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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 164-i House of COMMONS MINUTES OF EVIDENCE TAKEN BEFORE COMMUNITIES
MR HOWARD KNIGHT MR STEVE FREER, MR CHRIS BISLAND and MS ALISON SCOTT Evidence heard in Public Questions 1 - 70
USE OF THE TRANSCRIPT
Oral Evidence Taken before the Communities and Local Government Committee on Members present Dr Phyllis Starkey, in the Chair Sir Paul Beresford Mr Clive Betts Jim Dobbin Andrew George Mr Greg Hands Anne Main ________________ Witness: Mr Howard Knight, Independent Consultant, gave evidence. Q1 Chair: This is the first evidence session of our inquiry on local authority investments. I would like to start by asking you, Mr Knight, from the survey that I believe you have done of local authorities, how many local authorities and of what type have you surveyed on their approach to treasury management? Mr Knight: I have been trying to get responses from about 50 authorities which are representative of all authorities. Unfortunately, returns are still coming back in and I was taking them off the emails this morning. I would not claim to have a representative sample by any means, what I have got are indications and statements from leading members. I have not been surveying the authorities themselves, I have been talking to those elected members who have particular responsibility for treasury management, the leaders, the cabinet member for resources, the chair of the audit committee and the chair of the relevant overview and scrutiny committee to get their views and opinions. Q2 Chair: Presumably, as the information comes in you would be prepared to collate them and provide them in written form to the Committee? Mr Knight: Absolutely. Q3 Chair: Excellent. Insofar as you have got information already, what is it indicating? Mr Knight: I would divide that into a number of issues. The first I would say is mention about the skills and experience of those elected members who have responsibility for treasury management. The majority do not have any academic or professional training in finance or economics, about 50% have indicated that they have been on some basic local government finance courses but only a minority have done work on treasury management or specialist training on treasury management. I have asked them about whether they think they ought to have increased skills and training development in those areas and the vast majority have said yes. I do not think they would want legislation to do that but they would certainly want an encouragement for them to be given the opportunity to do that and for that to be monitored locally. Q4 Chair: Have they not thought of asking for it already? Mr Knight: Some have, but I think you just need to understand the wider context within which member training and development operates. It varies enormously between authorities up and down the country but there is a media climate, if I can put it that way, which suggests that member training and development is one of those unnecessary things that councils sometimes do. Q5 Chair: However, there is quite a media climate about councillors who do not seem to know what they are doing and who thereby may lose their authorities large sums of money, one would think? Mr Knight: That may be the case. Q6 Sir Paul Beresford: Presumably, they are therefore relying on advice from officers? Mr Knight: Correct. Q7 Sir Paul Beresford: Have you 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 Q8 Sir Paul Beresford: What about the small authorities? Mr Knight: It varies enormously. Again, I do not think there is a simple pattern which is based on either size or political control. I think you would expect that those large authorities, or authorities with the largest investment portfolios, would have their own specialist officers. Q9 Sir Paul Beresford: Is there any indication that smaller authorities pool their resources to obtain this information? Mr Knight: I do not know that, I have been trying to talk to members rather than the officer side of this. Q10 Anne Main: Is there any correlation though, from the information you have been able to glean, that authorities which do not have any particularly trained members and are relying on officers are doing any worse than those who do have trained elected members? Mr Knight: No, and certainly the level of information I have got would not provide me with a statistical correlation so far on that, no. Q11 Anne Main: It begs the question is there any point training the members, it might be better training the officers if they are not sufficiently well trained? Mr Knight: I would hope these officers would be sufficiently well trained. The training of members cannot be about detailed understanding of what securitisation measures or other financial instruments are being used, it is about giving people enough information to be able to ask informed questions into informed follow-through. After all, if the banks did not understand the level of risk they were taking with some of the things they were doing it would be a bit of a surprise if elected lay members could understand the detail of some of that risk. It is about giving people confidence and enough information to ask basic questions. Q12 Sir Paul Beresford: With the speed of change we have seen recently it would be rather an onerous task, presumably, to have a committee to meet and look at the issues? Mr Knight: Absolutely. What we have is a situation where every local authority is required to produce an annual strategy and policy paper by law and to report on its performance. Some authorities certainly do that twice a year rather than once a year. It is also clear that a number of authorities in the light of market information have taken to changing their policies, either formally and having recorded that, or that the chief financial officer, section 151 officer, has probably in consultation with the relevant cabinet member decided to make further restrictions on the sorts of investments that would be made, even if those were not officially reported and recorded. That is based on market information. I think those authorities which have probably got into some difficulty are those which have treated treasury management as either routine or mundane, have set a policy, have said, "We have not had any problems with this, we can carry on year to year". If you read the audit report on the Audit Commission's own failures in this matter, I think it describes their policy towards it as routine and mundane. Q13 Mr Hands: Can I ask you, one of the most important things in all this is actually the reporting lines from council officers to members. One of the problems of the annual Treasury Management Strategy, as rubber stamped by the annual council meeting, is that is pretty much the only time when treasury management comes before councillors. How much work have you done on looking at what reporting line there is, what needs to be reported to either cabinet