3 Local authorities' investments and
reserves
23. Supplementary evidence from the Department for
Communities and Local Government (CLG) describes why local authorities
have reserves:
The requirement for local authorities to hold financial
reserves is acknowledged in statute. Reserves are one component
of an authority's medium-term financial planning—other components
include revenue spending plans, income forecasts, potential liabilities,
capital investment plans, borrowing and council tax levels. These
decisions are inter-linked. This means that, to ensure prudent
financial management, some authorities will need to maintain reserves
at higher levels than others.[30]
24. The main reasons for holding reserves are for
cash flow purposes, as insurance reserves and a contingency provision
against risks. CLG's supplementary evidence highlights this point:
Holding adequate reserves is important for contingency
planning, and the capacity of authorities to respond to unexpected
events—such as the 2007 flooding, and the collapse of the
Icelandic banks—without affecting their ability to deliver
key services, pay staff and meet their contractual obligations.[31]
25. Local authorities use money earned in interest
raised from these investments and reserves to help fund their
spending on services. In its written evidence, Bournemouth Borough
Council, for example, states that it has invested £80 million
and is budgeting on a return of some £4.8 million for 2008-09.[32]
It comments:
This is a significant figure in our Budget and any
reduction in the amount because of a restriction in our investment
strategy would have a major impact on our services or council
tax charge.[33]
26. This example shows the pressure that local authorities
are under to invest not only wisely and prudently, but also so
that maximum returns are achieved. It also illustrates the large
amount of money that local authorities have available for investment:
Torbay Council, for example, has "annual gross expenditure
in excess of £300 million and currently has some £90
million invested in the money market."[34]
27. When news of the potential loss of local authority
money first hit the headlines, the general public was surprised
at the large amount of money involved. According to CIPFA, in
2006-07 local authorities in Great Britain managed around £63
billion of debt and £28 billion of investments. CIPFA provided
the following table in its written evidence to show the breakdown
of local authority investments as at March 2007:
Extract from CIPFA Capital Finance and Treasury
Management Statistics 2006-07
| As at 31 March 2007 £M
| Externally Managed Funds
| Cash deposits - banks/ building societies
| Other Internally Managed Funds
| Total |
Interest Earned
|
| London |
661 | 6,255
| 66 | 6,982
| 384 |
| English Counties
| 465 | 4,891
| 129 | 5,485
| 283 |
| English Districts
| 1,437 | 3,543
| 451 | 5,431
| 288 |
| English Mets/Unitaries
| 518 | 4,139
| 401 | 5,058
| 326 |
| Wales Unitaries
| 63 | 1,121
| 12 | 1,196
| 67 |
| All England & Wales*
| 3,719 | 21,018
| 1,155 | 25,892
| 1,460 |
| Scotland
| 438 | 1,147
| 380 | 1,965
| 93 |
| Total |
4,157 | 22,165
| 1,535 | 27,857
| 1,553 |
* Includes
Joint Passenger Transport Authorities, Fire and Civil Defence
Authorities, Waste Disposal Authorities and Police Authorities[35]
28. These amounts have increased since 2006-07, according
to the Audit Commission. The Audit Commission's report Risk
and Return: English local authorities and the Icelandic banks
was published in March 2009. This report states:
- On 7 October 2008, 451 authorities
had investments of over £31 billion;
- The total of deposits far exceeded the level
of reserves, because some of the deposits included borrowed money;
- In 2008-09, interest was around £1.8 billion,
just under 2% of total income;
- In a small number of district councils, income
from interest was of the same order as income from council tax;
- Interest rates fell between October 2008 and
March 2009, putting pressure on some budgets.[36]
29. Although the 2004 investment guidance gave local
authorities greater powers to invest in alternative instruments,
CIPFA states that, as at 31 March 2008, over 90% of local authorities'
cash investments were in cash deposits with banks and building
societies.[37] Where
a local authority chooses to invest depends on its Annual Investment
Strategy. The LGA describes why local authorities might choose
different types of financial institutions in which to invest:
a) Not all financial institutions are rated by
rating agencies, smaller UK building societies are typically not
rated. Some authorities will still include these, recognising
the extent of FSA regulation of this sector, but will lend them
less money and only for shorter periods (e.g. 180 days).
b) Authorities that have larger cash holdings
will have higher amounts they will deposit with individual institutions.
c) Some authorities will have money that is not
needed in the near future, and they may decide to deposit some
of that for longer periods, meaning they may place a greater emphasis
on long as well as short-term ratings.
d) Some authorities may choose to have slightly
wider range of institutions to place deposits with, others may
choose to only list institutions that have the very highest ratings.
e) The number of institutions available is reducing
as a result of mergers and takeovers of banks.[38]
30. There is also variation in the amount of money
that individual authorities have available for investment. This
variation depends on a number of factors, including what type
of authority it is. The LGA explains in its written evidence
that unitary authorities and county councils might have large
cash holdings because "they may be holding funds on behalf
of schools or social services clients, they may be planning a
major redevelopment project and their holdings are needed to finance
that project."[39]
Contrastingly, district councils may have smaller budgets, but
with significant cash holdings because they have built up capital
receipts (usually because of the sale of housing stock) or they
have collected business rates and council tax for upper tier authorities
that they subsequently pass on in line with an agreed payment
schedule. The LGA explains that "this may mean some small
authorities may temporarily hold significant funds from major
business ratepayers in their areas—e.g. airports and power
stations."[40]
Where should local authorities
invest their money?
