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Memorandum From Brighton & Hove City Council (LAI 16)

Summary

- Current arrangements provide for local discretion in making investments. A tightening of these arrangements will adversely affect investment returns.

- Local authorities should maintain a balanced investment portfolio in low risk instruments. Limiting investment to Central Government instruments only will adversely affect investment returns.

- Local government bodies should take a greater role in offering investment guidance to local authorities. The Bank of England and regulatory bodies should also take greater role.

- Protection of local authority investments is likely to result in greater control by Central Government.

What are the present arrangements for local authorities' Treasury Management - and in particular the requirement to produce Annual Investment Strategies - and how have these affected the performance of local authorities, both as service providers and employers, given recent potential losses experienced by many local authorities?

1 The present arrangements are set out in guidance issued by the Secretary of State under powers provided by the Local Government Act 2003. These arrangements provide for local discretion in terms of investments. Local discretion is achieved through the production and approval of an annual investment strategy.

2 The guidance requires the council to use credit rating agencies to define "high credit rating". This places a high degree of reliance on these agencies. Recent experience would suggest that these agencies have under-estimated the problems within the financial markets and are only now responding by down grading a number of institutions.

3 Rating agencies play a significant role in the selection of investment counterparties but confidence in their ability to assign the correct rating has been severely dented in recent months. Reclaiming this confidence is essential, otherwise investment portfolios will be skewed towards greater safety in terms of shorter period and counterparty. If this happens investment returns are very likely to suffer.

In the light of recent events, are any changes needed to the framework for the scale, spread and risk of local government reserves?

4 No. The issue is not about the scale, spread or risk of local government reserves but the decision taken on whether to invest funds or reduce borrowing requirements.

Should local authority money be invested in Government stock, with lower risk, but with a low return?  What effect would this have on UK banks and on council taxes?

5 Yes but only as part of a structured and balanced investment portfolio. A substantial proportion of council investments are held for less than 12 months, with the minimum being overnight. Investment in Government stock is better suited to a longer term view (say 3/5 years) due to price fluctuations, custodian arrangements and trading requirements.

6 Limiting investments in Government stock would impact on the council's investment performance through lower yields and with the possibility of a capital loss.

7 An alternative to investment in Government stock is the repayment of PWLB debt. However the decision by the PWLB to reduce the discount rate on premature repayments has effectively increased the cost of choosing the repayment option. The discount rate is below the cost of Government borrowing - effectively there is a net cost in repaying debt prematurely as opposed to investing in Government stock.

What is the role of central government in providing financial advice and guidance to local authorities?  Should any other bodies have a role?

8 Consultation is the key to any financial advice and guidance, whether issued by Central Government or other bodies. In general

- Central Government should focus on the impact of investment guidance on local government finances.

- Regulatory bodies such as the Bank of England, FSA, BBA and BSA should take a greater role in monitoring the activities of its membership, particularly the extent of any involvement in high risk areas. In addition the regulatory bodies should consider the role played by the rating agencies in assessing credit worth of counterparties, and

- Bodies such as the LGA and CIPFA should take a greater role in advising local authorities on investment decisions. At present local authorities rely on treasury management advisors for this advice. Advice from the LGA / CIPFA would promote consistency of investment decisions across the whole of the local authority sector.

Should the Government protect local authorities' investments in the same way that it is protecting personal assets?  What consequence does this have for the relationship between local and central government?

9 This option would allow local authorities to invest in financial institutions that offer the highest returns without any consideration of capital risk. The council recognises this scenario is clearly unacceptable to the Government. Government protection is very likely to be accompanied by a tightening on investment powers, most probably restricting only in government backed securities.

December 2008