members or to the council as a whole? Let us say, for example, if the council were to radically or even marginally change its debt or investment portfolio, because with my local authority I discovered that with the annual report filed and then the annual council meeting to approve it you could have a lag of anything up to 18 months before substantial changes in the debt or investment portfolio came before elected members, and I do not think that is unusual. How much work have you done seeing what needs to be reported to elected members? Mr Knight: The strategy and policy should be reasonably comprehensive and set down the set of investment parameters and criteria that are going to be used. What I have found both by internet search and as well as the survey is that there is very little evidence of the scrutiny or challenge of those officer recommendations going beyond a debate in the committee and asking officers. I have not been able to find a single authority, for instance, where the treasury management advisers were brought before the committee to give advice and to be challenged. Even in those authorities which said, "We had quite a lot of challenge in our committee on those issues", whether it be the audit committee or the cabinet, they actually had not gone beyond the officer report and the questioning of officers and that is why Ian Fifield and I for the Centre for Public Scrutiny wrote this report published last December which is basically a guide to how treasury management is and how you can set about an overview. Q14 Mr Hands: This is not a criticism because I am not sure anybody has done it, but it sounds like nobody has looked at the specific side of the reporting lines and how quickly things have to be reported if the officers decide to change essentially within the guidelines, within the remit of the annually agreed policy, but nevertheless they can make a substantial change to the portfolio without needing to report it. It sounds like there has not been any work done on that. Mr Knight: I do not have any evidence on how often that was done. I do know in a number of authorities, in the light of changing market information, officers decided to make more restrictive criteria for the decisions they were going to make for the future than was officially laid down in the council's policy, and usually had discussed that with the cabinet member. Q15 Chair: Can I intervene on the question you were asking for clarity. Is it within an individual council's remit to decide on the frequency with which these matters should be reported and what is delegated to officers to do without reporting or is it laid down somewhere in central guidance? Mr Knight: The statutory requirement is that every council needs to formally approve its strategy and policy and performance on an annual basis, but it is entirely within an authority's discretion to review that as often as it likes. Q16 Mr Hands: If I can interject there, Chairman, in my authority - this is going back a few years so it may have changed - basically the authority could switch, in this case the debt portfolio, anything up to a third of the debt portfolio between fixed and variable, without needing to report it for a period of up to 18 months to members, and I do not think that was unusual. Can I ask a further question about the recruitment of external advisers. How, in your experience, do councils go about (a) the decision to have an external adviser and (b) the decision as to which one to go for? Mr Knight: I think the use of the word "adviser" is an interesting one at the moment because all of them have historically called themselves treasury management advisers but if you look on their websites at the moment you will find the words "advice" and "adviser" are rapidly disappearing as they describe their role as providers of specialist information, and that is something you may wish to take up with those who describe themselves as treasury management advisers in due course. The second thing is I think most local authorities would routinely, and how often they would do this would be a matter for them, put their treasury management advice role and responsibility out to tender, either formal tender process or negotiated tendering processes. The exact relationship between each council and its treasury management adviser, of course, will be down to what is specified in the contract and that is going to be a fairly big issue on the agenda between local authorities and advisers in due course if some of the funds at risk are not returned. Q17 Mr Hands: But is it essentially a senior officer decision to (a) go for an adviser and (b) which one to choose subject to final approval by a Cabinet member? Mr Knight: I think in most authorities that decision will have been delegated to the section 151 officer in consultation with the Cabinet member responsible. Q18 Mr Betts: On the issue of scrutiny and the previous question, you are describing the budget process and I think probably local authorities have not changed that much in the last few years since I was on one with you, but the reality surely is that councillors will tend to focus on the level of council tax and the effect on some front line services, quite reasonably, and if there is a report about treasury management it may be in some annexe to budget papers and may or may not attract a bit of discussion and probably very little real, detailed scrutiny. I was wondering whether, in the light of the document you have provided to us on treasury assets and the advice here about how to go about scrutinising these matters, it might be appropriate in the CIPFA guidance, which authorities work to, to have a requirement that every year there should be a scrutiny hearing by the council into the treasury management report so it gets proper, detailed consideration by elected members and not the maybe very vague few comments which pass at budget time? Mr Knight: Could I say a couple of things? I have only found one authority where they
have admitted that members initially pressured officers to take a more risky
investment strategy in the light of the performance which other local
authorities were approving, but interestingly that was one which resiled from
the position quite early in 2007 because market intelligence suggested things
were getting difficult. Similarly, I
have only found one authority where an elected member has actually led a
narrowing of the investment strategy. I
