Chris Buss: Treasury management, caution and predicting the future

I am writing this after watching the England v Wales world cup rugby game and having recently finished rereading Ivor Stanbrook’s State of Emergency, a history of the Ted Heath government. Neither have anything directly to do with treasury management but both have classic examples of how strategies and policies can be overturned by getting a key decision wrong or being overtaken by events.

Back in 2008 the world of local authority treasury management seemed a relatively simple place, well at least in Wandsworth it was. Guided by a simple policy which avoided advisers but relied heavily on ratings agencies we kept all our cash short term, divided it up over 24 banks and building societies who met our rating criteria (our version then of diversifying).

By doing this we avoided exposure to riskier off-shore assets, like Iceland, although overseas banks did make up over 40% of our investments. Overall, our primary aim was to maintain the value of our assets, have a degree of liquidity and make a reasonable return on our assets which we did at between 5.5-6% . And then events happened.

Events

The Lehman Brothers crash had a significant impact on the world economy, as significant in many ways as the OPEC oil price in 1973 which brought the Barber Boom to a shuddering halt.

Both events led to a fundamental change in outlook and, in the case of Lehman, a long-term change in interest rates as central banks cut base rates to all-time lows which, some seven years later, still show little sign of moving upwards to any large extent.

This, together with the action taken by governments and regulators (to ensure, as far as possible, that there is no repeat) means that previously assumed safe havens are now no longer safe and new areas are being looked at to provide the triple purposes of security, liquidity and asset return – in that order.

I remember back in 2010 , wondering whether it was right to go for a two-year fixed deal at just over 2% using the government guarantee scheme for over £100m, wondering about the grief we might get if interest rates shot up to 2008 levels in the intervening years and we had missed out.

Happily it was, in hindsight, the correct decision, but we could have easily stuck with short-term deals and missed out. It’s a fine level of decision which can bring either reward or criticism. Just ask Chris Robshaw.

Seven years on

Our current treasury management portfolio looks significantly different to that of seven years ago.

Firstly, it’s much larger in cash terms, despite a large cash pay out to the government as part of the Housing Revenue Account settlement in 2012.

In part that’s due to increased revenue reserves both on the General Fund and HRA but also higher capital receipts.

This has meant that although we now have our cash invested in broadly the same number of places we have spread them so that our placings in UK banks are now negligible. Sums placed with overseas banked are a similar proportion as before, but the range is limited as we take a wider spread of factors into account. And we now use money market funds, plus the CCLA property fund, to an extent we wouldn’t have thought of in 2008.

Another development is a big increase in loans to other local authorities and a small but growing amount of loans, or deferred payments, to our commercial customers, in these cases being very careful not to breach state aid rules. Also our investment term is slightly longer with two year placements not being uncommon. Are we being over cautious? Perhaps, yes, but let me explain why.

Caution

It’s very easy to get drawn into the idea that your prediction of the future is a reality when in fact it is only a prediction.

In reading State of Emergency you can see how this happens and the consequences when, to put it bluntly, you guess wrongly on which way events will take you.

At present, in the words of Donald Rumsfeld, there are too many “unknown unknowns” to give any degree of certainty as to what is the right policy for anything other than the short term.

These unknowns at the macro level include the impact of reduced growth in China, immigration into Europe and ISIS terrorism to name just a few.

At a more local level they include reduced government funding, caps on reserves and the need to use reserves to fund investment in housing, or to cushion reductions in service expenditure.

The range of scenarios is almost endless, but they all lead to a view that to tie cash up for too long in the search for a few extra basis points is potentially futile, particularly when it’s unsure what the cash will be needed for next year. So it’s unlikely there will be any big changes in the way we do things over the next three years. It will be interesting to see if in 2018 anyone remembers if I’m correct in my predictions.

Chris Buss is the director of finance and deputy chief executive at the London Borough of Wandsworth.