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Rule changes pose major threat to investment and lending plans

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New financial conduct rules could force councils to completely rethink their treasury investment plans and make council-to-council lending more difficult, finance directors have warned.

The new regulations, which are set to be introduced by the Financial Conduct Authority in a year’s time, would mean councils having to renegotiate their relationships with investment firms and could prompt a “fire sale” of assets, meaning reduced returns.

The FCA has consulted on refreshing its rules in response to an update to the EU’s Markets in Financial Instruments Directive II.

LGC has previously reported on the impact the new regulations would have on council pension funds and in particular on their plans to invest in infrastructure projects. However, Mifid would also affect the ability of every council, in every tier, to invest the money it holds in its treasury.

MiFID II sets out different categories of investors. The FCA in turn has proposed to class councils as ‘retail’ investors, which are considered less sophisticated than ‘professional’ investors and are prohibited from buying into ‘complex’ investments.

It is investment management firms’ responsibility to assess whether their clients are professional or retail. The FCA has proposed to allow councils to ask their investment managers to treat them as professional investors via an ‘opt up’ process, but this means investment firms could refuse. In addition this option will not be available to councils with £15m or less in their treasuries.

Duncan Whitfield, finance director at Southwark LBC, said his authority invests two thirds of its treasury funds via external managers and that this is not uncommon. He added that every council would be affected by the regulations, but added that “the smaller the council, the more difficult you would find this administrative overhead”.

Mr Whitfield said: “The restrictions within which our treasury managers work are incredibly limited… by things like Chartered Institute for Public Finance & Accountancy guidance, which is why we earn so little on our cash.

“[Mifid is] another rope of strangulation around our cash. This is entirely disproportionate for the world we live in.”

Nigel Cook, head of pensions and treasury at Croydon LBC, said the new regulations would mean councils would have to renegotiate their relationships with all the firms to which they outsource the investment of their treasury cash.

As well as long-term investments, Mr Cook said councils often make overnight deposits in money market funds with banks such as Goldman Sachs and JP Morgan, on which they make a small earning. Under the new rules, even these firms would have to reassess their council clients.

Mr Cook also warned the regulations could affect short-term loans councils makes to each other because the lending council would have to assess the borrowing council as retail or professional, and may consider it safer not to lend at all.

Treasury cash comprises money borrowed from central government via the Public Works Loan Board, reserves and unspent grants.

Jeff Houston, head of pensions at the Local Government Association, said it was “not just parishes” that would be caught by the requirement to have more than £15m in their treasuries.

“More than half [of council treasuries] are above [the limit], but some districts and cities would be caught. It depends on what [the FCA] means by £15m; £15m at any point in the year, or across the year?

He said the £15m test was “arbitrary” and other tests due to be introduced under the new regulations, involving the frequency of an investor’s transactions in relevant markets or the qualifications held by its staff, should stop unprofessional investors.

He warned that although the Department for Communities & Local Government and the Treasury are aware of the problem, they may not be able to influence the FCA on the matter as it is an independent regulator.

Mr Houston also said the sector needs clarity on what will happen to councils that have not opted up by the proposed deadline of 3 January 2018, but still hold complex investments. “We need to avoid a fire sale next year; we need some sort of assurance from the FCA,” he said.

He added that the LGA is lobbying the FCA for an exemption for councils, to ensure the criteria used for assessing professional investors are ‘sensible’ and transitional protection for councils that do not opt up by the deadline.

However, he said: “Even if we get all three, there is a lot of work to do; it’s a massive logistical challenge.”

The FCA declined to comment while it considers responses to its consultation on the new rules which closed earlier this month.

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