will name it, it is Q19 Sir Paul Beresford: The advantage of the executive member system is that you can have a member officer report quite simply and quite quickly, the disadvantage of it in the committee system is that you would not have the normal audit panel which most local authorities used to have which looked at it. Am I right? Mr Knight: I think authorities have far more flexibility than they think and choose to use and which they pretend often to members and the outside world they have. I think they could be a lot quicker on the ground than is suggested. Q20 Anne Main: Speaking as the Member for St Albans, I was interested to hear you mention the fact that this was the one person who had chosen to narrow the remit. That suggests to me that there is a very diverse approach to this and there is no one way which seems to be the right way. What would you say could be done to improve matters then? Is there any way of having a sort of template which you would suggest local authorities follow? Mr Knight: I do not think the issue is about templates. I think the real issue is about information and how you handle it and market intelligence. What is clear to me is that overwhelmingly the authorities which have funds at risk are those which are least likely to have acted on the wider market information that has been available for some time. Some of them will say, "Well, we made a deposit 18 months ago when there was very little market information, that was made for 2 years and therefore our funds are at risk". I do not think that is satisfactory for authorities which were still making investments in September of last year when the market intelligence had been around for considerably longer. Q21 Anne Main: I do not think the reactiveness of that person you described, the former banker who sits and reads the paper every day, is something you would expect of many other authorities. Mr Knight: No, not at a member level, but I would expect it at a treasury management specialist officer level. Q22 Anne Main: So that is where you see there is a gap? Mr Knight: Yes. 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 rating agencies, and some information to us is that some of the "advisers" who have been external advisers to authorities have done little more than pass credit rating agency rating information on 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: I do not think your Committee is going to be doing an investigation into the global banking crisis, but it is clear that the credit rating agencies themselves were well behind the game of understanding the risks which were being taken by the banks and some of their securitisation and CGO processes. Undoubtedly the case of litigation will be going on between those banks and their investors and the CRAs for some time to come. You do have to have some reliance, it seems to me, on specialist information. That is one of the basic nuts and bolts of this process and the credit rating agencies are a fundamental part of it. 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 may be unfair but I will do it - if you looked at, say, Kent, it was relying on information only from one CRA, whereas if you look at Essex, which does not have any funds at risk, it was very clear about having information from three credit rating agencies and only relying on the lowest or worst scenario position from each of those agencies when taking information into account in terms of the way it moved forward. Of course, the other thing you have to be aware of is that the credit rating itself is commissioned by the financial institution which is wanting to put this thing into the market, so that leaves you with another area of risk. Q24 Mr Betts: There is one suggestion therefore that there might be some public body set up, or some existing public body, such as the Public Works Loans Board, given a role to help local authorities, probably particularly smaller local authorities who are going to have to go outside for specialist advice, and that they may be able to offer if you like more independent information sources? Have you explored that at all? Mr Knight: I think there is a separate way of doing it, which is to say that most authorities rely - and it appears the treasury management advisers relied - only on the published credit ratings and warnings or otherwise which may be given with them, whereas there is a clear facility for both councils or the Public Works Loans Board or the Government direct or treasury management advisers to commission interactive ratings which is more detailed information about the specific investment they are doing. I am surprised at the lack of information about authorities who were making significant investments in areas where the market was becoming riskier and not having commissioned interactive ratings. Q25 Mr Betts: Do we know the authorities who have done that? Mr Knight: I have not identified any yet but I have been concentrating on the member end of it rather than the authority end of it. Q26 Andrew George: Is there not a role here then for central government to take control? Or not so much take control but certainly start constraining the extent to which local authorities can actually make mistakes and take risks? In other words, the reintroduction of lists of approved investments and that kind of thing? Mr Knight: I think the legislative framework and the CIPFA code of guidance relating to treasury management is basically okay. What it does require them to do is not to simply treat it as a mundane, ritual thing but to treat the market as a live issue which is changing. I think it is entirely possible for authorities to work together to commission further intelligence and information as is necessary. They are often reluctant to work together, I have to say. Q27 Andrew George: Obviously there is a lot of repetitive work in terms of reinforcing the same advice or seeking the same advice independently; each local authority doing the same work very expensively. Would it not be better if central governments saved them a lot of that task and offered the advice to them and then gave them, if you like, parameters within which the chance of error was narrowed down for them? Mr Knight: I would put it this way, if an authority has got £50 or £100 million it needs to invest, then I would be looking to work with others in a similar position to commission that work and information myself rather than relying on the Government to do it. I think it would be strange, at a time when local authorities are arguing for more local discretion, to in effect nationalise this process. Q28 Andrew George: Is there not a role for government perhaps in introducing mandatory training or establishing other methods by which one might argue the mistakes - although we have not come to any conclusions ourselves - or the errors which have been made in the past could be avoided through such measures? Mr Knight: I would be reluctant to recommend anything additional in legislation. I think the important thing is to say that the code of conduct and guide should be updated more regularly and could take account of some recommendations about the capacity of the officer end of this process in terms of specialist staff and understanding treasury management and also potentially skills and training for elected members. Q29 Andrew George: On the role of local authorities in this regard, given all their expertise, have you come to any kind of assessment? What is the minimum requirement of a local authority in terms of staff hours or the