15 October 2009
By Tash Shifrin
The collapse of Iceland’s banks forced a rethink of local authority investment strategies. A year on, many councils are putting safety before returns, others are still skating on the edge and regulators are busy revising the rules. Tash Shifrin reports
The epicentre of the earthquake seemed a long way from the town hall when the financial crisis sent out its first shockwaves last autumn. The crash that sent Lehman Brothers out of business even provoked a brief moment of almost smug satisfaction in the often beleaguered public sector: here was a disaster that smacked of private sector greed.
But by the time Chancellor Alistair Darling got up to announce his £500bn bail-out of the UK’s banks on October 8, 2008, the tremors had also hit little volcanic Iceland – a country with a population about the size of the London Borough of Barnet but with far more dramatic scenery. Those bleak crags, glaciers and geysers turned out not to be Iceland’s only dramatic features.
In the Commons, questions from Liberal Democrat Treasury spokesman Vince Cable revealed that the geological rumblings, magnified by Iceland’s implosion, had reached the UK’s town halls. Local authorities, it emerged, had invested a total of almost £1bn of council cash in Iceland’s banks. Their once-liquid assets had been frozen solid.
A year later, Iceland is still in the news, with Sigurdur Einarsson, former executive chair of the failed Kaupthing bank, under investigation for fraud. In the UK, council treasury management practice is blanketed with a thick covering of caution. And a policy area not previously a hot topic outside of town hall finance departments has come under the spotlight as never before.
The Icelandic saga prompted investigations into local authority investment by the Audit Commission and the Commons communities and local government select committee, while CIPFA launched a consultation on revisions to its treasury management code.
The Audit Commission’s report, Risk and return, found that the majority of councils acted properly in managing their investments and were alert to the risks involved. But its message was somewhat lost behind the headline-grabbing move to name seven authorities as ‘negligent’. The watchdog has since been forced to withdraw that tag, following moves towards legal action by Kent County Council and the London Borough of Havering – both firmly denying the allegation.
More sweeping criticisms were made by the Commons committee, which accused councils and the commission alike of ‘complacency’, noting that the watchdog had £10m of its own money locked up in Iceland. Committee chair Phyllis Starkey spoke of wider flaws in treasury management practice.
‘It’s not simply about those authorities that have invested in Icelandic banks,’ she told Public Finance when the committee’s report came out in June. ‘It reveals problems across the piece. Some other authorities also have issues to face.’
That is a message that many councils have taken to heart as they seek the best way to handle current investments that total almost £30bn. There has been a flight to safety, with a huge shift away from placing money on deposit with the banks towards the Treasury’s Debt Management Office, seen as a secure haven for council cash.
At the DMO, cash management officer David Mander describes ‘a really quite massive’ increase in use of the DMO’s debt management account deposit facility – previously ‘something of a backwater’ – which began in September 2008 as the Icelandic banks hit trouble. ‘By November, we were swamped,’ he says.
DMO figures provided for PF show use of the facility has rocketed, growing about 15-fold in a year. In the first four months of 2009/10, councils placed between £12.4bn and £15.2bn with the government deposit facility in each month. In the same months last year, total deposits ranged from £838m to £1.09bn. Mander says the surge of council deposits ‘rapidly became quite significant’ to the government’s own cash flow management.
The trend sparked by the Iceland crisis has not been short-lived, he adds. ‘At the time, our thinking was that come the new year, we’d see a drop-off... but that hasn’t really happened.’
Mark Horsfield, director of treasury management advisory firm Arlingclose, says many councils ‘have gone into lock-down mode’. Extreme caution and use of the safest haven have been their watchwords. This is understandable, Horsfield says, particularly for authorities that have had ‘an Iceland experience’.
But not all authorities have taken this stance. Some are still investing ‘quite a long way beyond what we’d recommend’, in countries or institutions that don’t enjoy the high confidence levels that Horsfield believes are consistent with ensuring safety.
The difficulty is that return on investment is an important source of income for councils – already looking ahead to the likelihood of severe public spending restraint. And the effect of loss of returns is sharp. The Local Government Association estimates that councils’ income from interest on balances will slump from a 2007/08 total of £1.81bn to just £438m in 2009/10.
This is why Horsfield believes use of the ultra-safe DMO – with interest rates of around 0.25% – is ‘not a particularly sustainable option’ for the future when there are ‘comparable counterparties paying reasonably above that’.
Starkey, who will speak at CIPFA’s treasury management conference on October 22, is likely to urge a safety-first approach. She tells PF her emphasis is on ‘the need for authorities to have proper processes to properly assess risk and strike a balance between yield and the overriding concern of safety’.
She is not unsympathetic to councils’ desire for a decent return on investment. ‘I can understand that.’ But she adds: ‘Quite honestly, in tight financial circumstances, it’s even more catastrophic if you lose some money.’
