Part 1: Introduction Why are we focusing on financial assets?

1.1
The holdings of financial assets within the public sector have increased since the liberalisation of financial institutions and markets in the mid-1980s, particularly over the last couple of decades. Since 1999,¹ the Financial Statements of the Government of New Zealand (FSG) show that the value of financial assets has increased, on average, by about 13.5% a year, to $123.2 billion at 30 June 2014. The Treasury's projections suggest that financial assets will increasingly dominate the Crown's balance sheet.

1.2
The value of the Government's financial assets has exceeded the value of its debt since 2005, and has exceeded the value of its physical assets since 2011.

1.3
Local authorities' projections show that physical assets are, and will continue to be, the dominant asset class. However, financial assets such as investment funds are becoming increasingly important in infrastructure planning, as are share investments in arrangements between local authorities, central government, and/or private sector entities. In 2014, the total value of local government financial assets was $7.1 billion.

1.4
We note that the 2015 FSG were released in October 2015. We did not fully incorporate this information but, where relevant, we have added further commentary in this report.

The objectives of this report

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In the context of the increasing significance of financial assets to the public sector, this report:

• describes the extent of financial assets and how they are being used in the public sector;
• reviews how significant holdings of financial assets are being managed and governed in practice;
• provides some guidance for other public entities; and
• considers the implications for the public sector as a whole.

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This report is not an in-depth analysis of all public sector financial assets or public entities' management and governance practices. Rather, it is intended to increase awareness of how financial assets are being used and encourage more discussion and debate.

What we looked at

1.7
We looked at the financial assets held by both central and local government. The 2015 FSG define financial assets as:

Any asset that is cash, an equity instrument of another entity (shares), a contractual right to receive cash or shares (taxes receivable and ACC levies), or a right to exchange a financial asset or liability on favourable terms (derivatives in gain).

The extent of financial assets and their use

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For central government, we used the FSG data that consolidates financial information of all central government entities into one set of financial statements for the Crown. This includes, for example, all government departments, Crown entities such as district health boards, Crown financial institutions, and State-owned enterprises.²

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The FSG include tertiary education institutions as equity-accounted investments. At 31 December 2014, the value of tertiary education institutions' financial assets was about $1.8 billion. Adding this value to the consolidated FSG financial assets gives a total of about $125 billion.

1.10
In this report, we use "central government" to mean all of the public entities included in the FSG as well as tertiary education institutions' financial assets.

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For local government, we used the financial statements of all 78 local authorities. In this report, "local government" means the 78 regional and territorial authorities.

1.12
The Local Government Funding Agency (LGFA) was set up in 2011 to provide collective loan funding to local authorities. In 2014, the LGFA held $3.9 billion of financial assets. Although these financial assets need to be managed and governed by the LGFA on an arms-length and commercial basis, they should be eliminated when taking a consolidated view of the local government sector.

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We also read relevant literature, spoke with relevant experts, and analysed long-term projections of central government (from 2013) and local government (from 2014). For our international comparison, we analysed the financial statements of the governments of Canada, the United Kingdom, and Australia.

1.14
To analyse the financial assets held by both central and local government, we used the categories used in the FSG to group financial assets. The categories include:

• cash and cash equivalents – cash and deposits of less than three months;
• receivables, such as taxes or fines that are owed to the Government but not yet paid;
• marketable securities and deposits, such as cash invested by the Government in bonds (debt securities) and bank deposits (for more than three months) used to generate capital gains or interest revenue;
• derivatives – agreements between two parties whose features and value are derived from another investment or reference rate (such as an equity market index), with derivatives that are "in-gain" (currently profitable) being reported as financial assets (see Part 3);
• share investments – "non-controlling" or minority ownership interests in a company or venture used to generate capital gains or dividend revenue, including strategic share investments that support better governance and service delivery;³ and
• advances and other assets, such as mortgages provided by Kiwibank Limited and student loans.

How financial assets are managed and governed in practice

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The management and governance of financial assets depends on many factors, including legislative requirements, their investment features, and the reason for, and time frame involved in, holding them.