staffing available in order to be able to fulfil all its functions? Mr Knight: No. It is simply not an area I have been exploring. Q30 Chair: Is there anything else you wanted to say before we finish and move on to CIPFA? Mr Knight: Interestingly, I have been getting some responses back from authorities which do have funds at risk. Some of them have been saying, "Look, we have been really successful in our historic performance. Our funds have been doing really well in returns. Why should we have been changing our strategy?" In a sense, I have to say to them that historic performance is no predictor of future performance and that relying on a single indicator like, "We have the best percentage return on our funds" is not a very good policy. My analogy, having worked on, say, health performance indicators, would be looking at something as a single indicator like a short waiting time to see a consultant. Lots of people think a short waiting time to see a consultant is a very good thing. It could be a very good indicator of that consultant's performance and management of their team. It could also be because the other GPs are saying, "I would not recommend somebody to go there". Relying on a single indicator like historic performance is a very poor thing to do. Just as you would want to ask questions about funds which are consistently making returns above the market level, I think it is exactly the same for authorities. If your funds are doing really well, excellent, but now is the time to start thinking about whether, in the light of market changes, you need to change your investment strategy for the future. Chair: Thank you very much. As the rest of the returns come in from local authorities, if you could make sure that that detailed information is provided to the Committee it would be very helpful. Memorandum submitted by CIPFA Examination of Witnesses
Witnesses: Mr Steve Freer, Chief Executive,
CIPFA, and Mr Chris Bilsland, the Chamberlain of the City of Q31 Chair: You have obviously been listening to the first part of the evidence so I suppose the obvious thing to ask you first is about the CIPFA codes of practice, what the CIPFA codes of practice are intended to deliver and whether you feel that there is a need to update them in the light of recent events. Mr Freer: Self-evidently, the codes of practice are designed to try to deliver high quality treasury management across the sector in all local authorities. In particular in relation to that, the codes of practice try to ensure that treasury management is the subject of an effective governance arrangement that recognises we are dealing with organisations that have elected members as well as officers. There are some important provisions in the code in that respect. Also, the code majors on ensuring that careful risk management is at the centre of authorities' work on treasury management and in particular that security and liquidity considerations are at the forefront of the treasury management work and the treasury management decision making of authorities. Q32 Chair: In the light of the fact that a number of local authorities have apparently lost great sums of money in the Icelandic banks, do you regard that as demonstrating that the code itself is not adequate or is it just an unfortunate side effect of councils investing that you win a few and lose a few? Mr Freer: It goes without saying that
we accept there is a need to review the code at regular intervals, irrespective
of whether things appear to be going well or badly. That is just part of the discipline of having
an effective code of practice. In the
light of the events in relation to Q33 Chair: Does that mean that those authorities which lost money were abiding fully by the code? Mr Freer: That is one of the things we do not know. That is a key part of the work that the Audit Commission is currently undertaking. This is not something to make a cavalier, general statement about. It is something that needs to be looked at in each individual authority. Frankly, it is easy to rehearse that in some authorities they will have money in Iceland and have money at risk, despite the fact that they have operated within the terms of their treasury management strategy and equally it is conceivable in some cases that there may be difficulties because the practice has not been consistent with the authorities' treasury management strategy. Q34 Sir Paul Beresford: Does it add extra interest to the Audit Commission report that they were investing in Icelandic banks themselves? Mr Freer: That is a slight embarrassment for the Audit Commission but I am sure that will not influence the rigour and the thoroughness of the review that they are undertaking. Q35 Mr Hands: I am particularly interested in the decision making process and the reporting lines, especially between officers and members. It is not only on the counterparty risk in terms of change in counterparty structure, setup or moving counterparties around and how that decision is made and reported, but also an overall view on interest rates that might be reflected. If you took a scenario through 2007 and the early part of 2008 when presumably quite a few of these treasury management advisers were advising that interest rates were likely to be rising on the back of inflation expectation, rising commodity prices and so on, if a lot of treasurers took the view, "Yes, we agree with that treasury advice we are getting" and decided therefore to borrow a lot more fixed rate funds and at the same time invest rather a lot more variable rate funds, they would all be looking a little bit in difficulty today. When would members know about that? When should members know about (a) the decision being made and (b) if it is the wrong decision and essentially the wrong view? In my view, local authorities should not be taking views on interest rates anyway but if the wrong view is taken, when do members find out about it? How much work have you done on the process of (a) how the decision is made and (b) how it is reported to members? Mr Freer: The prudential code which is the over-arching code here formally requires two reporting points in the year to the full council, the reporting of the strategy and an annual report at the end of the year. The first clause of that requirement in the prudential code is as a minimum requirement. The expectation and I think also the practice in most authorities is more frequent reporting, not necessarily to the full council but in many cases to the executive and, if not to the executive, certainly there ought to be more regular dialogue with the cabinet member responsible. Q36 Mr Hands: We agree that other authorities may well operate beyond the minimum. From what I saw they did not. You still have a situation whereby the authority agrees the strategy and, within the parameters of the strategy, you could still have a very substantial change in your portfolio. You could make that decision the very next day after the strategy has been agreed by