Part 4: Management of the funding package by the local authorities

Management of the West Coast Economic Development Funding Package.

4.1
The 4 West Coast local authorities (Buller District Council, Grey District Council, Westland District Council, and West Coast Regional Council) each received $7 million as their share of the funding package.

4.2
In this Part, we describe the approach that each local authority has taken to managing its share of the funding package, and its involvement in economic development initiatives (where applicable).

4.3
We expected all 4 local authorities to have appropriate systems and processes in place to manage their share of the funding package, and to meet the requirements of the Local Government Act 2002.

4.4
Under the Local Government Act 1974, which was in force when the local authorities received the funding package, each local authority had an obligation to prudently manage all revenues, expenses, assets, liabilities and investments. Similar requirements were carried over into the Local Government Act 2002; namely, that a local authority must –

… manage its revenues, expenses, assets, liabilities, investments, and general financial dealings prudently and in a manner that promotes the current and future interests of the community.1

4.5
A local authority must adopt various financial management policies, including an investment policy. Section 105 of the Local Government Act 2002 states that a local authority’s investment policy must include policies for–

(a) the objectives in terms of which financial and equity investments are to be managed; and

(b) the mix of investments; and

(c) the acquisition of new investments; and

(d) an outline of the procedure by which investments are managed and reported on to the local authority; and

(e) an outline of how risks associated with investments are assessed and managed.

4.6
For each of the 4 local authorities, we:

  • outline what each council has done with its share of the funding package;
  • describe their involvement (if any) in economic development initiatives;
  • assess whether their investment policies meet the requirements of the Local Government Act 2002; and
  • discuss whether each local authority has acted in keeping with its investment policy.

4.7
Each of the 4 local authorities has an investment policy, but these policies vary in the extent to which they meet the requirements of the Local Government Act 2002.

Recommendation 11
We recommend that Buller, Grey, and Westland District Councils revise their investment policies to meet the requirements of the Local Government Act 2002.

West Coast Regional Council

4.8
Between July 2000 and June 2005, West Coast Regional Council increased its $7 million share of the funding package to more than $9.5 million.

4.9
After receiving the $7 million, West Coast Regional Council invested the money in a term deposit account until it decided on an investment strategy. After considering different investment options, the Council decided, on 31 July 2001, to invest in a portfolio of assets managed by Forsyth Barr Funds Management Limited (Forsyth Barr). Forsyth Barr still manages the portfolio for the Council.

4.10
Unlike the district councils in the West Coast region, West Coast Regional Council has not been actively involved in economic development initiatives.

4.11
Figure 7 summarises the Council’s investment and use of its share of the funding package between 1 July 2000 and 30 June 2005. The Council has chosen to invest passively, rather than to actively use its share of the funding package.

Figure 7
Summary of West Coast Regional Council’s investment and use of its share of the West Coast Economic Development Funding Package, as at 30 June 2005


$000
Opening capital 1 July 2000 7,000
Plus interest and dividend income to 30 June 2004 1,594
Plus interest, dividend and other income for 2004-05 (see Note) 1,140
Less transfer to the Council’s bank for working capital (200)
Balance at 30 June 2005 9,534
Made up of and reflecting:

Share of the Council’s investment portfolio at 30 June 2005

 9,534
Funding package assets as at 30 June 2005 9,534

Note: In 2004-05, the Council changed the accounting policy for valuing its investment portfolio from cost to fair value. Included in the $1,140,000 is an amount of $484,000 relating to unrealised gains recognised because of this change in accounting policy.

4.12
West Coast Regional Council resolved from 1 July 2004 to no longer account for the funding package separately from other Council funds. From that date, all available funds have been managed as a single portfolio. For the purposes of this report and Figure 7, we have assessed the return for the 2004-05 financial year proportionately.2

West Coast Regional Council’s investment policy

4.13
West Coast Regional Council has an investment policy that clearly sets out its objectives. The objectives of the investment portfolio are:

  • the generation of capital gains to protect the real value of the portfolio; and
  • the creation of income to be used for Council activities, and reinvested to ensure further growth in the portfolio.

