Icelandic investments update

Report: 07
Date: 23 October 2008
By: the Director of Resources on behalf of the Commissioner and Treasurer

Summary

This report provides members with the MPA position on exposure to Icelandic Banks, other MPA investments and future strategy.

A. Recommendations

That Members note this report and await the outcome of the internal audit review of investments with Landsbanki.

B. Supporting information

Icelandic Banks

1. MPA investments are made in accordance with the Authority’s Treasury Management Strategy, agreed by the Finance Committee on 21 February 2008, and comply with the CIPFA Code of Practice for Treasury Management in local authorities.

2. Following the initial impact of the credit squeeze and the Government support for Northern Rock in September 2007, the treasury sections of the GLA, its functional bodies and the MPS met to discuss the Greater London Authority group position. This confirmed that credit ratings across the group were consistent and provided an opportunity to discuss the alternative strategies within the group. Notably Transport for London, which manages a large investment portfolio, confirmed their use of Icelandic banks which had no exposure to sub prime debt and were dealing in all sections of the sterling market (retail, commercial, institutional and interbank).

3. Furthermore, conversations with brokers and other local authorities (many having contracts with treasury management advisory services) confirmed that the local authority sector was active in placing funds with Icelandic Banks. To increase the Authority’s ability to spread risk by the placement of funds across a wide range of institutions the Strategy 2008-09 extended the counterparty (or lending) list to include three Icelandic Banks that met MPA credit rating criteria as provided by Fitch Ratings.

4. Internal Audit report on Investments, Borrowings and Cash Management, dated January 2008, included the recommendation of an additional monthly check of counterparty credit ratings. This was accepted immediately. Also recommended was the consideration of other factors which could impact on counterparty creditworthiness. The response, as incorporated in the 2008-09 Treasury Management Strategy, is using professional expertise on the Treasury section other sources of information will be monitored. This will include press and other media comments, broker knowledge and analysis and networking with other local authority treasury practitioners.

5. Ratings continued to be monitored and in June 2008 Glitnir and Kauphing were removed from the counterparty list as a result of downgrading by Fitch Ratings. Landsbanki was reaffirmed as meeting the short term (F1), long term (A) and individual (B/C) ratings. This position remained until Landsbanki was downgraded by Fitch Ratings on 30 September 2008 and was immediately removed from the counterparty list although any existing deals cannot be recalled and must run through to maturity.

6. The Icelandic Government froze Landsbanki assets on 7 October 2008. Two MPA investments are outstanding totalling £30m:

Table 1- Outstanding MPA investments with Landsbanki

7. The UK Government continues to discuss with the Icelandic Government arrangements for the return of Local and Police Authority deposits which are understood to be in excess of £1bn. The Local Government Association and the Association of Police Authorities continue to put pressure on the UK Government for a speedy resolution.

8. The £30m of deposits frozen is approximately 8% of the MPA investment portfolio. The portfolio represents earmarked reserves and provisions, unapplied capital receipts and grants and cash flow balances. There is no immediate impact on the MPA being able to meet its commitments. The MPA has £40m cash on call and measures have been taken to cover the cash flow shortfall on 20 October 2008, which is the maturity date of the £20m deal.

9. The Director of Internal Audit on behalf of the Authority is conducting an urgent review of the action taken in placing £30m with Landsbanki. The outcome of this review will be reported to the next meeting of this committee.

The MPA Portfolio

10. To spread risk each financial institution on the lending list has an individual counterparty limit resulting in a spread of investments across the counterparties. Typically the portfolio will be made up of deposits made with about 15 to 20 counterparties.

11. The monthly portfolio is on average £300m and on 13 October 2008 had a balance of £366m with deposits with 18 counterparties. An analysis by sector is set out below:

UK Banks. Counterparties: 7. Individual limit £40m.

The MPA currently has £100m with three counterparties. Following the fall in the capital value of UK banks the Government’s support to this sector means that all deposits are underwritten and guaranteed by the Government. Three of the banks are part owned by the Government: Royal Bank of Scotland (60%), Halifax Bank of Scotland (43%) and Lloyds TSB (43%).

UK Building Societies. Counterparties: 18. Individual limit depends on asset value: £2m to £30m
The MPA currently has £56m with six counterparties. This sector will also receive Government support if required. The Building Society Sector also operates its own protection scheme in the event that an individual society requires support.

Foreign Banks. Counterparties: 15. Individual Limit £30m

The MPA currently has £210m invested with 9 counterparties (this includes the £30m deposit with Landsbanki). Following the collapse of the Icelandic Banks and the further lack of confidence in the banking sector Governments have been under pressure to offer guarantees for deposits and assistance in funding to their banks, similar to the UK and USA model adopted the week of 6 October.

The 15 Eurozone countries plus the UK have provided £1,465bn of support. Support is now provided to all the European banks on the MPA counterparty list by the Belgium, Dutch, French, German, Irish and Spanish Governments via the European Central Bank.

Australia and New Zealand have guaranteed all deposits in their banks. This will provide support to the two Australasian banks on the MPA counterparty list.

There are now no other foreign banks on the MPA counterparty list.

MPA Strategy

12. In contrast to the Icelandic Government’s actions the support that has now been guaranteed by Central Banks and Governments, as detailed above, gives a clear message that banking institutions in these countries will be supported. With these guarantees the current MPA portfolio is secure.

13. While the global initiatives should increase confidence in financial markets resulting in the turmoil and unprecedented recent events subsiding, investment decisions will be made that reduce exposure to risk. From August 2008 all investments have been short term (less that 30 days).

14. In accordance with normal practice, the annual review of the Authority’s Treasury Management Strategy is underway and will include a reassessment of counterparty limits and credit ratings, length of investments and will examine alternative investment opportunities.

15. Options and recommendations will be presented to Finance and Resources Committee in November as part of the annual six month Treasury Management stewardship report

E. Background papers

• Treasury Management Strategy 2008/09 – MPA Finance Committee, 21 Feb 2008, Report 7

F. Contact details

Report author(s): Simon Hart, MPS Acting Director of Finance.

For more information contact:

MPA general: 020 7202 0202
Media enquiries: 020 7202 0217/18

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