the full council and then, for the rest of the year, the remaining 364 days, you would not have to report anything to members until it came to the end of the year review of that strategy. If you just took the last 364 days, 364 days is a terribly long time in this world. It probably should not be more than 3.6 days. That also goes for counterparties, not just interest rates. What is CIPFA doing to try to make sure that the decisions are properly made with members being involved and understanding the risks, first of all, and secondly, if that decision has been made, that the consequent effect on the overall portfolio is reported to members? Is that something you are still working on? Mr Bilsland: We are still looking at that. I think you are right. Technically, it is possible that a whole year could go by without this issue appearing in front of members. Bear in mind that this is not the only issue which has to be reported to the full council. Absolutely everything a local authority does - treasury management, investment management - is so important as a single issue. How often that comes back to members depends entirely on the amount of discretions in the strategy. Any decisions that are taken within delegated powers need not come back. Any decisions taken which require a variation in the strategy would have to come back before the decision was taken, although in many modern authorities the executive member will have delegated authority to make that decision on the spot rather than waiting. You are really going to see reports coming back once a year if everything is in compliance with what was agreed at the beginning of the year or instantly if there is a need to change things. In the middle there will be a scrutiny process and a scrutiny committee can call these decisions in at any point in time. In a good authority, opposition members with a portfolio brief will be checking out what is going on and also in the middle is the audit. This is a high area for internal audit. You mentioned about authorities borrowing and lending which is technically illegal. This is high risk. They look at the treasury management strategy. They look at compliance. It is almost certainly going to be picked up as part of the audit half way through the year as well.. Q37 Mr Hands: Even if the authority were to do something that was within the strategy - in the particular case I saw it could move a third of its debt portfolio from fixed to variable or vice versa - it would not need to report that because it is still within the agreed strategy. How does the scrutiny committee even know that such an event has happened if it is within the strategy? Mr Bilsland: It depends on the practice of the authority but best practice is that all material decisions made by either officers or members under delegated powers are recorded and available for inspection by all members to allow scrutiny to perform. How well or badly that works depends on the individual authority. Q38 Anne Main: How well or badly that works is crucial. When there have been some bad headlines about councils having money tied up in Iceland I will say, rather than lost, because it may well not be lost, it will be the members who will say, "Why did this happen?" Are you convinced though that there is enough expertise, training and knowledge amongst members to scrutinise this or is it just that, yes, we have heard it; yes, we have agreed it, which is a rubber stamping system? Nobody is really understanding it because when you are elected as a councillor you do not have to write yourself a CV of any financial management which the electorate elects you on. You could have a large body of people on particular councils with no real expertise to actively scrutinise in the way that you say can happen in theory. Maybe they go into those meetings but it may not be happening in practice at all. Mr Bilsland: The general point is that this is a very specialist, complex area. There will be very few members who have the expert knowledge needed to challenge the detail. On the specific issue of Icelandic banks, it should be within familiar territory for most members to understand credit ratings because basically banks are divided into two grades: investment grade and speculative grade. If your strategy is that of, I would imagine, every local authority in the land, you only deposit money with highly rated banks in investment grade. That is a bit like at home, is it not, when you decide where you are going to put your money? Q39 Anne Main: As we heard from our previous expert witness, it depends on how many credit ratings you look at. If you look at one, you get a very selective view. If you have a compilation of these ratings, you may be able to come up with taking the lowest on each one. Again, it is open to not being interpreted in the same way and figures could be interpreted differently, depending on whether you have more information to surround them or not. Mr Bilsland: The Local Government Association did a time line of how the credit ratings move between the three major credit rating agencies. Although at any point in time there might have been a slight difference, they were all consistently the same as they consistently downgraded the Icelandic banks. The issue for me and perhaps for the Committee is that credit ratings are always of course in arrears. Q40 Anne Main: The public out there are going to want to know, if all those ratings were available to councils, how did this happen. Mr Bilsland: Because those credit ratings were at all times showing those Icelandic banks to be of investment grade. Mr Hands: I am still disturbed by the reporting line and the decision making process, but that is for later in our inquiry. Q41 Sir Paul Beresford: Does CIPFA or anybody run courses for members in this area? Mr Freer: Yes, we do. A number of members attend our courses. I said in my first answer that we try to put an emphasis on good governance in the style of the treasury management code. We do recognise this is an area of ongoing challenge and this is something that we will come back to when we do our substantive review in a few months' time. For me, the challenge is about working out a good procedure, to give assurance on how frequently a departure from the strategy or a significant move within the strategy will be reported and so on, the point that Mr Hands has raised. Also, there is the challenge about how we get confident engagement from members in this area. Inevitably, most members start from a pretty low base. Training courses may well be part of the solution to that. CIPFA provides some and I think some of the treasury advisers provide them as part of this service to clients as well. Also, we have to encourage members to role their sleeves up and pitch in. Even if they do not feel they are competent to carry out the five star scrutiny exercise in this area at the moment, let us start with a two star attempt. Let us recognise that we are working on a learning curve here, building