Download Subject: GLA Family Exposure to Counterparty Risk

Subject: GLA Family Exposure to
Counterparty Risk
Report Number: 11
Report to: Budget Committee
Date: 13 September 2001
Report of: Executive Director of Finance & Performance
1
Summary
1.1
This report presents the response from the core GLA to a member request for
more information on the GLA family-wide exposure to credit risk when placing
investments with financial institutions.
1.2
All information in this report pertaining to core GLA has been provided by each
of the functional bodies.
2
Background
2.1
The core GLA operates a Treasury Management function and each functional
body independently operates their own Treasury Management function in
accordance with local policies. Treasury Management involves the
management of each authority’s borrowing, its investments and the
containment of the obvious risks associated with carrying out these functions.
One of those risks involved is that the authority is not repaid in full or at all on
the day that monies fall due by the party on the other side of a trade i.e. the
counterparty. This may be for one of several reasons including the collapse of
the counterparty institution concerned. The GLA and its functional bodies
manage counterparty risks locally and at present no corporate strategy has
been formulated to manage the exposure to risk across the family
2.2
Any decision reached on whether to establish a GLA Group strategy will be by
way of mutual agreement between the S127 officers of the GLA and the
functional bodies who have the delegated authority for the implementation and
monitoring of the Treasury Management function within their organisations.
2.3
The report outlines the current arrangements within the core and each
functional body and concludes that existing arrangements manage risk.
However, other options considered by S.127 officers are outlined for
information.
Appendix 1 – Summary of arrangements
Appendix 2 – Joint counterpary list
Appendix 3 – GLA family counterparty limits options
3
CORE GLA
3.1
Introduction
All Treasury Management activities of the core GLA have been delegated from
the Mayor to the Executive Director of Finance and Performance (the core GLA
S.127 officer). The overriding objective of the core GLA Treasury Management
Investment function is to minimise the risks to the principal amounts invested.
The core GLA is conscious of the potential risks posed by counterparty
organisations not being able to fulfil their obligations to repay investments
placed with them and has built in controls within its policy and scheme of
delegation to ensure diversification and limits on investments placed in order
to minimise risk.
3.2
Criteria for selection
Only the most highly rated institutions are included within the core GLA’s
counterparty list. The main criterion for inclusion is that the institution is
rated by either of the three major credit agencies, Moody’s Investors Service,
Standard & Poors and Fitch IBCA. The core GLA has also appointed external
advisors whose responsibilities include the provision of a counterparty service.
They provide monthly updates of all our counterparties and their ratings from
all three bodies. This is further supplemented by their own in house research
and sector analysis together with a detailed investment matrix allowing the
core GLA to take informed decisions. The core GLA also receives, from its
advisors urgent notifications of institutions put under credit watch or
encountering other more serious problems that might lead to their demise.
The core GLA uses a combination of long term, short-term individual and
support ratings to determine the level of investment to place with counterparty
institutions. All the institutions with which we invest are rated by all three
agencies and have the highest short term rating and substantially high long
term ratings with sound individual financial strength and support ratings.
The highest amount that can currently be lent to any one institution is £25m.
3.3
Limits on Deposits
Specific dealing limits are placed to ensure that our exposure is limited and
diversified. In addition the time horizon of exposure is controlled and smaller
limits are placed for maturities scheduled beyond 6 months. Each day the
counterparty limit schedule is updated so the next dealer is aware of which
institutions the core GLA can invest with. On any given day four to five people
are involved in the process of dealing and transacting funds to a counterparty
bank account. The dealing verifier and supervisor check to see that the
counterparty limits have not been breached.
Due to the very short-term nature and high fluctuation of core GLA investments
mainly individual bank limits are maintained. However, institutional groups
are identified and though each institution within the group has an individual
limit, a limit is also assigned to the group as a whole. The institutional group
limit is paramount if one member of the group has a limit equivalent to the
group limit and has been invested with to it’s maximum investment limit, the
core GLA will not be able to invest concurrently with any other institution within
the group in question. Institutions are only grouped where a relationship is
formed by way of merger or acquisition (i.e. wholly owned subsidiaries).
