Risk
and return
English local authorities and the
Icelandic banks
Cross-cutting
National report
March 2009

---

The Audit Commission is an independent watchdog, driving economy, 
efficiency and effectiveness in local public services to deliver better 
outcomes for everyone.
Our work across local government, health, housing, community safety 
and fire and rescue services means that we have a unique perspective. 
We promote value for money for taxpayers, auditing the £200 billion 
spent by 11,000 local public bodies. 
As a force for improvement, we work in partnership to assess local 
public services and make practical recommendations for promoting a 
better quality of life for local people.
© Audit Commission 2009
This document is available on our website at: www.audit-commission.gov.uk
Amended version: June 2009
If you require a copy of this document in large print, in Braille, on tape,
or in a language other than English, please call: 0844 798 7070
If you require a printed copy of this document, please call: 0800 50 20 30
or email: [email address]
For further information on the work of the Commission please contact:
Audit Commission, 1st Floor, Millbank Tower, Millbank, London SW1P 4HQ 
Telephone: 0844 798 1212  Fax: 0844 798 2945  Textphone (minicom): 0844 798 2946
www.audit-commission.gov.uk
We welcome your feedback. If you have any comments on this report, are intending to 
implement any of the recommendations, or are planning to follow up any of the case 
studies, please do get in touch: please email [email address]

---

Contents
Preface 
3
Summary 
4
Recommendations 
5
Introduction 
8
1  Local authorities are custodians for large sums of 
public money 
12
2 Local authorities and the Icelandic banks 
16
3 The treasury management framework 
32
4 Treasury management in local authorities 
36
5 Conclusions 
51
Appendix 1 – Methodology 
52
Appendix 2 – Exposure to the failed Icelandic banks 
54
Appendix 3 – Credit ratings 
61
Appendix 4 – Glossary of terms 
62
Appendix 5 – References 
63
Risk and return | Contents | 1

---

Preface
The collapse of the Icelandic banks in October 2008 highlighted the large sums of 
public money on deposit with financial institutions outside as wel  as inside the UK. 
This report tel s the story of English local authority deposits in Icelandic banks and 
their UK subsidiaries, in which £954 mil ion is now known to be at risk.
Against that background, the report looks at treasury management in local 
authorities in which there are strengths as wel  as weaknesses. 
The findings have the benefit of hindsight, reflecting what we now know about the 
risks of lending to and by banks. Yet some treasury managers – the good ones 
– spotted risks at the time and took action. The lessons and recommendations 
here are not just applicable at times of financial turbulence. Those accountable for 
public funds must be ever vigilant.
The Audit Commission itself made deposits total ing £10 mil ion in two Icelandic 
banks. We have reviewed our own approach, identified weaknesses and taken 
action. The lessons were captured in an internal audit report and an external 
review which were published on the Commission’s website.I
The Commission’s own exposure does not compromise our duty to understand 
what went wrong nor lessen our ability to analyse and comment. We have access 
to local authorities, financial knowledge and independence and so are wel  placed 
to present this review, with the aim of improving the management of taxpayers’ 
money.
I  http://www.audit-commission.gov.uk/reports/NATIONAL-REPORT.asp?CategoryID=%26ProdI
D=8D06A805-9DB6-4BAB-BE17-8D0089352F9E
2 | Preface | Risk and return

---

Summary
Local authorities invest large sums of public money
•  On 7 October 2008, 451 authorities had investments of over £31 bil ion.
•   The total of deposits far exceeded the level of reserves; some of the deposits
included borrowed money.
•   In 2008/09, interest was around £1.8 bil ion, just under 2 per cent of total
income.
•   In a smal  number of district councils, income from interest was similar to that
from council tax.
•   Interest rates fel  between October 2008 and March 2009, putting pressure on
some budgets.
Deposits were widely spread
•   On 7 October 2008, local authorities held deposits in 144 different
organisations.
•   Fifty-seven per cent of funds were held in UK organisations, the remainder in
banks whose owners were based in 24 other countries. 
•  More than 20 per cent of deposits were in Irish institutions.
Local authorities had £954 million in Icelandic banks when they went into 
administration
•  Icelandic deposits amount to about 3 per cent of the total on deposit.
•  One hundred and twenty-seven authorities are affected.
•  Thirty have funds greater than 5 per cent of gross revenue expenditure at risk.
•   Councils are not expecting to cut services or increase council tax significantly
as a direct result.
Risk and return | Summary | 3

---

Summary
Some local authorities reacted to warning signals about Icelandic banks, 
but not all
•  The total on deposit halved between April and September 2008.
•   The number of new deposits fel , but net new deposits after 1 April 2008
exceeded £500 mil ion.
•   Seven local authorities deposited money after credit ratings in Icelandic banks
were downgraded below acceptable levels, failing, in the Commission’s view, 
to take reasonable steps to ensure they were using up-to-date information, 
and hence putting public money at risk.
The national treasury management framework is broadly right, but has 
weaknesses
•   Statutory guidance gives weight to credit ratings, but not to other relevant
information.
•   The Chartered Institute of Public Finance and Accountancy (CIPFA) guidance
gives insufficient attention to risks which may be inter-related, for example 
banks in the same group or country.
•  More guidance is needed about how to manage the ful  range of risks.
Local authority treasury management is of variable quality
•  The best authorities:
− explicitly balance risk and reward;
− review and scrutinise policies and procedures regularly;
− have wel  trained staff and engaged elected members; and
− use a wide variety of information.
•  Poorer authorities:
− have weak governance;
− depend exclusively on credit ratings; and
− have staff who are inadequately trained.
4 | Summary | Risk and return

---

Recommendations
Central government should:
•   Review and revise the weaker aspects of the national framework highlighted in
this report, especial y the weight given to credit rating;
•   Enable and require the Debt Management Office (DMO) to provide deposit
accounts to public bodies if those bodies cannot achieve the security they 
require in the market; and
•   Review the cost of early repayment of debt to the Public Works Loans Board
to ensure that the structure introduced in November 2007 is not acting against 
the wider public interest by encouraging authorities to hold unnecessarily large 
deposits.
 
CIPFA should:
•   Revise and tighten its code of practice for treasury management to take
account of the findings in this report;
•   Make more explicit the element of the prudential code that al ows loans to be
drawn down ahead of actual y spending the money. Loans should be drawn 
down only after risks are ful y assessed;
•   Continue to work with the Association of Corporate Treasurers to develop
appropriate training and qualification for those working in treasury 
management in local authorities; and
•   Coordinate information sharing between local authorities to enable them to
learn from one another. Any benchmarking activities should, as a minimum, 
highlight measures of security and liquidity of funds as wel  as yield.
Risk and return | Recommendations | 5

---

Recommendations
Local authorities should:
•   Set the treasury management framework so that the organisation is explicit
about the level of risk it accepts and the balance between security and liquidity 
and the yield to be achieved. At the highest level, the organisation should 
decide whether it has:
-   appetite and capability to be able to manage risk by placing funds with 
financial institutions; or
-   no appetite and/or insufficient capability to manage the risk of placing funds 
in the market, and should instead place funds with the UK government’s 
Debt Management Office;
•  Ensure that treasury management policies:
-  follow the revised CIPFA code of practice;
-   are scrutinised in detail by a specialist committee, usual y the audit 
committee, before being accepted by the authority; and
-  are monitored regularly;
•   Ensure elected members receive regular updates on the ful  range of risks
being run;
•   Ensure that the treasury management function is appropriately resourced,
commensurate with the risks involved. Staff should have the right skil s and 
have access to information and external advice;
•   Train those elected members of authorities who have accountability for the
stewardship of public money so that they are able to scrutinise effectively and 
be accountable for the treasury management function;
•   Ensure that the ful  range of options for managing funds is considered, and
note that early repayment of loans, or not borrowing money ahead of need, 
may reduce risks;
•  Use the fullest range of information before deciding where to deposit funds;
6 | Recommendations | Risk and return

---

•   Be clear about the role of external advisers, and recognise that local authorities
remain accountable for decisions made; and
•   Look for economies of scale by sharing resources between authorities or with
pension funds, while maintaining separation of those funds.
The Audit Commission will:
•   Ask auditors to follow up this report as part of their use of resources work for
2008/09 and future years;
•   Work with CIPFA to ensure that the lessons in this report and the research
on which they are based are included in the revised treasury management 
guidance; and
•   Work with others to produce guidance and tools for those in councils with a
need to understand the treasury management function.
Risk and return | Recommendations | 7

---

Introduction
1   The world is experiencing an 
3   During the summer and autumn of 2007, 
economic downturn of exceptional 
central banks in the US, UK and Europe 
proportions. The origins of the credit and 
attempted, unsuccessful y, to overcome 
manufacturing crunch can be traced 
the credit crunch by making bil ions 
back to the US and the sale of risky 
of dol ars available to banks that were 
mortgages, as well as to the creation of 
facing funding problems. Nonetheless, 
ever more complex financial products, 
the credit crunch intensified and claimed 
designed by the international banks to 
a number of casualties during spring 
package and sell on debt and risk.
2008, including UK high street bank, 
Northern Rock, and US commercial 
2   In February 2007, several large 
bank, Bear Stearns. As 2008 
American commercial banks, including 
progressed, the banking crisis deepened, 
Citibank, Merrill Lynch and Morgan 
world stock markets fell and economies 
Stanley, reported losses associated 
contracted. In September 2008, the US 
with mortgage defaults. By summer 
government took the unprecedented 
2007, what had previously been seen as 
step of rescuing Freddie Mac and Fannie 
America’s problem became international, 
Mae, the country’s largest mortgage 
as banks around the world began to 
lenders. The same month saw the 
realise that they too, had bought debt 
col apse of Lehman Brothers, the take-
and risk associated with the American 
over of Merrill Lynch and Halifax Bank 
sub-prime mortgage market. The banks 
of Scotland; and the nationalisation of
began to restrict new lending as they 
Bradford and Bingley.  
wrote off bil ions of dol ars of losses. 
4   Iceland was the first and, so far, only 
country, to see the col apse of its entire 
banking sector. In early October 2008, 
Iceland’s three largest commercial banks, 
Glitnir Bank hf, Kaupthing Bank hf and 
Landsbanki Islands hf, together with their 
UK registered subsidiaries, Heritable 
Bank plc and Kaupthing, Singer & 
Friedlander Ltd, went into administration. 
Press reports suggest that the failure 
of the Icelandic banks has put at risk 
approximately £11 bil ion in deposits 
made by UK investors, in addition to the 
£4.3 mil ion refunded to retail depositors 
by compensation schemes.
8 | Introduction | Risk and return

---

5   One hundred and twenty-seven English 
7   The repercussions of the col apse of the 
local authorities are among the many 
Icelandic banks have raised questions 
UK public sector institutions that have 
about the stewardship of funds held by 
funds in one or more of the Icelandic 
local authorities. Management of these 
banks. Between them, these 127 local 
funds is part of treasury management, 
authorities have deposits total ing more 
a small but important function within 
than £954 mil ion. While this money is 
authorities. Treasury managers are 
not necessarily lost, it is too early to say 
charged with maintaining the security 
how much will be recovered, or when 
and liquidity of an organisation’s cash 
and on what terms it will be repaid. 
assets, while generating a yield or return 
Deposits made by the local authorities 
on that money.
are not covered by any central 
government guarantee scheme.
8   With the benefit of hindsight, we now 
know that the risk of a banking failure 
6   Of course, banking and financial crises 
was greater than most people had 
are nothing new; nor is this the first
anticipated. Nevertheless, there are 
time that local authorities have faced 
lessons to be learned from the col apse 
losses fol owing the failure of a bank. 
of the Icelandic banks. Treasury 
Most notably, in 1991, 32 UK local 
managers could and should have been 
authorities faced losses total ing £90 
aware that there were risks associated 
mil ion fol owing the closure of the Bank 
with making investments and that, in 
of Credit and Commerce International 
particular, there were risks associated 
(BCCI). While BCCI creditors have so far
with investing in some institutions. Good 
recovered 86.5 per cent of their losses, 
treasury managers recognised those 
it took more than five years before any 
risks and managed them appropriately. 
repayment dividends were made. A total 
Others either did not appreciate the risks, 
of seven dividends have now been paid, 
or underestimated their significance. 
the most recent in December 2008. The 
liquidators say that at least one further 
dividend will be paid, but the amount 
and timing are uncertain.
Risk and return | Introduction | 9

