and understanding it well enough
to be able to see that they are getting value for money. There
is a proper role for qualified people but not to do the role of
credit assessment.
Q267 Mr Betts: What would you expect
local authorities to get from employing external treasury management
advisers?
Mr Warne: When it comes to employing
advisers, our member firms and asset managers manage money on
behalf of local authorities, either pension funds or in this case
their short-term cash. They should expect that money should be
managed appropriately within the guidelines. They have effectively
delegated the selection of where that money is placed to the asset
manager. I think this Committee has taken evidence from other
types of advisers who are involved in providing advice or information
to local authorities with regard to how they make that selection
and what they should be doing in that regard.
Q268 Mr Betts: Your members would
take over the whole function and effectively it would be contracted
out to your members to do for local authorities.
Mr Warne: That is correct, either
by investing it in a fund structure at a liquidity or money market
fund or having a separate mandate which effectively says you have
responsibility to manage this cash, place it in appropriate investments
which preserves the capital, provides liquidity, diversifies that
credit risk and gives a proper rate of return.
Mr Sears: At the risk of breaking
Dr Starkey's guideline on us both answering, scale is one of the
other things. If you access a major asset manager—and our
member firms manage between them more than the sovereign wealth
funds and hedge funds money of the world from the UK, £3.43
trillion—the scale you get in terms of the credit analysis
and the investment analysis is something that no one authority
could ever invest in.
Q269 Mr Betts: No local authorities
who had their treasury management function outsourced to your
members lost any money in the Icelandic banks.
Mr Warne: Not that I am aware
of.
Mr Sears: I have not heard from
any but I would not necessarily know. In preparing for this evidence
we asked around and no-one put their hand up. It is probably a
bit like the memoranda that come to you; no-one quite wants to
put their hand up if they were a big loser. People will lose.
I am not suggesting that people will not lose money. This is about
setting up a dynamic tension between people who have clear responsibilities
as to what they are doing. Perhaps one of the things we have noticed
through the evidence that has been given and the memoranda is
it is very difficult to see who is responsible for what in this
chain of investment. What I was suggesting is if it is clear you
have an external person who is managing it and responsible for
that but you have internal people who are checking and watching
it, that is the model we use for pensions for the local government.
That is the model we use for the pensions schemes in the United
Kingdom. By analogy, why is it any different for cash management?
It is maybe a one-year difference of needs rather than 20 years
but it is still management.
Q270 Mr Betts: Some local authorities
kept the treasury management in-house but nevertheless had external
advisers. What would you expect that advice to consist of?
Mr Sears: Again, I have seen in
some of the memoranda their internal advisers did better, but
it is the word "advice" that I am trying to get away
from. If you mean the receipt of information to people and then
you say "It is up to you to make your own decision. This
is all we are telling you, it is up to you" my concern about
the word "advice" is it presumes a level of competence—and
I do not mean to the opposite an incompetence—amongst people
to fully understand this information they are receiving and making
a judgment in context. One of the memoranda said how a local authority
was advised whether to go into Landesbanki or another UK bank
and they were just left to make that decision. What I am saying
is should that be a decision by a person who is responsible and
gets performance fees or does not get paid and who can be replaced
after three years?
Q271 Mr Betts: We were rather surprised
to see that local authorities literally had sheets of paper or
emails with nothing more than a list of credit ratings passed
over to them for them to work out what to do.
Mr Sears: To come back to what
was said before about credit rating and was there over-reliance,
I think there was widespread over-reliance right across many investing
sectors and was not limited to local authorities. That is why
we did that piece of work which we have copied to this Committee
on credit across Europe. If I may quote two lines from it: "The
analysis of the underlying asset structures risk can be challenging
and some asset managers may be tempted to avoid the cost of doing
so. There is a risk that tendency to save costs can become aligned
with an incentive to treat credit ratings as complete proxies
for the analysis that ought to be made." That is the incentive:
the incentive is to say we can save costs by using a proxy and
at times like this you lose it.
Q272 Mr Betts: You would therefore
be surprised to read, but not exactly shocked, that there may
be local authorities who neither have internal specialist advisers
nor have they subcontracted out their treasury management but
actually have almost solely relied on information being passed
by certain external firms offering credit rating information and
nothing else?
Mr Sears: It could not be the
complete set of things they should do because they should also
be analysing the terms they are using and the duration of investment
they should be making in order to match their needs. Whether or
not a bank is good from a credit rating, let alone a weaknesses
in credit rating, does not answer the question "Do I leave
it there one year, three years or three months?" so of itself
it is axiomatic you cannot answer what you need to do using a
rating.
Q273 Dr Pugh: Going back to the point
you made about performance rating, are there many big credit analyst
firms out there who are happy to be on a performance ratings basis
or a partial performance rating basis? I am sure if they perform
very well they no doubt will want a bigger fee but if they perform
very badly they would still want a bigger fee, would they?
Mr Warne: If you look typically
at the treasury function we are talking about, performance fees
are somewhat unusual. There is usually a base fee that is charged
for a service in managing the assets that pays for the credit
analysis and the advice that is being given and managing those
assets appropriately. That is the typical model.
Q274 Dr Pugh: There are not many
firms out there who want to be on a performance basis at all,
are there, in terms of their advice? They are like chartered surveyors:
you pay them whether or not they find out the right things about
the property you are buying and you have no recourse to them afterwards
if things go wrong.
Mr Warne: I can only comment on
the investment management model but, yes, typically that is the
case.
Q275 Sir Paul Beresford: The minister
is going to be tempted and be under pressure for regulation. This
government loves regulation. However, in this area is it not more
appropriate that there is advice and freedom so that the local
authorities can maximise the opportunities that their investments
would bring to them or do you think regulation is the right way
forward?
Mr Sears: I am not really sure
still at its heart what actually deeply went wrong. I think just
humanly, and from times when I worked at regulators, perhaps what
I have been trying to address is the fact that if you have external
advisers it can assist internal treasury management in resisting
drives from others to maximise return at the risk of everything
else. Sometimes what this is about is setting up tensions inside
organisations so that people have the power and the ability to
withstand calls to ask them to do things they should not be doing,
for instance chasing yield when you want security is not what
you should be doing.
Q276 Chair: Treasury advisers did
rather the opposite in local authority cases.
Mr Sears: I was not present in
the room as to what was said and what was not said. In the pension
scheme advice area there are many consultants who assist our pension
scheme clients with their work with considering where they should
be putting assets and with testing the terms on which the asset
managers are dealing with the pension scheme. That is quite a
usual model.
Q277 Anne Main: On the last evidence
session I was rather under the impression that those views rose
back from people who said they were giving advice and others who
said they were giving information. You have both used the terminology
"advice" and "information". Do you think it
is made clear enough to a local authority exactly what it is receiving
when dealing with some of these bodies, whether it is advice or
information?
Mr Sears: My answer would be I
have seen what you have seen but certainly not heard and not read
all of it. The word "advice" is a recommendation as
to whether or not to buy or sell a particular investment. That
is what I would understand advice to be. The word "recommendation"
carries with it some duty or obligation. To inform people about
the range of things that are available in the market is information
in my mind. If there is a mismatch between what is delivered and
what is received then you have risk. Whether or not it failed
in this case, I do not know, but in other words even if I went
down to an adviser if I thought I was getting advice and I was
getting information that gives rise to risk and what we are looking
at is de-risking this process.
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