MPA Investments into Icelandic Banks

Report: 13
Date: 20 November 2008
By: MPA Director of Internal Audit

Summary

On 8 October 2008 the Icelandic bank, Landsbanki, was nationalised. The MPA had two outstanding investments totalling £30m with Landsbanki at this time. £10m was placed on long-term deposit on 3 July 2008 and £20m on short-term deposit on 23 September 2008.

At the request of the Finance and Resources committee, Internal Audit has conducted inquiries relating to the Authority’s investments with Landsbanki. The evidence gathered through reviewing documents and holding fact-finding interviews with MPA and MPS staff has led to the conclusion that the potential £30m loss could have been avoided.

On 3 April 2008 the Treasurer had sought urgent advice from the MPS as to whether the Authority should be holding off from investing in the Icelandic sector. In particular he expressed concern about investing with Landsbanki and Kaupthing. The MPS gave the Treasurer an assurance that they would not renew any future loans with Icelandic banks but would continue to monitor the situation.

In the event no steps were taken to remove Landsbanki from the lendlist. As a consequence the MPS investment manager, having held off investing in April and May, was able to resume investments in June 2008 without consultation.

The Treasurer was not informed that investments had re-commenced in Landsbanki and that the MPS continued to place around £30m with them from 4 June 2008 onwards up to the point of nationalisation.

A. Recommendations

That members receive the Internal Audit findings report in relation to the investments with Landsbanki and consider if any further action is required.

B. Supporting information

Background

1. Overall responsibility for treasury management lies with the Authority through the office of the Treasurer. The Treasurer is responsible for securing appropriate banking arrangements and treasury management including loans and investments.

2. In November 2007 the MPS investment manager wrote a paper to the Director of Exchequer services, recommending that the lendlist should be expanded to include Icelandic banks. Subsequently this recommendation was discussed with the Treasurer and the use of Icelandic banks was then included as part of the report to the February 2008 Finance Committee that set out Treasury Management strategy for the year ahead.

Audit Findings

3. On 3 April 2008 the Treasurer wrote to the Director of Exchequer Services expressing concern about the use of Icelandic banks, and in particular Landsbanki and Kaupthing Edge. His e-mail sought urgent advice as to whether the Authority should be holding off from investing in the Icelandic sector. Later the same day the Treasurer received a reply from the Director of Exchequer Services, copied to the Director of Resources and the Acting Director of Finance, that concluded: However, in view of the Fitch report yesterday we have decided not to renew any future loans with Icelandic banks for the time being but will continue to monitor the situation. Throughout the rest of April and May there were no investments in any Icelandic bank.

4. The MPS mainly relies on Fitch ratings and reports to determine whether to lend money to particular banks on the lendlist. The Fitch report referred to in the e-mail from the Director of Exchequer Services put a Watch Negative mark against Landsbanki and the Icelandic sector. This did not change the overall rating but indicated that Fitch was reviewing the ratings.

5. On 7 May 2008 the covering memo to the Treasury Management Report for April 2008 to the Director of Resources and Acting Director of Finance from the investment manager referred to Icelandic banks, noting that: we have decided to put the Icelandic sector of our lendlist on hold and watch developments.

6. An assurance was given to the Treasurer in the e-mail of 3 April 2008 that investments in Icelandic banks were being placed on hold and this position was confirmed in the Treasury Management Report of 7 May 2008. However, no steps were taken to prevent investments being made with Landsbanki and other Icelandic banks. The lendlist was not amended and those responsible for authorising investment payments were not notified of the decision to place investments on hold.

7. The Fitch rating for Landsbanki did not change from the April 2008 rating through to the week before Landsbanki was nationalised. Fitch removed the Watch Negative mark on 9 May 2008 when they affirmed the outlook for Landsbanki as negative (the outlook given on 1 April 2008). On 9 May 2008 Fitch also downgraded the rating for Kaupthing and Glitnir banks and these were removed from the lendlist.

