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Mark Horsfield: Responding to the new risk landscape

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  • by Guest
  • in Blogs · Treasury
  • — 16 Dec, 2014

Bail-in legislation is evolving at a quickening pace and these developments are not particularly friendly towards local government.

As part of a series of commentaries by Room151 readers, looking back over 2014 and forward to the year ahead, Mark Horsfield, director of Arlingclose examines the rapidly changing nature of treasury investment and risk management in local authority. 

During 2014 local authority finance and treasury officers faced a number of key strategic treasury management challenges. Some being reasonably familiar and others less so.

Let me start this review of 2014 then by looking at the more familiar ones and commence with the financial backdrop. This needs little detail because anyone working in or with local government knows that it is at the frontier of the government’s economic policy. With the NHS, schools and international aid budgets being ring-fenced it translates to cuts in expenditure falling much harder on some than others. One of the hardest hit has been local government.

The consequences on treasury management as we see them are twofold. Firstly, capital expenditure funded by external borrowing is severely depleted to a point where we now find it quite difficult to find local authorities prepared to borrow on a long-term strategic basis not only because of costs and risks but because of uncertainty about the future. Get a long-term borrowing decision wrong and it can be very expensive to unwind. Secondly, the absence of supported borrowing and the financing of existing borrowing have also combined alongside other factors to mean that investment balances remain rather more buoyant than interest rates.

Turning now to interest rates. We have forecast the first expected increase in UK official interest rates to occur in the second half of 2015 which implies that the current rate of 0.5% will have been in place for almost 7 years. With inflation running comfortably above nominal interest rates throughout this has meant that those surpluses are largely invested at negative real rates of return. Purchasing power is not being preserved by investing purely in cash but eroded.

Longer term interest rates have fallen in almost every month during 2014. 10 year gilt yields averaged 2.87% in January 2014. By November the average was 2.13% and it will be lower still by the end of December. Long-term borrowing rates have followed this declining path but the majority of our clients look more to the ample liquidity that their own organisations maintain and if their requirements exceed this then turn to the plentiful, flexible and cheap supply of liquidity available elsewhere.

And so to investments. Last December the UK Government enshrined bail-in into legislation. This means that credit risk for local authorities, in particular, increased. In our opinion this has significant consequences for local authority risk management and investment activity undertaken on an unsecured basis. We have worked hard with clients during 2014 to ensure that they adjust to this new world.

Looking forward into 2015 we can be certain that the issues shaping treasury management in 2014 will remain and, indeed, accelerate. Whatever the outcome of the General Election we know that economic policy will remain tough. If the current Chancellor is returned to 11 Downing Street, then it will be very tough. His most recent forecast requires day-to-day departmental spending excluding welfare to fall from £147bn a year today to £86bn in 2019/20.

Interest rates will remain low and our strategic advice is now framed against a lower forever bias where lower is both a relative and absolute term. Meanwhile, HM Treasury has confirmed that the governance of the PWLB will change in 2015 and we and our clients will be watching this development closely in tandem with expected progress and delivery by the LGA’s bond agency.

Bail-in legislation is evolving at a quickening pace and these developments are not particularly friendly towards local government. The changes demand a response and we are continuing to assist our clients with doing so. In 2015 we will see a significant shift in the way our clients’ investment surpluses are managed as a consequence.

So 2015 will present real and exciting challenges – just like 2014 and every year beforehand.

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  • 151 BRIEFS – WHAT’s NEW?

    • Homes England agrees strategic partnership with two authorities
    • Soaring inflation and pay pressures to add £3.6bn to council budgets
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    • Government preparing to intervene in Nottingham City Council
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