4.14
The investment policy states that the objectives will be achieved by investing in a balanced investment portfolio, including:

  • New Zealand cash (defined as wholesale money market instruments with a duration of up to 12 months);
  • New Zealand bonds (defined as New Zealand dollar denominated bonds issued by the New Zealand Government, or New Zealand corporations, local authorities, State-owned enterprises, and banks);
  • Australasian equities (listed on New Zealand and Australian stock exchanges);
  • international equities;
  • Australasian property; and
  • alternative asset classes (emerging market bonds, absolute return funds, and structural credit).

4.15
For the funds invested on West Coast Regional Council’s behalf by its appointed fund manager, the investment policy sets out in detail the agreed asset classes and asset class benchmarks. The West Coast Regional Council and its investment advisors review these benchmarks and asset classes each year.

4.16
The investment policy also sets the procedures for acquiring new investments. For example:

  • For managed funds, the fund manager has full discretionary authority to purchase and sell investments for the Council. However, this is subject to an agreement between the Council and the fund manager covering issues such as investment objectives, detailed performance benchmarks, investment criteria, tactical asset allocations, and compliance reporting obligations.
  • Funds managed directly by the Council can be invested only in a money market call deposit account with a New Zealand-registered bank. Only appropriate council staff can make these investments.

4.17
The investment policy sets out quite detailed reporting obligations. For example:

  • the fund manager provides a report at the end of each month for each class of investments, showing full details of all transactions entered into during the period, and the performance of the investment during the period; and
  • details of both the fund manager’s portfolio performance and the money market call deposit transactions are reported to the Council monthly by the Corporate Services Manager.

4.18
Forsyth Barr provides the Council with monthly reports setting out all movements that have occurred over the previous month for the portfolio. Councillors are provided with a monthly summary of the status of the funds invested. Forsyth Barr provides a more comprehensive quarterly report that includes commentary and analysis for performance of the portfolio during the preceding quarter.

4.19
Finally, the investment policy sets out a detailed approach to risk assessment and management. For example, the policy states that:

  • West Coast Regional Council is a conservative investor. The asset class benchmarks referred to above reflect the Council’s risk-averse nature.
  • Where periods of negative returns are possible, the fund manager is required to invest the fund in a manner that will limit the likelihood of negative returns occurring in any period.

4.20
In our view, West Coast Regional Council’s investment policy meets the requirements of section 105 of the Local Government Act 2002.

4.21
We have assessed the council’s compliance with its investment policy, and have not noted any significant breaches.

Buller District Council

4.22
Buller District Council’s $7 million share of the funding package had a balance of more than $7.4 million at 30 June 2005.

4.23
After an investment workshop in August 2000, the Council resolved to engage Frank Russell Company (N.Z.) Limited (an investment services company) to invest its $7 million share of the funding package, and $6 million of existing surplus funds, as a single portfolio. This $13 million is held separately from other Council funds for the long-term benefit of the district’s ratepayers.

4.24
In December 2000, the Council adopted an investment strategy for the portfolio that allocated 25% of this $13 million to Managed Funds (Equities), and the remaining 75% to Managed Funds (Fixed Interest Securities).

4.25
The Council lost money with this investment strategy, and changed its investment policy in July 2002. The philosophy of the new investment policy was to optimise investment value and returns in the long term, while balancing risk and return considerations. Preference is to be given to conservative investment policies, despite the recognition that lower risk generally means lower return.

4.26
After the July 2002 review of its investment policy, the Managed Funds (Fixed Interest Securities) portion of the portfolio was realised and the funds were reinvested in keeping with the revised policy. The Council now invests only in bank deposits with registered New Zealand banks. The Council manages its bank deposits in-house.