Faced with the need to marry security with a better return than that offered by the DMO, councils are looking at new ways of managing their short-term investments.
At the LGA, director of finance and performance Stephen Jones believes councils have not been using their collective weight with the finance houses as well as they might: ‘We could be a more effective client than we are.’ The LGA is investigating the possibility of councils pooling their £30bn cash in a dedicated, professionally managed, investment fund. Outside local authorities, such mutual ‘money market funds’ are popular vehicles for relatively safe short-term investment.
The idea has ‘attracted considerable interest from the fund management industry’, Jones says. He adds that a professionally managed fund could relieve the pressure on council treasury managers. ‘Part of the advantage of a properly structured money market fund... is to provide a source of capacity they might not have themselves,’ he says.
One keen advocate of the plan is Chris Leslie, director of the New Local Government Network think-tank. He has warned that with the size of the UK public debt now a hot political issue, council treasury managers should beware ‘sticky ministerial fingers’ if they leave their money looking obvious in the DMO. If the government is desperate to restore its own finances, a ‘temptation to begin sequestering or holding on to those supposedly dormant assets’ could set in.
Now, Leslie tells PF: ‘The good thing that is bubbling around... is the sense that the sector itself, being so vast, has the potential to collectively marshal its own strength in a collective fund.’
There are also possibilities for councils ‘to be sharing, pooling or bulk-purchasing their treasury management arrangements’, possibly through Multi-Area Agreements, he argues. ‘The efficiency drive pushes it in that direction as well.’
Chris Anthony, managing director of treasury management advisory firm Butlers, says local authorities have pooled their investment money before, citing three Leicestershire councils in the 1980s. ‘They had surplus capital receipts and they pooled those resources and appointed a fund manager. I was involved in the early stages.’ Some fire and police authorities have also ‘assigned’ their funds to a county council, he says.
But sharing treasury management could hit legal problems, he warns. Documents would have to be drawn up tightly to protect each authority’s interests. ‘It’s one area for exploration, but it’s a potentially cumbersome route.’
Leslie counters that ensuring that any joint arrangement meets the potentially varying needs of its constituent bodies would be ‘a real test of whether policy is actually made by the elected members’.
The role of elected members in scrutinising where investments are placed – and the risks and rewards – will be increased by CIPFA’s new treasury management code, says the institute’s assistant director for local government, Alison Scott.
The new code – to be published before the end of the year – will maintain the general principle of discretion for authorities to set their own investment policies. The ‘overall structure of the framework was sound’ before the Iceland crash, Scott says. ‘But not all authorities applied the rules consistently.’
The code will include new guidelines on the role of treasury management advisers and use of credit ratings, as well as additional safeguards to promote diversification in investments – including ‘more advice on country and sector limits’, Scott adds.
CIPFA has also launched a new qualification, jointly with the Association of Corporate Treasurers, aimed at sharing skills across the public and private sectors. Scott says: ‘The two are different – corporate treasury managers have access to a lot more instruments – but we’re very keen to get the best from both sectors.’
She notes that many councils are also ‘looking at repayment of debt associated with existing assets’. By running down their balances and reserves, authorities can pay back more debt and avoid taking new loans. The scale of the shift from borrowing is revealed in figures from the Public Works Loan Board, which show that its lending fell by more than a third from £10bn in 2007/08 to just £6.36bn last year.
Starkey’s committee backed councils seeking to reduce debt, calling on the government to ‘urgently review’ the high cost of repayments to the PWLB, caused by the gap between borrowing and repayment rates. The PWLB is now consulting on the issue – the LGA’s Stephen Jones is particularly keen to hear the detail. ‘We’d like them to be more specific,’ he says.
Jones is also pressing ministers to allow councils with funds still stuck in Iceland to raise money from their capital assets – to cover the impairment charges they will soon face. The government has so far allowed the affected authorities to defer the charges, but this has only ‘postponed the evil day’, he says.
Unless capitalisation is allowed, that money must be found from 2010/11 budgets, and this could be a problem for ‘a number of authorities’. Jones has yet to hear back from the Department for Communities and Local Government.
Meanwhile, administrators for the UK-registered Icelandic banks – Heritable and Kaupthing Singer and Friedlander – have repaid almost £70m, the LGA says, with at least £30m more expected by the end of the year. The winding up process for Iceland-registered Glitnir and Landsbanki will take longer, although both are expected to be able to fund repayments.
But despite the likelihood that the lion’s share of the Iceland cash will eventually be retrieved from the permafrost, Phyllis Starkey warns that local authorities must stay alert to risks elsewhere, amid continuing economic turbulence. ‘People can’t get in the way of thinking that the Iceland thing was some sort of one-off,’ she says.
