Banking and RBS update

Report: 6
Date: 20 October 2011
By: MPA Treasurer

Summary

This report provides members with an update on the banking sector and the MPA banker Royal Bank of Scotland (RBS)

A. Recommendations

That members

1. note this report and amendments to the investment counterparty list;
2. Approve the continued use of the Royal Bank of Scotland for temporary overnight balances and for Proceeds of Crime Act (POCA), other detained funds and Police Property Act Fund (PPAF) monies.

B. Supporting information

1. The 2011/12 Treasury Management Strategy Statement and Investment Strategy, approved by Finance and Resources Committee on 24 March 2011 and Full Authority on 31 March 2011, set out the MPA objectives for managing treasury management risk. In seeking to manage credit and counterparty risk, the MPA adopted a set of criteria that investment counterparties must satisfy in order to provide a counterparty list of high credit quality.

2. With guidance and assistance from the MPA treasury advisors Arlingclose, the high credit quality assessment of a counterparty includes credit ratings provided by the three rating agencies Standard and Poors, Moody’s and Fitch. Counterparties must satisfy at least the minimum of a number of short term and long term ratings. These ratings, along with a range of other indicators that build up a comprehensive picture of credit strength, are continuously monitored and reviewed. Should a counterparty fall below the minimum credit rating criteria or there are other concerns about the credit quality of an institution or sovereign, they will be suspended from the list and be no longer available for new investments.

3. During August and September 2011 concerns began to emerge about French banks’ funding and sovereign exposure to other European nations, notably Greece. Due to this negativity towards French banks, which saw share prices fall markedly, Arlingclose advised that the three French banks on the MPA counterparty list are suspended for future investments even though their credit ratings remain at or above the minimum required. Furthermore following concerns about support from its principal National Australia Bank and the downgrade of Australia’s sovereign rating, the credit rating of Clydesdale bank fell below the minimum required and was suspended from the counterparty list.

4. On 7 October 2011 Moody’s announced the results of their review of UK institutions, which included a reassessment of systemic support in the UK. The resulting downgrades included a two step downgrade to two institutions on our counterparty list, Nationwide Building Society and Royal Bank of Scotland (RBS), meaning these institutions no longer met the minimum threshold of the A1 long-term rating. In line with the requirements of the treasury management strategy and advice from Arlingclose these institutions were suspended from the counterparty list for new investments.

5. Furthermore, on 13 October 2011 Fitch also announced downgrades to RBS but additionally downgraded Lloyds Banking Group to A, meaning it no longer met the minimum threshold of the A+ long-term rating. Again in line with the requirements of the treasury management strategy and advice from Arlingclose, Lloyds Group were suspended from the counterparty list for new investments. Call money of £35.0m was withdrawn on the 14 October and invested elsewhere.

6. A summary of counterparty suspensions are included on the 2011/12 counterparty list at Appendix 1.

7. While Moody’s and Fitch downgrades do not represent deterioration in the financial strength of the UK government or the banking system they do recognise that the government is now more likely to allow smaller institutions to fail if they get into financial difficulty. However, RBS remains 84% government owned, Lloyds Banking Group 43% government owned and along with Nationwide are key components of the UK economy and could not be allowed to fail. In the event of a catastrophic financial failure with the government meeting its obligation to guarantee £85,000 to private investors then there may be an increased risk to wholesale deposits.

Royal Bank of Scotland

8. Adhering to the approved investment strategy and Arlingclose advice means in practice that funds of £35.0m have been withdrawn from the RBS call account (in addition to the £35.0m withdrawn from the Lloyds call account). Liquidity will be maintained by using short-term placement with other counterparties.

9. The MPA has a four year contract for banking services with RBS, awarded in March 2011. The suite of MPA bank accounts is maintained so that the net position of credit and debit balances across the accounts is kept to a minimum and any surplus invested. Clearly the MPA will continue with these arrangements but from time to time, due to operational purposes such as the late receipt of funds, deposits may need to be retained temporarily either overnight or over the weekend Arlingclose recognise that the MPA bank with RBS and may use them on a temporary basis for operational and contingency purposes in these circumstances and members are asked to approve this arrangement..

10. Additionally under the banking contract RBS offer a third party monies facility where seized POCA funds or funds relating to other detained monies and the Police Property Act Fund are separately maintained. Balances of about £37.0m are currently held in over 5,500 individually named accounts and it is not feasible to arrange alternative contracted arrangements with another supplier.

Revenue Implications

11. The revenue implications of withdrawing £70.0m from the high yielding Lloyds Banking Group and RBS call accounts, with funds placed elsewhere at a less attractive rate, is estimated to be £0.3m per annum.

C. Other organisational and community implications

Equality and Diversity Impact

1. Consideration is given to the requirements of equality legislation through the Ethical Investment Policy whereby best practice standards are promoted. The MPS Ethical Investment Policy was considered and approved by Resources Sub Committee on 16 March 2009.

Consideration of MET Forward

2. The Treasury Management Strategy 2010/11 defines MPA treasury management activities as ‘the management of the organisation’s investments and cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks.”

3. The achievement of optimum performance from treasury management activities, by maximising yield from cash balances invested and minimising the cost of borrowing while effectively controlling associated risk, supports the objective of achieving better value for money.

Financial Implications

4. The financial implications have been discussed in the report.

Legal Implications

5. This is a financial report primarily for information only.

6. The Treasurer’s responsibilities are set out in the Financial Regulations under Part E of the MPA standing orders. In accordance with those standing orders, the Treasurer is responsible for advising the Authority on all matters relating to treasury management, investments and borrowing, and for ensuring that treasury management arrangements are in compliance with the CIPFA Code of Practice for Treasury Management in Local Authorities. This report fulfils this requirement.

Environmental Implications

7. There are no direct environmental impacts arising from the treasury management activity discussed in this report. However the MPA ethical investment policy seeks to avoid the investment of funds in organisations whose core activity contributes to significant negative environmental impacts the MPA will not invest funds in any organisation involved in animal testing, the fur trade and blood sports.

Risk Implications

8. The risks associated with treasury management activity are addressed by the CIPFA Code of Practice and set out in Treasury Management Practices. Furthermore the Treasury Management Strategy 2011/12 sets objectives to identify, monitor and control risk. Specifically the objectives and the associated areas of risk covered are:

• To undertake treasury management operations with regard for the security of capital invested (Credit and Counterparty Risk)
• To ensure that sufficient cash is available such that the MPA is able to discharge its financial obligations in accordance with approved spending plans (Liquidity Risk)
• To minimise the cost of borrowing and to maximise the yield from investments consistent with the security and liquidity objectives identified above (Market or Interest Rate Risk)
• To minimise the amount of borrowing to be replaced at any one time by maintaining an evenly spread maturity profile (Refinancing Risk)
• To undertake treasury management activity with regard to Prudential Code Indicators (All areas of Risk)

The suspensions from the MPA counterparty list discussed in this report deal directly with the credit and counterparty risk associated with the security of capital invested

Roles and responsibilities for treasury management are clearly established and set out in the Treasury Management Policy Statement 2011/12 and includes regular review, reporting and scrutiny of treasury management activity.

D. Background papers

None

E. Contact details

Report authors: Paul Daly, Director of Exchequer Services, MPS

For more information contact:

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

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