Richard Harbord: Treasury strategies, interest rates and inter-authority borrowing
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It is the time of year for the re-consideration of treasury strategies and preparation for the closing of accounts. I suspect in most authorities the changes in strategy will be minimal. It is a very difficult and uncertain time and there may possibly be some need for a re-think after the General Election or, there again, life may continue without major change. The differing approaches to the deficit and austerity do have an effect on interest rates going forward and may be material matters.
The factors which may also effect how rates move (though I think it almost certain they will move upwards and not down as has been recently mentioned as a possibility), are the various currency wars, particularly the strength of the dollar; productivity, which exists as a major threat to stability in the United Kingdom; and deflation.
Much has been said about the effect of deflation but generally I think it is unlikely to prove any sort of threat. Certainly the equity markets have discounted deflation as a real possibility. However, deflationary pressures in Europe and the United States are strong and currency wars will tend to emphasise that. In the United States as inflation has fallen to, around or just under, 1%, treasury yields have headed up and real interest rates are trending upwards.
So, there is uncertainty. But then there always is. Increases in interest rates are likely to be fairly small, at least to start with. This is only good news for borrowers, of course, and those with surplus funds will have to be content with peanuts for some time to come.
The problem of counterparty risk remains ever present and you only have to look back just a few years to see how the number of “suitable” counterparties has shrunk. It is also interesting to see how the pressure on treasurers to maximise interest has not changed since the 1990s and the BCCI saga. There is more information available now in terms of stress testing by central banks, but the consideration of reward v. risk is ever present.
I suspect the current trend toward greater inter-authority borrowing reflects these difficulties and the safety in lending/borrowing from people you know and trust. There are also opportunities for regular relationships and direct dealing to save fees.
Briefly, what of the year end? Well it is interesting that I understand auditors have become increasingly concerned about LOBOs and it is possible that there will be increased scrutiny of those authorities who have entered into such arrangements. There seems to be a belief amongst the technical departments of the main auditors that not all local authorities are clear what they have entered in to, and have not investigated and allowed for all possible outcomes. There is even an extreme view that local authorities do not have the powers to enter into these arrangements in any case.
Unless something goes wrong I suspect that nothing will come of this. Those of us with long memories will remember how we happily no, joyfully, entered into interest rate swaps and deep discounted loans on the assumption that the general borrowing powers were quite sufficient to cover us. Indeed, most authorities simply considered such instruments as a natural evolution in the market. There was amazement when they were challenged in the courts and held to be ultra vires. Mainly because they were seen to be speculation and protection rather than centrally borrowing. The court’s judgement was total. Unravelling the instruments as demanded by the courts took 10 years. I note the LOBO market reached £7.63bn by June 2014.
Richard Harbord
