Investments in Icelandic Banks

Report: 07
Date: 5 March 2009
By: MPA Chief Executive

Summary

The MPA Finance and Resources Committee requested an external independent specialist review into the investment of funds in Landsbanki. KPMG were subsequently appointed. The findings from the KPMG review compliment and support the initial work reported to the Finance and Resources Committee in November 2008 by Internal Audit.

KPMG has reported and made a number of recommendations. If the recommendations contained in the review report attached at Appendix 1 are implemented, senior management will have better oversight of investments being made, along with the associated risks, and will be able to give a more informed level of challenge. It is the opinion of KPMG that had these been in place, this may have resulted in a different investment decision being taken when placing the £10m with Landsbanki on 3 July 2008 for 12 months. Effective management challenge and the monitoring of market information may have prevented the investments with Landsbanki as market information, such as credit default swap prices, was available during 2008, which indicated the deterioration of the creditworthiness of Landsbanki

KPMG report that the investment of funds with Landsbanki by the Treasury Management team was in compliance with the treasury management and investment strategy 2008/09. However, to minimise the risk going forward KPMG recommend that:

1. The roles and responsibilities of the MPA and MPS for treasury management are clearly defined in one single document.
2. The financial regulations and the treasury management policy are updated and aligned in respect of individual roles and responsibilities.
3. Communication of treasury operations between the MPA Treasurer, the MPS senior management, MPS treasury team and the Finance and Resources Committee are improved.
4. The Finance and Resources Committee and the Treasurer receive sufficient information to enhance their oversight and challenge of treasury management.
5. The treasury management team collect additional information on counterparties such as credit default swap prices, counterparty share price and additional credit ratings from S&P and Moody. The detail of the recommendations are detailed at Appendix 1, pages 6-17.

A. Recommendations

That

1. members receive the attached report (appendix 1) from KPMG into Icelandic investments;
2. the Treasurer amend the investment strategy to reduce the sector limit on overseas banks (currently set at £200m) with immediate effect;
3. the Treasurer, in consultation with the MPS Director of Resources and the MPA Director of Internal Audit, produce an action plan in response to the recommendations in the attached report;
4. the Treasurer submit the action plan to the next meeting of the Finance and Resources Committee for approval; and
5. the MPA Corporate Governance Committee monitors implementation of the approved action plan at its quarterly meetings.

B. Supporting information

1. In November 2008, Finance and Resources Committee received a fact-finding report from the Director of Internal Audit concerning MPA investments in Icelandic banks. The Committee resolved to commission an external independent specialist review to establish whether appropriate actions were taken to protect the Authority’s investments and to determine if any action should be taken and whether any further lessons could be learnt.

2. KPMG was engaged to conduct the review and their report is attached as Appendix 1. The conclusion and key findings are contained in the executive summary of the report and the detailed findings and recommendations in the main body. The key findings against the terms of reference are summarised below.

To confirm the process leading to Icelandic banks being approved as suitable counterparties for the depositing of MPA funds was adequate.

3. KPMG confirms that Landsbanki was a valid counterparty in accordance with the MPA Treasury Management and Investment Strategy 2008/9. KPMG found that when the Treasurer and officers of the MPS proposed the addition of the three largest Icelandic banks to the lendlist in February 2008, the credit default swap prices for Landsbanki were in the region of 250 basis points (bps). Whilst this information, if available, may have not been sufficient to prevent the Finance and Resources Committee from approving the proposal, the subsequent monitoring of credit default swap prices would have highlighted the market’s increased concerns over the credit worthiness of the Icelandic banks and may have resulted in the decision to remove Landsbanki from the lendlist.

To establish the facts relating to the depositing of MPA funds with the Icelandic bank, Landsbanki, and confirm (a) that the investments were made in compliance with the MPA Treasury Management Strategy 2008/9, and (b) appropriate decisions and actions were taken in response to market intelligence when placing investments.

4. KPMG concludes that the investments with Landsbanki were made in compliance with the MPA Treasury Management Strategy 2008/9. However, if the recommendations contained in the KPMG report were in place, senior management would have had better oversight of investments being made, along with the associated risks, and would have been able to give a more informed level of challenge on the investment decisions. This may have resulted in a different investment decision when placing the £10m with Landsbanki on 3 July 2008 for 12 months and a timely challenge from the Treasurer and senior management after the investment was placed.

5. KPMG also found that market information, such as credit default swap prices, was available during 2008 which indicated the deterioration of the creditworthiness of Landsbanki. They conclude that effective management challenge and the monitoring of market information, such as credit default swap prices, may have prevented the investments with Landsbanki.

To obtain an understanding of the use of advisers and ratings agencies in the investment process and recommend a strategy for the use of advisers.

6. KPMG recommends that the benefits obtained by the MPS dealing directly with counterparties and/or using an online dealing portal be investigated. Additional information on counterparties should also be collected such as credit default swap prices, counterparty price and additional credit ratings from S&P and Moody.

To review the MPA Treasury Management Strategy for 2008/9 (as originally approved in February 2008) and its operation, to confirm that the policies and procedures in operation represent good practice and are in line with those employed by comparable public bodies.

7. KPMG makes a number of recommendations regarding treasury management policy and its application within their report. The Policy Statement, that the MPS Finance Directorate exercise the treasury management function under delegation from the Treasurer, was approved by the inaugural Finance, Planning and Best Value Committee on 20 July 2000. This was drawn up and approved at the time the Authority was established and now needs updating.

To form an opinion on the operation of the treasury management function of the Authority and MPS in relation the deposits made with Icelandic banks and whether or not the loss or freezing of the funds could and/or should have been avoided; or the extent to which this could have been mitigated.

8. In forming their opinion on the operation of the treasury management function of the Authority and MPS, KPMG conclude that the delegation of authority for treasury management by the MPA, as set out in the financial regulations and supplemented by the treasury policy, is not clearly or consistently documented. They conclude it is not, therefore, clear what the roles and responsibilities are for named posts within the MPA and MPS in respect to treasury management and that this combined with insufficient reporting and communication of treasury operations between the MPA Treasurer, the MPS senior management, MPS treasury team and the Finance and Resources Committee has resulted in an inadequate level of management oversight of treasury management.

To make recommendations, where necessary, in relation to the MPA Treasury Management Strategy, as revised on 20 November 2008, or the MPA/MPS procedures that would mitigate the risk of funds being lost in the future.

9. KPMG has concluded that the MPA Treasury Management Strategy, as revised on 20 November 2008 is conservative and appropriate for the current climate. Consideration will need to be given to the impact on the MPA budget and the MPA’s attitude to risk and return. The Authority is also advised to revise its investment guidelines to reflect the current economic climate and in particular to set a lower sector limit for deposits in overseas banks.

10. The KPMG report contains twenty-two recommendations – twelve high risk, six medium risk and four low risk. The action plan proposed in recommendation 2 at the start of this covering report will result an action plan to implement the KPMG report being brought before the next meeting of this Committee.

C. Race and equality impact

There are no race and equality implications from this report.

D. Financial implications

1. The Authority may in the long term recover wholly or in part the £30m invested with Landsbanki in July and September 2008 but the position remains unclear at this stage. The Authority is also bearing the loss of interest on the investment.

2. The specialist review has cost the Authority £28,000.

E. Risks

1. Failure to take appropriate action in response to the recommendations by KPMG could put further funds at risk.

2. If appropriate action is not taken regarding the extent of the use of overseas banks that further funds could be at risk.

F. Contact details

Report author(s): Jane Harwood, Assistant Chief Executive, MPA.

For more information contact:

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

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