---

Introduction
9   This report examines local authorities’ 
•   Almost 3.1 per cent of al  deposits
arrangements for placing and managing 
were held in the failed Icelandic banks. 
cash on deposit. The report aims to 
One hundred and twenty-seven local 
help local authorities to learn lessons 
authorities held deposits, but delivery 
from the recent economic events and 
of services has not, as yet, been 
improve their treasury management 
affected.
processes. This report does not cover 
local authorities’ treasury management 
•   The national treasury management
arrangements for borrowing or managing 
framework is broadly right, but 
debt. Nor does it review the performance 
weaknesses in the detail have 
of external treasury advisers, brokers 
contributed to poor practice. In 
or credit rating agencies. Research for 
particular, there is little recognition 
this review was carried out between 
that risks associated with placing 
December 2008 and March 2009. 
deposits with different banks may 
Details of the study methodology can be 
be highly correlated because they 
found in Appendix 1.
are in the same group, country or 
sector. Additional y, the government’s 
10   There are five key messages.
investment guidance gives too much 
weight to credit ratings at the expense 
•   Local authorities have used interest
of using a range of information 
from cash deposits as a valuable 
sources.
source of income.
•   Local treasury management
•   The sums of money involved are large
arrangements vary. The best 
and invested widely. On 7 October 
organisations balance risk and reward 
2008, 451 local authorities had 
and arrangements include: regular 
invested £31 bil ion, more than 40 per 
review and scrutiny of policy and 
cent of it overseas.
procedure; appropriately trained staff
and engaged elected members; and
the use of a wide range of information 
including, but not limited to, credit 
ratings.
10 | Introduction | Risk and return

---

11  This report has five chapters:
12   Further advice and guidance will be 
•   Chapter 1 – Local authorities are
available to download from the Audit 
custodians for large sums of public 
Commission’s website in summer 2009.
money
•   Chapter 2 – Local authorities and the
Icelandic banks
•   Chapter 3 – The treasury management
framework
•   Chapter 4 – Treasury management in
local authorities
•  Chapter 5 – Conclusions
Risk and return | Introduction | 11

---

1   Local authorities are 
custodians for large 
sums of public money
13   This chapter considers the sums of 
Local authorities manage large 
public money held, managed and 
sums of public money
invested by local authorities.
14   Local authorities manage large sums 
of public money.I The amounts have 
increased in recent years (Figure 1). For
example, in 1997/98, net expenditure on 
services was £51 bil ion and in 2008/09 
expenditure will be in the region of £112 
bil ion. 
Figure 1
Expenditure in local authorities
Local authorities manage large sums of public money
120
 
100
80
60
40
Net current expenditure (£bn)
20
0 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09
Source: Audit Commission
I  Local authorities in this report include councils, police authorities, fire and rescue authorities, 
waste authorities, passenger transport executives, passenger transport authorities and 
pension authorities.
12 | Local authorities are custodians for large sums of public money | Risk and return

---

15   Local authorities hold some money in 
16   The level of reserves held by local 
reserve to manage cash flow and to 
authorities has more than doubled 
meet predicted liabilities. The Local 
in recent years. In 2008, the Audit 
Government Finance Act, 1992 (Ref. 1)
Commission reported that English 
requires local authorities to consider 
local authorities held £12.6 bil ion or 13 
the level of reserves required when 
per cent of their annual expenditure in 
setting budgets and council tax. CIPFA 
reserves in March 2008, compared with 
advises that local authorities consider 
£5.5 bil ion or 8 per cent five years earlier 
the establishment and maintenance of 
(Ref. 3).
reserves when reviewing medium-term 
Local authorities draw an 
financial plans and when preparing 
annual budgets (Ref. 2). CIPFA’s
income from surplus cash
guidance indicates that reserves are 
17   Local authorities draw an income from 
necessary, but recognises the different 
surplus cash, by placing it on deposit 
circumstances of each local authority 
in bank or building society accounts, 
and rejects the idea of a general y 
or in money market investments. The 
prescribed optimum or minimum level of 
amounts invested have doubled in the 
reserves.
past decade; and at the end of March
2008, local authorities held deposits 
total ing £29 bil ion, compared with £15 
bil ion in March 2000. On 7 October 
2008, 451 local authorities held deposits 
worth £31 bil ion (Table 1).
Risk and return | Local authorities are custodians for large sums of public money | 13

---

1 |  Local authorities are 
custodians for large sums of 
public money
Table 1
19   For example, one local authority took 
Local authorities held deposits worth 
advantage of favourable interest rates by 
£31 billion on 7 October 2008
investing money that had been borrowed 
up to three years in advance of planned 
Local authorities invest surplus cash
capital expenditure. It reported building 
up substantial amounts of additional 
Local authority
Deposits (£bn)
funds using this strategy. The same local 
County councils
6.9
authority recently changed its approach 
District councils
6.1
as market rates no longer favour having 
London borough councils 6.0
large amounts of borrowing. However, 
Unitary authorities
3.7
the authority intends to reintroduce a 
strategy of borrowing in advance of need 
Metropolitan district 
3.6
if and when favourable conditions arise.
councils
Fire authorities and other  3.0
20   Interest earned from investments is an 
bodies
important source of income for local 
authorities. Indeed, applying a typical 
Police authorities
1.7
interest rate of 5.9 per cent to total 
Total
31.0
deposits suggests that local authorities 
Source: Audit Commission
earned around £1.8 bil ion in income 
from interest in 2008/09. For some small 
18   The sums on deposit on 7 October 2008 
local authorities, budgeted income from 
far exceeded reported reserves. The 
interest has equal ed the amount realised 
money invested came from a number 
from council tax receipts in recent years. 
of sources, including reserves and 
other cash arising from, for example, 
the disposal of assets and the normal 
timing differences between receipt of 
income and expenditure. Additional y, 
some funds will have come from money 
borrowed in advance of need in order 
to take advantage of favourable interest 
rates, or from not repaying debt despite 
having the cash to do so. 
14 | Local authorities are custodians for large sums of public money | Risk and return

---

21   It is both practical and prudent for local 
authorities to draw an income from 
their surplus cash. But, as custodians 
of large sums of public money, local 
authorities must exercise due diligence. 
In particular, the recent fal s in interest 
rates mean that income from interest 
earned on cash deposits is likely to 
decline in the current and, possibly, 
future years. However, interest costs 
on borrowed funds are typical y fixed. 
Consequently local authorities that have 
borrowed in advance of need will now 
be experiencing significant net interest 
costs due to significantly lower returns 
on cash investments, where there was 
a positive contribution during 2008. 
Local authorities will need, therefore, to 
manage budgets and medium-term 
financial plans accordingly; and they
must ensure that an appropriate balance 
is struck between protecting capital and 
maximising interest returns. 
Risk and return | Local authorities are custodians for large sums of public money | 15

---

2  Local authorities 
and the Icelandic 
banks
22   This chapter considers local authorities’ 
25   The commercial banks and the 
exposure to the failed Icelandic banks. 
Central Bank of Iceland responded by 
It considers the scale of the sums at 
developing a recovery plan that was 
risk and discusses local authorities’ 
based on:
responses to the warning signs. 
•   gaining foreign deposits to back
A short history of the Icelandic 
assets acquired abroad;
banks
•   creating, by acquisition, international
23   The rise and fall of the Icelandic banking 
subsidiaries, such as UK-based 
sector can be traced back to political 
Heritable Bank plc (Heritable) and
and financial decisions taken in the 
Kaupthing, Singer and Friedlander Ltd 
mid to late 1990s, when the Icelandic 
(KSF); and
economy began a period of rapid 
•  raising domestic interest rates.
growth, particularly in heavy industries 
associated with cheap, clean, renewable 
26   The recovery plan appeared to be a 
energy, such as aluminium smelting. At 
success and, by late 2007, between 
the same time, the Icelandic government 
them Glitnir, Kaupthing and Landsbanki 
began a programme of privatisation 
had enabled Icelandic companies, such 
of state assets, which included 
as Baugur, to acquire foreign assets 
deregulating the financial sector, creating 
worth almost nine times the value of the 
an independent Central Bank of Iceland, 
Icelandic economy. However, financial 
and privatising the commercial banks. 
commentators began to voice concerns 
that the banks had expanded too quickly, 
24   The three largest commercial banks, 
that they had borrowed too much 
Glitnir Bank hf (Glitnir), Kaupthing Bank
foreign currency and that they would 
hf (Kaupthing) and Landsbanki Islands hf
face problems refinancing their debts, 
(Landsbanki), evolved quickly into major
particularly in the face of a global credit 
international operators, funded largely 
crunch. Indeed, by March 2008, the cost 
by borrowing money on the international 
to the Icelandic banks of insuring debt 
wholesale markets. Some commentators 
was among the highest in the world at 
raised concerns at the high levels of 
between 7 and 9 per cent of debt. In 
borrowing, and rising domestic debt 
contrast, other European banks were 
and inflation rates. But, to others, these 
paying an average of 1.5 per cent.
were offset by perceived strong financial 
regulators, low unemployment and a ful y 
funded pension system. However, the 
markets reacted negatively, leading to 
a fall in stock prices and a drop in the 
value of the Icelandic krona in early 2006. 
16 | Local authorities and the Icelandic banks | Risk and return

---

27   Commentators continue to debate the 
The scale of UK deposits in 
precise circumstances surrounding the 
Iceland
col apse of the Icelandic banks. Many 
argue that the trigger was the decision 
29   The Icelandic banks attracted many 
of the US government to al ow Lehman 
UK investors and their failure has put at 
Brothers, the US bank, to col apse in 
risk more than £11 bil ion. Government 
September 2008. What is clear, however, 
guarantee schemes and other initiatives 
is that the credibility of the Central Bank 
mean that around £4.3 bil ion has already 
of Iceland as a lender of last resort was 
been returned to individual depositors. 
cal ed into question, given the level of 
But public sector bodies, charities, 
debt in comparison with the size of the 
universities and private sector institutions 
domestic economy. Concerns were also 
hold deposits that are not covered by 
raised about the ability of the banks to 
government guarantee schemes. While 
repay the number of short-term deposits 
the absolute sums of money at risk are 
that were due to mature. 
difficult to quantify, it is estimated that 
public sector institutions hold deposits 
28   The consequence was that, once again, 
of at least £1 bil ion, charities hold 
financial share prices fell and the value 
around £120 mil ion; and press reports
of the Icelandic krona dropped, but this 
suggest that private sector institutions, 
time so sharply that the banks faced 
including a number of building societies, 
short-term funding problems. The 
hold deposits of at least £10 bil ion. 
Icelandic government made preparations 
This money is not necessarily lost, but 
to nationalise Glitnir partial y on 29 
it is too early to say how much will be 
September 2008 and suspended trading 
recovered, or when and on what terms it 
in some financial shares on 6 October 
will be repaid.
2008. But on 7 October 2008, before 
arrangements for nationalisation could 
be completed, Glitnir and Landsbanki 
went into receivership, closely fol owed 
by Kaupthing on 8 October 2008. On 
the same day, the UK government froze 
UK-based assets of the Icelandic banks.
Risk and return | Local authorities and the Icelandic banks | 17

---

2 |  Local authorities and 
the Icelandic banks
English local authorities hold 
(Heritable and KSF) (Table 2). Of the
deposits totalling £953.53 
127 local authorities that are affected, 
million
councils have the largest exposure, 
with 105 holding deposits worth more 
30   English councils, police, fire and rescue, 
than £793 mil ion. The other 22 are 
passenger transport, national parks, 
police, fire and rescue and passenger 
pensionsI and waste authorities hold 
transport, national parks, pension and 
deposits worth £953.53 mil ion in two of 
waste authorities, which between them 
the three failed Icelandic banks (Glitnir
hold deposits of almost £160 mil ion 
and Landsbanki) or their UK subsidiaries
(Appendix 2).
Table 2
Local councils hold most deposits 
Of the 127 local authorities with Icelandic deposits 105 are local councils
Local authority
Number affected and as percentage  Deposits (£m)
of number of type of authority
County councils
15 (44%)
269.77
District councils
58 (24%)
231.05
London borough councils
11 (33%)
152.61
Unitary authorities
13 (28%)
105.40
Police authorities
12 (32%)
84.51
Fire authorities and other bodiesII  10 (16%)
77.91
Metropolitan district councils
8 (22%)
32.28
Total
127 (26%)
953.53
Source: Audit Commission
I  This does not include pension funds administered by local authorities.
II  Fire and rescue authorities, passenger transport bodies, national parks, pension authorities 
and waste authorities.
18 | Local authorities and the Icelandic banks | Risk and return