The core GLA have also assigned a limit to its own bankers the Royal Bank of
Scotland (RBS). The effect of this being that even though funds are left with
RBS on days when their Corporate Money Market Account is offering a better
rate than the money market only their assigned limit is left in the bank. The
highest amount that can be lent to any one institution under the current agreed
strategy is £25m. The building societies all have a £5m limit except for
Nationwide, which has been assigned a £15m limit in view of its substantial
asset base.
3.4
Reporting Arrangements
Clear reporting arrangements exist within the core GLA and have been
incorporated within the core GLA scheme of delegation. The Executive Director
of Finance & Performance, being the officer to whom the Mayor has delegated
all treasury functions, is kept informed of all Treasury Management activities
on a weekly basis. All breaches are also reported immediately to the Executive
Director. In addition no investment is placed for longer than three months
without the prior agreement of the Executive Director of Finance and
Performance. The Treasury Section within the core GLA is subject to at least
one annual Internal Audit review, which examines all of the internal controls
surrounding the Treasury Management function. The recommendations are
reported to Executive Director of Finance and Performance and the Audit Panel.
3.5
Conclusion
The core GLA takes a local proactive approach to the containment of risk and
practices a robust diversification policy with respect to investments. The
Treasury Policy and annual strategy have been designed to ensure that there
are clear limits and guidelines to ensure effective management of the treasury
management function.
4.
TRANSPORT FOR LONDON
4.1
Introduction
TfL has developed a draft Group Treasury Policy for consideration by the
Finance and Audit Committee. This takes account of the CIPFA
recommendations contained in Exposure Draft March 2001 for Treasury
Management in the Public Service and will be revisited after CIPFA has
completed its consultation process and issued its Standard.
4.2
Criteria for Selection
With the exception of the Bank of England, all banks used are assessed using
the ratings systems of Moodys, Standard & Poors and, if a bank has not applied
for either of these, IBCA.
Ratings are updated every six months using Thomson Global Banking Resource
and bank-lending limits are reviewed at the same time.
For practical operating purposes the number of banks used is kept to no more
than a dozen.
Apart from the Bank of England, deposits secured by gilts (Gilts Repos) and the
UK Clearing Banks, limits are imposed by reference to a bank’s credit rating
rather than by sector.
4.3
Limits on Deposits
Limits applied are set out below
National Loans Fund account at the Bank of England
No Limit
Gilt Repos
No Limit
UK Clearing Banks
£30m
Other Banks rated PRIME 1
£25m
Other Banks rated PRIME 2
£20m
Other Institutions rated PRIME 2 introduced through brokers
£20m(in
total)
Our relationship banker is covered by the above criteria.
4.4
Reporting Arrangements
It is the responsibility of the individual authorising the payment (always a
mandated account signatory) to ensure limits/positions have not been
breached. If a breach were to be discovered this would be reported to the Group
Treasury Manager who is responsible for reporting this to the S127 officer.
5.
LONDON DEVELOPMENT AGENCY
5.1
Criteria for Selection
The LDA use The Royal Bank of Scotland (RBS) for all their banking services.
They were chosen as preferred banker primarily because the Greater London
Authority had already conducted a tender exercise, from which the RBS
emerged with merit.
As well as a current account facility, RBS undertake our automated treasury
management function. The LDA wants to adopt a minimal risk approach, and
use the corporate overnight money market rate offered by RBS. This has
proven to be competitive and offers instant access.
5.2
Limits
The cash flow forecasts used by the LDA dictate how much money is drawn
down by way of grant. The RBS treasury system automatically sweeps any
amount into the overnight accounts, and therefore the LDA do not at this time
operate a limit for treasury purposes with RBS. i.e. any unspent balance could
be invested overnight.
5.3
Reporting arrangements
The LDA report treasury management activity to the Performance and Audit
Committee (one of the LDA Board delegated committees), who are content with
matters at the present time. Were there to be any abnormal or irregular
activities this committee would be alerted. In addition the LDA has exceptional
reporting arrangements to the Board.
