Contact: Paul Carey-Kent, Deputy Treasurer, Tel 01962 847525

1 Introduction

1.1 The recent collapse of the Icelandic banking sector has highlighted the need for a clearly defined policy on the equitable treatment of cash losses potentially arising from the collapse of a bank or building society where cash has been deposited.

1.2 This report sets out for Members such a proposed policy for consideration and approval.

2 Existing treasury management arrangements

2.1 The Treasury Management and Investment Strategy approved by the Authority delegates its treasury management responsibilities to Hampshire County Council.

2.2 If the Authority had sufficiently large cash balances, specific deposits would be made on its behalf by the County Council. The Authority is generally a `net borrower' rather than an investor of funds, however, and no specific deposits have yet been made.

2.3 On those occasions when the Authority has cash balances available, they are pooled with those of the County Council, Hampshire Police Authority and the Hampshire Pension Fund. Interest is paid on its cash balances at the average 7-day rate.

2.4 In line with the Treasury Management and Investment Strategy approved annually by Hampshire County Council's Cabinet, the list of financial institutions with which cash may be deposited is kept under constant review by the County Treasurer, taking into account each institution's credit ratings, asset base, market capitalisation, press reports, etc. The list would be used if specific deposits were made on behalf of the Authority, as well as the pooled deposits.

2.5 Lending is restricted to certain of the major UK clearing banks and the larger UK building societies which are currently listed as follows:

· Lloyds TSB

· Royal Bank of Scotland (NatWest)

· Barclays

· HSBC

· Abbey

· Nationwide Building Society

· Britannia Building Society

· Yorkshire Building Society

· Coventry Building Society

· Chelsea Building Society

· Skipton Building Society

· Leeds Building Society

In addition to the above, cash may be invested in three AAA-rated money market funds which are currently listed as follows:

· Standard Life Sterling Fund

· Fidelity Institutional Sterling Cash Fund; and

· RBS Global Treasury Sterling Fund.

Furthermore, monies can also be placed with other local authorities and, if necessary for security, the Government's Debt Management Office.

2.6 Limits are placed on levels of total deposits made with individual institutions, based on their relative strength as a counterparty. Whilst the Treasury Management and Investment Strategy sets a maximum lending term of 364 days, this will be shortened in respect of those institutions with a relatively lower credit rating.

2.7 The County Treasurer will continue to manage cash balances on a cautious basis with the emphasis on capital preservation at the expense, where necessary to avoid unjustifiable risks, of additional interest returns.

2.8 For information, the County Council has never placed deposits with Icelandic banks and has not used any overseas institutions in the last 18 months.

3 Proposed policy on sharing cash losses

3.1 With the collapse of the Icelandic banks, it has become apparent that a clear agreed policy is necessary on how any losses of cash should be shared between this Authority, the County Council, Hampshire Police Authority and the Hampshire Pension Fund, in the event that a counterparty institution fails.

3.2 If a deposit made specifically on behalf of the Authority is lost, the whole loss would be borne by the Authority.

3.3 For cash that is pooled with the County Council's own cash balances, there are two options. First, the County Council could indemnify the Authority against any potential capital losses. However, for the County Council to offer that level of protection, the interest paid would have to be reduced to the average 7-day rate less 1%, which is broadly based on the differential between the 7-day rate and the Government's Debt Management Office interest rates where the potential for capital loss is considered to be negligible. This 1% deduction would be subject to a minimum interest rate payable of nil on positive cash balances, and would be reviewed annually for reasonableness.

3.4 In simple terms, the annual cost of such indemnification would be £10,000 per £1m average cash balance.

3.5 The second option would be for the risk of default to be shared between this Authority, the County Council, Hampshire Police Authority and the Hampshire Pension Fund on a proportionate basis. For example, if 1% of the pooled cash balances on deposit related to the Authority then it would bear a 1% pro rata share of any losses of capital. Interest would continue to be received at the average 7-day rate.

4 Conclusions

4.1 The cautious approach taken by the County Treasurer in terms of lending cash balances means that the risk of capital loss is low. The first option of full indemnification from the County Council could be both costly and overly prudent. The second option of sharing capital losses on a pro rata basis would seem more appropriate under the circumstances.

Recommendation

1 That it be recommended to the Authority that it agrees to share any capital losses on pooled cash balances on a pro rata basis and that any losses on deposits specifically made on behalf of the Authority (as set out in paragraph 2.5) should be borne in full.

Section 100 D - Local Government Act 1972 - background documents

The following documents discuss facts or matters on which this report, or an important part of it, is based and have been relied upon to a material extent in the preparation of this report.

NB the list excludes:

1. Published works.

2. Documents which disclose exempt or confidential information as defined in the Act.

None

I:\Treasurers\Corporate Finance\Jane\Fire\misc\FGP Fire investment loss treatment - Jan 09.doc