---

31   Local authorities manage large and 
33   Local authorities have a statutory 
diverse investment portfolios. It is, 
obligation to plan and deliver a balanced 
therefore, important to consider the 
budget. Consequently, any losses arising 
sums at risk in context. On 7 October 
from placing deposits in the Icelandic 
2008, local authorities held deposits 
banks would normal y need to be 
in 144 different organisations, or 
provided for as soon as they could be 
counterparties. Almost 3.1 per cent of 
reliably estimated. Such losses would 
all investments were deposited in the 
ordinarily be charged to the general 
Icelandic banks or their UK subsidiaries. 
fund, in ful , in the year they were 
identified, either by raising additional 
32   Local authorities’ combined exposure 
income or by reducing expenditure. A 
to the col apse of the Icelandic banks 
statutory override (Ref. 4), which makes
amounts to less than 1 per cent of the 
amendments to the 2003 Capital 
planned spend of all local authorities 
Finance Regulations, will come into 
for 2008/09. However, the exposure of 
effect on 31 March 2009. The measure 
individual local authorities varies and, for 
will al ow local authorities to defer 
some, the impact could be significant. In 
recognition of any potential losses arising 
cash terms, the largest single exposure 
from investments until 2010/11. 
is in a county council, which holds 
deposits of £48.9 mil ion. But both 
34   Unless further statutory changes are 
large and small authorities have been 
made, local authorities will need to 
hit. When deposits are standardised to 
account for any losses in the medium 
adjust for size, 30 organisations have 
term. There is no evidence as yet that 
sums at risk that exceed 5 per cent of 
the sums at risk in the Icelandic banks 
gross revenue expenditure (GRE), of
will lead to service cuts or to council 
which 27 are district councils, two are 
tax rises and it is unlikely that the 
passenger transport bodies and one is 
performance of local government will 
a police authority.I Four district councils 
be affected in the short or medium term. 
hold deposits that exceed 20 per cent of 
But the level of reserves held by each 
GRE (Appendix 2).
local authority will affect its ability to 
 
recover from the impact of the Icelandic 
banks’ failure. Eighteen local authorities 
have sums at risk that exceed 100 per 
cent of their reserves;II and 14 of the 
local authorities so affected are district 
councils (Appendix 2).
I  Sums at risk were compared to the GRE, a broad measure of spending.
II CIPFA: Memorandum – Estimated unearmarked and earmarked general reserves (excluding
schools’ reserves, housing revenue account and pension funds) as at 1 April 2008.
Risk and return | Local authorities and the Icelandic banks | 19

---

2 |  Local authorities and 
the Icelandic banks
Where is the money?
35   Local authorities hold 60 per cent of 
their Icelandic deposits in the Icelandic 
banks themselves, rather than in their 
UK subsidiaries. Overal , most deposits 
(38 per cent) are held in Landsbanki
(which was Iceland’s second largest
commercial bank) and almost 21 per
cent of deposits are held in Glitnir. No 
deposits are held in Kaupthing (which
was Iceland’s largest bank) (Figure 2).
Figure 2
Landsbanki
Patterns of investment vary
Glitnir
Most deposits are held in Landsbanki or its UK subsidiary, Heritable
Heritable
 
KSF
Fire authorities
and other bodies
Police
authorities
Unitary
authorities
Metropolitan
district councils
London
borough councils
District
councils
County
councils
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Source: Audit Commission
20 | Local authorities and the Icelandic banks | Risk and return

---

There were warning signs and 
37   Concerns about the stability of the 
most local authorities heeded 
Icelandic economy were first raised 
them
during 2006 and continued into 2007. 
These concerns were neither abated 
36   Local authorities, along with other 
nor heightened during 2007; and
investors, judge creditworthiness using 
while there were some suggestions 
credit ratings, which give an indication 
that the Icelandic banks were at risk 
of the likely ability of an organisation 
from domestic economic uncertainty, 
to repay a loan along with any interest 
the credit ratings of individual banks 
owed. Three agencies, Fitch, Moody’s, 
general y remained stable until early 
and Standard and Poor’s, hold 95 
2008. 
per cent of the global market share of 
38   But during 2008, confidence in the 
the credit ratings business.I A variety 
creditworthiness of some of the Icelandic 
of credit ratings exist to describe 
banks changed relatively rapidly and 
creditworthiness. For example, different 
between January and September 2008, 
credit rating scales exist to describe the 
a number of credit rating downgrades 
risks associated with making short-term 
were announced, which should have 
(defined differently by each of the rating
prompted treasury managers to review 
agencies, but general y around a year)
the creditworthiness of the Icelandic 
and long-term investments. Details and 
banks (Figure 3).
standardised descriptions of these can 
be found at Appendix 3. Fitch was the 
only agency to produce credit ratings for 
all of the Icelandic banks.
I  Variances 32, ENSAE, December 2007.
Risk and return | Local authorities and the Icelandic banks | 21

---

2 |  Local authorities and 
the Icelandic banks
Figure 3
Credit ratings fell during 2008
A variety of credit ratings were downgraded
30 Sep:
8 Oct:
 
Fitch downgrades
Fitch downgrades Kaupthing
28 Feb:
1 Apr:
Landsbanki, Glitnir
to vulnerable grade and
Moody’s downgrades
Fitch puts all
and Kaupthing to
Landsbanki and Glitnir to
Landsbanki, Glitnir
Icelandic banks
adequate grade.
defaulting grade. Moody’s
and Kaupthing to
on negative
Moody’s downgrades
downgrades Landsbanki and
strong grade
rating watchI
Glitnir to adequate grade
Glitnir to vulnerable grade
Jan
Feb
Mar
Apr
May
June
July
Aug
Sep
Oct
Nov
Dec
21 Apr:
9 May:
9 Oct:
Standard and Poor
Fitch downgrades Glitnir and 
Fitch downgrades Kaupthing
downgrades Glitnir
Kaupthing to strong grade and
to defaulting grade.
to adequate grade
confirms Landsbanki as strong grade.
Moody’s downgrades
All banks outlook negativeI I
Kaupthing to vulnerable grade
AC Standardised ratings
AAA - Extremely strong grade  AA - Very strong grade 
A - Strong grade 
BBB - Adequate grade
BB - Speculative grade 
B - Very speculative grade  CCC - Vulnerable grade  D - Defaulting grade
Source:  Audit Commission adaptation of credit ratings produced by Fitch, Moody’s, and 
Standard and Poor’s
I  A ratings watch indicates that there is a heightened probability of a rating change in the short 
term www.fitchratings.com
II  A negative rating outlook indicates that a credit rating may change in the next one to two 
years www.fitchratings.com
22 | Local authorities and the Icelandic banks | Risk and return

---

39   As a group, local authorities heeded 
40   The value of local authority deposits 
the warning signs and anticipated the 
held in the Icelandic banks declined by 
downward shift in credit ratings. Some 
more than half, from more than £2 bil ion 
56 per cent of local authorities either 
in January 2008, to £953.53 mil ion in 
never invested in the Icelandic banks, or 
October 2008, when the Icelandic banks 
made no deposits after 31 October 2007. 
ceased trading (Figure 4). The number of
Furthermore, between November 2007 
new deposits also fell and, in particular, 
and 6 October 2008, 18 per cent of local 
declined sharply after April 2008, by 
authorities removed all their deposits in 
which time Moody’s had downgraded 
the Icelandic banks as they matured. 
credit ratings for Landsbanki, Kaupthing 
and Glitnir and Fitch had placed all 
three banks on a negative ratings watch 
pending a review of their financial risk 
profiles.
Risk and return | Local authorities and the Icelandic banks | 23

---

2 |  Local authorities and 
the Icelandic banks
Figure 4
Local authorities heeded the warning signs
Deposits in Icelandic banks halved between January and October 2008
 
8 Oct:
Fitch downgrades Kaupthing to vulnerable
grade and Landsbanki and Glitnir to defaulting
Grade. Moody's downgrades Landsbanki and
Glitnir to vulnerable grade
30 Sep:
1 Apr:
Fitch downgrades Landsbanki, Glitnir
Fitch puts all
and Kaupthing to adequate grade.
Icelandic banks
Moody's reduces Glitnir to
on negative
adequate grade
watch rating
9 May:
28 Feb:
Fitch downgrades Glitnir and
Moody's downgrades
Kaupthing to strong grade and
Landsbanki, Glitnir and
confirms Landsbanki as strong grade.
Kaupthing to strong grade
All banks outlook negative
2,000
1,500
1,000
Total deposits (£m)
500
0
Nov
Dec
Jan
Feb
Mar
Apr
May
June
July
Aug
Sep
Oct
2007
2007
2008
2008 2008 2008
2008
2008
2008
2008 2008 2008
Source: Audit Commission
24 | Local authorities and the Icelandic banks | Risk and return

---

41   Local authorities with investments in the 
42   However, the picture is complicated. For 
Icelandic banks generally responded to 
example, in May 2008, Fitch downgraded 
less favourable credit ratings by removing 
the ratings of Glitnir and Kaupthing 
funds as they matured and by reducing 
and placed them on negative outlook, 
the number of new deposits that they 
meaning that further rating changes 
made. They also reacted to emerging 
were possible in future. At the same 
differences in credit ratings between the 
time, the credit rating of Landsbanki was 
Icelandic banks by reducing the number 
confirmed as A (strong grade). Local
of new deposits placed in those banks 
authorities responded by increasing the 
with the lowest credit ratings. By April 
total number of new deposits to 130, 
2008, Moody’s had downgraded the 
placing 104 of them in Landsbanki or its 
credit ratings of the Icelandic banks and 
UK subsidiary, Heritable. 
Fitch had placed the Icelandic banks on 
a negative rating watch and the number 
of new deposits fel  from 168 in March 
2008 to 93 (Figure 5).
Risk and return | Local authorities and the Icelandic banks | 25

---

2 |  Local authorities and 
the Icelandic banks
Figure 5
Local authorities responded to changes in credit ratings
The total number of new deposits declined during 2008
 
8 Oct:
Fitch downgrades Kaupthing to vulnerable grade
and Landsbanki and Glitnir to defaulting grade.
Moody's downgrades Landsbanki and Glitnir to
Landsbanki
vulnerable grade
1 Apr:
Heritable
Fitch puts all
30 Sep:
Glitnir
Icelandic banks
Fitch downgrades Landsbanki, Glitnir and
on negative
Kaupthing to adequate grade. Moody's
KSF
rating watch
downgrades Glitnir to adequate grade
28 Feb:
9 May:
Moody's downgrades
Fitch downgrades Glitnir and
Landsbanki, Glitnir
Kaupthing to strong grade and
and Kaupthing to
confirms Landsbanki as strong
strong grade
grade. All banks outlook negative
300
250
200
150
100
Number of new deposits
50
0
Nov
Dec
Jan
Feb
Mar
Apr
May June
July
Aug
Sep
Oct
2007 2007 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008
Source: Audit Commission
26 | Local authorities and the Icelandic banks | Risk and return

---

43   Large sums of money were deposited in 
44   Local authorities responded to the 
the Icelandic banks from April onwards. 
changing credit ratings by making fewer 
Between April and October 2008, 84 
new deposits. But they did not manage 
local authorities deposited almost £564 
deposits that had not yet matured as 
mil ion that was due to mature after 
actively. It is sometimes possible to 
October 2008. Had all local authorities 
break a deposit before maturity. This is 
stopped placing deposits in the Icelandic 
not a regular occurrence; some banks
banks in April 2008, the total amount of 
charge a fee or a penalty to return 
funds at risk when the banks col apsed 
funds, but others do not. There was a 
in October would have been £389 mil ion 
general reluctance to break deposits, 
instead of £954 mil ion. 
or ignorance of the facility. However, 
some local authorities did consider the 
possibility of breaking deposits, but were 
told by their brokers that this would not 
be possible. One local authority broke 
a deposit fol owing the credit rating 
downgrade but at a cost of £38,000. 
Another local authority considered 
breaking a deposit, but the penalty, 
between 20 and 50 per cent of the 
principal sum, was too expensive.
Risk and return | Local authorities and the Icelandic banks | 27