31. As our opening quotation states, "no treasury
management transaction is without risk and management of risks
is the key purpose of the treasury management strategy."[41]
Treasury management guidance stresses the need for local authorities
to take into account the risks surrounding security, liquidity
and yield. In order to satisfy those three requirements, giving
priority to security and liquidity, where should local authorities
invest their money? Clearly, the three criteria need to be balanced
against each other.
32. Primarily, local authorities' investments should
be secure. If security were the only consideration, local authorities
would simply look for the safest options, such as higher-rated
institutions and the Debt Management Agency Deposit Account Facility
(DMADF), which is backed by the Government. This was the approach
advocated by Arlingclose, one of four main local authority treasury
management advisers, late last year, in response to the financial
crisis. Arlingclose's written evidence argues that "it was
important that local authorities received advice and responded
to the clear emergence of a crisis rather than to carry on regardless."[42]
Mr Horsfield, Director of Arlingclose, reiterated this to us
in oral evidence:
On 29 September we issued a note saying, "Do
not invest in any banks or building societies with any of your
funds, put it in the DMADF" […] because it was that
serious at that point in time from our perspective.[43]
33. However, and notwithstanding Arlingclose's advice
at that particular time, there are other considerations which
local authorities must take into account in deciding where to
invest, and which the Government must take into account when setting
the framework for their investments and in giving guidance. In
written evidence, CIPFA notes that local authorities:
play a key role in wholesale money markets and their
impact on market liquidity is seen as vital in the current economic
climate. It should also be recognised that the £1.6 billion
earned in interest by English, Scottish and Welsh local authorities
annually is used in support of services. Any reduction in that
income would result in further pressure on local authority budgets
at a time when authorities are faced with difficult decisions
about service and council tax levels. It should be noted that
at present the only 'secure' counterparty investment open to local
authorities is through the Debt Management Office's deposit facility
which pays much lower rates of interest or government stocks which
have an underlying price risk unless held to maturity.[44]
34. Local authorities, then, must also consider:
- liquidity: the ability of the
authority to access their money when required, and
- yield: the revenue obtained from appropriate
investment of their reserves.
Furthermore, given the scale of councils' investments,
the Government itself needs to consider the potential effect on
the UK financial sector were local authorities to withdraw from
all but the very safest investments. As the Building Societies
Association notes:
At a time when the Government wants banks to continue
lending to business, and building societies to continue lending
to homebuyers, taking away a substantial part of their funding
base would be entirely counterproductive.[45]
35. The Society of Local Authority Chief Executives
and Senior Managers (SOLACE) sums up the considerations in response
to our question of whether local authorities' investment should
be placed in Government stock:
To do so would remove a huge amount of liquidity
from the banking and building societies. The Government would
need to recognise the potential impact of this on local authority
funding and therefore council taxes. It would also significantly
reduce funding from investment returns currently used to support
service delivery. This would result in reduced services or increased
council taxes.[46]
36. Investing in Government stock only, though certainly
ensuring security, would severely limit local authorities' investment
options, hamper the role they play in financial markets, and be
unlikely to provide the required liquidity and return. The more
realistic approach is the one which obtains at present: to allow
riskier investments which provide good levels of liquidity and
return, but to have in place a responsive, flexible network of
advice, guidance and scrutiny which ensures a proper spread of
risk.
37. We conclude that it would be inappropriate
to seek to restrict local authorities' investment options. Although
interest rates are now at historically low levels, returns on
investments are usually an important source of local authorities'
revenues and investment by local authorities an element in the
health of the UK financial sector. The primary consideration
of local authority investment, as emphasised by CIPFA, should
remain security and liquidity; but yield should not be neglected.
The risk involved in seeking yield should be mitigated by robust
and responsive Codes, guidelines and best practice.
30 Ev 114 Back
31
Ibid Back
32
Bournemouth Borough Council submitted written evidence in 2008,
so this budgeted return might have changed. Back
33
Ev 72 Back
34
Ev 151 Back
35
Ev 62 Back
36
Audit Commission, Risk and return, English local authorities
and Icelandic Banks, Cross-cutting National report, March 2009,
p 3. Back
37
Ev 62 Back
38
Ev 97 Back
39
Ibid Back
40
Ibid Back
41
CIPFA, Treasury Management Panel Bulletin, Treasury Management
in Local Authorities - Post Inclandic Banks Collapse, March
2009, page 1. Back
42
Ev 54 Back
43
Q152 Back
44
Ev 65 Back
45
Ev 121 Back
46
Ev 57 Back
|