member knowledge and confidence. Q42 Chair: I do not think people generally do get elected to a council in order to become a huge financial expert. If it is not reasonable to expect them to have the knowledge to be able to challenge the professional staff who should be properly qualified to do it, is there any scope in the CIPFA advice for the suggestion of bringing in an external expert to a scrutiny committee? The FE college where I am on the audit committee has people who are not on the board on the audit committee in order to bring in the additional expertise. Mr Freer: There is the facility for authorities to do that and I think some authorities do bring that kind of expertise in. Q43 Chair: It would be helpful to know of any authorities which do. If you cannot tell me now, perhaps you could tell the Committee later. That would be very useful. Mr Freer: Whether they have done that specifically in the treasury management area I do not know but certainly as a general approach to good scrutiny that approach is taken. Q44 Mr Betts: Authorities can do that. Is there any way in which you ought to be revising your guidance to encourage them to do that, to give a bit more guidance about how to do scrutiny properly on what, I accept, is a very technical and quite complicated area, where most members are probably saying, "We would rather not be involved in that; let us go on to something more interesting"? Mr Freer: That is a good point and certainly one we should consider. Q45 Mr Betts: If we were briefly characterising what the guidance says, it says to local authorities, "Rely on credit rating agencies, even though we know they are only going to tell you the bad news once it happens." Mr Bilsland: The ODPM guidance is specifically to use credit ratings but not to rely on them entirely. That is why we are where we are. If all you did was rely on credit ratings, you would be at real risk because credit ratings are historical. Q46 Mr Betts: Many councils might say, "We are told in the public guidance credit ratings are everything. We are not really told we have to do anything else." An authority can have no specialist officers, rely on external advisers and those advisers might simply give information about credit ratings. How is that of any real help? They are complying with the guidance but the guidance is not really any use in that sense, is it? Mr Bilsland: The guidance first of all says look at credit ratings but do not rely entirely on credit ratings. For years that has been good enough. Q47 Chair: BCCI was not exactly good enough, was it? Mr Bilsland: BCCI is interesting because BCCI was on a Bank of England list of approved banks to place deposits with. Those authorities who put money in BCCI claimed that one of the reasons they put it there was simply because it was on that list. The list has disappeared and we have a whole new system in place for localised decision making and instead we use credit ratings. Q48 Chair: What that demonstrates is that councils were looking at the credit ratings and not doing the other bit which is, "Do not rely on them entirely". Mr Bilsland: Until this year the chance of an investment grade bank defaulting was not on anybody's radar screen at all. I do not think the Committee should be surprised if it finds out that, in a lot of local authorities, once they were comfortable that a bank's credit rating put it at investment grade, as long as there was not anything that they picked up from the newspapers or which came to their attention, it was probably safe to deposit money there. With the Icelandic banks, it was not in the public domain that there were serious problems to do with their position. It was not well known right until the very end. Q49 Sir Paul Beresford: Would you not say that BCCI proves the point you have just been making? Very few local authorities took heed of the fact that BCCI was on that list. They did their own assessment and got out or did not get in. Very few got caught with BCCI. Mr Freer: The important point to emphasise is the whole structure and framework that we are now operating post-BCCI. In many ways its origins lie in the difficulties of BCCI. Those were the days of approved lists. BCCI was on the list and therefore people put money into it. The other great lesson of BCCI was that some authorities were not disbursing their risk across a number of institutions. One or two organisations were famously caught out having all of their money in that one pot. I hope the Committee will see copies of the code. Even though it may sound like less than interesting weekend reading, the code is very brief and I think very distinctive in its approach and its emphasis on all of the risks that are associated with this area and its prioritisation of the risks on security and liquidity. If you read the code, you will see that speaks it very loudly. The position on ratings agencies comes from the 2004 guidance from what was then ODPM and is now DCLG. It does not encourage people only to look at the ratings and place complete reliance on them. On the contrary. It emphases the need to take the information into account but also have regard to any other information. The challenges for authorities are what can be done in that second space. What other information can they gain access to? Obviously there is the information that comes from their advisers. Another important source is the information that comes from brokers who are out there, on the front line every day, doing deals and therefore often well informed about what is happening and what is being said in the market; as well as the press too. The best authorities are having regard to all of those sources. I am sure not all authorities are as well positioned in those respects. Q50 Mr Betts: The problem for authorities surely is that the guidance does encourage them to use credit rating agencies even though you have just told us now that all they do is effectively give an historic view of what has happened rather than a prediction about the future. That is worthless, is it not? It does not take a great financial arrangement and all these agencies being paid lots of money to produce these figures to say that the bank has gone bust when it has gone bust. Mr Freer: I would say it is not useless. Q51 Mr Betts: It has not been very useful. Mr Freer: It sometimes does not tell you the right answer. That is evident. Perhaps the other important thing here is that all of this is clearly the province of the FSA and the FSA is already on public record ---- Q52 Mr Betts: Let us look at what local authorities have been advised. They are told, "Use credit rating agencies" - we now have severe doubts about how much use they are but you say they are of some use - but then not to rely on them completely. There is not any clear advice in the guidance, is there, about what other advice local authorities should be taking on board? Mr Bilsland: That is a fair point. The advice does not then go on to say, "This is the kind of