By Tash Shifrin
The collapse of Iceland’s banks forced a rethink of local authority investment strategies. A year on, many councils are putting safety before returns, others are still skating on the edge and regulators are busy revising the rules. Tash Shifrin reports
The epicentre of the earthquake seemed a long way from the town hall when the financial crisis sent out its first shockwaves last autumn. The crash that sent Lehman Brothers out of business even provoked a brief moment of almost smug satisfaction in the often beleaguered public sector: here was a disaster that smacked of private sector greed.
But by the time Chancellor Alistair Darling got up to announce his £500bn bail-out of the UK’s banks on October 8, 2008, the tremors had also hit little volcanic Iceland – a country with a population about the size of the London Borough of Barnet but with far more dramatic scenery. Those bleak crags, glaciers and geysers turned out not to be Iceland’s only dramatic features.
In the Commons, questions from Liberal Democrat Treasury spokesman Vince Cable revealed that the geological rumblings, magnified by Iceland’s implosion, had reached the UK’s town halls. Local authorities, it emerged, had invested a total of almost £1bn of council cash in Iceland’s banks. Their once-liquid assets had been frozen solid.
A year later, Iceland is still in the news, with Sigurdur Einarsson, former executive chair of the failed Kaupthing bank, under investigation for fraud. In the UK, council treasury management practice is blanketed with a thick covering of caution. And a policy area not previously a hot topic outside of town hall finance departments has come under the spotlight as never before.
The Icelandic saga prompted investigations into local authority investment by the Audit Commission and the Commons communities and local government select committee, while CIPFA launched a consultation on revisions to its treasury management code.
The Audit Commission’s report, Risk and return, found that the majority of councils acted properly in managing their investments and were alert to the risks involved. But its message was somewhat lost behind the headline-grabbing move to name seven authorities as ‘negligent’. The watchdog has since been forced to withdraw that tag, following moves towards legal action by Kent County Council and the London Borough of Havering – both firmly denying the allegation.
More sweeping criticisms were made by the Commons committee, which accused councils and the commission alike of ‘complacency’, noting that the watchdog had £10m of its own money locked up in Iceland. Committee chair Phyllis Starkey spoke of wider flaws in treasury management practice.
‘It’s not simply about those authorities that have invested in Icelandic banks,’ she told Public Finance when the committee’s report came out in June. ‘It reveals problems across the piece. Some other authorities also have issues to face.’
That is a message that many councils have taken to heart as they seek the best way to handle current investments that total almost £30bn. There has been a flight to safety, with a huge shift away from placing money on deposit with the banks towards the Treasury’s Debt Management Office, seen as a secure haven for council cash.
At the DMO, cash management officer David Mander describes ‘a really quite massive’ increase in use of the DMO’s debt management account deposit facility – previously ‘something of a backwater’ – which began in September 2008 as the Icelandic banks hit trouble. ‘By November, we were swamped,’ he says.
DMO figures provided for PF show use of the facility has rocketed, growing about 15-fold in a year. In the first four months of 2009/10, councils placed between £12.4bn and £15.2bn with the government deposit facility in each month. In the same months last year, total deposits ranged from £838m to £1.09bn. Mander says the surge of council deposits ‘rapidly became quite significant’ to the government’s own cash flow management.
The trend sparked by the Iceland crisis has not been short-lived, he adds. ‘At the time, our thinking was that come the new year, we’d see a drop-off... but that hasn’t really happened.’
Mark Horsfield, director of treasury management advisory firm Arlingclose, says many councils ‘have gone into lock-down mode’. Extreme caution and use of the safest haven have been their watchwords. This is understandable, Horsfield says, particularly for authorities that have had ‘an Iceland experience’.
But not all authorities have taken this stance. Some are still investing ‘quite a long way beyond what we’d recommend’, in countries or institutions that don’t enjoy the high confidence levels that Horsfield believes are consistent with ensuring safety.
The difficulty is that return on investment is an important source of income for councils – already looking ahead to the likelihood of severe public spending restraint. And the effect of loss of returns is sharp. The Local Government Association estimates that councils’ income from interest on balances will slump from a 2007/08 total of £1.81bn to just £438m in 2009/10.
This is why Horsfield believes use of the ultra-safe DMO – with interest rates of around 0.25% – is ‘not a particularly sustainable option’ for the future when there are ‘comparable counterparties paying reasonably above that’.
Starkey, who will speak at CIPFA’s treasury management conference on October 22, is likely to urge a safety-first approach. She tells PF her emphasis is on ‘the need for authorities to have proper processes to properly assess risk and strike a balance between yield and the overriding concern of safety’.
She is not unsympathetic to councils’ desire for a decent return on investment. ‘I can understand that.’ But she adds: ‘Quite honestly, in tight financial circumstances, it’s even more catastrophic if you lose some money.’