6.
METROPOLITAN POLICE AUTHORITY
6.1
Introduction
Section 127 of the Greater London Authority Act 1999 requires that each
authority shall ‘make arrangements for the proper administration of its
financial affairs’ and ‘shall secure that one of its officers has responsibility for
those affairs’. The Section 127 officer for the MPA is the Treasurer.
Under delegation from the Treasurer the Director of Resources of the
Metropolitan Police Service undertakes Treasury Management operations
(among other functions) within the Finance Directorate.
The Treasury Management Policy Statement was accepted by the MPA Finance,
Planning and Best Value Committee on 20 July 2000. This statement operates
within general principles including:


To undertake treasury management operations with primary regard for the
security of capital invested
To maximise the return on investments subject to (the point) above.
Investment instruments, prescribed by the Secretary of State, include deposits
with authorised institutions, (i.e. banks regulated by the Bank of England under
the Banking Act 1987), deposits with UK mutual building societies, and short
term loans to UK local authorities.
A list of approved organisations for investment (The Lending List) is maintained
by the Treasury Team.
6.2
The Lending List – Criteria for Selection
The financial institution section of the lending list is based on credit ratings
provided by Fitch IBCA, Duff & Phelps (Fitch). Fitch provides a monthly ratings
book and informs the MPS immediately by fax any rating changes or credit
rating warnings (both favourable and adverse). The ratings we use are
therefore always current.
Institutions that meet the criteria are added to the list. The individual lending
limit is determined by the institution’s size, based on its net worth, again
provided by Fitch IBCA but the MPS also refer to The Banker’s top 1000 banks
published each July. Additional information for Building Societies is obtained
from Butlers Building Society Guide compiled by Garban Intercapital. The MPS
also follow the financial press for comment on mergers etc but Fitch will always
provide their own summary of market developments.
A credit rating reduction below the minimum results in immediate suspension
from the list.
The MPS fully review the list annually. This is an additional measure to confirm
each institution’s credit rating criteria and enables a reassessment of the size
of the institution. This is carried out each July to coincide with the publication
of The Banker top 1000 banks.
Proposed additions to the lending list resulting from the MPS review will be
recommended to the Treasurer. The Treasurer similarly approves any other
changes to the list (for example the addition of foreign banks previously
excluded from the lending list).
6.3
Limits
Net worth is used to determine an institutions individual limit within a tiered
structure up to £25million. The majority of UK and foreign banks have a £20
million limit. The top tier also requires an institution is AAA rated (Fitch
criteria).
There is no limit with the MPS own bank, National Westminster Bank plc. In the
unlikely event funds cannot be invested on the money market they remain with
the MPS banker. A limit is not therefore appropriate.
The lending limit for local authorities is also tiered, based on SSA.
To maintain a balanced portfolio overall limits are imposed for the four market
sectors. Overall limits are imposed for these sectors and are reviewed as
required. Currently the maximum limits are:




6.4
£ Million
UK Banks
150
Foreign Banks
150
UK Building Societies
70
Local Authorities
70
Reporting Arrangements
A monthly report on investment activity includes analysis of sector size and
return achieved. A quarterly report on Treasury Operations is submitted to the
Finance, Planning and Best Value Committee.
If a limit is breached the Head of Exchequer Services or Head of Finance are
informed immediately. The Treasury Manager will provide a risk assessment
and analysis of events surrounding the breach with proposals for preventing a
similar future occurrence. The Treasurer will be advised of the breach at the
regular meeting with the Head of Exchequer Services and the Treasury Manager
when operational activities are discussed.
6.5
Conclusion
The lending list and the limits that apply to sectors and institutions are
designed to spread risk and provide a balanced investment portfolio. Credit
ratings that underpin the list are continually monitored to maintain the risk
adverse position of the MPA.
Sector and individual limits are monitored daily within treasury management to
ensure compliance with parameters set. Breaches are rare but are immediately
advised to senior management and subsequently reported to the Treasurer.
7.
