Innes Edwards on beating benchmarks and treasury centres of excellence

Innes Edwards is Treasury Manager of The City of Edinburgh Council. His responsibilities cover both treasury (including leasing and investment of Lothian Pension Fund cash) and banking.

Room151: How did your approach to cash management achieve its benchmark-beating gains during the credit crisis?

Innes Edwards: If you have a look at Performance Graph 1 which shows what our net performance was before and during the credit crunch against benchmark and money market funds at the time.  Our in-house fund (CEC Cash Fund) gained in the region of £5.5m relative to the benchmark and that was achieved in a number of ways.

Firstly, we went out longer with some banks like HSBC right at the top of the crunch. As we saw things were getting bad we went out to a year and as rates came down, significantly and very rapidly, we made a large gain through that lengthening of the weighted average maturity.

The other thing we’ve done is use innovative instruments. We used treasury bills (T-bills) for a while when there was a decent return on those relative to, say, the DMO. We used government guaranteed bonds which offer a high level of security and put very little of your capital at risk but were gaining a much greater level of interest than a similar direct government investment. We used floating rate notes (FRNs) as well.

One of the advantages of doing things in-house is the ability to know your cash flows in detail. We’re able to make a better estimate about what’s going to be there for a while, both for ourselves and the pension fund, and so take on greater, longer-term volatility in the weighted average maturity of our fund which is why we went out longer with HSBC and a couple of Irish banks, once the government had stepped in with a government guarantee, and how we got a better investment rate at those times.

Room151: So were you taking liquidity risk that other authorities would have been uncomfortable with had a money market fund been taking the same risk on their behalf?

IE: Well, we were taking liquidity risk basically because we had a better in-house understanding of our cash flows than a money market fund would be allowed to have. We could take a reasonable view on a one year basis of what we thought our core cash would be and altered our maturity to take advantage of that, taking liquidity risk as interest rates fell.

Room151: What have you been doing more recently to generate additional returns?

IE: We entered into strong negotiations with a number of UK and oversees banks regarding both interest rates and terms with our intentions to achieve a premium rate for the cash invested. We were getting substantially above base on call accounts although some of those banks have recently served notice that their rates are coming down.

More importantly, we took government guaranteed FRNs way back in August 2011 just as Libor was starting to be squeezed upwards because of the sovereign debt crisis in Europe. By buying FRNs which are set every quarter we made significant gains but retained a high level of security because the nominal and interest were guaranteed. So by using FRNs, which a lot of authorities probably wouldn’t look at, we’ve been able to leverage up some of the performance.

Room151: Does running a treasury unit like this boil down to size?

IE: I think there are two things to it. Firstly, we’ve got a good team here who’ve got the knowledge and been through various qualifications. Secondly, we’ve got the arrangement with the pension fund, the Police Board, the Fire Board and the Transport Authority and we manage their cash in one whole fund. By putting it all together we have anywhere between £250m and, at times, over £500m in funds under management. That allows us to be more innovative. Thanks to the close relationship with the pension fund we were able to piggy-back on their custody accounts and have access to multiple brokers as opposed to an arrangement where you’re stuck with a single nominee.  We mostly buy on a ‘hold to-maturity’ basis but having access to different brokers means we can look around for the best offers in the market.

Room151: Is your model scalable or does requiring a thorough understanding of cash flow limit you to the organisations you’re currently managing cash for?

IE: I think it is scalable to an extent. If you look at our portfolio we tend to have quite a high allocation in the inter-authority market. If you wanted to be a fund of several billion pounds then you couldn’t maintain the same percentage allocation of cash with other locals as the capacity isn’t there.

The other issue is the shared service agenda and the regulatory position which has never really been resolved. We manage cash for a number of different organisations but they’re all linked in one way or another. The arrangement is almost like a private company doing it for joint subsidiaries. So you can interpret the perimeter guidance within the FSA’s Conduct of Business Sourcebook reasonably in a local authority context there.  If you want to manage cash for another local authority then deposits with a bank might be fine but if we wanted to buy T-bills, for example, that would need to come under investment authorisation and I don’t think we would particularly want to go down the route of being regulated by the FSA or whoever’s going to succeed them.

It’s always seemed a wee bit daft that we could manage the cash of another authority purely by depositing it with, say, Icelandic banks, and that might not need to be regulated. But if we wanted the secturiy of buying T-bills or Gilts, it would.

However, I do think the whole concept of ‘centres for excellence’ works. I know at one stage a number of my colleagues had quite a lot of money with the DMO even when other government guaranteed instruments were yielding much more. We were tempted to look into setting up a government bond fund for them at competitive fee rates.

Room151: Is the treasury centres for excellence idea a well-developed one? How far down the road are we with them?

IE: It depends how you get into it. I see people in London like Jonathan (Jonathan Hunt, Westminster & Tri-Borough) who bring a certain level of expertise that maybe some of the smaller authorities don’t have. I think it’s fair to say that the report the Audit Commission did after Iceland found that there was quite a range of experience and ability within authorities. Some are very well geared up and know what they’re doing and some less so. So is there willingness for authorities to look at an arrangement where bigger, better resourced teams manage cash on their behalf?

Certainly up here, the reality is that most people don’t want to give up their treasury function. A, because it’s quite sexy and B, because compared to some of the other shared service initiatives there’s simply not a great saving to be generated in terms of people.

Room151: How would Scottish independence affect treasurers north of border in respect of ratings and their relationship with the DMO and PWLB?

IE: As it stands at the moment because it’s a couple of years away even until a referendum I think it’s basically business as usual.

Room151: What role can the treasury play in shoring up the balance sheet?

IE: For years treasury management has dug local authorities out of large holes in their revenue budgets. If you look in our last annual report you’ll see how much the cost of our debt has come down and how much cumulatively we have saved over the last ten years or so – about £150m – which is a phenomenal amount. I don’t think that treasury managers across the country have really got the credit for what they have delivered. The difficulty of course is that debt restructuring was effectively killed off by the PWLB a few years ago now so there’s very little pro-active debt management we can do at the moment to make the big, big savings we did during the 2000s.