Kāpiti Coast District Council's proposal to invest funds

10 December 2018: We wrote to Kāpiti Coast District Council, setting out our expectations about due diligence and sound management, given the Council's intention to borrow money in order to set up investment funds.

5 December 2018

Wayne Maxwell
Chief Executive
Kāpiti Coast District Council
PO Box 60 601
Paraparaumu 5254

Dear Wayne

Investment funds proposal

Thank you for your time, and the information provided, when I visited Kāpiti Coast District Council (the Council) on 30 October 2018 to discuss the Council’s proposal to establish two new investment funds. Thank you also for the material provided subsequently.

As discussed when we met, several people have contacted us to raise concerns about the investment funds proposal, specifically the proposal to borrow in order to invest in two new investment funds. We generally encourage people who contact us with concerns to contact the entity involved directly, and we have done so in these cases.

As the Council’s auditor we have an obligation to assess whether the Council is being financially prudent in its activities. Borrowings and investments by councils are something that we consider through both our annual and long-term plan audits. Assessing financial prudence is a matter of judgement. Relevant factors auditors use for their judgements on prudence include the processes councils have used to complete their own prudence assessments, together with the quality and completeness of the information available to the Council.

Investment fund proposals

I acknowledge that the Council is committed to doing further work on the proposed funds, and has yet to make a final decision on establishing them. However, I consider it is important that I set out my views on the proposal.

The Local Government Act 2002 (the Act) requires councils to have policies to guide their borrowing and investment decisions as part of prudent financial management. There is nothing in the Act that would prevent the Council from borrowing money in order to invest it (unless the borrowing is in foreign currency), provided it fits with the relevant Council policies and is prudent.

That said, I note that the Council currently has the second highest level of debt per capita of all councils in New Zealand.1 The Council is exploring how to manage its finances over the long term, in accordance with its financial strategy. I understand that the proposed investment funds are intended to be long-term investments, with the expected returns used for growth and resilience purposes. The proposed funds are due to be established by borrowing up to $20 million from the Local Government Funding Agency, and you are expecting to achieve an overall net return of 3.5% after costs.

It is widely accepted that there is generally a strong correlation between risk and return.

Also, there is little doubt that interest rates and returns on equities are likely to continue to fluctuate over time. When we met it was acknowledged that the return on the investment funds could go up as well as down. Current interest rates are at historical lows, so it would be reasonable to expect interest rates to trend up in future rather than down. I also note the proposed funds could include an investment mix of up to 65% investment in equities, to achieve the overall investment returns expected. Clearly there is an element of risk with such an investment mix, and the Council needs to be clear on the level of risk it believes is acceptable for each of the proposed funds.

Section 14(1) of the Act requires the Council to satisfy itself that the expected returns are likely to outweigh the risks inherent in the investments. I would expect such a consideration by the Council to be formally documented.

The proposals are unusual compared to other funding arrangements we are aware of in the local government sector, in particular that the initial investment would be funded by borrowing. Similar situations we are familiar with involve councils that have invested money after asset sales, rather than by borrowing.

Our expectations

It is not our Office’s role to question the Council’s policy decisions, including the Council’s decision to establish these investment funds. However, we do expect the Council to carry out appropriate due diligence, given the nature and inherent risks involved with the proposals. We expect the Council will:

  1. seek independent financial and legal advice on the proposal;
  2. seek independent quality assurance over the establishment of the funds;
  3. provide suitable information and advice to elected members to enable them to make an informed decision; and
  4. provide clear public information about decisions to progress the establishment of the funds, and criteria and governance for the funds.

On the basis that the investment funds are established, we expect the Council will ensure:

  1. good governance over the funds; and
  2. there is clear and transparent reporting on the performance of the funds, including the net return earned on the funds, taking into account investment management, administration fees, and the cost of borrowing.

Next steps

I would be grateful if you could tell me about any additional financial and/or legal advice you intend to seek on the proposal, or will receive in due course.

Given the nature of the proposal, the appointed auditor for the Council will consider the management and reporting relating to proposals, and any associated risks, as part of the annual audit. Any concerns will be reported to the Council in our management letters, and where appropriate in our audit reports.

I request that you arrange for this letter to be tabled at the next meeting of the full Council.

Yours sincerely

Greg Schollum
Deputy Controller and Auditor-General

Cc  K. Gurunathan, Mayor, Kāpiti Coast District Council

1: Statistics New Zealand, Local Authority Financial Statistics (2018).