Local authorities are likely to sue treasury management advisors Butler and Sector over councils’ potential losses from Icelandic banks, according to local government financial consultant Howard Knight.
“In the light of the evidence given at the [Communities and Local Government] Select Committee on January 26th, I have no doubt that councils will be seeking expert advice in relation to their contracts regarding their expert treasury advisors,” says Knight, who also gave evidence to the committee’s ongoing investigation into local government investment losses.
The Local Government Association says it will support members if they do take legal action against Butler and Sector. “We would be firmly behind any action our members wanted to take,” says a spokesman.
It is unclear how far consideration of legal action has gone. Neither Kent County Council nor Nottingham City Council – the two largest potential losers from Icelandic banking losses – responded to enquiries about whether they were taking legal advice on suing their investment advisors, Butlers. Westminster City Council, which is advised by Sector, said that it is neither taking action against the company, nor thinking of doing so.
A spokeswoman for Sector said she was unaware of any action being considered against it, while Butler’s spokesman declined to comment.
But there remains confusion over what roles the investment advisory firms were expected to undertake for their local authority clients. The inconsistency of approach between Butler and Sector on the one hand (many of whose clients have substantial sums at risk in Icelandic investments) and Arlingclose (none of whose clients have funds exposed) was starkly revealed at a recent Communities and Local Government Select Committee hearing, at which all three of the companies gave evidence.
Mark Horsfield, a director of Arlingclose, told the committee: “We do believe we give investment advice. That is what we are mandated to do.”
However, the other two leading advisory firms both insisted they do not provide detailed investment advice to council clients and therefore were not in any way responsible for the potential Icelandic losses. Chris Anthony, a director of Butlers, told the committee: “We act as a passer of information. We do not provide advice on counter-parties.”
This perspective was shared by David Whelan, managing director of Capita subsidiary Sector. Whelen informed the committee: “Sector provides…. strategic advice and consultancy….. We also provide input into their investment strategy…… We do not provide advice to local authorities on which financial institutions or sovereign states to place their funds.”
But the committee was told by Councillor Richard Kemp on behalf of the LGA: “My feeling is that most councils – and I can’t speak for everyone – assumed that what they were getting was informed advice. I have no doubt that councils thought they were getting advice.”
Both Butlers and Sector’s directors told the committee they merely refer on the credit ratings agencies’ information, while making that information easier to undeerstand. But Arlingclose’s Horsfield insisted in his evidence to the committee that his firm does more than that, warning councils, for example, when share prices or newspaper reports suggest that a more negative view should be taken of an institution.
Butler’s spokesman Mike Sheard told LGC that comparisons between his company and Arlingclose were unfair. “Arlingclose have a different role,” he says. “They are entitled to that different role and the responsibilities that come along with that.”
In his evidence, Arlingclose’s Horsfield suggested that by its nature, credit ratings agency reports were of limited value. One problem was that it could take some time before the latest market information would feed through into a credit ratings agency report. Another difficulty was that there could still be variations between the investment grade assessments of the agencies and the assessment of risks priced in by the market. Horsfield argued that local authorities needed to be aware of the market’s pricing of risk as it affected investments.
Knight, a former investment banker and elected member, makes a similar point. One of the simplest lessons for local government chief financial officers is that in future they should read the Financial Times every day, he suggests. Those who did would have been aware some time in advance of doubts about the wellbeing of the Icelandic banks. They would also have been aware of the difference between the risk assessments made by credit ratings agencies and the premium loadings in the credit swap markets on Icelandic bank debts. This should have given major warnings to anyone reading the stories about investments in the Icelandic banks, says Knight.
This point was also raised by London Councils’ chairman, Councillor Merrick Cockell, in his evidence to the select committee. The potential Icelandic losses raised issues not merely of what sources of advice local authorities should look to, but also how well trained councillors should be.
“There is a lack of knowledge by elected members,” said Cockell. “We should be looking not to turn out councillors who are experts on the City, who can out-expert the experts we are paying on the Treasury teams, but who know the right questions to ask,” he told the MPs. More of them should be people “who do read the FT, do know what questions to ask and can ask the right questions of the treasurer and say, ‘I’ve been reading about Iceland, what do you think?’”, argued Cockell. He added: “It’s those sorts of discussions rather than simply relying on advisors and advice that I would like to see.”
A similar recommendation has been put forward by the Audit Commission, which is telling councils that elected members need to think seriously about investment strategy, ensuring that councillors on key committees understand sufficient about the subject to guide their authorities towards sound investment strategies.
To that end, the Audit Commission has published a case study on best practice on its website, which features the London Borough of Havering. However, even apparently best practice can have limited benefits – Havering has £12.5m at risk in Icelandic investments in Kaupthing and Heritable.
Arlingclose 40 clients 9% of market No clients exposed to Iceland
Butlers 144 clients 31% of market 51 clients exposed to Iceland
£469.5m potential losses
Sector 250 clients 53% of market 46 clients exposed to Iceland
£313.5m potential losses
Sterling N/k number of clients 3 clients exposed to Iceland
£17.2m potential losses
No external advisor – at least 16 councils 16 exposed to Iceland
£13m potential losses
London Borough of Havering – best practice?
The London Borough of Havering was assessed as weak by the Audit Commission in the 2002 CPA. It has since improved markedly. The council was criticised for weak leadership by senior officers and members. The Audit Committee, the Investment Committee and its scrutiny and overview functions all failed to perform as required. There was no consistency of membership of the two committees, with a lack of commitment by members, a high turnover and poor understanding by members of key issues. The council instigated a personal development programme for members and officers, with a comprehensive skills training programme for members. Councillors have become more confidence and more competent, with the performance of the Investment Committee (now called the Pensions Committee) much improved.