Faced with the need to marry security with a better return than that offered by the DMO, councils are looking at new ways of managing their short-term investments.
At the LGA, director of finance and performance Stephen Jones believes councils have not been using their collective weight with the finance houses as well as they might: ‘We could be a more effective client than we are.’ The LGA is investigating the possibility of councils pooling their £30bn cash in a dedicated, professionally managed, investment fund. Outside local authorities, such mutual ‘money market funds’ are popular vehicles for relatively safe short-term investment.
The idea has ‘attracted considerable interest from the fund management industry’, Jones says. He adds that a professionally managed fund could relieve the pressure on council treasury managers. ‘Part of the advantage of a properly structured money market fund... is to provide a source of capacity they might not have themselves,’ he says.
One keen advocate of the plan is Chris Leslie, director of the New Local Government Network think-tank. He has warned that with the size of the UK public debt now a hot political issue, council treasury managers should beware ‘sticky ministerial fingers’ if they leave their money looking obvious in the DMO. If the government is desperate to restore its own finances, a ‘temptation to begin sequestering or holding on to those supposedly dormant assets’ could set in.
Now, Leslie tells PF: ‘The good thing that is bubbling around... is the sense that the sector itself, being so vast, has the potential to collectively marshal its own strength in a collective fund.’
There are also possibilities for councils ‘to be sharing, pooling or bulk-purchasing their treasury management arrangements’, possibly through Multi-Area Agreements, he argues. ‘The efficiency drive pushes it in that direction as well.’
Chris Anthony, managing director of treasury management advisory firm Butlers, says local authorities have pooled their investment money before, citing three Leicestershire councils in the 1980s. ‘They had surplus capital receipts and they pooled those resources and appointed a fund manager. I was involved in the early stages.’ Some fire and police authorities have also ‘assigned’ their funds to a county council, he says.
But sharing treasury management could hit legal problems, he warns. Documents would have to be drawn up tightly to protect each authority’s interests. ‘It’s one area for exploration, but it’s a potentially cumbersome route.’
Leslie counters that ensuring that any joint arrangement meets the potentially varying needs of its constituent bodies would be ‘a real test of whether policy is actually made by the elected members’.
The role of elected members in scrutinising where investments are placed – and the risks and rewards – will be increased by CIPFA’s new treasury management code, says the institute’s assistant director for local government, Alison Scott.
The new code – to be published before the end of the year – will maintain the general principle of discretion for authorities to set their own investment policies. The ‘overall structure of the framework was sound’ before the Iceland crash, Scott says. ‘But not all authorities applied the rules consistently.’
The code will include new guidelines on the role of treasury management advisers and use of credit ratings, as well as additional safeguards to promote diversification in investments – including ‘more advice on country and sector limits’, Scott adds.
CIPFA has also launched a new qualification, jointly with the Association of Corporate Treasurers, aimed at sharing skills across the public and private sectors. Scott says: ‘The two are different – corporate treasury managers have access to a lot more instruments – but we’re very keen to get the best from both sectors.’
She notes that many councils are also ‘looking at repayment of debt associated with existing assets’. By running down their balances and reserves, authorities can pay back more debt and avoid taking new loans. The scale of the shift from borrowing is revealed in figures from the Public Works Loan Board, which show that its lending fell by more than a third from £10bn in 2007/08 to just £6.36bn last year.
Starkey’s committee backed councils seeking to reduce debt, calling on the government to ‘urgently review’ the high cost of repayments to the PWLB, caused by the gap between borrowing and repayment rates. The PWLB is now consulting on the issue – the LGA’s Stephen Jones is particularly keen to hear the detail. ‘We’d like them to be more specific,’ he says.
Jones is also pressing ministers to allow councils with funds still stuck in Iceland to raise money from their capital assets – to cover the impairment charges they will soon face. The government has so far allowed the affected authorities to defer the charges, but this has only ‘postponed the evil day’, he says.
Unless capitalisation is allowed, that money must be found from 2010/11 budgets, and this could be a problem for ‘a number of authorities’. Jones has yet to hear back from the Department for Communities and Local Government.
Meanwhile, administrators for the UK-registered Icelandic banks – Heritable and Kaupthing Singer and Friedlander – have repaid almost £70m, the LGA says, with at least £30m more expected by the end of the year. The winding up process for Iceland-registered Glitnir and Landsbanki will take longer, although both are expected to be able to fund repayments.
But despite the likelihood that the lion’s share of the Iceland cash will eventually be retrieved from the permafrost, Phyllis Starkey warns that local authorities must stay alert to risks elsewhere, amid continuing economic turbulence. ‘People can’t get in the way of thinking that the Iceland thing was some sort of one-off,’ she says.