---

2 |  Local authorities and 
the Icelandic banks
Some local authorities 
46  On 29 September, the Icelandic 
continued to invest despite 
government announced it was partly 
clear warning signs
nationalising Glitnir. Many media reports 
reiterated concerns about the fragility of 
45   2008 saw unprecedented turmoil 
the Icelandic economy in general, and 
in world financial markets. During 
its banking system in particular. On 
September increasingly frequent signs 
30 September, there were significant 
of instability emerged. Fanny Mae 
changes to the credit ratings of the 
and Freddie Mac were rescued by 
Icelandic banks, with Fitch downgrading 
the US government on 7 September 
them to BBB (adequate grade), below the
2008. Lehman Brothers col apsed on 
level general y considered acceptable for 
15 September 2008, the first major 
public money.
bank to fail since the start of the credit 
crisis. Financial institutions on both 
sides of the Atlantic were then rescued 
46a  Seven local authorities subsequently 
in quick succession, including Merrill 
deposited £32.8 mil ion between them 
Lynch, AIG, HBOS, Washington Mutual, 
during October 2008 (Table 3).
Fortis, Hypo Real Estate, Bradford and 
Bingley and Dexia. The Irish government 
guaranteed all deposits in Irish banks on 
30 September. These exceptional events 
were widely reported and extensively 
discussed in the media and elsewhere. 
28 | Local authorities and the Icelandic banks | Risk and return

---

Table 3
Seven local authorities deposited money with Icelandic banks after their credit 
ratings were downgraded below acceptable levels
£32.8 mil ion was deposited during October 2008 
Local authority
Amount deposited (£m)
Date deposited
London Borough of Havering
2.0
01/10/2008
Kent County Council 
3.3
01/10/2008
Redcar and Cleveland Borough Council
4.0
01/10/2008
Restormel Borough Council
3.0
01/10/2008
Bridgnorth District Council
1.0
02/10/2008
Kent County Council
5.0I
02/10/2008
South Yorkshire Pensions Authority
10.0
02/10/2008
North East Lincolnshire Council
3.0
02/10/2008
North East Lincolnshire Council
1.5
03/10/2008
Source: Audit Commission
46b The deposits made in October were 
•   an officer placing a deposit that
with institutions whose credit ratings 
exceeded the local authority’s 
were lower than those required in the 
investment limit for a single institution;
treasury management policies of each of 
and
the authorities. The explanations for this 
include:
•   not receiving a credit rating update
from the treasury adviser until after the 
•   breach of internal procedure which
deposit was made.
resulted in a treasury adviser’s email 
warning of the rating change not being 
read before the deposit was placed;
•   using a different approved lending or
counterparty list to that used by the 
treasury adviser;
I  This deposit was made under a contract signed on 19 September 2008. Kent County Council 
considered breaking the contract, but concluded that the penalty for doing so was too great.
Risk and return | Local authorities and the Icelandic banks | 29

---

2 |  Local authorities and 
the Icelandic banks
46c  One of the seven authorities, Kent 
46d  Having considered these details careful y, 
County Council, accepted that its 
the Commission is of the view that the 
policy was breached in making the 
seven authorities did not take adequate 
deposit of £3.3 mil ion on 1 October 
steps to ensure the security of their 
and that its actions can be described 
deposits. While authorities that invested 
as ‘carelessness’. Another council, the 
earlier may have breached their policies, 
London Borough of Havering, asserts 
or be open to criticism for other reasons, 
that it was monitoring the financial press, 
the Commission considers that all 
and was concerned about the world 
authorities should have been alert to 
financial turmoil and its implications 
the extraordinary circumstances of the 
for the council’s exposure to risk. In 
time. They should not have made new 
response to enquiries, its financial 
investments without taking reasonable 
adviser gave it assurances about its 
steps to ensure that they were using up-
investment strategy. Since the treasury 
to-date information, such as the credit 
management policy in force al owed it 
ratings from Fitch, which downgraded 
to rely on the receipt of advice from a 
the credit-worthiness of the relevant 
single adviser without actively checking 
institutions on 30 September, as well 
on the current position, it considers 
as ful y complying with their policies. 
it acted properly. When it placed £2 
Irrespective of whether their actions 
mil ion on 1 October, it did not know that 
are described as negligent, careless, 
the bank’s credit rating was below an 
unprofessional, or over-reliant on 
acceptable level because it only received 
policies that were inadequate for the 
notification about the downgrade from 
rapidly-changing circumstances, there 
its adviser 15 minutes later. It considers 
is no escaping the simple fact that a 
it was ‘unfortunate’. A third council, 
substantial sum of public money was 
Redcar and Cleveland Borough Council, 
put at risk which would not have been 
stated that although weaknesses in 
if the seven authorities had responded 
controls have been identified, with 
effectively to the warning signals. In 
recommendations made to address 
the Commission’s view, they should 
them, it considered that officers’ actions 
have been taking reasonable steps, 
associated with the re-investment of £4 
certainly by the end of September 2008, 
mil ion with Heritable Bank on 1 October 
to ensure that they were using up-to-
were ‘reasonable, given the information 
date information prior to making further 
available to them at that time’.
deposits in the relevant banks.
30 | Local authorities and the Icelandic banks | Risk and return

---

3  The treasury 
management 
framework
47   This chapter considers the national 
50   Local authorities operate within a 
framework and guidance used by 
national investment framework that 
local authorities to develop treasury 
is broadly sound and CIPFA helpful y 
management arrangements. It also 
describes the practices that define good 
discusses the role of staff, elected 
treasury management. In summary, local 
members and external auditors in 
authorities are expected to: 
managing and assuring treasury in local 
authorities. 
•   define local investment limits and
guidelines in an annual investment 
The national framework
strategy prior to the start of each 
financial year and ensure that it 
48   Local authorities manage surplus 
is approved by the ful  council (or
cash as part of their broader treasury 
equivalent);
management responsibilities. CIPFA 
defines treasury management as:
•   prepare an annual treasury
management strategy and plan prior 
‘The management of the 
to the start of each financial year; and
organisation’s cash flows, its 
banking, money market and capital 
•   prepare an annual report after the
market transactions; the effective 
year-end.
control of the risk associated with 
51   The investment framework requires that 
those activities; and the pursuit of 
local authorities should invest prudently 
optimum performance consistent 
and should primarily seek to safeguard 
with those risks.’
public funds rather than to maximise 
49   Local authorities have restricted 
returns. Due consideration must, 
freedoms with regard to the investment 
therefore, be given to: 
of surplus funds. The rules are 
•   security: the creditworthiness of the
prescribed by statute and are laid 
counterparty; and
out under section 15(1)(a) of the
Local Government Act 2003 (Ref. 5).
•   liquidity: how readily available cash is;
Local authorities are also required 
the term of the investment.
to have regard to supplementary 
52   Local authorities also consider yield, or 
guidance provided by the Office of the 
the rate of return on their investments. 
Deputy Prime Minister (ODPM; now
Security and liquidity take priority over 
Communities and Local Government)
yield, but local authorities may seek the 
(Ref. 6) and by CIPFA (Refs. 7 and 8).
highest yield possible, once security and 
CIPFA’s guidance is defined as a proper 
liquidity have been assured. 
practice for these purposes. Pension 
and trust funds are covered by a 
separate regulatory regime and are not 
discussed or considered here.
Risk and return | Local authorities and the Icelandic banks | 31

---

3 |  The treasury
management framework
53   The treasury management framework 
56   While the guidance states clearly that 
used by local authorities general y 
credit ratings are not the only means 
appears to work wel . Both the 
of assessing risk, organisations are left 
government and CIPFA guidance, rightly, 
to define high credit ratings local y; and
emphasise an approach to investments 
no advice on other potential y useful 
based on identifying and managing risk. 
sources of information is provided. It 
But weaknesses in the guidance have 
may be appropriate to reconsider the 
contributed to poor practice in some 
definition of short term. A revision 
areas of treasury management and there 
downwards to six or even three months 
is scope to provide additional support 
might be pertinent in recognition that the 
and guidance to local authorities. 
longer the term of a deposit, the greater 
the risk of the bank being unable to 
54   In particular, the government’s 
repay at maturity. 
investment guidance places undue 
weight on credit ratings at the expense 
57   While the types of risk that 
of other information sources. Credit 
organisations need to consider and 
ratings are a useful indicator of likely 
manage are described, the potential 
performance and, therefore, a credible 
correlation between related risks is 
means of judging and managing risk. 
not acknowledged. For example, the 
However, while ratings are an important 
CIPFA guidance highlights the need 
piece of information, they do not give 
to address counterparty risk and to 
the whole picture. Their use should be 
create a diverse investment portfolio. 
supplemented with other information.
But the risks associated with seemingly 
different institutions may be highly 
55   The government’s guidance advises 
correlated because they are in the same 
local authorities to manage risk by 
group, sector or country. These are not 
making two different types of investment: 
acknowledged. 
•   Specified investments, considered to
offer high security and liquidity. They 
are short term. That is they mature 
within one year, are made in sterling 
and are placed in institutions with high 
credit ratings.
•   Non-specified investments, considered
to be riskier. They are longer-term 
investments and/or investments made 
with institutions that are not highly 
credit-rated. 
32 | The treasury management framework | Risk and return

---

58   There is scope for the treasury 
60   Treasury staff need to understand 
management practices recommended 
and interpret local risk tolerance, or 
by CIPFA to be tightened. In particular, 
appetite for risk, which necessitates 
further advice and guidance could be 
a clear separation of duties between 
offered to help local authorities:
those executing deals and those 
•  set a credit limit;
monitoring compliance. However, while 
the guidance issued by CIPFA clearly 
•  define a high or strong credit rating;
specifies how to delegate duties, there 
•   conduct research into individual
is little to inform local interpretation of 
counterparties;
risk tolerance. In particular, the guidance 
does not outline how the function should 
•   put in place adequate controls, such
be managed and monitored in order to 
as segregation of duties of trade 
provide an appropriate assessment of 
execution from checking, reconciliation 
risk. Instead, these arrangements are left 
and compliance; and
to individual local authorities.
•   specify the role of elected members
61   In addition, the CIPFA guidance 
in the governance and scrutiny of 
requires that staff involved in treasury 
treasury management.
management are appropriately qualified 
Treasury management functions 
and that ongoing training is provided 
to maintain expertise, knowledge and 
in local authorities
skil s. There is, however, no specification 
59   Local authorities must strike an 
of the level of qualification required. As 
appropriate balance between protecting 
yet, there is no standard qualification or 
capital and realising income from 
training course that is geared specifical y 
investments. In practice, this means 
to the needs of staff responsible for 
that local authorities must put in 
treasury management functions in local 
place appropriate controls that enable 
authorities. 
treasury managers to make a systematic 
62   The treasury management framework 
assessment of risk and reward, including 
also sets out responsibilities for elected 
the potential for loss. Therefore, 
members. The ful  council (or equivalent)
local authorities must put in place a 
is required to approve the annual report 
framework that clearly states how much 
and the treasury management strategy 
risk wil  be tolerated; and that ensures
and plan before the start of the next 
appropriate reporting and oversight, 
financial year. At the same time, elected 
commensurate with the agreed risk 
members are expected to consider a 
appetite. 
review of performance in the previous 
year. 
Risk and return | The treasury management framework | 33