4.27
In altering its investment policy, the Council resolved to continue to hold the Managed Fund (Equities) portion of the portfolio until such time as it recovered to the amount originally invested, and then to withdraw and reinvest in bank deposits. By March 2003, the balance of the funding package invested in the Managed Fund (Equities) – originally $1.75 million – had fallen by about $1.08 million to around $0.67 million. Two years later, at 30 June 2005, the Managed Fund (Equities) investment had recovered to around $1.68 million.

4.28
When the Managed Fund (Equities) investment recovered to its original investment amount, the Council opted to review its investment policy again. The review was undertaken in late 2005. We describe Buller District Council’s revised investment policy in paragraphs 4.36-4.42.

4.29
Figure 8 sets out a summary of the investment and use, between 1 July 2000 and 30 June 2005, of Buller District Council’s share of the funding package.

Figure 8
Summary of Buller District Council’s investment and use of its share of the West Coast Economic Development Funding Package, as at 30 June 2005


 $000
Opening capital 1 July 2000 7,000
Plus interest income 433
Plus share of net return on managed fund (fixed interest securities) investment 494
Less provision for doubtful economic development loans made (430)
Less share of managed fund (equities) net loss of value (67)
Balance at 30 June 2005 7,430
Made up of and reflecting:

Economic development loans made

 1,166

Less loan repayments received

 (493)

Less provision for doubtful loan repayments

 (430)

Economic development loans outstanding

 243

Share of bank deposits and managed funds investments

 7,187
Funding package assets at 30 June 2005 7,430

Buller District Council’s involvement in economic development initiatives

4.30
Buller District Council decided that $1 million could be drawn down and used for economic development loans. The Council has been directly involved in making loans to businesses to promote economic development in the district, as authorised by its investment policy.

4.31
The Council had an Economic Development Unit that was responsible for facilitating and assisting existing and new businesses to develop, expand, and create employment. A committee of the Council, the Economic Development Committee, oversaw economic development policies and also made recommendations to the Council, as appropriate.

4.32
Buller District Council gave economic development loans to 9 companies in the district. Of those 9 loans, 4 have been fully repaid, 4 have been partially repaid, and the Council has decided not to pursue repayment of the final loan. The latter loan was to develop and support West Coast Socks Limited, which subsequently collapsed.

4.33
Buller District Council’s management of the West Coast Socks Limited investment has been heavily criticised by the media, and by the community. The Council considered whether a review of its processes for this investment was appropriate, but opted not to proceed. It was not within the scope of our audit to review in detail the Council’s actions in its investment in West Coast Socks Limited. However, we note that, despite having obtained a guarantee over the loan, there is little likelihood that the Council will recover the amount outstanding.

4.34
The Council’s current investment policy states that any funds loaned for economic development must not exceed $1 million. It also requires that security is obtained for the loans, and that interest and principal repayments are made in accordance with the loan agreement. Where an organisation defaults on repayments, the Council will take steps to recover the debt. An economic development funding policy has been written, and requirements for loan monitoring have been established.

4.35
Buller District Council’s Economic Development Unit will remain inactive until the Council reviews its economic development strategy in 2006.

Buller District Council’s investment policy

4.36
Buller District Council’s investment policy is set out in its Long-term Council Community Plan. The investment policy includes the investment objectives, stating that–

Council recognises its fiduciary responsibility as a public authority and any investments that it does hold should be at an appropriate level of risk, giving preference to conservative investment policies and avoiding speculative investments.

4.37
The investment policy allows Buller District Council to invest in a mix of the following investment classes:

  • equity;
  • loan advances;
  • property;
  • forestry; and
  • financial.

4.38
For each investment class, the investment policy sets out and defines the scope of each investment. The investment policy also sets out how risks associated with each investment are to be managed.

4.39
The investment policy sets out in some detail how the results of investments should be reported. In particular, the investment policy states that–

All aspects of the investment process will be reviewed regularly, including, but not limited to:

  • monthly reporting of investment results;
  • regular review of investment strategies; and
  • 3-yearly review of investment policy.

