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Memorandum from
Plymouth City Council wishes to take this
opportunity to respond to the specific questions in relation to the Select
Committee enquiry into Local Authority Investments. In making this response
Any resulting actions should not be reactive to the Icelandic situation but must look at the wider implications of treasury management. Recommendations must recognise the success that local authorities have generated from their treasury management strategies whilst ensuring, as far as possible, the protection of public monies. In addition to the review of investment strategies, the Committee should have regard to the current local authority borrowing regime and the implications that recent changes to PWLB borrowing may have on future budgets.
Our response to the specific questions posed is as follows:
Select Committee Question 1 What are the present arrangements for local authorities' Treasury Management - and in particular the requirement to produce Annual Investment Strategies - and how have these affected the performance of local authorities, both as service providers and employers, given recent potential losses experienced by many local authorities? Response 1.1 Local authorities follow the Chartered Institute of Public Finance and Accountancy (CIPFA) Treasury Management Code. This code sets out the procedures local authorities should follow in the organisation of their treasury management functions. 1.2 The Treasury Management Code is given legislative weight by the 2003 Local Government Act. This is supplemented by guidance on investments issued by the Office of the Deputy Prime Minister in March 2004. 1.3. With regard to Investments, the Prudential Code states that Local Authorities should bear in mind that prime policy objectives of their investment activities are to encourage safety and liquidity, and to avoid exposing public funds to unnecessary or un-quantified risk. The pursuit of optimum performance from the investment of legitimate surplus funds, as a secondary policy objective, is a best practice approach to treasury management and is to be encouraged. Authorities must not borrow more than, or in advance of their needs, purely in order to profit from the investment of the extra sums borrowed - a practice referred to as 'round-tripping'. Freedoms afforded to local authorities to invest longer-term or in investment instruments should therefore be used always with these principles in mind. 1.4. Each year Full Council is required to approve the investment strategy for the year. This is part of the authority's financial framework and can only be varied by further resolution of Full Council. In drawing up its strategy, the Council supplements it's in house expertise by taking advice from employed Treasury Management advisors, currently Sector Treasury Services. Monitoring of the strategy is undertaken during the year as part of normal budget monitoring reports, regularly reported to Cabinet and Scrutiny Overview Committees. At the end of the year a final Treasury Management report is taken to Cabinet as part of the Council's budget outturn for the year. 1.5. At the heart of the Council's
investment strategy is a set of approved counterparties and counterparty
limits. Counterparty lists are informed by an independent assessment of the
financial stability of the institutions, the normal source of which is the
rating given by one or more of the three main rating agencies, and advice and
discussion with our Treasury advisors. The credit rating agencies give short
and long-term ratings for financial institutions, some agencies give further
information - for example about countries. Our investment strategy sets out the
minimum acceptable rating that an institution must achieve to be included on
the counterparty list. Not all financial institutions are rated by rating
agencies, smaller 1.6 Our treasury advisors, (Sector), provide us with regular updates and/or changes to credit ratings for individual organisations. Day to day responsibility for management of the Counter party list is delegated to our Director of Corporate Resources (the Section 151 Officer) and the list is updated immediately we are notified of any credit rating changes for individual organisations. In the event of an organisation having its rating downgraded, the Council either suspends further trading or adjusts the maximum amount or duration for investment on the Counterparty listing. On occasions, existing investments might exceed the revised maximum limits brought about through credit-rating downgrades and in these circumstances the Council manages risk through: (a) Regularly monitoring investments above revised limits (b) Regular senior officer meetings discussing the investment portfolio (c) Not undertaking any further transactions with organisations that have been downgraded (d) At the earliest opportunity re-investing in companies with higher credit ratings or using maturing investments to repay debt 1.7 In June 2008 in response to concerns in the money market through developments with Northern Rock and Bradford and Bingley, the Council commissioned Sector to undertake a review of the Council's investment strategy. The resulting report raised no specific concerns, and contained several reassuring messages such as: "The Council has an approved Investment strategy which complies with best practice as defined by the CIPFA code" "The Councils lending list is very robust and takes into account consideration of the rating criteria, amount limits and also duration limits, which is exactly what Sector recommends from authorities that are looking to place money with any institution" "The Council currently spreads risk duration by investing for varied periods of time and Sector recommends that the Council continue to do this in order to remove duration and interest rate risk from its portfolio" 1.8 The amount available for investment is determined by the Capital Financing Requirement, a key measure in the Prudential Code. In recent years advantage has been taken to undertake an element of borrowing in advance of immediate needs, not only in order to achieve the best rates for both borrowing and, in the shorter term, lending, but also to ensure that the overall sums that will be needed to fund the Council's capital programme will be available. Such activity is permitted within the prudential code and is checked annually as part of the external audit. 1.9 Over the last few years the Council has been successful in achieving favourable investment returns and the improved position on Treasury budgets has been key to both balancing the budget and investing in essential maintenance and service improvement. We are still forecasting an additional £2m investment interest above budget in 2008/09, brought about by 'locking in' investments at high interest rates earlier in the year for periods of up to 364 days (before the fall in interest rates). However, this does not account for any losses in relation to Icelandic investments. 1.10 In response to the Icelandic situation and potential loss of investment income the Council has taken a much more risk adverse position to its treasury management investments and implemented a short term investment strategy as follows:
"That all investments are made for a maximum of three months in the UK only with the highest credit rating organisations or through the Government Debt Management Office" 1.11 Whilst
in the current year this is having a 'limited and manageable' impact on budget
projections, there will be a significant impact in terms of next year's revenue
budget as a result of the fall in interest rates and the decision to invest for
