Treasury Management Financial Review

Report: 7
Date: 18 June 2009
By: Director of Resources on behalf of the Commissioner

Summary

This report presents the Annual Review of Treasury Management for the 12 month period ended 31 March 2009.

A. Recommendation

That the annual report of the Treasury Management function is noted.

B. Supporting information

Background information

1. The MPA operates in accordance with CIPFA’s Code of Practice on Treasury Management which requires that the Authority receives an annual report on treasury management after the year’s close.

2. Additionally, under Part 1 of the Local Government Act 2003, the Authority is required to have regard to the Prudential Code for Capital Finance including the setting of Prudential Indicators. Relevant treasury management indicators were incorporated into the Treasury Management Strategy 2008-09 approved by this Committee on 21 February 2008.

3. This report sets out:

•  a review of investment operations during 2008/09
•  a summary of interest rate movement and investment performance for 2008/09
•  a review of risk and compliance issues
•  a review of debt management operations
•  a review of the treasury management Prudential Code indicators

Investment operations during 2008/09

4. The average size of the investment portfolio during 2008/09 was £259 million. These cash balances available for investment include balance sheet reserves and provisions, unapplied capital receipts and grant and cash arising from the timing of large receipts and payments.

5. The structure of the portfolio continues to reflect the investment instruments selected for investment purposes as defined by the Treasury Management strategy. Table 1 provides an analysis of average investment balances for each counter-party sector.

Table 1 – Portfolio average sector size 2008/09

6. Difficulties in world economies have continued to have an impact on the sterling money market, with most banks suffering credit downgrades by the rating agencies. The collapse of the Icelandic banking sector in October 2008 led to more anxiety with many public bodies, including the MPA, having funds frozen in Iceland. As a result of this turmoil revisions to the Treasury Management Strategy 2008/09 were considered as part of the six monthly review of treasury management and approved by this Committee on 20 November 2008.

7. The call money sector represents instant access funds held with Bank of Scotland (BOS) until December 2008 and Royal Bank of Scotland (RBS). As part of merger activity in the banking sector BOS became part of the Lloyds Banking Group and because this group no longer meets our minimum rating criteria we have withdrawn this call facility. RBS continued to offer a competitive 0.55% above Bank of England Base Rate. Subject to cash flow we have maintained high cash levels in this account, subject to the counterparty limit of £60m (now revised to £50m) providing liquidity to cover short-term cash flow requirements.

8. During the year RBS credit ratings were also downgraded below the minimum required. However because RBS are the MPA banker this position was considered by this Committee on 22 January 2009 and the retaining of RBS as a counterparty was noted.

9. The purchase of New Scotland Yard in December 2008, which has been funded through reserves, has contributed to reduced cash balances during the fourth quarter of the year.

10. A total of 350 investment transactions were undertaken (not including call money, see paragraph 7 above). The average size of investments was £10.9 million and average term 14 days.

Interest rate movement and investment performance for 2008/09

11. Between April 2008 and March 2009 the Bank of England reduced base rate from 5.25% to 0.5%. This was part of worldwide Central Bank intervention to help ease the difficulties in the credit markets. Typically a base rate reduction would ease money market rates but we continued to see a positive yield curve (upward sloping indicating higher future rates) with money market rates at 1.90% for one year compared with base rate of 0.5%.

12. We continue to monitor performance against the British Bankers Association (BBA) LIBOR rate. The MPA return of 4.27% compares with BBA LIBOR (1 week) of 3.82% and BBA LIBOR (1 month) of 4.16%. The higher MPA return includes some longer term fixed rate loans taken out before the aggressive cuts in interest rates.

Risk assessment and compliance with agreed limits

13. The Treasury Management strategy restricts lending to institutions with a high credit rating or, as set out in the 2008/09 strategy and in line with guidance, to building societies that are not credit rated but are in the top 20 in terms of asset size. As already stated this Committee, in November 2008, approved a revised Treasury Management strategy. The revised strategy raised the minimum required credit rating (see paragraph 14 below), removed all Building Societies from the lending list except Nationwide and introduced the Debt Management Office (DMO).