thing you ought to be doing." That is absolutely right and that is something we have picked up as we have been looking back into why it was a surprise that people found that they even had money with Icelandic banks, let alone that they had lost money there. Q53 Mr Betts: Is this an area that you want to look at? Mr Bilsland: Yes. Q54 Mr Betts: Is looking at what Howard Knight said previously about authorities commissioning their own particular research into institutions and maybe doing it on a collective basis something you are going to do as well? Mr Freer: I think potentially that is worth looking at, yes. Q55 Mr Betts: When you are having a look at the role of advisers or providers of information as we might call them, sometimes passing on no more than the recommendations from the credit rating agency, would you want to give any guidance to authorities or think about including in your guidance whether an authority ought to be careful about taking on board advice from an organisation when another part of the same organisation is being paid commission to invest in some of the institutions it is giving advice about? Mr Freer: One of the areas where potentially we could make a contribution is looking at the relationship between the client and its adviser and what the contract between those two parties stipulates. Clearly, if you have thought about that deeply - and it is not an area that CIPFA has been active in previously - one of the things that we would be looking to ensure is that the advice that you were receiving from an independent adviser was suitably independent. I do not want to give the impression that there is an easy goal for us to score in that area or that we start exploring that area on the basis that we think treasury advisers are giving anything other than their best information to their clients. Q56 Mr Betts: You would not have any concerns as a professional accountant about a conflict of interest of one part of an organisation giving advice and another part of the same organisation taking commissions for potentially an authority acting on that advice? Mr Freer: If it was as clear as that, I would have some concerns. Therefore, this is an area worth approaching but my instinct would be to approach it on a more general basis, looking at that point but trying to test out if we have the right agreement there and the right conditions to ensure that the advice given to the authority is suitably independent. Q57 Chair: Could I ask about CIPFA being ahead of the game as well? It was exactly an organisation which had this apparent conflict of interest that was advising well over 50 local authorities. Should CIPFA not have been aware of this potential conflict and ought you not to have been advising authorities that this was maybe slightly dodgy? Mr Freer: We are not the market regulator. Q58 Chair: I understand that. Mr Freer: I think that is an issue for the regulator of the market. That would be my first instinct. Chair: You are a body that tries to provide advice and guidance to local authority finance people. Sir Paul Beresford: And you are providing courses. Q59 Chair: Indeed. This would seem to be an area that you might have been providing authority and guidance on. I accept you are not the regulator. Mr Freer: I stress that if we saw something in our view that was glaringly wrong, then I am sure we would find a way of expressing it, but it is not our responsibility to regulate the market and oversee the market in that way. Frankly, if there was something as glaring as you are suggesting, I would expect the regulator to know about it and take action on it ahead of merely an interested party like CIPFA. Q60 Mr Hands: I am going to come slightly to your defence here. I think there has been a lot of misunderstanding in Parliament about the role of credit rating agencies. Essentially, I am sure your members are viewing credit rating agencies as providing an assessment of a relative creditworthiness so that a triple A credit rating is viewed to be more creditworthy than a double A, but it does not mean to say that a triple A credit rating cannot go bust or indeed a double A. That is the right way to view credit rating. In my view, that is likely to be far more independent than listening to the advice of a broker. Let us face it: if you are the treasury manager running the borough of Worthing portfolio, you are likely to be a much smaller client of that broker than the person on the other side who could be a large bank. The broker is most unlikely to tell the local authority if he or she thinks there is some problem with the bank. The credit rating agency is ironically more likely to give an independent view of that bank than the broker is. I think you hinted at the importance of diversification. The difference between what happened with BCCI and some of the Icelandic banks is that, thanks to diversification, no local authority took an absolutely crippling hit, although some have taken very large hits; whereas with BCCI and the Western Isles which did not diversify but put all of its money into BCCI one or two local authorities took a big hit but the others were not affected. I think diversification is a good thing but should we also not be looking at the traditional country risk when local authorities approach their investments? You cannot just say, "We want to have a certain amount of triple A and a certain amount of double A." You also have to cross over that how much money they have invested with banks or institutions from a particular sovereign banker. Obviously in Iceland and what happened with those banks, it was no coincidence that the three major Icelandic banks all went under at the same time. Should there not be greater stress on local authorities (a) diversifying their investments but (b) also diversifying the sovereign nature of those investments as well? What has CIPFA done on that? Mr Freer: I think we see that as potentially one of the big learning points from this most recent experience and almost certainly something we will address in our next revision of the code and guidance. Now that it has become so apparent, it is an obvious area for us to try to encourage authorities to take into consideration. Q61 Mr Hands: Should that be something that authorities have in their treasury management document agreed each year, to have country risk limits as well as individual risk limits on particular banks? Mr Bilsland: It is quite common that local
authorities will apply different credit rating requirements on foreign owned
banks. In other words, they may well
apply a higher credit rating on a foreign owned bank than a Q62 Mr Hands: Why is that? Mr Bilsland: Simply because instinct is