---

3 |  The treasury
management framework
63   Some authorities have made provision for 
66   It is a fundamental principle that public 
elected members to carry out detailed 
auditors should be independent of 
scrutiny of the treasury management 
those who are responsible for the 
function. However, this is often left to 
stewardship and use of public money. 
chance and can be dependent on 
The Audit Commission’s primary 
elected members having a financial 
statutory function is to appoint auditors 
background. While at least one local 
on behalf of the taxpayer and preserve 
authority provides training in treasury 
their independence. This is essential 
management for its elected members, 
if taxpayers are to trust auditors’ 
this initiative is not widespread. There 
judgements and conclusions. 
is scope for elected members to be 
more engaged in the scrutiny of the 
67   Auditors cannot comment or advise on 
treasury management activities. Some 
an authority’s treasury management 
guidance has recently been published 
strategy or policies, as they may 
(Ref. 9), but there is a need to provide
subsequently have to review the 
elected members with more support and 
effects of their implementation. Nor 
assistance to enable them to exercise 
can they substitute their judgement 
their responsibilities effectively.
on risk or second guess specific 
investment decisions by managers, as 
The role of external auditors
these are properly the responsibility of 
management.
64   Public audit is an essential element 
in the process of accountability for 
68   Both appointed auditors, in planning 
public money. The Audit Commission’s 
the audit to meet their statutory and 
appointed auditors provide independent 
professional responsibilities, and 
assurance on whether public money 
the Commission, when mandating 
has been properly safeguarded and 
elements of the annual audit programme, 
accounted for, and how well it has been 
are mindful of the need to adopt a 
used in the delivery of services. 
proportionate approach and to target 
audit work on the areas where the risks 
65   The focus of auditors’ work is a local 
that something might go wrong are 
authority’s annual accounts and the 
highest. This risk-based approach also 
financial management systems and 
serves to reduce the cost and burden of 
processes that underpin them. Their 
audit for audited bodies. 
work is therefore essential y retrospective.
34 | The treasury management framework | Risk and return

---

69   Fol owing the development of the 
72   Once the news of the col apse of the 
CIPFA Code of Practice on Treasury 
Icelandic banks broke, the Commission 
Management (the CIPFA Code) in light
immediately issued guidance to those 
of the events surrounding the col apse 
auditors who had yet to complete their 
of BCCI in the early 1990s, neither the 
audits of the 2007/08 accounts, on 
Commission nor appointed auditors 
the implications for their opinion on 
perceived treasury management to be 
the accounts. The Commission also 
a significant risk. Indeed the view was 
asked all auditors to review use of 
that this was general y a well managed 
resources assessments in relation to 
function. 
financial standing and, in a number of 
cases, auditors chose to revise their 
70   In carrying out their audits of the 2007/08 
assessments on the basis of the new 
accounts, auditors would not have had 
evidence available to them.
cause to draw attention to potential risks 
relating to investments in Iceland, and 
73   Auditors continue to monitor the situation 
neither the opportunity nor the powers 
local y. Many of the authorities that have 
to intervene. They can only intervene in 
money at risk in the Icelandic banks 
extreme circumstances, primarily if they 
have already commissioned independent 
believe unlawful acts are imminent.
reviews of their practice, which have 
made recommendations. Auditors 
71   In giving their annual value for money 
will consider whether the authorities’ 
conclusions and making use of 
responses are appropriate and whether 
resources assessments, auditors 
they need to take any action themselves, 
reviewed the treasury management 
for example in terms of public reporting.
arrangements put in place by an 
authority. This involved the auditor 
74   The Commission will also ask all auditors 
satisfying him or herself that an authority 
to fol ow up the findings from this study 
had put in place arrangements to 
at the local level over 2009/10, whether 
comply with the CIPFA Code. The CIPFA 
an authority had investments in Iceland 
Code was considered the appropriate 
or not, to ensure that the appropriate 
standard, as it not only represents 
lessons are learned by all authorities. 
general y accepted best practice in this 
This report will inform auditors’ work 
area but is defined in regulations as a 
on their value for money conclusions 
proper practice to which authorities 
and use of resources assessments 
should have regard. 
for 2008/09, which will be issued in 
September 2009. 
Risk and return | The treasury management framework | 35

---

4  Treasury 
management in 
local authorities
75   This chapter considers how local 
77   Most policies refer to the statutory 
authorities fulfil their treasury 
framework and to the need to prioritise 
management functions and, in particular, 
security and liquidity above yield. 
how cash deposits are invested and 
Policies also, rightly, make it clear that 
managed. 
investments will be used to generate 
Local treasury management 
income. But good policies emphasise 
local accountability and responsibility, 
policy meets national 
the criteria within which it is appropriate 
requirements
to maximise yield, and also define the 
rules for determining:
76   All local authorities have, as required, 
adopted the CIPFA Code of Practice 
•  a high credit rating;
for Treasury Management in Local 
•   the maximum periods for which funds
Authorities. They use the Code to govern 
may be invested;
the way that surplus funds are invested. 
Local authorities also produce an annual 
•   the total principal sums invested with
investment strategy in accordance with 
counterparties at any point in time;
the requirements laid out in the Local 
•   the criteria for choosing investment
Government Act 2003. 
counterparties with adequate security;
•  the types of investment; and
•   an appropriate balance between short-
term and longer-term deposits.
78   The quality and content of individual 
policies varies markedly. For example, 
21 per cent of treasury management 
policies do not specify what a high credit 
rating is. Thirty-two per cent of policies 
do not outline how frequently ratings 
should be monitored and 29 per cent 
do not specify procedures to deal with a 
rating change that means counterparties 
no longer meet local thresholds. In some 
cases, policies have been formulated 
using a template supplied by treasury 
advisers. In others, policies contained 
wording copied verbatim from the CIPFA 
Code of Practice guidance, with little 
evidence that due consideration has 
been given to local policy or priorities. 
36 | Treasury management in local authorities | Risk and return

---

79   In general, treasury management policies 
81   Treasury advisers are consultancy 
are reviewed and revised as part of an 
firms that provide information to local 
annual process and are not considered 
authorities. Most local authorities use 
in between. But policies tend to be rol ed 
one or more external firms of treasury 
over from year to year and, consequently, 
advisers to provide expert information 
most have been unchanged for some 
and guidance. Treasury advisers play 
years. A small number of policies have 
a variety of roles in helping to draw up 
been revised in response to the Icelandic 
local treasury management policy and 
banking crisis. But in most cases, 
strategy, including: 
policies for 2008/09 have not altered;
instead, operational changes have been 
•   assisting an authority to develop its
made, such as revisions to counterparty 
treasury management policy;
lists or deposit limits. 
•   helping an authority to develop
approved lending, or counterparty, 
80   However, treasury management policies 
lists;
for 2009/10 are being revised. Local 
authorities intend to include, for example, 
•   providing information on the
refined credit rating criteria, such as 
creditworthiness of counterparties;
more clearly defined limits for investing 
•   advising on the criteria to take
abroad, limits for investing in banking 
into account when determining 
groups, and support ratings.I 
which organisations to include on 
counterparty lists;
•   advising on the investment instruments
that should be used;
•   advising on the maximum sums
that should be invested in each 
organisation, ratings criteria, 
investment limits and the duration of 
deals; and
•   advising on borrowing, borrowing
limits and when to refinance at lower 
interest rates. 
I  Fitch defines support ratings as the potential for a bank’s owner or a central bank to provide 
support should the bank get into difficulty www.fitchratings.com/corporate/fitchResources.
cfm?detail=1%26rd_file=spprt
Risk and return | Treasury management in local authorities | 37

---

4 |  Treasury management 
in local authorities
82   In the best authorities, policy is 
84   The counterparty lists developed 
developed local y and information 
by local authorities with more highly 
provided by treasury advisers is used as 
developed arrangements for assessing 
reference material alongside information 
and managing risk are also likely to 
gathered from other sources. Few local 
specify thresholds for determining an 
authorities gather information directly 
appropriate split between investments 
from credit rating agencies and, instead, 
in UK and non-UK banks, together with 
rely on information provided by their 
the maximum amounts that can be 
treasury advisers. However, a direct 
deposited in banks with the same owner 
relationship with one or more of the 
(group limits). These local authorities are
credit rating agencies is not, on its own, 
also likely to manage counterparty lists 
an indicator of good performance.
actively, in anticipation of bank mergers. 
Local authorities specify risk 
The more risk-aware local authorities 
do not judge risk by relying solely on 
thresholds
a single credit rating or a single credit 
83   In line with best professional practice, 
rating agency. Instead, they consider 
local authorities manage risk by 
the credit ratings quoted by one agency 
developing counterparty lists that 
alongside those quoted by others.
specify minimum credit ratings and other 
85   The local authorities that managed 
thresholds. The thresholds vary between 
risk most effectively were those that 
local authorities in accordance with 
specified additional measures of risk in 
local policy and appetite for risk. As a 
conjunction with long and short-term 
minimum, counterparty lists specify:
credit ratings. For example, the Icelandic 
•   the group of institutions that comprise
banks met one local authority’s credit 
a counterparty list;
rating threshold, but failed to make the 
counterparty list because they did not 
•   the minimum credit ratings for each
meet the support ratings threshold.  
counterparty;
86   The best local authorities use a range of 
•   the length of time that money wil  be
knowledge and information to judge risk 
invested; and
and set credit rating thresholds before 
•   the maximum sums that wil  be
developing counterparty lists. The same 
invested with different types of 
local authorities also use a range of 
institution. 
information before making investment 
decisions, including information gathered 
from treasury advisers, the financial 
press, and other sources, such as 
Reuters and Bloomberg. However, just 
over half of local authorities (51 per cent)
relied solely on information provided by 
treasury advisers. 
38 | Treasury management in local authorities | Risk and return

---

87   Some local authorities ask treasury 
Local authorities manage risk 
advisers to compile and manage 
by diversifying their investments 
counterparty lists on their behalf. 
Outsourcing arrangements can be 
89   The pattern of deposits held on 7 
beneficial: for example, to small local 
October 2008 suggests that local 
authorities with limited capacity. However, 
authorities were, in general, making 
the role of treasury advisers does not 
appropriate judgements regarding risk 
extend to assuring compliance with 
and return:
good practice in treasury management. 
•   Most funds were invested for terms of
Hence, such arrangements need 
one year or less, of which £12.6 bil ion 
appropriate management, oversight 
(41 per cent) was deposited on terms
and scrutiny. For instance, one local 
of between one day and six months 
authority failed to adopt a revised 
and £12.2 bil ion (39 per cent) was
counterparty list prepared by its treasury 
deposited for more than six months, 
adviser. The revised list did not include 
but less than one year. Less than 20 
the Icelandic banks. Instead, the local 
per cent of deposits (£6.1 bil ion) were
authority continued to place deposits 
placed for more than one year.
in accordance with an outdated 
counterparty list, which included the 
•   Most funds (38 per cent) were
Icelandic banks. 
deposited in AA-rated, very strong 
grade, institutions; 14 per cent of
88   Local authorities also make use of 
funds were deposited in A-rated, 
brokers who act as an intermediary 
strong grade institutions; and 2
between the authority and the lender. 
per cent of funds were deposited 
They do not provide advice but enable 
in the small number of AAA-rated, 
depositors to access a wide range of 
extremely strong grade, institutions. 
banks. Brokers perform a useful role, but 
The remaining funds were placed 
authorities may sometimes benefit from 
in building societies. Most building 
a direct relationship with counterparties. 
societies do not have credit 
And brokers should not be used 
ratings. Instead, judgements of 
as a source of advice on individual 
creditworthiness are made based on 
investments.
the size of the building society.
Risk and return | Treasury management in local authorities | 39

---

4 |  Treasury management 
in local authorities
90   In general, there is a pay-off between 
Local authorities hold most of 
risk rating and yield. The AAA-rated, 
their deposits in UK banks and 
extremely strong grade institutions offer 
maximum security for investments in 
building societies
return for lower yield. On the other hand, 
92   On 7 October 2008, local authorities 
an A-rated, strong grade institution, 
held deposits in 25 different countries. 
offers less security, but higher yield. 
More than £19.4 bil ion (63 per cent) was
Local authorities were, therefore, making 
deposited in institutions registered in the 
judgements balancing risk and return.
UK, of which £17.7 bil ion (57 per cent)
91   However, the management of risk and 
was deposited in institutions owned 
return varied between local authorities, 
by UK companies. Almost 43 per cent 
and suggests that different authorities 
of funds was deposited overseas or in 
were wil ing to take different amounts of 
institutions that were not owned by UK-
risk. All local authorities held deposits 
based companies. More than 20 per cent 
in A-rated, strong grade, institutions;
of funds (£6.99 bil ion) was deposited in
and 97 per cent of local authorities held 
banks based in the Republic of Ireland. 
deposits in AA-rated, very strong grade, 
The remainder was deposited in financial 
institutions. In contrast, 38 per cent of 
institutions across Europe, the United 
local authorities held deposits in AAA-
States, the Middle East, the Far East and 
rated, extremely strong grade institutions.
Australia (Figure 6).
40 | Treasury management in local authorities | Risk and return

