Icelandic legacy: Local Government Chronicle

Posted on February 23, 2010 · Posted in Local Government Chronicle

 

Iceland may not have changed everything as far as local government investment policies are concerned. But the collapse of the country’s three banks certainly had a big effect on councils, their finance directors and elected members, who have no intention of being caught-out the same way again.

 

CIPFA responded to the Iceland-related crisis by revising guidance for investment policy, which was published in September. CIPFA’s assistant director local government, Alison Scott, says that councils have made important changes in policy and practice since the crisis hit. “There is greater member scrutiny than before,” she explains.

 

Certaintly we have now engaged with members much more in terms of treasury management,” adds Scott. “It has moved much higher up the agenda. There is a much better understanding of what treasury management can achieve, but also what the risks are.”

 

Councils are now looking to a wider range of information sources to help them make their investment decisions, including in the pages of the Financial Times and by reference to credit default swap rates, says Scott. Local authorities have become concerned with exposure to particular countries. Many councils had investments in all three Iceland banks: now the lesson, for example, is not to have multiple exposure to Irish banks.

 

Initially there was a massive flight to the Debt Management Office,” adds Scott. “That has now slightly come back from that position as more authorities see the cost of doing so.”

 

One of the hidden realities exposed not just by the Icelandic crisis, but also by the collapse of Lehman Brothers, is that local authorities were often engaged in strings of transactions, where it was unclear who all the counterparties were. That counterparty risk exposure has been made much more transparent in recent months, says Scott.

 

John Simmons, Kent County Council’s cabinet member for finance – himself an ex-banker – reports significant change to investment policy and practice in his authority since the Iceland banking crisis put £50m of taxpayers’ money at risk.

 

We are a large authority and at most times we have £400m in funds available,” says Simmons. So investment policy practice is very important to the council. Yet in the immediate aftermath of the Iceland crisis the authority moved its balances to the Debt Management Office, where it received a mere 0.25% to 0.30% interest.

 

One of the messages absorbed by Kent County Council was not merely the fact of the collapse of the Iceland economy and the country’s banks, but that the global systemic failure was such that the potential investment losses could have been much greater. “There but for the grace of God could have gone RBS and Halifax,” suggests Simmons.

 

As Kent drew-up its revised investment policy, the council considered the revised CIPFA guidance. It also carefully evaluated its counterparty exposure. “One thing we have put in place that was not there before is country exposure,” says Simmons. Another is “group banking exposure – who owns what”. A further consideration is “reputational risk”, with the Financial Times and other sources read more carefully to obtain a variety of perspectives on market risks.

 

Previously we had relied on the credit ratings agencies,” continues Simmons. “When push came to shove, the ratings system was found not to be the flexible beast we would have wished it to be. The advice did not perhaps keep pace with what was happening in the market.”

 

Questions are now more likely to be asked about how much exposure a bank has to a particular asset class, such as property. There is also a smaller list of institutions in which the council will place its money – these are limited to the Government’s Debt Management Office, Abbey National, Barclays, HSBC, Lloyds, RBS and, just added to the list, the Nationwide Building Society.

 

As well as restricting the number of institutions in which funds are placed, there are stronger limits on the size of deposits – the limit is now a strictly observed £40m maximum per counterparty – and a maximum investment period of six months.

 

With a shorter investment time frame, Kent is now much better placed to respond to any changes in the credit rating of institutions and governments. And that, explains Simmons, includes the UK’s own rating. After recent experience, Kent is not in the mood to take any chances.