LONDON FIRE EMERGENCY PLANNING AUTHORITY
7.1
Introduction
The Authority lends only to banks and building societies (both subject to credit
rating), nationalised industries or public corporations, Local and Joint
Authorities, and levying bodies, all of which are as laid down as approved
investments under the terms of the Local Authorities (Capital
Finance)(Approved Investments) Regulations 1990.
In addition the Authority has adopted the CIPFA Code of Practice for Treasury
Management in Local Authorities and has approved a Treasury Policy
Statement, which lays down the ground rules under which treasury
management activities are undertaken.
7.2
Criteria for Selection
The LFEPA have a contracted service with Fitch, the international ratings
agency, who provide unlimited faxed updates and news flashes relating to all
financial organisations rated by them.
Only those banks and building societies that meet LFEPA’s very tight criteria for
counterparties are added to our approved list. They are immediately removed if,
and when they fall below the ratings contained within our defining matrix. The
institutions have to be FSA listed, and licensed for operating within the
European Union.
The approved list is updated as often as is necessary, and copies provided to all
LFEPA’s money brokers. The list is also submitted regularly to Authority
meetings
7.3
Limits
The loan portfolio (at the day of lending) shall not exceed the following
percentage limits:30% per non UK country,
15% per institution,
50% overall limit to Local Authorities,
15% overall Building Society limit.
There is also a financial limit of £1 million and a term limit of 3 months to all
building societies (other than to the Nationwide), who must in any case be
credit rated by Fitch.
7.4
Reporting Arrangements
The Authority approves the lending strategy on an annual basis, monitors
activity on a quarterly basis, and receives an annual performance report after
the end of the financial year.
In addition fully reconciled monthly internal management reports are issued to
all senior management in the Directorate of Finance & I.T. (the Director is
currently the Section 127 Officer). Any problems concerning treasury activities
would be discussed with the Director as a matter of standard procedure.
Internal and external auditors regularly examine the treasury activities, and
any breach of the various statutory, Code of Practice and Authority
requirements would be reported to the Section 127 Officer.
8.
CREDIT RISK GLA FAMILY WIDE ISSUES
8.1
All bodies within the GLA family except the LDA have to operate a treasury
management function by virtue of receiving their budgeted income without
recourse to need. The preceding sections have outlined the current practice
within each organisation. However, to date no review has been carried out of
family-wide exposure. As shown above all the functional bodies operate a sound
counterparty risk management strategy using a combination of credit ratings
and exposure limits to manage risk. Appendix 1 is a matrix, which summarises
the position within each functional body.
Also, family wide approach would not reduce the overall exposure and funds
would be higher and therefore limits per institution would be higher see
Appendix 2
The deliberations leading to the S127 officers deciding that a family-wide
approach is not appropriate are outlined in Appendix 3.
9.
Strategic Implications
9.1
Proper and effective management of the treasury management function is an
essential element of the financial administration process within the core GLA
and functional bodies. The function also makes a significant contribution to the
resources available to each organisation in fulfilling their strategic objectives.
10.
Financial Implications
10.1 There are no direct financial implications from this report.
11.
Recommendations
11.1 That each body continues to operate its Treasury Management function
independently.
11.2 That a corporate register of GLA family-wide exposure is maintained and
updated and monitored.
11.3 That any significant changes to Group-wide exposure are reported to the GLA
S.127 officer group.