---

Figure 6
Most funds are placed in institutions owned and based in the UK
Fifty-seven per cent of funds is held in UK-owned banks
  Spain
Australia
Germany
Iceland
Ireland
United
Kingdom
Other
0
10
20
30
40
50
60
70
Proportion of deposits (%)
Domicile of institution
Domicile of owner
Source: Audit Commission
Risk and return | Treasury management in local authorities | 41

---

4 |  Treasury management 
in local authorities
93   On 7 October 2008, local authorities held 
95   There is no requirement for the DMO to 
61 per cent of their deposits in banks 
maintain the DMDAF. The operational 
and just over half of that amount (35 per
notice that governs the facility al ows the 
cent) in building societies. The remainder
DMO to suspend or terminate it at any 
was invested in money market funds, 
time, potential y without notice. However, 
other local authorities and in other types 
it would be useful if the DMO were to 
of account, including instant access call 
guarantee the DMDAF as a place of 
accounts and the Debt Management 
safety and security for local authority 
Deposit Account Facility (DMDAF). The
funds.
DMDAF is operated by the government’s 
DMO. It offers local authorities the 
Local authorities consider yield 
facility to place deposits in an AAA-rated, 
when setting budgets
extremely strong grade body, but with a 
96   Each local authority makes its own 
significantly reduced yield. The amount 
assumptions about investment income 
deposited in the DMO on 7 October 
and the extent of local authorities’ 
2008 was £580 mil ion, or 1.9 per cent of 
reliance on interest receipts varies. 
the total on deposit that day. 
Where investment targets are set, most 
94   Local authorities have tightened their 
local authorities assume income from 
criteria for identifying counterparties 
interest at between 1 and 5 per cent 
since the col apse of the Icelandic 
of net budget. However, in two local 
banks. They have set higher credit rating 
authorities, budgeted income from 
thresholds in addition to reducing the 
interest earned in 2008/09 equated to 
maximum sums that will be invested in 
almost a quarter of annual spend. The 
each institution. Local authorities are 
spending plans of some local authorities 
finding it increasingly difficult to place 
will be material y affected by reduced 
deposits within the higher thresholds 
rates of return from invested funds as a 
and many are relying increasingly on 
result of interest rate cuts. Indeed, one 
the DMDAF. After the col apse of the 
local authority has already cut services 
Icelandic banks, many local authorities 
as it overestimated investment returns in 
wanted to open DMDAF accounts but, 
2007/08, during which time interest rates 
for operational reasons within the DMO, 
were rising.
account opening often took six weeks or 
longer.
42 | Treasury management in local authorities | Risk and return

---

97   While there is no direct evidence that 
99   Reliance on interest receipts has 
local authorities prioritise yield above 
reduced since the col apse of the 
financial security and liquidity, some 
Icelandic banks and local authorities 
treasury teams experience pressures 
have adjusted their income assumptions 
to ensure that investments perform wel . 
downwards. There is also evidence 
For example, local authorities benchmark 
of a broader shift in attitude and a 
their treasury management functions. 
reinterpretation of the relationship 
A key indicator is investment returns in 
between security, liquidity and yield. In 
comparison with an average interest 
the past, local authorities were more 
rate, and treasury teams are encouraged 
wil ing to risk security in return for 
to out-perform the benchmark where 
yield. Current attitudes towards risk 
possible. Staff in two local authorities 
management reflect an increasingly 
considered that they could not afford 
cautious approach that focuses on 
to use the DMO or to place deposits of 
protecting capital, sometimes at the 
less than three months, which general y 
expense of yield. 
offer lower rates of return. Staff at a third 
local authority reported that investments 
100  However, extreme caution costs money 
were made in the Icelandic banks in the 
and it may not be appropriate for all 
light of the high interest rates offered and 
future deposits to be made only with 
local pressures to maximise revenue.
AAA-rated, extremely strong grade 
institutions. Such decisions are a matter 
98   Benchmarking is a useful and beneficial 
of local choice and local authorities need 
means of assessing performance. 
to set and communicate policy that 
However, a focus on benchmarking 
describes the local risk appetite and the 
yield, to the exclusion of other aspects of 
local thresholds for managing the trade 
treasury management such as security 
off between risk and reward. 
and liquidity, may lead to an undesirable 
concentration on yield. If benchmarking 
of the treasury management function is 
required, a broad range of performance 
indicators, including security and liquidity, 
should be monitored.
Risk and return | Treasury management in local authorities | 43

---

4 |  Treasury management 
in local authorities
Local treasury management 
104  Local authority staff working in treasury 
practices and staff 
management hold a variety of general 
qualifications vary
accountancy qualifications, including 
CIPFA; Association of Chartered
101  There are variations in local treasury 
Certified Accountants; the Chartered
management arrangements. Some 
Institute of Management Accountants;
local authorities manage the whole of 
and the Association of Accounting 
their investment portfolio; others divide
Technicians. Treasury managers from 
responsibilities and manage simple 
two of the 37 case study sites hold, 
investments such as bank term deposits 
or are studying for, specific treasury 
and cash funds and outsource other, 
management qualifications, including 
more complex activities, including 
those awarded by the Association of 
managing gilts and certificates of deposit, 
Corporate Treasurers. 
as well as property portfolios. A small 
105  There are currently few training and 
number of local authorities rely almost 
development opportunities specifical y 
entirely on external fund managers. 
designed for local authority treasury 
102  Some smal er local authorities have been 
management staff. While the best local 
unable to al ocate sufficient resource to 
authorities actively encourage staff to 
treasury management functions, with 
seek further training and to identify 
a consequent failure to understand the 
and access networking opportunities 
markets and counterparties properly. 
where possible, the lack of training 
Local authorities are now recognising 
opportunities means that staff are very 
that safeguarding invested cash requires 
dependent on on-the-job learning and 
an adequate level of resource; and many
development. The quality of such training 
have either al ocated extra resource, 
will vary and may mean that poor or 
or are now considering how best to 
outdated practices persist in some local 
al ocate extra resource to this function.
authorities. General financial awareness 
is an indicator of good treasury 
103  In some cases, county councils look 
management. Indeed, the most effective 
after funds for police and fire authorities. 
staff tend to be those who manage more 
This arrangement is potential y a good 
than one type of investment portfolio, 
way of reducing costs. However, if this 
such as pension funds or school 
approach is adopted, there needs to be 
reserves, or who work closely with 
clear separation of funds, which should 
managers responsible for pension funds.
be managed in line with the policy of the 
owner of the deposits rather than the 
manager.
44 | Treasury management in local authorities | Risk and return

---

106  Local authorities need to determine the 
108  The national framework requires that 
level of resources they need to manage 
treasury management arrangements 
the function in accordance with advice 
are considered annual y at a meeting of 
provided by the director of finance or 
the full council, or equivalent. However, 
equivalent. In some cases, decisions 
such meetings general y afford little 
will be made to outsource some or all 
time for discussion and debate and 
responsibilities. Such decisions should 
the contribution of elected members 
take full account of the relative costs and 
is weak. Full council meetings are, 
benefits. It is for the local authority to 
therefore, unlikely to be the best place 
specify the type of support it needs and 
for a detailed review of policy and 
at what level and, having let a contract, 
performance. Other bodies, particularly 
to monitor performance against this 
audit committees, should, therefore, 
specification and satisfy itself that it is 
play a more prominent role providing 
getting good value for money from the 
an oversight of treasury management 
arrangement. When outsourcing is used, 
policy and practice. In addition, a 
the accountability for public money, 
backward-looking, annual review of 
however, remains with the authority.
policy is not sufficient to ensure that 
Governance and scrutiny
treasury management arrangements are 
functioning effectively. 
107  While officers from the best local 
109  Few elected members have received 
authorities tend to be proactive 
training or have backgrounds that 
in seeking feedback on treasury 
enable them to scrutinise or chal enge 
management policy and compliance, 
effectively. In some local authorities, this 
the governance and scrutiny of treasury 
means that officers seek to exclude 
management arrangements is general y 
elected members from discussions. 
poor. 
In others, elected members are 
content to delegate responsibility for 
treasury management to the officers. 
Local authorities need to develop a 
governance framework of reporting 
and review alongside the annual review 
process and should work to improve 
the level of awareness and engagement 
of all elected members. As a minimum, 
such arrangements would include:
•   an elected member (or equivalent) with
responsibility for all aspects of finance, 
including treasury management;
Risk and return | Treasury management in local authorities | 45

---

4 |  Treasury management 
in local authorities
•   regular awareness-raising briefings to
Local authorities have different 
other elected members about treasury 
attitudes to risk
management, investment strategies 
and approaches for managing risk;
111   There are differences in the behaviours 
displayed by local authorities that were 
•   inclusion of treasury management in
non-investors in the Icelandic banks, 
the annual programme of internal audit 
those whose deposits matured between 
reviews;
1 November 2007 and 7 October 2008, 
•   reporting to the council, cabinet (or
and those that have funds at risk. Non-
equivalent) and audit committee on a
investors general y had more effective 
regular basis, in addition to the annual 
governance and scrutiny arrangements 
review;
and took more measured approaches 
to managing risk than either local 
•   arrangements for producing
authorities whose deposits matured 
management information that enables 
between 1 November 2007 and 7 
and prompts a user to consider 
October 2008 or those that have funds 
security and liquidity as wel  as yield;
at risk (Table 4).
and
112   Non-investors tended to display a 
•   maintenance of a list of al  current
combination of one or more of: more 
deposits available for scrutiny at any 
risk averse; more risk aware; more
time.
effective users of information. Their 
110   Local authorities also need to ensure that 
treasury management policies indicated 
they have in place arrangements to test 
a cautious approach, which was 
for compliance that include: 
reflected in high rating thresholds and/
or the use of more than one type of 
•   segregation of duties between staff
credit rating. Others used additional 
making deals from those checking 
information to supplement credit ratings 
them;
and came to their own judgements 
•   regular (at least monthly) compliance
about the suitability of potential 
checks; and
counterparties. As early as the start of 
2008, a small number of local authorities 
•  regular spot checks.
reacted proactively to increased risks 
in the markets. They adopted a more 
risk-averse approach by restricting 
counterparty lists to banks with the 
strongest credit profile. 
46 | Treasury management in local authorities | Risk and return

---

113   In contrast, local authorities with the 
114   Local authorities with deposits that 
largest sums at risk tended to have weak 
matured between 1 November 2007 and 
governance and scrutiny arrangements, 
6 October 2008 displayed elements of 
were overly dependent on external 
the behaviours of local authorities that 
advice and failed to consider adequately 
had never invested and those with funds 
the risks associated with their decisions. 
at risk. In other words, deposits made 
For example, when comparing deposits 
in the Icelandic banks were returned 
made on the same day for the same 
because they had good judgement, 
amount of money and the same duration, 
were lucky, or both.
on average, the Icelandic banks offered 
better interest rates than other banks 
 
with the same credit rating. On average, 
local authorities received an extra 0.065 
per cent interest when they invested 
in Iceland in comparison with other, 
similarly rated institutions, equivalent 
to an extra £650 per year per mil ion 
deposited.
Risk and return | Treasury management in local authorities | 47

---

4 |  Treasury management 
in local authorities
Table 4
Treasury management behaviours vary
Local authorities without Icelandic deposits tended to exhibit more of the characteristics outlined 
in the left-hand column. Those with funds at risk tended to exhibit more of the characteristics 
outlined in the right-hand column.
Characteristic Non-investors
Investors
Attitude to risk 
Cautious. Recognise the need to own  Reactive. Conduct little research into 
all risk-reward decisions and the need  the risks being taken.
to maintain a questioning, chal enging 
mindset.
Approach to risk  Manage risk proactively: 
Manage risk reactively:  
management
• invest funds with riskier 
• wait for rating agencies to change 
  counterparties only for short periods  a rating before amending limits; 
of time; 
  and 
• consider the possibility of breaking a  • regard policy as only relevant for 
deposit before maturity; 
  new investments not existing ones.
• manage the counterparty list without 
waiting for a rating downgrade; and 
• consider country limits for 
  counterparties.
Use of credit 
Recognise that credit ratings and 
Rely on a single short-term or long-
ratings
comments from advisers are merely 
term credit rating. Highly dependent 
one source of information that can 
on information provided by treasury 
be used to build an understanding 
advisers.  
of risks in the markets and with 
 
counterparties.
Have gaps in understanding 
regarding the use of credit rating 
agencies, including: 
• which one(s) to use; 
• the measures to use (long-term/ 
short-term and so on); and 
• what to do when a counterparty 
  has different ratings with different 
  credit rating agencies.
48 | Treasury management in local authorities | Risk and return

---

Characteristic Non-investors
Investors
Governance 
Elected member oversees finance 
Elected members do not engage 
and scrutiny
function, takes an interest in the 
in the treasury policy and, instead, 
treasury policy and chal enges 
leave it to the experts in finance. 
assumptions built into the limits and 
 
minimum credit criteria. 
Failure to question policies year-on-
 
year and mechanistical y using their 
Finance staff proactively approach 
advisers’ policy template.
elected members and provide 
briefings on key issues relevant to the 
treasury policy, including risk limits. 
Elected members are able to provide 
robust chal enge to the key policy 
parameters.
Use of 
Extensive. Includes actively 
Limited. Overly reliant on a single 
information
researching counterparties and the 
information source, for example  
markets. 
emails from a treasury adviser. 
 
