Manchester Roundtable: the flight from banks, collaboration and best practice

Room151’s Treasury Think Tank in Manchester, sponsored by Payden & Rygel, explored the changing environment for treasurers, including the move away from banks, the need for greater expertise and the importance of managing debt

Local authorities who’d like to join our London Think Tank on April 26th, please register here. 

Gavin Hinks: We’re seeing a raft of changes in banking and money markets some of which are arguably being watered down. As professional treasurers, is there an opportunity for you to get ahead of the regulatory environment and drive best practice?

Robin Creswell: The EU Bank Recovery and Resolution Directive (BRR) makes it illegal for countries to subsidise their banks in the future, it makes it illegal for governments to bail out banks. The only basis on which they can bail out the banks in the future is if depositors, that’s your cash from treasury, is first subject to a minimum haircut of 8%. We’ve looked at some independent studies that say that that could be as high as 20%, in a worst case scenario.

So the first thing is the European Union has introduced legislation designed to put counterparty risk into your bank deposits. We know that’s where local authorities hold a lot of cash, and that’s something we think should be thought about.

Then we need to look at the alternatives. The money market fund sector is a good next place to hold transactional cash for short periods, the highest quality we think.

And then there are other areas to hold cash. One destination that we might get to in the discussion today – this is something that we as a company do in the United States, we do it in Europe, we do it for corporations and we do it for pension funds – is we look at an organisation’s complete cash flow.

In your case it would be from the point at which money comes in from council tax receipts, business rates receipts and so on, all the way through to meeting the payroll to developing infrastructure and buying buildings. We can do that for an entire corporation. And that’s where we think best practice, fit for purpose might look a little bit different going forward.

Luke Webster: Historically, we’ve had a huge concentration of bank risk so I think the last time I checked, a couple of days ago, 93% of our exposure was to a single industry – banking, and the BRRD has allowed me to make a very powerful argument to diversify.

We should have done that anyway, of course, but people have historically been very nervous about change from the traditional asset classes of local government.

We’ve put proposals forward for residential mortgage backed securities, for instance, and a wider selection of corporate bonds. I finally managed to get the argument across that if you’re comfortable with the risk of say a one-year deposit with a AA-rated bank, then it’s absolutely preposterous that you wouldn’t be comfortable with a two-week exposure to a BBB corporate bond.

The default probability is far, far lower in the latter case. I suppose this understanding of risk has provided a great opportunity in that regard. A more fundamental change that I think will hopefully start to be discussed in the sector is a bit more of a mature attitude towards liquidity.

I think actually people need to understand that call accounts and so on are not going to exist at sensible returns forever, and one would be far better off with a pool of highly liquid, short dated securities, for instance treasury bills, that you can sell or repo to generate cash when you need it. This sort of an obsession with holding things to maturity needs to be revisited and people need to move away from the sort of lazy mantras of fearing a capital loss. 

Mark Stanley: I want to pick up on something that Luke said about the

obsession with liquidity. Are you therefore also suggesting that there has also become too much of an obsession with stability and stable NAVs, for example?

Luke Webster: Yes, absolutely, that is my point. I think an obsession with liquidity is, just to be clear, absolutely appropriate for a local authority treasurer, really the most important thing.

But people need to look at their portfolio [as a whole]. So, when we talk about security, which over the course of years has sort of shaped our treasury strategy, the important thing is that you don’t lose public money, i.e. you don’t end up with less than you started with.

That doesn’t mean that every single transaction has to generate a gain. It’s perfectly legitimate to bare a cost for liquidating things as long as you’re managing a portfolio in such a way that the net return is still positive and you’re not experiencing defaults as a result of poor risk management.

Mike Jensen: At Lancashire we haven’t made a bank deposit or building society deposit or bought a bank or building society CD (certificate of deposit) for four years, maybe five.

And now any bank or building society deposits or CDs that we do hold, I’ve separated and moved them from my agreed investment risks, primarily because of the new legislation that has been alluded to, but before that strictly from a credit perspective.

But I cannot understand why now any local authority would invest in these deposits, full stop. From a risk Vs return perspective, I no longer believe they are acceptable or appropriate for any local authority.