4.40
Accordingly, Buller District Council receives a monthly report from Council staff that summarises the status of all its investments, borrowings, and economic development loans. In addition, during the course of our audit, the Council was reviewing its investment strategies and its investment policy.

4.41
Buller District Council’s investment policy does not set out the processes for acquiring new investments. However, given the limited nature of what the Council can invest in (only debt instruments), this is of limited concern.

4.42
We did not find any instances where Buller District Council’s investment policy had been breached.

Grey District Council

4.43
Grey District Council’s $7 million share of the funding package had a balance of slightly under $5 million at 30 June 2005.

4.44
When Grey District Council received its $7 million, it opted for the first year of investment to adopt a “least risk” position, where it invested only in bank deposits, government and local government stock, and State-owned enterprise and corporate bonds. In March 2001, the Council decided to continue with that approach.

4.45
Grey District Council manages its share of the funding package in-house.

4.46
Of Grey District Council’s share of the funding package, $3.4 million has been used as part of the community’s contribution towards a major sewerage upgrade in Greymouth. This contribution was made to support the Council’s application to the Ministry of Health’s Sanitary Works Subsidy Scheme.

4.47
In November 2003, the Council opted to allocate, on a population basis, the remaining funds into smaller funds for use by each community in the district. Each community can determine how it wishes to use its portion of the funding. No applications to use this funding have yet been lodged with the Council.

4.48
Small amounts of the investment income have been used for a water supply infrastructure upgrade and to make a non-repayable grant.

4.49
Figure 9 sets out a summary of Grey District Council’s investment and use, between 1 July 2000 and 30 June 2005, of its share of the funding package.

Figure 9
Summary of Grey District Council’s investment and use of its share of the West Coast Economic Development Funding Package, as at 30 June 2005


 $000
Opening capital 1 July 2000 7,000
Plus interest income 2,066
Plus revenue from Economic Development Facilitation Fund* activities 239
Less expenditure for Greymouth sewerage upgrade (3,409)
Less expenditure on Economic Development Facilitation Fund activities (467)
Less cash funding for Greymouth water supply infrastructure upgrade (110)
Less cash funding for economic development office and GROW** (316)
Less non-repayable grant made (30)
Balance at 30 June 2005 4,973
Made up of and reflecting:

Industrial properties developed and available for sale (see Note)

 155

Share of bank deposits and stocks and bonds

 4,818
Funding package assets as at 30 June 2005 4,973

Note: The industrial properties available for sale were developed as part of the Economic Development Facilitation Fund activities. They are recorded at cost. Based on the sale prices attained for other properties developed and sold, their market value is probably about $284,000 more than cost. If recognised, this would bring the value of the funding package at 30 June 2005 to around $5,257,000.
* See paragraph 4.51.
** See paragraph 4.54.

Grey District Council’s involvement in economic development initiatives

4.50
Grey District Council also chose to use $1 million of its $7 million share of the funding package to facilitate economic development within the district.

4.51
Of the $1 million set aside for economic development, $860,000 has been managed as an Economic Development Facilitation Fund, and used primarily for the development of an industrial commercial property site. As individual properties are sold, the proceeds are returned to the Facilitation Fund and are available for future initiatives. A protocol detailing the use of the Facilitation Fund was written, which included objectives for the scheme and requirements for applicants to meet. A Facilitation Committee was established to oversee the use of this fund.

4.52
The remaining $140,000 has been set aside to help fund the development of the port.

4.53
Grey District Council used the interest from its investment of the funding package to fund an Economic Development Office, and employ an Economic Development Officer. However, Grey District Council no longer employs an Economic Development Officer or funds an Economic Development office, because of the Trust’s active involvement in economic development.

4.54
The interest has also been used to help fund the Greymouth Regional Opportunities Workshop (GROW), which took a community development approach to the future of the district. GROW is now reviewing its role, given the work that is done by the Trust.