Background papers: None
Contact Officer: Bridget Uku, Finance Manager, Treasury
Tel: 020 7983 4252
Appendix 2
APPROVED LIST
LIMIT IN £
MILLIONS
GLA
TFL
MPA LFEPA
BUILDING SOCIETY
Bradford & Bingley
Britannia
Chelsea
Cheshire
Coventry
Derbyshire
Dunfermline
Leeds & Holbeck
Nationwide
Newcastle
Norwich & Peterborough
Nottingham
Portman
Principality
Skipton
West Bromwich
Yorkshire
5
5
5
5
5
3
3
3
15
3
3
3
5
3
5
3
5
15
15
2
2
4
2
Local Authorities
**
70
up to
£1m
10
20
5
UK CLEARING BANKS &
SUBSIDIARIES
Abbey National pl Time Deposit Ledger
2260
Abbey National plc Business reserve R15237396GRE
Alliance & Leicester
Bank of New York Europe
Bank of Scotland
Barclays Bank
Halifax plc
HSBC plc
Lloyds TSB Bank plc
co-operative Bank
National Westminster Bank plc
- Ulster Bank Markets
Nothern Rock plc
Royal Bank of Scotland
- Royscot Trust
1
1
2
20
2
4
2
2
2
10
1
1
1
10
10
5
20
25
20
20
20
25
5
5
25
5
TOTAL
20.00
21.00
7.00
7.00
10.00
5.00
3.00
5.00
35.00
3.00
5.00
3.00
9.00
6.00
8.00
5.00
16.00
35.00
10.00
25
30
30
20
25
25
20
5
20
20
20
20
20
5
5
5
5
0
5
20
5
60.00
5.00
45.00
50.00
45.00
75.00
70.00
20.00
55.00
5.00
5.00
75.00
5.00
- Adam & Co.
Woolwich plc
N M Rothschild & Sons LTD
Merril lynch
Robert Flemming & Co
Standard Chartered
5
10
20
5
5
25
5.00
10.00
20.00
5.00
5.00
25.00
OVERSEAS BANKS
AUSTRALIA
Australia and New Zealand Banking
Group
Commonwealth Bank of Australia
National Australia Bank Ltd
Westpac Banking Corporation
10
10
20
10
20
20
5
15.00
5
5
5
35.00
45.00
15.00
AUSTRIA
Bank Austria
10
BELGIUM
Banque Brussels Lambert
Fortis Bank NV
KBC Bank NV
10
10
10
5
5
5
15.00
15.00
15.00
CANADA
Bank of Montreal
Bank of Nova Scotia
Canadian Imperial Bank of Commerce
Royal Bank of Canada
Toronto Dominion Bank
National Bank of Canada
10
10
10
20
10
5
5
5
5
5
5
15.00
15.00
15.00
70.00
35.00
5.00
DENMARK
Danske Bank International
Jyske Bank
10
5
5
15.00
5.00
5
20
5
5
5
5
10.00
40.00
5.00
5.00
60.00
5
5
5
20.00
5.00
20.00
40.00
25.00
FRANCE
BNP Paribas
Credit Agricole (Casse nationale de)
Credit Agricole Indosuez
Credit Commercial de France
Societe Generale
GERMANY
Bayrische Landesbank Girozentrale
Commerzbank
Dresdner Bank AG
Deutsche Bank A G
Hamburgische Landesbank Girozentrale
10
20
5
15
15
20
10.00
25
20
20
20
25
20
20
Landesbank Baden-Wurttemberg
Landesbank Berlin Girozentrale
Landesbank Hessen Thuringen
Girozentrale
Landesbank Schleswig-Holstein
Girozentrale
Landeswirtschaftliche Rentenbank
Norddeutsche Landesbank Girozentrale
Westdeutsche Landesbank Girozentrale
Hpovereins(HVB)
IRELAND
Allied Irish Bank Corporation plc
Bank of Ireland
DePfa Bank Europe plc
20
20
20
20
25
20
20
20
20
10
10
5
NETHERLANDS
ABN Amro Bank NV
NV Bank Nederlands Germeenteen
Rabobank International
Bank Nedelandse Gemeenten
ING Bank
NIB Capital bank NV
20
20
20
20
20
5
45.00
20.00
20.00
5.00
5
5
5
15.00
15.00
30.00
5
5
5.00
5.00
5
45.00
5
5.00
20
5
25
20
5
5
5
45.00
20.00
50.00
20.00
5.00
5.00
5
5.00
5
10.00
5.00
20.00
20.00
5
15.00
20
20
PORTUGAL
Banco Commercial Portugues
SPAIN
Banco Bibao Vizcaya Argentaria
Banco Santander Central Hispano
Banco Popular Espanol
Caja de Ahorros y Monte De Piedad De
Madrid
SWEDEN
Svenska Handelsbanken AB
5
5
5
20
20
10
45.00
50.00
25.00
20.00
ITALY
San Paolo IMI
Unicredito Italiano
LUXEMBOURG
Dexia Banque Internationale a
Luxembourg
Banque Generale Du Laxemburg
5
5
5
SWISS
Credit Suisse First Boston
UBS AG
USA
Bank of America
Bank of New York
Bank One
Chase Manhattan
Citibank
First Union National Bank
Morgan Guaranty Trust Company of New
York
GURNSEY
Kleinworth Benson
10
20
25
10
10
5
20
20
5
20
5
5
15.00
50.00
5
15.00
10.00
5.00
25.00
25.00
5.00
25.00
5
5
5
7
7.00
Appendix 3
GLA FAMILY COUNTERPARTY LIMIT
One option is to formulate and operate a GLA Group wide exposure limit for all
counterparty institutions.