Local authority deposits is a different story altogether. Corporate deposits [is a] different story altogether. I’m talking specifically about the banking sector and specifically as a UK local authority (investor). After the equity of maybe some of the really, really junior bonds in a bank’s balance sheet, local authorities are effectively in the worst position of any investor.

So I am slightly perturbed that having made a suggestion to CLG some time ago, via the CIPFA treasury panel that they change or put up some notice of change to the guidance on specified and non-specified investments, that there hasn’t been any action. This is core to what local authority treasury should be about going forward.

And there are so many alternatives available to authorities, that currently very few are taking up, that it’s almost a dereliction of duty (that they’re not)…almost. It would be going too far to say it’s unsafe, but it’s bordering on the inappropriate.

Paul Woods: Local authorities are going to continue to see austerity measures

over the next four or five years, so returns are particularly important.

I’ve done a piece of work on local authority short-term investments in the balance sheet as a whole. And depending how you read the statistics that are published (for England it was somewhere between 33 and 38 billion pounds that local authorities were actually putting into short-term deposits) … the issue for local authorities like mine is how do we maximise the return on some very large deposits and can we do that collectively, as London are doing with pooling arrangements.

Because within my seven authorities, we’re talking about £1.1bn. We know that we have to have liquidity, but clearly within that sort of magnitude of resource, we can take slightly different perspectives about how much liquidity you maintain versus how much you can afford to put into higher income opportunities. And I think it’s looking to the whole balance sheet that’s becoming particularly important.

Mike Jensen: I’d like to throw in one extra thing. Obviously, at the moment we’re tending to focus on the assets…, but obviously, in general, the debt position of most local authorities is substantially higher than their asset base, and really whilst we should be spending a deal of time, and a deal of expertise, getting the asset side in better shape, and we’ve got lots of tools available to do so, debt management ultimately is more important, just because the quantum is bigger at the moment.

Most local authorities are wearing a huge systemic curve position, which for the last eight years has been unhelpful. So, I think we need to spend at least as much time and at least as much effort … on debt management as on investment.

Luke Webster:  Just to echo that, I think this is an important conceptual point for local government treasury, we ought to be positioning ourself as a strategic balance sheet management service.

People get very excited about investment management, it’s kind of an easy thing to talk about, ultimately. But managing the liability side of the balance sheet is conceptually harder, though financially much more significant.

I think one of the great advantages of working together as a sector, be that in shared service arrangements like ours or perhaps more informal networks, is identifying potential balance sheet synergies.

If you collectively look at the sort of shape of local government finances, let’s take 2008 as a convenient starting point, I think it’s a pretty disgraceful picture, to be honest, as a tax payer – bearing in mind that by definition, any money that we’re managing in the treasury context is the receipts of taxation that have been collected in advance of need. …

So clearly, I think everybody’s been quite good at exercising moral duty number one, which is don’t lose it… But moral duty number two I think is quite an important one, maintaining the spending power of that money, has been really neglected in our sector.

Mike Jensen: We as an industry have not had access to the tools that would allow us to effectively and efficiently manage these positions. So the fact that we can’t do inter-authority swaps for example is just ludicrous.

Robin Creswell: On the debt side of the balance sheet, there’s really an almost once in a three generation opportunity. You can borrow at a cheaper rate than the private sector over ten, 30, 50 or 100 years. And why wouldn’t you? If you were going to build Victorian sewers today that you know are going to last 100 years, you would issue a 100-year bond. So I think about the debt side of the balance sheet, about issuing debt that lines up quite accurately with liability.

But, and this is where Payden and our sector has a role to play, as all these sums come in, there’s a ton of work that can be done to line it all up, line up the flows, then think in terms of what duration can I get on my bonds to match the duration of my liability.

Luke Webster: True. Just to be clear, … when I was talking about the diminishing of the spending power, I was not suggesting that’s as a result of not taking enough risk and inappropriate investment returns, because the constraints that you set out are absolutely proper.

My point was that essentially we’ve miscalculated the balance sheet. We’ve failed to acknowledge that there was a £20bn odd structural cash positivity to it that didn’t need to be there.

So, if the public sector balance sheet just for local government had been managed better, people I think should look at their accounting reserves as perhaps facilities that justified borrowing if required in the future.

