A panel of sector experts last week discussed local authority treasury management strategy at Room151’s Local Authority Treasurers Investment Forum. The panel discussed the merits of borrowing to invest, local-to-local lending, and the opportunities presented by cheap long-term borrowing rates.
Borrowing to invest
In recent years, the trend of local authorities borrowing cheaply from the Public Works Loan Board to fund commercial property investment has exploded. The practice has attracted close interest from government officials, who last year revised investment guidance to guide councils in such ventures.
Martin Easton, head of financial strategy at Birmingham City Council, kicked the debate off by comparing borrow-to-invest strategies in the public sector with similar activities in the private sector. He said: “I think the question is I would ask is, is that an appropriate activity for local authorities?
“If you’re an investment bank, then the people who’ve invested in the bank, know what they’re getting into, they’re putting their money at risk in order to make that return and take those risks. But local authorities don’t have equity, they have taxpayer and they don’t have a choice over paying tax.”
He said that local authorities’ role was to provide services to the public, and not to be financial institutions. “It is not our prime expertise as local authorities. Are we really skilled and competent to do that kind of activity? But, more fundamentally, still, is that kind of risk the right thing to be doing with public money? And in my view it is not.”
Luke Webster, chief investment officer at the Greater London Authority agreed that “in the general course of things, if this is something that has not been made absolutely explicit to voters when a administration comes into local authority, then I don’t think it’s a prudent activity of finance officers to recommend this kind of this kind of thing.” However, he said that if local taxpayers were aware of the risks “and are prepared to bear the council tax consequences of that, then that’s not illegitimate in any sense”.
Mike Jensen, director for investment at Lancashire County
Council also voiced concerns. “The idea of spending treasury money on things
like equity and property fills me with dread. The risk profiles of those
investments just are not understood by fixed income investment people and
certainly not by treasury advisors. So unless you take really specific advice
from people who know, those sectors wouldn’t touch with a stick.”
Easton worried that increasing activity in the area could result in more and
more formal restrictions on what councils could do with their money. Pointing
to the revisions to investment guidance, he said: “Where does this end? We’re
not financial institutions. And we don’t have to report like financial
institutions or be regulated as financial institutions. “But the more we go
down this path, and you know, the government are looking at this question,
then, are we going to create a scenario where there will be further regulation
around this area?”
Tim Seagrave, group finance lead – capital & treasury management – at Manchester City Council agreed that councils should not borrow to invest. But he voiced frustration about the amount of attention that has been focused on this topic. Using the example of business rate appeals, he said: “I think if we’re going to look at the question of where the local authorities should borrow to invest, and look at the issue of local authority, resilience, together, then that means to look up the whole balance sheet, not just decisions that local members are making about local priorities. There are things on a balance sheet that are not widely in the open, they’re not reported.”
Webster backed the point, saying: “If you look at the business rates regime, both in terms of its underlying behaviour, revaluations, and then the total uncertainty of appeals, the volatility risk to revenues there far exceeds you perhaps investing £10m of your reserves in an equities fund. It’s absurd to generate a load of focus on a second order issue when there are really very, very large ones are much more fundamental level.”
LA-to-LA lending
Appetite for inter-authority lending remains buoyant. Twice as many councils predict an increase in borrowing from other councils next year as those forecasting a reduction, according to the 2019 Room 151 Treasury Investment Survey. And the panel was in agreement that this was for very good reason.
Jensen said: “Anything that gets us away from lending unsecured to banks and building societies has to be a positive.” He said that government intervention to help Northamptonshire County Council overcome its financial problems showed that the sector was a “comfort area” for lending, “which should continue to grow and grow”. However, he said that the current approach of limiting such borrowing and lending to short-term durations was a “tactical mistake”.
Webster said he was a big fan of inter-local authority lending, describing it as “effectively internal borrowing at a large scale”. He said: “That is a financial efficiency in a way that doesn’t generate the same risk that other means of achieving outperformance or savings might do.”
An audience member from the floor asked the panel whether the inter-authority lending market would continue if interest rates turned negative. Jensen said he thought it would. “I think ultimately, if you have nowhere else to go, and need the security of credit that local authorities bring you, would you want to lend to a local authority at minus 10 basis points or would you want to lend to the unringfenced side of NatWest at negative 10 basis points?”
Low long-term interest rates
Another recent trend has seen a number of local authorities pull out of some of their short-term debt loans to other local authorities in order to take advantage of the cheap long-term rates on offer from the PWLB. The panel was asked whether this had affected their treasury investment strategies.
Easton said: “At Birmingham we only have investments for treasury purposes as opposed to service delivery purposes in order to provide a short-term liquidity buffer. We have maintained a substantial short-term borrowing book ever since the bank crisis, and we must have saved millions and millions as a result of of doing that versus borrowing long term. Strategically, we see that position continuing.”
However, he said that the authority has taken advantage of some of the longer term rates on offer. He said: “We have borrowed long term to the detriment of the size of that short-term portfolio in the short term, but I’ll be expecting over time to be rebuilding the short-term portfolio.”
Jensen said that his authority had repaid all of its long-term debt at the start of this decade. He said: “I have run shorter, much like Martin, ever since. Recently, we have started taking a little bit of long-term money but only a little bit – 5% maybe of the the total portfolio with an aim possibly to do another 5% if rates revisit the absolute lows we saw a few weeks back.”
Financial derivatives
The thorny question of how much use local authorities should make use of financial derivatives to cover their risk was raised by an audience member. Webster said: “A lot of these things, if you are using them for risk management purposes, are very easy to understand and can lead to very good outcomes. And obviously, they are much less easy to understand as investments in their own right. And that’s not something that I would recommend for a public body.”
Jensen was even more enthusiastic. He said: “Frankly, not using financial risk management derivatives, given the size of our balance sheets, and their nature, is pretty close to negligent, I would suggest. It is not a popular opinion. But I think if there was another accident, we will pay the price.”