Reliant on benchmarking information 
that focuses on using lowest rate 
achieved on borrowings and highest 
rate achieved on cash investments, 
which encourages local authorities 
to take on more risk to show an 
improved placing in the benchmarks.
Relationship 
Know the bankers that they are 
Excessive reliance on brokers 
with 
investing with. 
means that some local authorities 
counterparties
do not have direct contact with their 
banking counterparties. 
Reliance on 
Prioritise security and liquidity above 
Highest returns available in market 
yield
yield. Maintain a balance between 
place are sought. Some (overt or
security, liquidity and yield by investing  covert) pressure to maximise returns
short term where risk dictates. For 
to balance budgets.
some, it is rare to invest for longer 
than three months.
Risk and return | Treasury management in local authorities | 49

---

4 |  Treasury management 
in local authorities
Characteristic Non-investors
Investors
Achievement 
Carry out scenario testing to ensure 
Rely on advisers for many aspects of 
of security and  that the sensitivity of the portfolio 
credit risk and interest rate risk.  
liquidity
to the market is understood. 
 
Normal expectation is for specified 
Tend to invest for long terms in 
investments of six months or less. 
excess of one year in order to lock in 
yield, at the expense of being able to 
react should the credit profile of the 
counterparty change.
Resource 
Al ocate the equivalent of least one 
Reliant on advisers for market and 
management, 
ful -time member of staff to the role 
credit information. 
staff 
of investing funds and performing 
 
development 
research into counterparties and 
Ignorant of the commercial nature of 
and expertise
investment instruments. 
their relationship with the banks and, 
 
therefore, of the potential to break 
Actively encourage networking and 
deposits before term if conditions 
training. 
become unfavourable. 
 
 
Staff gather information about the 
Weak knowledge of products and 
markets and counterparties that 
markets. Take few steps to train and 
includes:  
develop staff.
• reviewing information and credit 
  measures available from all rating 
agencies; 
• actively seeking out information 
  available from newspapers and the 
internet; and 
• looking into other measures of risk.
Source: Audit Commission
50 | Treasury management in local authorities | Risk and return

---

5  Conclusions
115   The chaos in the financial system that 
118   The overarching treasury management 
led to the col apse of the Icelandic 
framework is the right one. Authorities 
banks had no recent precedent. But the 
should remain in control of their own 
col apse has revealed much about the 
funds within a national prescribed 
way that local authorities look after their 
structure. The current structure has 
money.
gaps, but the system can be adjusted 
rather than replaced. But if authorities 
116   Many authorities have acted prudently, 
are going to deposit in the commercial 
used advice and information wisely 
sector to benefit from the higher rates of 
and balanced their risks. Others have 
interest available, they must ensure that 
been less cautious, by fol owing ratings 
their treasury management is properly 
exclusively and perhaps striving to 
resourced, managed and scrutinised. 
achieve a high yield without due regard 
The full range of risks needs to be 
to the risks involved. And a small group 
recognised and managed. 
of authorities that made deposits in 
Icelandic banks after the credit ratings 
119   There is always the risk that a 
had been downgraded did not, in the 
commercial bank will col apse. Local 
Commission’s view, take adequate steps 
authorities may, as a consequence, lose 
to ensure that they were using up-to-
money. But with a better approach to 
date information when making deposits 
managing their deposits, the chances of 
at a time of great financial instability, 
suffering such a loss can be reduced.
and when the fragility of the Icelandic 
banking system had been widely 
reported and was common knowledge.
117   The consequence of this lack of caution 
has been the potential loss of large sums 
of public money. Had all authorities 
stopped depositing in Icelandic 
institutions after April 2008, then the 
amount of money at risk would have 
been over £500 mil ion lower than is the 
case.
Risk and return | Conclusions | 51

---

Appendix 1 – 
Methodology
120  Research for this review was carried out 
121  Completed responses were received 
between December 2008 and March 
from auditors of 451 out of a total of 489 
2009. The research comprised four 
local authorities, representing 92 per 
elements:
cent coverage (Table 5).
•   Col ection of data from appointed
auditors of English local authorities to 
determine the value of cash deposits 
held in banks, building societies and 
other institutions on 7 October 2008, 
together with details of deposits 
placed in the Icelandic banks since 
November 2007.
•   Visits to 37 English local authorities,
to examine treasury management 
arrangements. The local authorities 
were selected to include organisations 
that had deposits in one or more 
Icelandic bank, including UK 
subsidiaries, on 7 October 2008;
organisations that had either never 
placed deposits in an Icelandic bank, 
or whose deposits had matured 
before 1 November 2007; and
organisations that had placed deposits 
in an Icelandic bank since 1 November 
2007, deposits that had matured prior 
to 7 October 2008.
•   A desk-based review of 30 sets of
treasury management documentation 
(including policy, strategy, annual
investment strategies and annual 
reports); and 179 counterparty lists.
•   A review of the national guidance on
managing cash reserves and deposits.
52 | Appendix 1 – Methodology | Risk and return

---

Table 5
A high coverage was achieved
Auditors submitted data returns for 92 per cent of local authorities 
Local authority
Number of bodies Coverage
County councils
34
33 (97%)
District councils
238
234 (98%)
London borough councils
33
33 (100%)
Metropolitan district councils
36
33 (92%)
Unitary authorities
47
44 (94%)
Police authorities
38
34 (89.5%)
Fire authorities and other bodies 63
40 (63.5%)
Total
489
451 (92%)
Source: Audit Commission
122  The three main commercial banks in 
124  Deloitte LLP carried out the visits 
Iceland col apsed in early October. Glitnir 
to authorities on behalf of the Audit 
and Landsbanki went into receivership 
Commission and col ected information 
on 7 October 2008; and Heritable Bank
in a framework designed by the 
froze all funds. Kaupthing went into 
Commission. The work was performed 
receivership on 8 October 2008. For 
by treasury management specialists 
the purposes of our review, we have 
who also provided advice to the Audit 
assumed that 6 October 2008 was the 
Commission on good practices in 
last day of normal trading.
treasury management.
123  Sarah Furlong project managed the 
125  A project steering group assisted in 
study, supported by Agnieszka Scott. 
developing the research framework 
David Caplan was the project director. 
and analysing the findings. The 
Leah Sparks, Mark Burkett, John 
Commission’s Local Government 
Sandhu, Rosamund Chester, Laura 
Financial Management Advisery group, 
Hol oway, Ben Oxenham and Marcine 
whose members include representatives 
Waterman provided additional support.
of local authorities, CIPFA and central 
government also provided comments.
126  The Commission thanks all those who 
were involved. However, the views 
expressed in this report are those of the 
Audit Commission alone.
Risk and return | Appendix 1 – Methodology | 53

---

Appendix 2 – 
Exposure to the 
failed Icelandic banks
Table 6
127 local authorities hold deposits in the failed Icelandic banks
Local authorities hold deposits total ing £953.53 mil ion
Local authority
Value of  GRE 
Value of  Value of 
Value of 
deposits  (£m)I
deposits  reserves 
deposits (% 
(£m)
(%GRE)
(£m)II 
reserves)
Buckinghamshire County 
5.0
720
0.7
39
13
Council
Cheshire County Council
8.5
1037
0.8
37
23
Cornwall County Council
5.0
989
0.5
75
7
Dorset County Council
28.1
576
4.9
41
69
Gloucestershire County 
12.5
895
1.4
47
27
Council
Hertfordshire County 
28.0
1641
1.7
50
56
Council
Kent County Council
48.9
2000
2.4
107
46
Lancashire County Council
8.9
1663
0.5
82
11
Norfolk County Council
32.5
1579
2.1
61
53
Northumberland County 
23.0
644
3.6
35
66
Council
Oxfordshire County Council 5.0
978
0.5
39
13
Somerset County Council
25.0
822
3.0
21
119
Surrey County Council
18.5
1600
1.2
46
40
West Sussex County 
12.9
1148
1.1
58
22
Council
Wiltshire County Council
8.0
698
1.1
32
25
I  GRE is defined as the gross expenditure figure shown in the net cost of services section of the 
income and expenditure account or equivalent. It has been used to provide a broad indication 
of the exposure of authorities adjusted for size. The GRE figures shown here are auditors’ 
estimates for 2008/09.
II  Source: CIPFA Memorandum – Estimated unearmarked and earmarked general reserves 
(excluding schools’ reserves, housing revenue account and pension funds) as at 1 April 2008;
www.cipfastats.net/
54 | Appendix 2 – Exposure to the failed Icelandic banks | Risk and return

---

Appendix 2 – Exposure to the 
failed Icelandic banks
Local authority
Value of  GRE 
Value of  Value of 
Value of 
deposits  (£m)I
deposits  reserves 
deposits (% 
(£m)
(%GRE)
(£m)II 
reserves)
Amber Val ey Borough 
1.0
64
1.6
6
17
Council
Aylesbury Vale District 
3.0
24
12.5
19
16
Council
Bassetlaw District Council
8.0
74
10.8
3
267
Bolsover District Council
3.0
65
4.6
5
60
Braintree District Council
5.0
67
7.5
5
100
Breckland Council
12.0
66
18.2
7
171
Bridgnorth District Council
1.0
30
3.3
2
50
Burnley Borough Council
1.0
100
1.0
2
50
Cambridge City Council
9.0
136
6.6
27
33
Canterbury City Council
6.0
109
5.5
11
55
Charnwood Borough 
1.0
74
1.4
3
33
Council
Cheltenham Borough 
11.0
99
11.1
14
79
Council
Cherwell District Council
6.5
62
10.5
18
36
Chorley Borough Council
2.0
47
4.3
2
100
Colchester Borough 
4.0
122
3.3
9
44
Council
Cotswold District Council
2.0
38
5.3
4
50
Daventry District Council
8.0
34
23.5
8
100
Derwentside District 
7.0
114
6.1
5
140
Council
Dover District Council
1.0
83
1.2
5
20
East Lindsey District 
4.0
77
5.2
15
27
Council
East Staffordshire Borough  5.0
52
9.6
8
63
Council
Epping Forest District 
2.5
123
2.0
10
25
Council
Exeter City Council
5.0
95
5.3
10
50
Gloucester City Council
2.0
85
2.4
6
33
Risk and return | Appendix 2 – Exposure to the failed Icelandic banks | 55