Steve Thompson: I feel a bit out of sync here, because with current climates and conditions, my appetite for holding cash is averse.

You know, we spend the cash as soon as we get it, particularly around security. And when looking at yield, it’s around getting returns from alternative sources, as you say. Interest rates have never been as low for borrowing or looking at other sources of rates and finance.

Perhaps we’re a bit peculiar and unique in Blackpool, but when you own a water park, a tram way, a tower, winter gardens, a zoo, and we’ve invested a lot of capital into that, which are bringing in returns, and we’re diversifying that with a proliferation of companies including private sector housing and converting external borrowing into private rented accommodation, that’s bringing in a much higher yield.

So, we’re working with other partners across the public sector who are struggling to raise capital investment and making a return on that, which is a win-win for everybody. And even setting up a business loans fund, almost as a bank of last resort, but the risks in doing so [are] reflected in the interests rates that are charged. And yes, you do get insolvencies and defaults, but overall the return is far better than some of the suggestions you make around investment strategy.

Neil Thornton: From an investments point of view a significant part of our

investment portfolio is with other public sector organisations, which reflects the desire for security in relation to our investments.

And that is sort of a conscious decision taken in the light of issues that have arisen in the recent past such as the Icelandic banks problem, for example. And it’s also a reflection of, I would say, the level of expertise in relation to treasury activities within Salford City Council.

Some of the points that have been made earlier in relation to the need for more sharing of treasury expertise I think are really important, because we simply don’t have the expertise to get into some of the more sophisticated investment instruments that are available in the market place. That is an area that I’d sort of be interested in exploring further.

But whether that’s with public sector organisations, in terms of sharing of treasury expertise, or whether it’s with third party organisations, I’d want to look at both of those options and see what benefits would actually materialise from each of those.

Richard Harbord: The thing is that here, in this group, there’s a self-selecting  treasury management elite in a class of its own. But you’ve got 360 authorities and the expertise in a great number of those authorities, even some of the quite larger authorities, is very poor in terms of treasury management.

A lot of those authorities are so risk adverse they can’t actually find anywhere to put their money, they’re scared stiff of the whole thing, really. And a lot of them have suffered grievously at the hands of external advisors who don’t really go very much along that route either.

So you’ve got to encourage people to go out and share and come in to larger [authorities], but they are so risk averse and there have been so many difficulties.

And the other point I’ll make is that a lot of local authorities clearly see the low cost of borrowing as being an invitation to keep up their capital requirements by way of borrowing and not using internal cash. And there’s got to be various arguments about whether you can do better on investment than borrowing, if you see what I mean.

Richard Paver: The combined authority [I work for], which is expanding its

role, has already got a treasury portfolio of about a billion pounds of loans and £150m of cash on deposit at the moment. And just to do away with the notion that this is council tax payers’ money that’s been raised in advance, actually it’s government funding received well in advance. …it’s funding projects that we’ve got to deliver, so there’s a fairly immediate cashflow needed.

The only trouble is by the time you’ve used half, you’ve got another grant, so your cash pile is extended again, but it’s coming from a different source.

But [the authority has] many of the same issues. A bit like others we still lend to banks on unsecured deposit, but very small amounts of money, probably only 10% of the total is on unsecured, we have moved away from that into more secure things. We are looking at treasury bills, custodial relationships, the bit that’s in the way of that at the present time.

But we’re also trying to match our cash flows to, not a 30-year building but a 30-year tram, which is wearing out, …it will take a 30-year repayment because you want to be amortising the asset along the way, and annuity-based loans or a series of shorter duration loans to match the profile of the assets. Those are the things that we’re struggling with.

What we are taking up from next year will be the portfolios of the police and crime commissioner and the fire authority. And that’s something to get our head around because that will have quite a different profile, I think, than investing in transport, which is what we’re largely doing at the present time.

We’ve got investment funds looking at the private rented sector, business loans and the like. We manage those separately. We have a core investment team that are managing those separately from the treasury operation and they need to mesh-in for cashflow. But it’s a very different range of skills if you’re investing in residential property than running a treasury book… .

David Smith: For us, and I’m sure for all the treasurers around here, it’s really important that our treasury management strategy and our borrowing strategy reflects the overall financial strategy of the council.

