Councils need sector-wide custody arrangements

Local authorities need a sector-wide solution to resolve custody of their investments, according to a leading treasury expert.

Mike Jensen, investment manager at Lancashire County Pension Fund, made the remarks during a panel discussion of cash management at the 2015 Local Authority Treasurers’ Investment Forum at the London Stock Exchange.

“Everything we should be doing requires custody arrangements. That’s something the local government sector en masse needs to come to some rather more general solution than maybe the larger funds, that have pension funds attached, can manage.”

Custody arrangements see an institution acting as custodian of securities to ensure they are not lost or stolen. Custodians are also not permitted to use the assets themselves.

During the discussion Jensen listed the investment categories he believes local authorities should target following the introduction of European Union bail-in legislation, which has made placing cash with banks more risky.

He suggested the use of residential and commercial backed securities, as well as the asset backed variant, along with sovereign supranational agency bonds, covered bonds and bank paper, as long as it is supported by extra security from a pool of residential mortgages.

But he also backed the use of repurchase agreements (REPOs).

Jensen said REPOs offered: “A very active market in London, very large levels of liquidity, and a wide range of maturities with relatively little documentation required to exercise.”

He also repeated his belief that local authorities should use the derivatives market as an investment option. First reported by Room151 in August Jensen said Lancashire has legal opinion saying investment in derivatives to mitigate risk would be legal.

Jensen insisted local authorities should not be investing in banks or building societies following the introduction of bail-in legislation by the EU.

“The risk/reward on any of those is now extremely poor and ultimately dangerous. It’s unclear when the first action on bail-in legislation will take place in the UK but it’s already taken place in Europe, so there are models to follow.”

His point about UK banks was illustrated by Chris Buss, finance director at Wandsworth Borough Council, who described the journey his authority’s reserves have been through since 2008.

Just after the crisis Wandsworth had its cash reserves in 25 different banks and building societies, with 40% overseas.

These days the cash is across 26 counterparties but only 15 are banks, and out of almost £500m, only £40m is in UK banks. Wandsworth also has money with seven money market funds and in four other local authorities.

“We had to diversify,” said Buss.