much shorter periods. Overall, 1.12 When we add to this 'loss' of income other pressures on local authorities such as reduction in other fee and charges income following the general economic downturn, increasing demographic expenditure requirements and increasing need to find efficiency savings in order to balance our budgets it is clear that this will have a substantial impact on our ability to provide essential front line services. 1.13 One key part of the Treasury Management system available to local authorities is the Public Works Loans Board (PWLB) run by the Debt Management Office (DMO). This makes loans available at a government rate, and is the main source of debt finance. A key part of the overall treasury management strategy is the ability of authorities to restructure debt. In recent years this has been one of the main attractions of taking PWLB long-term debt, in that it could be done in the knowledge that if the rates reduced in future, the council could restructure (paying a premium over the life of the new loan), in order to reduce costs. 1.14 Approximately 1 year ago, the PWLB changed the rates available to restructure debt, and this has had a major adverse effect on local authority treasury management. In particular, in the current market of reducing interest rates, it removes the logical way to offset the impact of those rate reductions on investments. We comment further on this issue at the end of our submission. Select Committee Question 2 In the light of recent events, are any changes needed to the framework for the scale, spread and risk of local government reserves? Response This response has been made on the assumption that the question relates to local government investments rather than reserves 2.1 Before considering any proposed changes it is important to recognise, as stated above, that this was an extremely unusual event. It was unlike previous financial episodes that affected local government treasury management. This was a case of an entire banking system of a highly developed European country unexpectedly collapsing. 2.2 Putting our investment into 2.3 Authorities rely not only on the advice of treasury management advisors, but also on credit ratings. Improvements could be made by clarifying the responsibilities of professional advisors and credit referencing agencies and by building country credit ratings into decision making and also by establishing systems that make it easier for authorities to lend to each other. 2.4 Our view is that whilst the broad structure of the guidance does the correct things, recent events have emphasised the need to revisit the risks, both financial and reputational, of treasury activity. Historically, in the pre prudential controlled system we had modest sums to invest and could usually place them with a range of high street banks and building societies. Money was often needed within a relatively short period, so investments were short term. More recently when we began to have larger sums to invest, (borrowed to help fund the Council's ambitious capital programme), we have had to expand our lending list considerably in order to invest the sums, as a key risk issue is ensuring that the proportion of investments with any one institution is limited. 2.5 The current, unprecedented market position means that authorities have to review their risk assessments and many have taken a much more risk adverse approach to investments. Our view therefore is that the framework is a reasonable one, with authorities acting and responding to circumstances as required. However one of the key issues for our authority is the extent to which a bank can be expected to be supported if it gets into difficulty. Our investments are now only made in institutions where support is strongly expected, or guaranteed. If the Irish or British Governments were unable to support the banks whose investments have now been guaranteed, then the framework would need to be changed (as would many other things). Select committee question 3 Should
local authority money be invested in Government stock, with lower risk, but
with a low return? What effect would
this have on
Response 3.1 3.2 We do not take the view that the purchase of Government Stock should be the only investment permitted for local authorities. Such investments are not really suitable for "cash flow" investments. The largest amounts of money come into the authority monthly at the start of the month, (e.g. local tax), and mid month (Government grants) but expenditure occurs daily, with the largest regular item being salaries, towards the end of the month. Authorities that have covered their long term borrowing requirements need to make short term investments between the two. As a general principle AAA rated money market funds and call accounts with reputable banks provide the most suitable investment vehicle for this purpose. 3.3 Government stock is not 'liquid' enough for the daily dealing that is required, particularly if, as is now the case for many, the Authority's own bank does not have a high enough credit rating to justify leaving sums in its accounts. 3.4 Local
Authorities as a whole are significant investors in the wholesale bank markets,
and withdrawing their funding will have an impact on the funds available to
banks at a difficult time. Select Committee Question 4 What is the role of central government in providing financial advice and guidance to local authorities? Should any other bodies have a role? Response 4.1 Central government has established the framework for local authority capital accounting and investment management. Within this framework CIPFA provide more detailed technical advice, drawing on advice from expert practitioners from within local government when doing this. We consider this appropriate. 4.2 We believe that Central government should not have a role in advising what authorities should or should not invest with particular institutions. Select committee question 5 Should the Government protect local authorities' investments in the same way that it is protecting personal assets? What consequence does this have for the relationship between local and central government? Response 5.1 Local authorities are generally regarded as professional counterparties in the market place, and employ professionally trained and qualified staff in senior finance roles, and in most cases purchase professional advice about their treasury activities from professionally qualified advisors with substantial market experience. 5.2 In response to your question, we do not believe that a blanket unconditional guarantee is appropriate especially if this comes with increased regulation. However we do believe that protecting Local Government investments should be considered carefully in the context of particular circumstances. 5.3 With regard to the Icelandic bank crisis for instance, we have already stated that this crisis has arisen as a result of unprecedented turmoil both in economic and financial markets and therefore in this instance believe that this is a situation that should be supported. Whilst authorities are hopeful that they will get some of their money back, it is too early to identify the resulting shortfall or impact and thus what support each authority may look towards the Government to provide. However the consequences of not providing any support will lead to local authorities progressively withdrawing funds from the international banking system and thus progressively worsening the current financial and economic climate. 5.4 With regard to the relationship between central and local government, one key aspect in treasury management terms is, as noted above, the relationship between the government (DMO) run PWLB and local authorities. The PWLB substantially worsened its lending terms on 1 November 2007. Until then, the PWLB had permitted the repayment of most loans, with any discount or premium calculated at the present interest rate for a loan of the remaining period of the loan being repaid. 5.5 For
authorities who have borrowed ahead, one response to the current market
conditions would be to repay a part of the borrowing, to reduce treasury risk.
The action of the PWLB last year has made this unaffordable for an authority
like Thank you for allowing us the opportunity to respond
to the committee questions. We are an authority that has potentially lost money
in
December 2008 |