Grey District Council’s investment policy

4.55
Grey District Council’s 2-page investment policy sets out both the objectives of the investment policy and the investment mix. Broadly, the objectives of the investment policy include:

  • optimising investment returns using low-risk investments;
  • ensuring that investments are “liquid” and sufficiently flexible;
  • managing capital losses as a result of interest rate movements; and
  • prohibiting speculative investments.

4.56
The investment policy allows Grey District Council to maintain investments in:

  • equity investments and advances;
  • property investments (including land holdings);
  • forestry investments; and
  • treasury investments.

4.57
The investment policy does not set out any procedures for acquiring new investments.

4.58
In addition, the investment policy does not provide any rules for managing risks, even though the policy states that–

Each investment or category will have its own unique characteristics and a specific risk management policy for each will be formulated for council approval and annual review.

4.59
Grey District Council has not yet determined its approach to risk management.

4.60
Finally, the investment policy does not set out any procedures for reporting to the Council about the funding package. In practice, monthly reports are provided to the Council.

4.61
In our view, Grey District Council needs to review and update its investment policy. Specifically, the investment policy needs to:

  • set out specific risk management policies for each investment class or category;
  • include the policy for acquiring new investments; and
  • provide an outline of the procedures by which investments will be managed and reported to the Council.

4.62
We did not find any instances where Grey District Council’s investment policy had been breached.

Westland District Council

4.63
At 30 June 2005, the balance of Westland District Council’s $7 million share of the funding package was a little under $5 million.

4.64
When Westland District Council received its $7 million share of the funding package, it decided to set aside $3 million for economic development. In June 2000, a committee of the Council called “Westland’s Working” was set up, with the purpose of initiating economic development in the region.

4.65
After considering the recommendations of several fund managers and investment brokers, the Council decided to invest the remaining $4 million in ASB Bank Limited’s Managed Funds. The investment, in accordance with the Council’s investment policy adopted on 29 June 2000, comprised 40% Australasian equities, 40% international equities, and 20% New Zealand fixed interest cash and bonds. Other surplus funds of the Council were also invested as part of the ASB Bank Limited portfolio. Withdrawals have been made since 2000. For the purposes of this report, we have considered only the $7 million package, including the $3 million administered on behalf of the Council by Westland’s Working.

4.66
After the Council invested in ASB Bank Limited’s Managed Funds, equities worldwide generally experienced a significant fall in value. The Council decided, in March 2003, to reinvest in less volatile, cash-based instruments. The effect of the fall in equities value was a loss of more than $1.3 million.

4.67
Westland District Council updated its investment policy on 17 December 2004, with the objective of ensuring that the portfolio is managed in a prudent, competent, and conservative manner. Managed fund investments are now restricted to wholesale bond and cash investments, with entities holding a credit rating from Standard and Poor’s of A or better. A prudential limit has been set for individual counter-party exposure. These funds are still managed by ASB Bank Limited’s Managed Funds, in keeping with the Council’s investment policy.

4.68
Figure 10 sets out a summary of Westland District Council’s investment and use of its share of the funding package, between 1 July 2000 and 30 June 2005.

Figure 10
Summary of Westland District Council’s investment and use of its share of the West Coast Economic Development Funding Package, as at 30 June 2005


 $000
Opening capital 1 July 2000 7,000
Plus interest income 1,116
Less loss on managed fund equity investments (1,338)
Less cash funding of Business Development Fund (421)
Less cash funding of free building and resource consents (191)
Less cash funding of biodiversity strategy for Westland (350)
Less provision for doubtful economic development loans made (582)
Less expenses associated with recovering economic development loans in default (148)
Less operating costs associated with Westland’s Working/Council (163)
Balance at 30 June 2005 4,923
Made up of and reflecting:

Economic development loans made

 1,381

Less loan repayments received

 (547)

Less provision for doubtful loan repayments

 (582)

Economic development loans outstanding

 252

Share of managed funds investment portfolio

 4,671
Funding package assets at 30 June 2005 4,923

Westland District Council’s involvement in economic development initiatives

4.69
The functions of Westland’s Working included providing loans, funding the costs of building and resource consent applications, and operating the Council’s Economic Development Unit. Westland’s Working made 9 economic development loans on behalf of the Council.