Disadvantages
This option will not be practicable because the Treasury Management function of
the GLA Group is not consolidated. It would be unrealistic to expect all the various
Treasury officers to liase each day to establish which institutions are clear to be
invested with. Breaches could occur regularly under such a scheme.
ASSIGN PARTICULAR INSTITUTIONS TO THE CORE GLA & EACH FUNCTIONAL
BODY
Disadvantages
All institutions will be disadvantaged because this would restrict their
diversification strategy. They will each have fewer banks to deal with and may find
that they have difficulty offloading their investments. This could lead to increased
risk as funds may have to be left with the functional bodies own bank which is not
risk free as it may cause them to breach the limit assigned to their own bank.
Best value principles and S.127 responsibilities require the core GLA and all its
functional bodies to ensure that they obtain the best rates whilst securing the
principal sum involved. It may be that an institution assigned to a particular
Functional Body is not invested with on a given day, however all other GLA Group
members would be precluded from investing with the institution concerned even
though they may be offering the best rate of the day.
It will be difficult to allocate approved institutions to each functional body for a
number of reasons. The core GLA for instance have a large counterparty list, but
mainly deal with a handful of these institutions as they are the institutions
prepared to take the smaller sizes that the core GLA mainly invest on the money
market. Furthermore, some Functional Bodies and the core GLA have established
direct dealing lines with various banks, and it would be unreasonable to expect
them to sever these established relationships.
GENERIC FAMILY–WIDE LIMIT, ALLOCATED ACROSS THE GLA AND
FUNCTIONAL BODIES.
Under this option the GLA Group would establish a framework around which there
can be corporate as well as local management of exposure to counterparty risk.
This would entail the section 127 Officer group reaching a consensus on the
maximum exposure the family is prepared to have with each counterparty or class
of counterparties. Where more than one functional body use a particular
counterparty, individual limits would be allocated amongst the organisations
concerned. Effectively, where the individual limit allocated is more than the
functional body’s local counterparty limits, their individual counterparty limit
would be paramount. However, where the limit allocated to the individual
functional body is less than it’s local counterparty limit then the limit allocated by
the core GLA will become paramount. Where there are no conflicting demands
between the core GLA and functional bodies more flexibility can be built around
this option to accommodate local needs.
The GLA as a whole has a budget of some £3 billion and it would be unreasonable
to expect the generic limit set for each institution to be £20m as this would make
it virtually impossible for the core GLA and functional bodies to manage their
treasury dealing functions effectively, especially where more than one party use
the same institution. The generic counterparty exposure limit set for the GLA
Group would therefore have to be substantially higher than the current individual
limits that exist within each functional body.
However, it can be argued that since each body currently takes a proactive
approach to the management and monitoring of their counterparty exposure the
GLA Group exposure (i.e. the aggregate) should not exceed an amount considered
too high for an organisation of this size i.e. if we have combined limits this would
result in the same level of exposure as we have now. The GLA Group counterparty
limits are outlined in Appendix 2. This shows that the maximum exposure to any
one bank is £75m for the Royal Bank of Scotland and HSBC and mainly due to the
fact that the GLA and TFL bank with these institutions.
Disadvantage
Any corporately agreed limit may have an impact on existing counterparty limits.