Testing Times for Treasury Management

1
Testing Times for Treasury Management

• Implications for the Public Sector

Mike Griffiths Lead Associate CIPFA Treasury
Management Forum
2
Testing Times

• Accounting changes the 2007 SoRP
• PWLB changes differential repayment yields
• Financial market changes yield curve shifts
• Iceland provokes greater scrutiny of treasury
  management practices
• Established financial market beliefs are
  questioned

3
What CIPFA has been doing

• Treasury and Investment Management in Local
  Government Guidance Notes for Practitioners
  (November 2007)
• CIPFA Treasury Management Panel Discussion Paper
  on Risk Management (October 2008)
• CIPFA Treasury Management Panel Bulletin
  Treasury Management in Local Authorities Post
  Icelandic Banks Collapse (March 2009)

4
The 2007 SoRP

• STRGL, fair value, disclosures
• Focus on objective setting, economic cost and
  fair value, risk controls
• Concentrates attention on implications of
  grossing-up of interest rate risk inherent in LA
  approach to borrowing and investment
• Offers potential to identify and manage
  investment risk more effectively

5
Leveraging risk? Interest rate and credit?

• Borrowing (60bn)
• Long duration
• UK government credit
• Investment (30bn)
• Short duration
• Bank and building society credit
• If you were starting from scratch is this where
  you would want to be?

6
Treasury and Investment Management in Local
Government (2007)

• whilst a long-term borrowing/short-term
  investment
• strategy may not have been inappropriate at the
  start
• of a period when interest rates across the yield
  curve
• were set to rise from a low level, this general
  stance is
• one that has tended to be held by local
  authorities
• throughout the market cycle and, by definition,
  it
• involves the adoption of a huge degree of
  interest rate
• risk (given that an alternative would be for
  local
• authorities to immunise an element of interest
  rate risk
• by repaying debt)
• this approach also creates a higher degree of
  credit risk

7
Treasury and Investment Management in Local
Government (2007)

• In borrowing long-term while investing
  short-term, local authorities may effectively be
  grossing up to the expression of an 85bn (90bn
  now) view that interest rates will be going up.
  An alternative approach might have been either
  to repay debt or otherwise immunise an element of
  the interest rate risk, which could be brought
  down to a net 25bn (30bn now) view
• It is in recognition of the fact that interest
  rate views can be wrong that organisations
  establish neutral, least-risk positions for their
  portfolios of financial instruments and use
  these benchmarks to gauge and temper the risks
  they are running
• Defining objectives, and setting the appropriate
  benchmarks to meet those objectives, should be a
  discreet and individual process for each
  authority

8
Discussion Paper on Risk Management (October
2008)

• The treasury risk management agenda
• At the basic level, the management of risk is all
  about recognising the possibility of different
  outcomes and trying to make sure that activities
  are directed towards making an acceptable set of
  outcomes more likely
• The risk management agenda is about making sure
  that everything possible is done to make sure
  that local authorities are equipped to the best
  of their ability to manage treasury management
  risk effectively
• Aim to strengthen the culture of risk management
  awareness in local authorities
• Authorities are encouraged to understand their
  exposures understand the treasury products and
  techniques which are available to them develop a
  cohesive strategy based on achieving a set of
  explicit objectives within a risk-controlled
  framework and implement it

9
Discussion Paper on Risk Management (October 2008)

• The Treasury Management Toolkit
• Clearly defined objectives
• Neutral or benchmark positions
• A recognised approach to sensitivity analysis
• Market-standard techniques to assist
  decision-making
• Emphasis on monitoring total or net treasury
  exposures
• Training and skills development, including an
  accredited qualification
• A practitioners manual of treasury principles
  and techniques

10
Treasury Management in Local Authorities Post
Icelandic Banks Collapse (March 2009)

• Revised TM Code and Guidance
• Treasury Management Objectives
• adequately reflect risk
• diversification should be a key component
• Governance Arrangements
• member training and involvement
• role of Director of Finance in treasury
  management
• Monitoring
• Gross and Net Borrowing
• recognise risks where substantial variation
  between gross and net debt
• make reasons explicit

11
Treasury Management in Local Authorities Post
Icelandic Banks Collapse (March 2009)

• Skills and Training
• adequate resources and understanding of risks
• CIPFA/ACT qualification June launch
• risk management paper prospective development
  of practical guidance and toolkits
• Counterparty lists
• credit ratings use with understanding of
  limitations
• supplement with other sources of information
• apply tiering and diversification framework
• Use of TM advisers
• responsibility for investments and borrowing
  remains with authority
• be clear on status of service being received
• Benchmarking
• Not just yield but should reflect risk inherent
  in TM activities

12
Its not just about Iceland!

• The need for a balanced response
• Icelandic losses focused attention almost
  exclusively on credit risk
• Audit Commission report Risk and Return may
  exacerbate a focus on credit risk to the
  detriment of a more balanced approach to the
  range of risks which need to be managed.
• Do no harm! There are no panaceas for replacing
  the misplaced role of credit ratings
• But a fundamental understanding of all treasury
  management risks, how they interact with each
  other and how far they can be controlled, is a
  good start