A review of public sector financial assets and how they are managed and governed

53 Pages·2016·1.36 MB·English

B.29 [16c]
A review of public
sector fnancial
assets and how
they are managed
and governed
Ofce of the Auditor-General
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B.29[16c]
A review of public
sector fnancial
assets and how
they are managed
and governed
Presented to the House of
Representatives under section 20 of
the Public Audit Act 2001. ISBN 978-0-478-44232-8
Octobe2015Contents
Auditor-General’s overview 3
Our recommendations 5
Part 1 – Introduction 6
Why are we focusing on fnancial assets? 6
The objectives of this report 6
What we looked at 7
What we did not look at 9
Legislation about using fnancial assets 10
Part 2 – The increasing role of fnancial assets in the public sector 11
Using fnancial assets efectively 11
Opportunities for public entities and the whole of government 12
The extent of fnancial assets in the public sector 14
What could the future look like? 19
How does New Zealand compare with other countries? 20
The 2015 Financial Statements of the Government 21
Part 3 – How public entities manage and govern fnancial assets 22
Financial assets of 14 selected public entities 22
Three stages of managing and governing fnancial assets 28
What is good practice? 28
Reviewing practices in the 14 public entities 30
The use of derivatives in the public sector 35
Part 4 – Challenges in managing and governing fnancial assets 41
Challenges and risks for public entities 41
Nine guiding principles for managing internal and external risks 42
Challenges at a whole-of-government level 44
Planning for future opportunities and challenges in managing public sector fnancial assets 48
Figures
1 – The 14 public entities that we reviewed 9
2 – Using fnancial assets to help deliver public services 12
3 – Public entities with the largest fnancial assets by value 14
4 – Composition of fnancial assets in central government 16
5 – Composition of fnancial assets in local government 17
6 – Increase in central government transactions involving fnancial assets 18
7 – Forecast growth in fnancial assets across central government 19
8 – Public sector fnancial assets and total liabilities in New Zealand, Australia, Canada, and
the United Kingdom 20
9 – Amount, type, and reasons for holding fnancial assets – Crown fnancial institutions 23
10 – Amount, type, and reasons for holding fnancial assets – special-purpose entities 24
11 – Amount, type, and reasons for holding fnancial assets – universities 25
12 – Amount, type, and reasons for holding fnancial assets – local authorities 26
13 – Attributes of good practice for managing and governing fnancial assets 29
14 – How well the 14 public entities practised good management and governance of fnancial assets 31
15 – Review of fnancial asset management and governance practices in the four groups of entities 32
16 – Change in the notional value of central government derivatives 36
17 – Types of derivatives used by the Accident Compensation Corporation and the New Zealand
Superannuation Fund 38
18 – Changing credit exposure of central government’s “in-gain” derivatives 39
19 – Key risks in holding fnancial assets 41
20 – Efect of fnancial asset gains, losses (including derivatives), and interest on the Crown’s operating
2 balance, 2008-14 46
Auditor-General’s overview
For many years, the public sector has had a focus on managing debt. However, in
the last couple of decades, the public sector’s ownership of fnancial assets, such
as cash, deposits, shares, and derivatives, has steadily increased. At 30 June 2014,
the public sector’s fnancial assets were worth about $132 billion.
The public sector’s increased holdings of fnancial assets has coincided with
increasing innovation and technological change in fnancial markets around the
world. Unlike physical assets, many of the fnancial assets now in use are complex,
interconnected, evolving quickly, traded often, and highly responsive to external
circumstances. As a result, many of these fnancial assets ofer new opportunities
and challenges.
This report discusses the increasing signifcance of public sector fnancial assets
and, using a sample of public entities, reviews how these assets are being
managed and governed.
Value and use of fnancial assets expected to continue to increase
Historically, the holdings of fnancial assets in the public sector were relatively
small and usually based around managing short-term cash needs and supporting
debt requirements. Today, they are also being used to increase liquidity, fexibility,
and risk management in the delivery of public services.
Central government entities hold by far the most fnancial assets in the public
sector. Most of these assets are in the Accident Compensation Corporation (ACC)
and the New Zealand Superannuation Fund (NZSF). Marketable securities (such
as bonds and deposits) are the dominant fnancial asset class. However, the use of
derivatives has increased signifcantly in recent years. Treasury projections suggest
that fnancial assets will increasingly dominate the Crown’s balance sheet.
In local government, share investments are the dominant fnancial asset class.
They include partnering and joint ventures with other local authorities, central
government, and private organisations. Auckland Council holds the largest value
of fnancial assets in local government.
Good management and governance practices but with room to
improve
We reviewed the fnancial assets of 14 public entities that, together, hold about
65% of all fnancial assets in the public sector. By and large, all 14 had reasonably
good structures and systems in place for managing and governing those assets.
As expected, ACC, the NZSF, and the Government Superannuation Fund have
efective management and governance practices in place over fnancial assets.
They are also leaders in promoting responsible investment practices.
