I went along to a PAC hearing the other day because Simon Fraser, permanent secretary at the Foreign Office, was being grilled on recent currency trades at the department which left it with a £150m black hole. I co-wrote the original story about this with Alex Barker, formerly of this parish.
In the course of the hearing it emerged that all government departments are ordered by the Treasury to do their currency hedging on the same day of the month: and that it is the 15th.
The National Audit Office did a report into government currency hedging a while back, which offered some interesting points which may be highly relevant.
As we wrote back in February:
The Rural Payments Agency, which administers the single payment scheme, receives an annual lump sum of £2.7bn in euros via the Bank of England. It hedges the sum immediately to fix its value. However, the Bank uses the prevailing rate at the time of the transaction to convert euros to pounds, while commercial markets may fix the rate for a specific time of day.
The agency was therefore left unprotected if rates moved markedly on the day of each trade and, in 2007, this resulted in a £6.2m loss. The agency, Bank of England and Treasury then met to resolve the issue. However, the agency and the Bank of England continued to use different rates, resulting in losses of £21.6m [in 2008],” according to the NAO. The agency has since struck an agreement to use a specific rate and has reported no losses since.
Meanwhile, the agency made further forecasting errors of £40m and administrative errors of £1.6m, the report reveals – taking the total extra costs up to £69m.
The report also reveals that the date of the hedging, which is not disclosed by the authorities, had become common knowledge among hedge funds, which had speculated “several billion pounds” on the back of the transaction. “In 2010, on the day of the hedge, the value of the pound depreciated by 0.5 per cent against the euro,” it said.
So the question arises: if hedge funds have worked out how to profit from the RPA transactions, are they also aware of all other government currency transactions? And are taxpayers therefore getting a less good deal than they should?
And now that a Treasury official has told the PAC that the day of all such deals is the 15th of every month, is it time for a rethink?
This is what Alex and I wrote about the FCO’s currency disaster at the time:
The budgetary troubles follow what the Conservatives have dubbed a “botched experiment” in currency hedging that has left the department facing higher overseas bills than expected. The FCO has long been shielded against falls in sterling by the Treasury, which guaranteed its purchasing power was steady.
However, the Treasury withdrew this protection in late 2007, just as the pound began a sharp decline, dropping about 30 per cent from its peak in November that year against the dollar. Even as the pound fell, FCO officials were locked in talks with the Treasury for more than six months to win permission to hedge their exposure. This was finally granted in May 2008, allowing the “forward purchase” of dollars and euros, which helped mitigate rising costs.
The “rolling programme” protected the department for about a year. The FCO hedged for 2009 and 2010 but it was forced to sell sterling while it was in the doldrums – meaning the department’s overseas costs are now much higher than when its three-year budget was set.
Back to the PAC. So Simon Fraser said that the Treasury had instructed the FCO to do its forward purchase currency deals on the same day of the month to avoid “speculating around exchange rates“.
“There were conditions placed on the arrangement by the Treasury and the Bank of England that meant there were certain restrictions on when we could purchase, we had to purchase each month on a certain date.”
As Fraser said this, you could hear an audible “Jesus” from one of the committee members.
The perm sec continued: “The reason being that it was deemed inappropriate for government departments to speculate in markets.”
You could then hear Margaret Hodge, chair of the committee, say “dear, oh dear.”
Richard Bacon, another MP on the committee, said the ministry was “stuffed up like a kipper“. “They stymied you, that’s what you’re basically saying,” he said.
Fraser confirmed that the Treasury did “impose some pretty rigid conditions“. He pondered, “was it ideal in terms of…..?” but didn’t complete the sentence.
The unnamed Treasury official then confirmed that government departments all have the same set date to do their currency forward trades. Hodge asked whether this was in taxpayers’ best interests.
At this point another FCO official helpfully supplied the secret date: “the 15th of the month“. So now we all know.
Fraser suggested that the FCO deals were quite small: “I’m not sure the amount of money we’d be dealing with would move markets.” That may or may not not be true of other big deals by, for example, the Ministry of Defence or indeed Defra’s CAP payments – as the NAO report above suggests.
Hodge pointedly asked Amyas Morse, head of the National Audit Office – who attends PAC hearings – to “explore” the issue.