4.70
Of the 9 loans made, 4 have been fully repaid, 4 have been partially repaid, and one – to FT Manufacturing (Westland) Limited (FT Manufacturing) – has the full balance still outstanding. FT Manufacturing was placed in liquidation in November 2003, and is in default of the terms of the loan.

4.71
In August 2003, we undertook an independent review of the Council’s economic development loan processes. That review found many positive features in the management of the loan processes. However, in the case of the loan to FT Manufacturing, there were significant weaknesses in the loan application process.

4.72
Westland District Council has decided that, since the establishment of the Trust, and the increase in economic activity in the West Coast region, there is less need for the Council to be involved in direct business lending.

Westland District Council’s investment policy

4.73
It is a requirement of the Local Government Act 2002 that a copy of the investment policy is included in a council’s Long-term Council Community Plan. Westland District Council included only a summary of its investment policy in its Long-term Council Community Plan.

4.74
Westland District Council’s full investment policy explicitly sets out its objective, which is to ensure that “the portfolio is managed in a prudent and competent manner, in terms of the governing legislation”.

4.75
The investment policy then states that the philosophy of Westland District Council is to optimise investment value and returns in the long term, while balancing risk and return considerations. The investment policy also acknowledges that, as Westland District Council is a public authority, any investment that it holds should be low-risk, with preference given to conservative investments, particularly in the case of short-term investments. The investment policy recognises that lower risk usually means lower returns.

4.76
The investment policy sets out a series of strategies aimed at ensuring that Westland District Council meets its investment aims. The investment policy sets out the mix of allowed investments. They are:

  • equity;
  • property;
  • forestry;
  • infrastructural assets;
  • financial; and
  • loan advances.

4.77
Although the investment policy provides further details about the rules relating to each type of investment, it does not set out any investment levels or benchmark returns for Westland District Council’s managed fund investments, managed by a private sector provider. In our view, these should be set out either in the investment policy, or in the agreement with the private sector provider.

4.78
The investment policy refers to the procedure for acquiring new investments, giving the Manager Finance and Policy (with the approval of the General Manager) the power to approve individual transactions, provided they are within the scope of the recommended and approved general investment strategy that is documented in the investment policy.

4.79
In addition, the investment policy sets out some reporting obligations. For example:

  • all transactions approved by the Manager Finance and Policy must be reported to Westland District Council’s Finance Committee at the next meeting after the date of the transaction; and
  • the Manager Finance and Policy must report to the monthly Westland District Council meeting on the balance of all loans outstanding and any variations of loan made by Westland District Council for all loans.

4.80
However, the investment policy does not contain any reporting obligations by any person for the performance of the Council’s investments. This needs to be reviewed. Despite the lack of reporting obligations, the Council is provided with information on investment performance at its monthly meeting.

4.81
Finally, the investment policy sets out an outline of how risks associated with some investments are assessed and managed (for example, in their general policy and credit and liquidity risk, as they relate to financial instrument investments), but the risk assessment does not cover all potential investment types.

4.82
In our view, Westland District Council’s investment policy needs to be improved by providing further specific details about its managed fund investments, particularly:

  • the reporting obligation of the fund manager; and
  • the asset class benchmarks (if any) that have been agreed.

4.83
In addition, Westland District Council needs to include a full copy of its investment policy in its Long-term Council Community Plan, rather than the summary currently provided.

4.84
We did not find any instances where Westland District Council’s investment policy had been breached.

1: Section 101(1), Local Government Act 2002.

2: Based on a proportionate share of the investment portfolio increase for that year, relative to the funding package percentage of the total portfolio at 30 June 2004.

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