1.16
We asked Fidato Advisory Limited to review publicly available documents and talk in more detail with 14 selected public entities about how their financial assets were managed and governed. Together, these public entities hold 65% of all financial assets in the public sector. Fidato Advisory Limited did not analyse or review receivables, because receivables are managed differently from other types of financial asset.

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Figure 1 lists the 14 entities that we reviewed.⁴

Figure 1
The 14 public entities that we reviewed

1.18
Interviews were carried out with at least one senior executive and one representative of the governing body of each public entity. Interviews were used as an opportunity to obtain information that was not publicly available through documents such as annual reports, financial statements, third-party reviews, and investment policies.

1.19
The public entities' financial statement data refers to 2013/14. Most public entities' balance dates are 30 June, but some balance dates are 31 March or 31 December.

What we did not look at

1.20
We did not look at the financial returns earned on financial assets or public reports about expected and actual returns that are available through the Treasury and from the public entities themselves. Rather, this report focuses on the management and governance involved in planning for and earning returns.

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We did not look at controlling ownership interests held by public entities or investments in physical assets (such as the ownership of ports, utility companies, real estate, or investment-holding subsidiaries). However, because we used group financial statements, our analysis includes any financial assets held within controlled subsidiaries.

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We did not focus on the regulation of financial assets. Since the global financial crisis in 2008, the regulatory framework for financial markets and financial market participants has been extensively overhauled. The Financial Markets Authority, a new regulator with enhanced powers and capabilities, has been set up.

1.23
We did not look at the management and governance of the financial assets held by the Reserve Bank of New Zealand. The Bank holds significant financial assets worth more than $29 billion as at 30 June 2015. Its financial assets mainly comprise government and near-government securities, which are both liquid and of high-credit quality, allocated to six major currencies. The Bank also holds New Zealand Government bonds. Some of these assets are available to support the country's foreign currency market in a crisis. Under section 167 of the Reserve Bank Act 1989, the Minister of Finance may appoint one or more persons to assess the performance by the Bank of its functions and of the exercise of its powers. The Bank is not subject to the Auditor-General's general powers under the Public Audit Act 2001 to review an organisation's efficiency and effectiveness or to inquire into its use of resources.

Legislation about using financial assets

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Several Acts deal with how public entities use financial assets.

1.25
For central government entities, the Public Finance Act 1989 and the Crown Entities Act 2004 place general controls on the acquisition of financial assets and, in particular, derivatives. As a general rule, departments cannot, in their own right, enter into derivative transactions. However, under delegations from the Minister of Finance and the Secretary to the Treasury, and subject to the Treasury's oversight,⁵ departments can use derivatives to manage their foreign exchange risk.⁶ A Crown entity's own Act can have further specific controls over the use of financial assets. The Education Act 1989 applies to the management of tertiary education institutions' financial assets.

1.26
For local government entities, the use of financial assets needs to be in keeping with the entity's financial strategy and investment policy, with risks considered and managed.⁷

1: The earliest Financial Statements of the Government on the Treasury's website were published in 1999. Tertiary education institutions' financial assets are excluded from the value of financial assets in the Financial Statements of the Government.

2: See the Financial Statements of the Government, Note 2 for a description of the public entities that are included.

3: Some minority holdings of investments in physical assets are recorded in the Financial Statements of the Government as share investments.

4: The Guardians of New Zealand Superannuation maintain the New Zealand Superannuation Fund. The Government Superannuation Fund Authority maintains the Government Superannuation Fund. The New Zealand Debt Management Office is an operating unit of the Treasury. Although they are not separate entities, they hold and are responsible for almost all, by value, of the controlling entity's financial assets. In this report, we refer to them as public entities.

5: See the Guidelines for the Management of Crown and Departmental Foreign-Exchange Exposure, available on the Treasury's website, www.treasury.govt.nz.

6: See Part 10 of our 2007 report, Central government: Results of the 2005/06 audits, for more on the use of derivatives in central government.

7: See the Local Government Act 2002, sections 14(1)(f) and (fa), 101A(3)(d), and 105.