---

Appendix 2 – Exposure to the 
failed Icelandic banks
Local authority
Value of  GRE 
Value of  Value of 
Value of 
deposits  (£m)I
deposits  reserves 
deposits (% 
(£m)
(%GRE)
(£m)II 
reserves)
Great Yarmouth Borough 
2.0
94
2.1
2
100
Council
Hertsmere Borough Council 1.0
53
1.9
18
6
High Peak Borough Council 2.0
57
3.5
5
40
Ipswich Borough Council
5.0
113
4.4
5
100
Lancaster City Council
6.0
109
5.5
5
120
Lewes District Council
1.0
79
1.3
6
17
Mid Devon District Council
1.1
35
3.1
1
110
Newark and Sherwood 
2.0
64
3.1
7
29
District Council
Newcastle Under Lyme 
2.5
56
4.5
13
19
Borough Council
North Wiltshire District 
5.0
51
9.8
13
38
Council
Nuneaton And Bedworth 
3.0
79
3.8
4
75
Borough Council
Oxford City Council
4.5
232
1.9
3
150
Purbeck District Council
2.0
23
8.7
2
100
Reigate and Banstead 
15.5
59
26.3
5
310
Borough Council
Restormel Borough Council 4.0
58
6.9
2
200
Rugby Borough Council
3.0
58
5.2
5
60
Rushmoor Borough Council 2.0
51
3.9
2
100
Sevenoaks District Council
1.0
51
2.0
17
6
South Hams District 
1.3
47
2.8
8
16
Council
South Oxfordshire District 
2.5
51
4.9
47
5
Council
South Ribble Borough 
5.0
47
10.6
4
125
Council
Stroud District Council
3.0
79
3.8
7
43
Surrey Heath Borough 
4.0
37
10.8
15
27
Council
56 | Appendix 2 – Exposure to the failed Icelandic banks | Risk and return

---

Local authority
Value of  GRE 
Value of  Value of 
Value of 
deposits  (£m)I
deposits  reserves 
deposits (% 
(£m)
(%GRE)
(£m)II 
reserves)
Tamworth Borough Council 7.5
53
14.2
9
83
Tewkesbury Borough 
1.0
34
2.9
2
50
Council
Tonbridge and Mal ing 
1.0
54
1.9
23
4
Borough Council
Uttlesford District Council
2.2
38
5.8
1
220
Vale of White Horse District  1.0
56
1.8
1
100
Council
West Lindsey District 
7.0
35
20.0
7
100
Council
West Oxfordshire District 
9.0
41
22.0
13
69
Council
Winchester City Council
1.0
74
1.4
10
10
Wychavon District Council
1.5
70
2.1
5
30
Wycombe District Council
2.5
108
2.3
32
8
Wyre Forest District Council 9.0
49
18.4
5
180
Dorset Fire Authority
1.0
27
3.7
Not 
Not available
available
East London Waste 
1.0
35
2.9
26
4
Authority
Kent and Medway Fire and  1.6
75
2.1
9
18
Rescue Authority
Lancashire Combined Fire  0.4
Not 
Not 
Not 
Not available
Authority
available
available
available
New Forest National Park 
0.5
Not 
Not 
2
25
Authority
available
available
South Yorkshire Passenger  5.0
127
3.9
Not 
Not available
Transport Authority
available
South Yorkshire Passenger  6.0
105
5.7
Not 
Not available
Transport Executive
available
South Yorkshire Pensions  18.5
Not 
Not 
Not 
Not available
Authority
available
available
available
Transport For London
40.0
723
5.5
Not 
Not available
available
Risk and return | Appendix 2 – Exposure to the failed Icelandic banks | 57

---

Appendix 2 – Exposure to the 
failed Icelandic banks
Local authority
Value of  GRE 
Value of  Value of 
Value of 
deposits  (£m)I
deposits  reserves 
deposits (% 
(£m)
(%GRE)
(£m)II 
reserves)
West Midlands Passenger  4.0
151
2.6
9
44
Transport Authority
Barnet London Borough 
27.4
782
3.5
22
125
Council
Brent London Borough 
15.0
911
1.6
19
79
Council
City of Westminster Council 16.3
992
1.6
91
18
Haringey London Borough  37.0
1048
3.5
54
69
Council
London Borough of 
5.0
604
0.8
51
10
Bromley
London Borough of Ealing
2.0
892
0.2
47
4
London Borough of Enfield
5.0
871
0.6
38
13
London Borough of 
12.5
581
2.2
31
40
Havering Council
London Borough of 
20.0
801
2.5
12
167
Hil ingdon
London Borough of Sutton
5.5
460
1.2
18
31
Newham London Borough  7.0
1312
0.5
29
24
Council
Bolton Metropolitan 
6.0
618
1.0
20
30
Borough Council
City of Wakefield 
9.0
737
1.2
11
82
Metropolitan District Council
Doncaster Metropolitan 
3.0
685
0.4
16
19
Borough Council
Gateshead Metropolitan 
4.5
537
0.8
88
5
Borough Council
Kirklees Metropolitan 
1.0
1242
0.1
46
2
Council
Rotherham Metropolitan 
3.8
634
0.6
33
12
Borough Council
Solihull Metropolitan 
3.0
418
0.7
23
13
Borough Council
58 | Appendix 2 – Exposure to the failed Icelandic banks | Risk and return

---

Local authority
Value of  GRE 
Value of  Value of 
Value of 
deposits  (£m)I
deposits  reserves 
deposits (% 
(£m)
(%GRE)
(£m)II 
reserves)
Wirral Metropolitan Borough  2.0
890
0.2
30
7
Council
Dorset Police Authority
7.0
132
5.3
16
44
Hertfordshire Police 
3.0
197
1.5
9
33
Authority
Humberside Police 
4.6
197
2.3
30
15
Authority
Kent Police Authority
11.1
351
3.2
36
31
Lancashire Police 
0.7
303
0.2
12
6
Authority
Metropolitan Police 
30.0
3511
0.9
Not 
Not available
Authority
available
Northumbria Police 
3.5
350
1.0
62
6
Authority
Surrey Policy Authority
1.5
Not 
Not 
Not 
Not available
available
available
available
Sussex Police Authority
6.8
325
2.1
34
20
Thames Valley Police 
5.0
395
1.3
29
17
Authority
West Midlands Police 
5.4
634
0.9
52
10
Authority
West Yorkshire Police 
6.0
1148
0.5
17
35
Authority
Bracknell Forest Borough 
5.0
262
1.9
11
45
Council
Bristol City Council
8.0
978
0.8
38
21
North East Lincolnshire 
7.0
370
1.9
39
18
Council
North Lincolnshire Council
5.5
337
1.6
10
55
North Somerset Council
3.0
387
0.8
14
21
Nottingham City Council
41.4
925
4.5
49
84
Peterborough City Council
3.0
403
0.7
18
17
Plymouth City Council
13.0
607
2.1
15
87
Risk and return | Appendix 2 – Exposure to the failed Icelandic banks | 59

---

Appendix 2 – Exposure to the 
failed Icelandic banks
Local authority
Value of  GRE 
Value of  Value of 
Value of 
deposits  (£m)I
deposits  reserves 
deposits (% 
(£m)
(%GRE)
(£m)II 
reserves)
Redcar and Cleveland 
6.0
420
1.4
9
67
Borough Council
Rutland County Council
1.0
80
1.3
2
50
Slough Borough Council
2.5
369
0.7
14
18
Stoke on Trent City Council 5.0
680
0.7
47
11
Wokingham Borough 
5.0
285
1.8
13
38
Council
Source: Audit Commission
60 | Appendix 2 – Exposure to the failed Icelandic banks | Risk and return

---

Appendix 3 – 
Credit ratings
Table 7
Long and short- term credit ratings
Credit ratings may be confusing to laypeople, including elected members who may be charged 
with local governance.
Audit Commission 
Fitch
Moody’s
Standard and 
grading (for the purpose 
Poor’s
of standardisation)I  
Long 
Short 
Long 
Short 
Long 
Short 
term
term
term
term
term
term
Extremely strong grade
AAA
F1+
Aaa
P-1
AAA
A-1+
Very strong grade
AA+
F1+
Aa1
P-1
AA+
A-1+
AA
F1+
Aa2
P-1
AA
A-1+
AA-
F1+
Aa3
P-1
AA-
A-1+
Strong, but susceptible to 
A+
F1+  F1
A1
P-1
A+
A-1+ A-1
adverse conditions grade 
A
F1
A2
P-1  P-2 A
A-1+
(strong grade)
A-
F1  F2
A3
P-1 P-2 A
A-1+ A-2
Adequate grade
BBB+
F2
Baa1
P-2
BBB+
A-2
BBB
F2  F3
Baa2
P-2 P-3 BBB
A-2 A-3
BBB-
F3
Baa3
P-3
BBB-
A-3
Speculative grade
BB+
B
Ba1
Not 
BB+
B-1
prime 
(NP)
BB
B
Ba2
NP
BB
B-2
BB-
B
Ba3
NP
BB-
B-3
Very speculative grade
B+
B
B1
NP
B+
 - 
B
B
B2
NP
B
 - 
B-
B
B3
NP
B-
 - 
Vulnerable grade
CCC
C
Caa1
NP
CCC+
C
CCC
C
Caa2
NP
CCC
C
CCC
C
Caa3
NP
CCC-
C
CC
C
-
NP
CC
C
C
C
Ca
NP
C
C
Defaulting grade
D
D
C
NP
D
D
Source:  Audit Commission adaptation of information from Fitch, Moody’s and Standard and Poor’s
I  Standardised gradings are based on the Standard and Poor’s credit rating definitions www2.
standardandpoors.com/portal/site/sp/en/eu/page.article/2,1,1,0,1204844424546.html?vregio
n=eu%26vlang=en%23ID233
Risk and return | Appendix 3 – Credit ratings | 61

---

Appendix 4 – 
Glossary of terms
Term 
Description
Broker
An agent who handles orders to buy and sel . Brokers charge a 
commission that, depending upon the broker and the amount of the 
transaction, may or may not be negotiated.
Credit rating 
A measure of the credit worthiness of an institution, corporation, or even 
a country. Credit ratings are calculated from financial history and current 
assets and liabilities. Typical y, a credit rating tel s a lender or investor the 
probability of the subject being able to pay back a loan. 
DMA
The Debt Management Account – the account established in November 
1999 through which the DMO’s government debt and exchequer cash 
management transactions flow.
DMO
The United Kingdom Debt Management Office.
Liquidity
An assessment of how readily available an investment is; the length of term
of an investment.
PWLB
Public Works Loan Board. The PWLB has been part of the DMO since July 
2002.
Rating agency
Bodies that assess the financial strength of companies and governments, 
both domestic and foreign, particularly their ability to meet the interest and 
principal payments on their bonds and other debt.
Security
An assessment of the creditworthiness of a counterparty.
Treasury adviser
Consultancy firms that provide information to local authorities, including 
information regarding counterparty creditworthiness.
Yield
Interest, or rate of return, on an investment.
62 | Appendix 4 – Glossary of terms | Risk and return

---

Appendix 5 – 
References
1  Local Government Finance Act 1992 (sections 32 and 43). HMSO, 1992.
2   CIPFA, ‘Guidance on Local Authority Balances and Reserves’, LAAP Bul etin no. 55, CIPFA, 
2003 updated by LAAP Bul etin no. 77, CIPFA, 2008.
3   Audit Commission, Crunch Time? The Impact of the Economic Downturn on Local 
Government Finances, Audit Commission, 2008. 
4   DCLG, The Local Authorities (Capital Finance and Accounting) (England) (Amendments) 
Regulations 2009, DCLG, 2009.
5  Local Government Act 2003, HMSO, 2003.
6   Local Government Investments’ Guidance under section 15(1)(a) of the Local Government
Act 2003, ODPM, 2004.
7   CIPFA, Treasury Management in the Public Services. Code of Practice and Cross-sectoral 
Guidance Notes, CIPFA, 2001.
8   CIPFA, Treasury Management in the Public Services. Guidance Notes for Local Authorities 
Including Police Authorities and Fire Authorities (Ful y revised second edition 2006), CIPFA,
2006.
9   Centre for Public Scrutiny, Treasure Your Assets: A Jargon Free Guide to Scrutiny of Local 
Authority Investments, Centre for Public Scrutiny, 2009.
Risk and return | Appendix 5 – References | 63

---

64 | Risk and return

---

Design and production by the Audit Commission Publishing Team

---

Audit Commission 
1st Floor  
Price £15
Millbank Tower 
Stock code: LNR3514
Millbank  
London  
SW1P 4HQ
Telephone: 0844 798 1212  
Fax: 0844 798 2945
Textphone (minicom): 0844 798 2946
www.audit-commission.gov.uk
09_0183

---