Treasury Q&A: Innes Edwards, Edinburgh City Council

The CIPFA Scottish Treasury Management Forum saw issues such as loans charges and the struggle to attract spending by developers at the top of the conference agenda. Forum chairman and Edinburgh City Council treasury manager Innes Edwards gives his view of institutional investors, the impact of austerity on borrowing and investment diversification.

Room151: One theme among treasurers currently is whether it’s a good time to borrow (given long-term low interest rates). What’s your view on borrowing currently?

Innes Edwards (IE): Like most authorities we have been using internal balances to fund our capital financing requirement in the short term.  In fact, apart from some interest free loans from Salix (well you would take them wouldn’t you), we haven’t borrowed since 2012.

We heard at the workshop that public sector expenditure in the UK is projected to the smallest share of GDP since the 1940s.

Local authorities are taking their share of the downsizing which makes affording the revenue consequences of major capital expenditure very challenging.

As Capita showed, even with constant loans charges the effect of a reducing Net Revenue Expenditure is to increase the proportion of income spent on loans charges.

Although interest rates are historically low, most of the revenue provision relates to repaying the capital advance, which makes it difficult unless some additional income is generated.

However, in Edinburgh we still have an approved capital programme of £988m up to 2020/21, so local authorities are continuing to invest for the future in difficult circumstances.

Room151: We heard about a “wall of cash” sitting with institutional investors, and developers looking for places to invest. Why do you think local authorities are struggling to attract as much of it as they perhaps might?

IE: I think the constraining factors are different for developers and institutional investors. Developers seem to mitigate the construction risk by incremental development and sale, which is why the National Housing Trust approach – in which the local authority funded LLP guaranteed purchasing of homes at a fixed price from the developer once they were built – worked so well in opening up sites which otherwise might not have been developed.

Institutional investors are looking for yield, particularly for long-term liability matching.  The likes of private rented sector development, where there is high demand with more limited supply, might seem to fit the bill, but it was suggested that the volume needed to make it an economic model maybe isn’t there outside major conurbations.

Room151: Two years ago we heard treasurers were concentrating investment risk in too few places. This year we heard from Arlingclose that 64% of their clients’ assets are held in unsecured bank deposits. Has diversification gone far enough in your opinion?

IE: I agree with Arlingclose although, compared with two years ago, I believe there is a significantly increased level of diversification.

The second and third largest counterparty exposures of Scottish local authorities in the figures this year were UK Treasury Bills and other local authorities.

There is also increased use of money market funds, which themselves give a level of diversification, and the remaining investments were with a wider range of institutions.

It’s appropriate for each authority to consider their appetite for risk, which is why the investment regulations give authorities the powers to make whatever investments they consider appropriate as long as elected members approve the investments in advance having considered the risks involved.

However, some authorities do still have a significant proportion of their investments unsecured with a single counter party and I am personally not sure that’s so appropriate, post the new bail in regime.  Or, maybe I am just a born worrier.

Room151: We heard that treasury investing is becoming more like pension investing. What’s your view of the range of opportunities and asset classes that treasurers should consider?

That is true to an extent, but there aren’t the debt-free authorities in Scotland so the investment horizon here is inevitably somewhat shorter.

Local authority pension funds can withstand a greater level of volatility and can tie their monies up for much longer periods to harvest the illiquidity premium in direct lending, and other credit opportunities for example.

I did a presentation at CIPFA’s main capital and treasury management conference in October where I suggested that local authorities should seek to take on sovereign risk and, when lending to financial institutions, we should be seeking to be fixed charge holders on the basis that if my investment ranks above “Liquidators’ fees and expenses” I really fancy my chances of getting the investment back.

By sovereign risk I mean UK Treasury Bills, supra national bonds like the European Investment Bank, explicitly guaranteed bonds like Network Rail, or pseudo sovereigns like local authorities.  I think we should also look at capital market transactions, such as covered bonds and reverse REPO against Gilts, although I have found it frustratingly difficult to gain access to the REPO market.

Of the £1.6bn of Scottish LA investments, over £500m was sovereign risk with a small amount more if you drill through the MMFs to the underlying investments, so that’s a good start.

I’m lucky in having a very cost effective custody arrangement in our relationship with the pension fund.  It may be that a similar cross-sector custody arrangement would make the type of investment I think we should be looking at easier for LAs.

Room151: You commented at the conference that local authorities were getting “the worst of both worlds” where MiFID is concerned. Can you tell us what you meant by that? 

There have been two EU directives recently relating to investor protection.  For MiFID II we are going to be classified as retail clients so will have to go through the hassle of opting up to professional status with each institution we deal with.

However, under the directive for bank bail-ins, local authority deposits have no protection and are immediately above equity and junior debt in the bail in hierarchy.

Genuine retail clients, such as individuals and SMEs, have all their deposits higher in the hierarchy and even large corporates have their deposits protected up to £75k with each institution.

It seems inconsistent that we are afforded less protection under the compensation scheme than the biggest FSTE company, yet will be classified as de-facto retail clients under MiFID II?

Room151: Overall, what were the key messages you took away from this year’s conference?

IE: Some of the key messages were:

• The risks, whether relating to the global economy or more locally regarding the UK’s relationship with the EU, are higher than they have been for some time;
• Local Authorities are continuing to invest for the future and Treasury Management strategies are playing a significant part in achieving that in difficult financial times;
• The sophistication (and I am loathe to use the word ‘professionalism’, but in some ways it’s very appropriate) of cyber criminals we are faced with is frightening;
• It seems that bank deposits will be out of scope of MiFID rather than being non-MiFID business but realistically we will be expected to opt up to professional clients; and
• Innovative Capital Financing initiatives such as NHT and City Deal can and do make a significant difference for the better to peoples lives.

Innes Edwards is principal treasury & banking manager for the City of Edinburgh Council and chairman of the Scottish Treasury Management Forum.