that with a Q63 Mr Hands: They are treating the foreign equivalent as being lower than a domestic so if it is a double A bank the foreign one will take a double A minus for our purposes. Mr Bilsland: It is not or should not be unusual to see that. Q64 Andrew George: It strikes me that your evidence seems to suggest that you are rather sanguine about the role of local authorities. You tell us that the treasury management is based on sound principles and that the governance arrangements are fine. There is no need for any further regulatory control and the job is not risk free and therefore problems will arise from time to time. You see that there is not really very significant room for improvement here? Mr Freer: What we have been trying to say is that we think the code is fundamentally sound. I said earlier I hoped that at some stage in your deliberations you would look at the code and form your own views on that. It is very clear in the code that it tries to get this linked to elected members and establish that strongly and clearly. It does encourage very comprehensive risk management work in this area. That is not the same as saying that we think everything has gone brilliantly. All these funds are at risk in the banks that have failed. In some cases, I think it is possible to rehearse scenarios that say that could have happened despite people observing their strategies and also taking very sound and appropriate decisions. In other cases - I am speaking now about individual cases - when all this is washed up we probably will find that some authorities may have taken decisions that fall outside of their strategy or are simply poor decisions. It is likely that there will be some of those. I do think there is a danger for all of us in this that we exercise 20/20 hindsight on a wonderful scale. It is not surprising that, in the context of the global banking crisis, some of the difficulties that flow from those unprecedented conditions have washed back into local authority finance. I do think it is important that, although we are suitably critical where people have not followed proper procedures or made good decisions, we avoid sweeping, generalised criticisms when in fact a lot of the practice in this area is very good practice and is certainly in a different league than we were in during the days of BCCI. Q65 Andrew George: You are kind of repeating what you say in the evidence. Either there is fraud or incompetence or there is lack of capacity within the finance departments. I do not think it is the first. Are there answers which you think arise from the evidence, which is that there need to be more peer reviews or there is an issue of the economies of scale and maybe some of these departments are struggling to fulfil all of their functions within the limited, professional staff available within their departments? Have you not been able to identify anything where there is fault? Mr Freer: It is wrong to characterise the staff who carry out this work generally as being all generalist or inappropriately trained or people who do not really understand what they are doing. Certainly in the vast majority of authorities that I am familiar with and have worked in, it is a specialist function within the finance department but in many of the authorities that I have worked in and been associated with over the years the expertise of the staff in this area is very impressive. That is not the same as saying that is the case in every single local authority in the land. Mr Bilsland: What is interesting is that
so many local authorities have exposure to Icelandic banks ranging from the
very large to the very small, including some authorities with excellent,
outstanding reputations in financial management. It looks very odd at first sight to find any
single, common factor that has caused those local authorities all to be exposed
to Q66 Mr Betts: Looking at the authorities who got involved, is there any evidence of any difference in performance between authorities which used their own specialist, in-house advice and those which brought in external advice? Mr Freer: We do not know the answer at the moment. That is one of the things we are hoping might come through the Audit Commission work which is this detailed scrutiny at individual authority level about the decision making, whether it was within strategy or outside strategy or based on advice, or whether there were no advisers. Since the Commission is doing that, we are not trying to replicate it. Q67 Mr Betts: Do you think there is a role for some form of external body to either lay down a level of risk which authorities should not go beyond or to offer maybe some more specialist advice within the public sector, something like the Public Works Loans Board, where particularly smaller authorities could go to get that reinforcement rather than just having to rely on the credit rating agencies? Mr Bilsland: I do not think it would be better if we had central direction and central prescription which said, "This is the level of risk to take, no more and no less." These decisions are usually best taken as locally as possible. That is not to say there is not a gap. You mentioned the smaller local authorities, the ones who are more occasional players in this area. How can we make sure they have the same expert skills and intelligence as the bigger operators? There is certainly a learning point here. There is a gap between the skills of different local authorities, not unnaturally, and something needs to be done to level that gap. Q68 Mr Betts: What might that something be? Have you any ideas, even if you have not fully worked up a model at this stage? Mr Bilsland: In a way, CIPFA helps plug the gap because we provide the same advice and information support service to every chief financial officer wherever they operate. There is a need for more local authorities probably to work together and to share what they are doing with each other and to buy in perhaps to the skills which are freely available locally from bigger local authorities. Q69 Chair: I think you were both coming round to saying essentially that it was inevitable that some people would have money in the Icelandic Bank because nobody could have foreseen that it would go bust. Therefore, it is just a win some/lose some routine, in which case, Mr Bilsland, I understand you are involved with the City of London Council. Your council did not have any money in Iceland at all. Is that just fortuitous or did you decide it was not a good place to put money? Mr Bilsland: We did not discriminate particularly against Icelandic banks. We operated a top credit rating and the Icelandic banks never quite scored that top credit rating, so they never appeared on our lending list. Q70 Chair: If everybody else had followed your policies, there would not have been a problem. Mr Bilsland: Yes, but we had investments with a bank which was risky, so I do not think any local authority can eliminate all the risk entirely. One police authority treasurer was telling me the other day they cannot even leave their money in their own bank because that is not on their lending list either. These are strange times. Mr Betts: They probably read the financial press for a few months before the Icelandic banks went bust. Chair: Thank you both very much. |