David Green: Consultations risk an Unhappy New Year for treasury managers
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2017 has been a year of preparing for regulatory change. Many of the changes to the global financial system designed to prevent a repeat of the 2008 financial crisis will take effect in 2018, including MiFID 2, Basel 3, IFRS 9 and in the UK, bank ringfencing.
The financial regulators of UK local authorities took rather less than ten years to react to the last crisis. DCLG published its revised Investment Guidance in 2010 and CIPFA followed this up with a new Treasury Management Code in 2011, following recommendations made by the CLG Select Committee in 2009.
Fast forward to 2017 and they are now both trying to prevent what some think could be the next big crisis to hit local authorities — a property bubble.
Location, location, location
There is nothing new of course with councils making property investments; the Local Authorities Property Fund was formed in 1972 to facilitate just that. But the pace of purchases has certainly grown in recent years.
Travelodge wrote to 124 councils in 2013 encouraging them to invest after completing deals in Aylesbury and Eastleigh. When Mansfield got in touch they probably didn’t expect them to buy hotels in Edinburgh and Doncaster.
But if a potential buyer values an asset higher than its current owner, after allowing for transaction costs, then an efficient market will lead to a deal being struck.
The three most important factors when buying property might be location, location and location, but that generally refers to the building itself, not the buyer.
The general power of competence in 2011 also removed questions over the legality of borrowing to invest, always a nebulous concept in any case. With investment properties clearly forming part of an authority’s “underlying need to borrow” in CIPFA’s Prudential Code, and with PWLB lending at interest rates a fraction of the yield available on property, why stop at only investing your own cash? (Hint: search for “leverage” and the name of any failed bank.)
So, there is a worry in some quarters that local authorities are putting their long-term financial viabilities at risk for short-term gain.
Some of the higher profile investors have been quite vocal about their “successes” in commercial property acquisitions, and other authorities are increasingly worried about missing out.
Some council reports explicitly say that “we have to buy because everyone else is!” But those late to join an overcrowded bandwagon are usually the first to fall off when it hits a pothole.
There is also a worry that property investment is being driven by a small number of members and officers, without buy-in from the wider organisation.
And while there are many detailed regulations, guidance and codes of practice on local authorities’ treasury investments, there is currently nothing analogous for property investment.
Requirements and obligations
Most interested parties agree that some new guidance is needed, but CIPFA and DCLG are taking different quite approaches to tackle the issue.
CIPFA is seeking to redress the balance by reducing some of the requirements for treasury investments and adding some for property investments; DCLG is just adding to the list of obligations.
In particular, CIPFA understands that property is a fundamentally different asset class to the cash and bonds typical of treasury portfolios. It will therefore recommend that authorities set out their procedures for assessing risk, making decisions and measuring the performance of property investments and how these differ from the procedures for treasury investments.
DCLG on the other hand has proposed shoehorning property into its mantra of security and liquidity before yield, but with commercial property guaranteed to be valued below its initial cost due to stamp duty, and being the hardest investment to sell in a hurry, this hardly seems appropriate.
CIPFA also realises that long technical reports sent to full council for approval rarely receive the scrutiny that they deserve, and is recommending a short capital strategy report instead, summarising the key issues in a format that maximises accessibility to a mostly non-technical audience.
But DCLG has proposed sending additional technical detail to full council for approval.
I can guarantee that a minority of councillors will read the sections on barriers to entry and exit in financial markets or the training requirements for statutory officers to assess individual assessments. These people quite rightly have other priorities for the time they have volunteered.
Finally, CIPFA has taken a pragmatic approach by deleting some of the prudential indicators that might be sensible in theory but are often erroneously calculated by officers and poorly understood by members.
Few will miss the incremental impact on council tax or the exposure to variable rate borrowing. DCLG though is proposing an additional set of indicators on risk exposures and the funding of investments to enable comparison across authorities.
We can just hope that DCLG has a Merry Christmas considering its consultation responses and adopts an approach more in line with CIPFA’s.
Otherwise 2018 will start with an Unhappy New Year for treasury managers, trying to reconcile two conflicting sets of statutory guidance on investments.
Season’s greetings to you all.
David Green is strategic director at Arlingclose Limited.