14. The MPA uses Fitch Ratings to assess counterparty risk and in November 2008 added Moody’s credit ratings. The minimum selected standards are:

15. Institutions meeting the credit rating criteria have an individual lending limit determined by the financial size of the institution. The highest limit during the year was £60 million and applied to all UK banks and Nationwide Building Society on the lending list. The highest limit for other banks was £30 million and the limits or other building societies ranged from £30 million for the largest society to £2 million for the smallest.

16. The circumstances leading to the MPA having two investments with Landsbanki frozen by the Icelandic Government have been the subject of reviews reported to this Committee. The KPMG report commissioned by the MPA was considered on 5 March 2009 leading to a number of recommendations and action plan, the implementation of which is being monitored by the MPA Corporate Governance Committee.

17. One of the KPMG report’s recommendations on treasury management governance highlighted members’ responsibilities for the oversight of treasury management operations through the review of treasury management reports. The Resources Sub Committee receives quarterly reports on treasury management activity and to assist members with their responsibilities the Treasurer arranged in April 2009 for an independent consultant to provide training which was offered to all members of the Finance and Resources Committee.

18. All transactions undertaken during the year were conducted within the criteria set out in the 2008/09 Treasury Management strategy (revised November 2008). Constant monitoring of the lending list against Fitch Ratings and Moody’s credit information ensured that all institutions met the prescribed credit ratings and all investments were compliant.

Debt management operations

19. The 2008/09 Treasury Management Strategy allowed for the possibility of limited long term borrowing. During the year a loan of £5 million was repaid and a new loan of £10 million undertaken leaving the balance of debt on 31 March 2009 at £47.34 million. (This balance includes £9.89 million held on behalf of the former Inner London Magistrates Courts Service and the former Inner London Probation Service).

20. The average size of the portfolio during 2008/09 was £41.89 million with an average rate of interest paid on the portfolio of 5.66%. All debt is with the PWLB and is fixed rate.

Treasury management Prudential Code indicators

21. Prudential Code indicators specific to treasury management are designed to ensure that treasury management is carried out in accordance with good professional practice. Indicators for 2008/09, 2009/10 and 2010/11 were presented as part of the 2008/09 treasury management strategy.

22. The 2008/09 indicators and actual figures for the year are set out at Appendix 1. Investment activity has been maintained within indicator limits except for the indicator for variable rate investments. The upper limit for variable rate investments is 40% of total investments and this limit was set to reflect the expected balances in the call account (which is variable because it tracks base rate). As explained above the funding of the NSY purchase from cash balances reduced the size of the portfolio from December 2008 resulting in a disproportionate amount of funds being held as liquid funds within the call account. This does not indicate any additional risk to the MPA because cash flow requirements and a reduced portfolio mean that MPA fixed term investments are very short term.

C. Race and equality impact

Consideration is given to the requirements of equality legislation through the MPA/MPS Environmental Strategy and Ethical Investment Policy whereby best practice standards are promoted.

The MPS Ethical Investment Policy was considered and approved by Resources Sub Committee on 16 March 2009.

D. Financial implications

Any 2008-09 figures discussed in this report are consistent with those previously advised. However members should note that the combination of reduced interest rates, the very short length of investments due to lower cash balances and the implementation of a revised treasury management strategy has reduced the counterparty lending list and requires that at least 25% is invested with the DMO. This will have a significant impact on future investment income.

E. Background papers

• Treasury Management Strategy 2008/09 – MPA Finance and Resources Committee Report 21 February 2008
•  Treasury Management Half Year Review 2008/09 - MPA Finance and Resources Committee Report 20 November 2008
•  Investments in Icelandic Banks - MPA Finance and Resources Committee and Strategic and Operational Policing (joint meeting) 5 March 2009
•  MPA Ethical Investment Policy Statement - MPA Resources Sub Committee 16 March 2009

F. Contact details

Report author: Paul James, Director of Finance Services, MPS

For information contact:

MPA general: 020 7202 0202
Media enquiries: 020 7202 0217/18

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