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Weekly UpdatesEditor's note: In its October meeting, the GFOA Executive Board approved an alliance with Grant Street Group to create GFOA YieldAdvantage, a real-time electronic marketplace for investing short-term government cash holdings. To learn more about this new product, contact Jeff McElravy at jmcelravy@gfoa.org.
While harnessing the advantages of the Internet remains a challenge for many local governments, there is little doubt that many core business processes could be readily enhanced by abandoning customary practices and embracing the use of the digital highway. One such area is cash management, namely, the process of investing idle cash. Local governments can now optimize their investment earnings by auctioning investments online--a process that increases competition for public funds by making those dollars available to a larger pool of financial institutions. This article describes how Monroe County, New York, has used a Web-based auction platform to achieve superior yields, greater internal control over assets, and increases in worker productivity.
MONROE COUNTY'S E-EVOLUTION
Monroe County's use of the Internet to purchase investment vehicles, while unique in terms of the prevailing practices among municipal governments, represents a logical step in the evolution of public cash management practices. Driving this initiative is a strategic effort to optimize non-tax revenue--in this case, investment returns on available cash. For county management, every dollar earned through sound investment is ultimately a dollar earned without cutting services or increasing taxes.
In 1992, the county found itself confronting a growing budgetary imbalance. A crisis-driven review of the county's financial performance found that the cash management function was fertile ground for significant gains. Despite an operating budget of roughly $650 million, the county had earned just $2.6 million on its investments the previous year. Compared to the 90-day Treasury rate index, Monroe County had under performed by five basis points.
Prior to 1992, the county followed a very traditional approach to investing. One full-time accountant in the finance department procured appropriate investments through an informal process of calling local banks and placing orders over the phone or via fax. Some banks offered limited personal computer-based transaction services, but these services did not allow for either a survey of all market participants or efficient placement of county funds with the winning bidder.
Compounding this inefficiency was the observation that funds in various accounts remained unduly idle at various points in time throughout the year, thereby generating dismal returns. The county lacked suitable performance benchmarks to ensure that the outcomes of the investment process were consistent with prevailing rates of return for the money market. In short, the county needed an overhaul of its cash management process to ensure the returns it desired.
The county soon engaged an investment advisory firm to perform an objective, thorough analysis of the procedures and practices of the cash management function. While this review could have been handled internally, the county recognized that the expertise needed to achieve wholesale improvements could not be easily obtained and deployed by a government facing severe budgetary pressures and the constraints of an arcane civil service system. Moreover, an outside adviser could provide the necessary expertise as needed, drawing its compensation directly from a portion of the returns it generated on behalf of the county.
This approach has proven extremely effective over the last 10 years. The county's investment returns now consistently exceed established market benchmarks. This dramatic improvement in performance is attributable in no small part to a series of procedural improvements that has minimized idle funds and facilitated the acquisition of yield-productive investment vehicles.
The perspective that "we ought to be able to do it better" eventually evolved into the notion that "we ought to be able to do it better with technology." Hence, the county replaced its manual, ad hoc approach to investing with a manual, systematic approach that resulted in substantial performance improvements. The county then sought to incorporate technology into its investment process for even greater efficiency and productivity.
Just three years ago, Web-based municipal investing was virtually unheard of. Fortunately for Monroe County, its investment adviser had the foresight to recognize the potential of this technology and to recommend that the county adopt it. This online, real-time approach to municipal investing was consistent with Monroe County's online, real-time financial management system. However, the question remained: Would the purveyors of our investments, namely, the banks that sold us interest-bearing investments, accept it? Before answering this question, let's look at the history and workings of Web-based auctions.
THE FORERUNNER: BID OHIO
In early 1999, new staff members at the Ohio State Treasury recognized the need to improve the agency's inefficient, cumbersome process for investing in certificates of deposit. At GFOA's annual conference that May, they approached Grant Street Group's MuniAuction, creator of the first online municipal bond auction, to develop an Internet alternative to the agency's time-consuming, paper-based process. Besides improving efficiency, the Ohio Treasury believed a Web-based auction could increase its investment returns and spread funds more evenly throughout the state.
Over the ensuing months, MuniAuction developed the BidOhio Web site in a collaborative effort with agency staff. In October 1999, Ohio became the first state in the nation to conduct an Internet auction for certificates of deposit. Since then, the Treasury has won numerous national awards for the success of BidOhio, including GFOA's Louisville Award for Financial Innovation. Six other states have developed their own versions of BidOhio for investing in CDs.
Each of these state Web sites was designed for large CD programs, in which auctions are conducted on a regular schedule, for a fixed amount and term, and with a large universe of approved banks. Although many cash managers were intrigued with the Web-based process, the fixed parameters of a BidOhio-type platform did not fit the needs of local governments with uncertain cash flows. Thus came the idea for YieldAuction, a Web site offering local governments the flexibility to conduct their own discrete auctions on an as-needed basis.
MAKING THE TRANSITION: ISSUES TO CONSIDER
Government cash managers can access the YieldAuction Web site at any time and create their own customized auctions. Their pre-approved banks receive automatic e-mail notification of requests for bids. The banks then log in, submit bids, and receive immediate feedback regarding the rank of their bids; however, they cannot see the bids of the other banks. Bidders have the opportunity to improve their rates, triggering the auction dynamic that works to achieve optimal rates for government funds. Government officials view the auction in real time and, at the end of the auction, award funds at their discretion. Settlement information is exchanged online with the winning banks. Exhibit 1 outlines the steps for an online investment auction, while Exhibit 2 is an example of the screens used to initiate and view an auction.
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YieldAuction's Web-based format keeps technical challenges to a minimum. There is no need for additional hardware or software on the part of either government investors or financial institutions--just a Web browser and access to the Internet. The wave of technology and e-commerce has reached even the smallest community banks, dispelling concerns that small banks would be technologically handicapped. Users on both sides of the auction find the YieldAuction platform to be straightforward and user-friendly.
Monroe County's investment advisory firm was first introduced to YieldAuction in the spring of 2001. The firm quickly seized on the increased efficiency and enhanced execution to be gained by using YieldAuction, as well as the opportunity to maximize return on clients' funds. Given the investment adviser's unique agency relationship with its government clients, adaptations to the Web site's initial design were required to enable third parties to initiate investment solicitations on behalf of these clients. Once the programming modifications were complete, YieldAuction was introduced to several of its upstate New York government clients. Monroe County was the first to sign on.
Statutory Considerations. Before implementing this new process, the county had to consider the state and local legal limitations governing the investment of public funds. For example, state statutes typically specify which investment instruments are permissible and set limits on the duration (maturity) of those instruments. Governments must also take into consideration any other restrictions self-imposed by local ordinance.
On YieldAuction, governments create individual "profiles" that conform to their specific investment guidelines. These customized profiles, along with stringent validation rules, prevent solicitations or bids for unauthorized investments. The county viewed these features as effective means of ensuring compliance with its investment policy.
Governments using the online investment platform must also determine whether an "open" auction is permissible. An open auction is one in which bidders may improve upon their original bids during the auction. Until the advent of Web-based bidding, the manual process of investing funds via telephone or fax necessitated a closed format for obtaining bids. Experience has shown, however, that open auctions are optimal, since they promote competition and drive up yields. Still, local practices may not permit an open auction format. In Monroe's case, county officials recognized the benefits of an open auction and had no objection to using such a format.
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