8. The MPS re-commenced investments in Landsbanki on 4 June 2008, when £30m was placed on short term deposit. The investment manager took the decision to resume investments without consultation and was able to do so as no steps had been taken to prevent this. The 4 June 2008 was a day when grant money was received and the investment manager had over £200m to place. The authorised limit for overseas bank investments was breached by £6m on 4 June 2008. The rolling £30m level of investment in Landsbanki continued until nationalisation.

9. The MPS investment manager’s covering memos to the Treasury Management Reports dated 6 June 2008 and 3 July 2008 to the Director of Resources, Acting Director of Finance and copied to the Director of Exchequer Services do not refer to investment in Landsbanki being resumed. Page 7 of the monthly reports does show that investment in Landsbanki had re-commenced but the recipients of the report did not note this. The Treasurer was not consulted or informed of the decision to re-invest and did not receive copies of the Treasury Management Reports for April 2008 through to September 2008.

10. On 3 July 2008 £10m was placed in long term deposit with Landsbanki, although the Fitch outlook remained Negative. MPS staff did not refer to the Fitch outlook assessment in making a decision about this investment. The Fitch outlook is not considered when placing investments unless it is Watch negative. Information concerning this investment was included in the monthly Treasury Management Report for July 2008 sent to the Director of Resources and Acting Director of Finance, copied to the Director of Exchequer Services.

11. On 23 September 2008 a short-term investment of £20m was placed in Landsbanki, that deposit was still with Landsbanki when they were nationalised.

12. The Treasurer expected to be consulted and informed if consideration was being given to re-investing with Icelandic banks and prior to any investments taking place following the Director of Exchequer Services reply to his e-mail of 3 April 2008. Monthly Treasury Management Reports went to the Director of Resources and the Acting Director of Finance.

13. The Treasury Management team held regular meetings with the Acting Director of Finance and also met regularly with the Director of Resources. No minutes are kept of these meetings. The Treasurer has quarterly meetings with the Director of Exchequer Services and the Treasury Manager but the meeting planned for this period did not take place. Both the Director of Resources and the Acting Director of Finance had regular weekly or fortnightly meetings (respectively) with the Treasurer but did not discuss any change of the stated position on Icelandic banks.

14. The Treasurer has stated that he had a reasonable expectation that any change to the agreed position would be discussed with him because of the e-mail response that he had received. Had the MPS continued the position set out in 3 April 2008 e-mail exchange and the covering memo to the May 2008 Treasury Management Report the Authority would not have had any money in Icelandic banks at the point when Landsbanki was nationalised.

15. The investment in Landsbanki was made in accordance with the Treasury Management Strategy approved by the Finance Committee on 21 February 2008 in that the Fitch ratings met the standard to remain on the lendlist. However, there was a lack of appropriate action in response to the e-mail exchange on 3 April 2008 that enabled the investment management to re-commence investments in June 2008.

16. Current market conditions will require adjustments to be made to the Treasury Management Strategy and a separate report to this committee contains recommended revisions to the strategy. However, the potential loss as a consequence of the investments in Landsbanki has resulted primarily not from a failure of process but from a failure to exercise effective management control.

Lessons learnt

17. Implementation of the following would enhance control of the treasury management function:

• The lendlist should be promptly updated to reflect any decision taken that affects the placing of investments. The lendlist and any changes to it should be approved in writing by a senior manager not involved in day-to-day treasury management transactions.
• Minutes are maintained of decisions and action points taken at all Treasury Management meetings.
• Greater emphasis should be placed on the outlook commentary on the Fitch reports.
• The monthly Treasury Management Report and its covering memo should be supplied to the Treasurer.
  

C. Race and equality impact

The MPS operates an ethical investment policy that is under on-going review.

D. Financial implications

The process for dealing with the fallout from the failure of Landsbanki is still at very early stages but there is optimism by local authorities that in time some or all of the funds will be recovered. The MPA has a strong balance sheet and the current position is manageable.

E. Background papers

Report (7) to Finance and Resources Committee: Icelandic Investments Update, 23 October 2008

F. Contact details

Report author(s): Peter Tickner, MPA Director of Internal Audit

For more information contact:

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

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