3
Auditor-Generals’ overview
Investment portfolios of fnancial assets can be complex. Those entities that use
investment portfolios to support their core operational activities face a risk of
such portfolios becoming isolated from the organisation’s general management
and governance. In these circumstances, governors could be supported by using
independent expertise more or by public entities pooling fnancial assets for
management purposes, as happens with the Local Government Funding Agency
and the New Zealand Debt Management Ofce.
Public entities could also consider how to improve communication with
stakeholders (including the public) about the objectives and performance of
their fnancial assets. The NZSF does this well, and public entities with signifcant
fnancial assets can learn from the way the NZSF’s investment beliefs, policies, and
approaches are written and communicated to stakeholders.
Future opportunities and challenges require careful thought
As the value and use of fnancial assets continue to increase, we expect to see a
wider set of opportunities, challenges and risks. This is particularly so for central
government, which holds a large (and changing) portfolio of fnancial assets.
The fnancial assets and associated liabilities of central government should be
considered together, with a clear understanding of the risks being taken, how
they are being managed, and the opportunities and challenges they create. Wider
matters such as how public assets and liabilities interact with, and infuence,
each other, the Government, the investment industry, and the economy also need
careful thought at a whole-of-government level.
The Treasury has started some of this work, with the Investment Statement
published every year and its ongoing project on managing risk to the Crown’s
balance sheet. These are positive steps, but more is needed, including an overall
strategic framework and plan, similar to the one the Treasury has for physical
assets (the National Infrastructure Plan).
I thank Fidato Advisory Limited and the 14 public entities we reviewed. These
were the NZSF, the Government Superannuation Fund, ACC, New Zealand Venture
Investment Fund Limited, Housing New Zealand Corporation, the New Zealand
Debt Management Ofce, Te Tumu Paeroa, the University of Otago, the University
of Canterbury, Auckland Council, Dunedin City Council, New Plymouth District
Council, Otago Regional Council, and Public Trust.
Lyn Provost
Controller and Auditor-General
2 March 2016
4
Our recommendations
1. We recommend that those public entities holding investment portfolios that
support their core operational activities regularly assess how they can
strengthen the skills and capabilities for governing their fnancial assets.
2. We recommend that public entities with signifcant fnancial assets regularly
assess how well they are managing and governing their fnancial portfolios and
reporting to stakeholders using the following questions:
• Are the investment objectives clear and consistent with the purpose of
holding the assets?
• Are the designs of the management and governance processes appropriate?
• Are responsibilities clearly assigned?
• Are delegations used appropriately?
• Are duties clearly separated?
• Are incentives well-aligned?
• Is there a clear and documented process?
• Is monitoring efective?
• Are communications clear and relevant to the needs of stakeholders?
3. We recommend that the Treasury prepare a strategic perspective on and vision
for holding fnancial assets in the public sector.
5
1 Introduction
Why are we focusing on fnancial assets?
1.1 The holdings of fnancial assets within the public sector have increased since the
liberalisation of fnancial 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 fnancial 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 fnancial assets will increasingly dominate
the Crown’s balance sheet.
1.2 The value of the Government’s fnancial 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, fnancial 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 fnancial
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
1.5 In the context of the increasing significance of financial assets to the public sector,
this report:
• describes the extent of fnancial assets and how they are being used in the
public sector;
• reviews how signifcant holdings of fnancial 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.
1.6 This report is not an in-depth analysis of all public sector fnancial assets or public
entities’ management and governance practices. Rather, it is intended to increase
awareness of how fnancial assets are being used and encourage more discussion
and debate.
1 The earliest Financial Statements of the Government on the Treasury’s website were published in 1999. Tertiary
education institutions’ fnancial assets are excluded from the value of fnancial assets in the Financial Statements
6 of the Government.
Part 1
Introduction
ahW t ew ol odek 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 fnancial asset or liability on favourable terms (derivatives in
gain).
The extent of fnancial assets and their use
1.8 For central government, we used the FSG data that consolidates fnancial
information of all central government entities into one set of fnancial statements
for the Crown. This includes, for example, all government departments, Crown
entities such as district health boards, Crown fnancial institutions, and State-
2
owned enterprises.
1.9 The FSG include tertiary education institutions as equity-accounted investments.
At 31 December 2014, the value of tertiary education institutions’ fnancial assets
was about $1.8 billion. Adding this value to the consolidated FSG fnancial 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’ fnancial assets.
1.11 For local government, we used the fnancial 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 fnancial assets. Although these fnancial 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.
1.13 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 fnancial 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 fnes that are owed to the Government but not yet
paid;
2 See the Financial Statements of the Government, Note 2 for a description of the public entities that are included. 7
Part 1
Introduction
• 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 proftable) being reported
as fnancial 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
3
service delivery; and
• advances and other assets, such as mortgages provided by Kiwibank Limited
and student loans.
How fnancial assets are managed and governed in practice
1.15 The management and governance of fnancial 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 fnancial
assets were managed and governed. Together, these public entities hold 65% of
all fnancial assets in the public sector. Fidato Advisory Limited did not analyse or
review receivables, because receivables are managed diferently from other types
of fnancial asset.
4
1.17 Figure 1 lists the 14 entities that we reviewed.
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 Ofce 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 fnancial assets. In this report, we refer to
8 them as public entities.