I think we all face a fundamental dilemma, and just like the banks, we’re selling our assets and we are tempted between a strategy that says we will, in the short term, pay down our debt, reduce our borrowing, stop borrowing as a proportion of our revenue.

Because ultimately, what we’re about is providing services, not lending money or providing assets to others. Therefore we have a local and fundamental dilemma as to where we go. The proportion of our revenue budget that was being absorbed by the consequences of past decisions – it’s growing at an absolute rate of knots – we’ve tried to reverse that.

We are also in a position where our cash balances should fall over the next few years, because we are drawing on reserves to balance what is an incredibly difficult set of circumstances. We think that the government are moving to a sense of autonomy for the local authorities, but for my local authority that will just not work.

Our income is not growing as rapidly as others. That income position is a real challenge for us. So, I need to make sure that I’m not over-borrowing, that I don’t go into that spiral of decline whereby my adult services can’t be funded because I’ve borrowed so much money, or I’ve deferred the liability so much into the future.

We are trying to think long term. It’s incredibly hard because our politicians are on a very short-term life cycle, but I think that’s my job, to think about future generations, not necessarily my own.

Luke Webster: Yes, really just to build on all of those points. I think perhaps there are a very few local authorities, if you look across the 360, that present this information in a fully transparent way, I would say, in the budgets.

And I think we do need to, as a sector, reflect on how we make this clear to tax payers.

The points about the acts of encumbering future generations is an absolutely vital one. It’s highly possible that a lot of decisions now could lead to a situation, in say nine to ten years time, where the impact of tinkering, for instance with the minimum revenue provision – kicking the cost of historical expenditure further down the road – will lead to situations where really very horrible cuts will have to occur just to meet and essentially fix liabilities.

Mike Jensen: I wanted to cover a bunch of things, but maybe start off with something I think that was very important, said by Richard earlier, and that’s the quality of advice the sector has received.

I think we’re all being tremendously let down by the advisers in our sector. A lot of local authorities think they’re running conservative low-risk strategies when they’re not. And they’re not because they don’t know what those risks are and an advisor should have been telling them about duration risk, curve exposure and convexity of debt, technical things that you wouldn’t expect a local authority treasurer to have instantaneously. That should have been the function of the advisors and they have not delivered.

I arrived in the sector just after the treasury select committee published their report on the Icelandic banks and two things stood out for me at the time: [firstly] proper access to market data, I’m amazed how few authorities have Bloomberg terminals; and [secondly] hiring experienced, properly qualified staff.

I’m absolutely amazed how few of those there are, given that through most of this period they have been extraordinarily cheap – cheap in the real sense rather than the local authority sense.

And much of that poor advice could be replaced by internal resource which would have given you transactional skills as well as understanding of how markets work, how markets impact balance sheets and how risks flow through the whole process.

And then finally coming to the point earlier about revenue costs. There’s a whole suite of tools that we could use that would take away all of those problems – forward swap trading, forward options trading, all of it relatively simple and something corporate treasurers have been doing more or less every day for the last 20, 30 years, that should have been part of the toolkit for local authorities. And the fact that it hasn’t has probably cost billions, effectively for the public purse.

The fact that that still hasn’t been resolved ten years after the market started go into meltdown is frankly a dereliction of duty by central government. They shouldn’t be waiting for us to ask for those powers, they should have been effectively ensuring that we have those powers and that we have the expertise and that we use them.

Think Tank Participants

Public Sector
Richard Harbord, independent consultant

Mike Jensen, chief investment officer, Lancashire County Council

John McGrail, group director of finance and resources, OneManchester

Richard Paver, City Treasurer, Manchester City Council and treasurer, Greater Manchester Combined Authority

David Smith, director of resources, Kirklees MBC

Steve Thompson, director of resources, Blackpool Council

Neil Thornton, director of finance & corporate business, Salford Council

Luke Webster, chief investment officer, GLA

Paul Woods, chief financial officer, North East Combined Authority

From Payden & Rygel

Robin Crewel, managing principal

Mark Stanley, senior portfolio director

Room151

Gavin Hinks, editor

Peter Findlay, publisher

Get the Room151 Newsletter