Treasury Management half year review 2010/11 (including 2nd quarter update)

Report: 4
Date: 6 December 2010
By: Treasurer

Summary

This report invites members to review Treasury Management activity for the period 1 April 2010 to 30 September 2010 and approve amendments to the MPA investment counterparty list and prudential code indicators.

A. Recommendations

That members

1. Note the half year review of the Treasury Management function and the 2nd Quarter update.
2. Note the statement of assurance from the Treasurer and Director of Finance.
3. Approve amendments to the MPA counterparty list for investments:
4. Increase the individual lending limit for UK counterparties from £30m to £35m, as set out in paragraph 21 of this report.
5. The addition of Clydesdale Bank to the counterparty list, as set out in paragraph 22 of this report.
6. Approve to raising the prudential code limit on variable rate borrowing from 15% to 30%, as set out in paragraph 26 of this report.

B. Supporting information

1. To satisfy the requirements of the Chartered Institute for Public Finance and Accountancy (CIPFA) guidelines for the monitoring of treasury management operations this half year report reviews treasury management and performance for the period 1 April 2010 to 30 September 2010.

2. The Resources and Productivity Sub Committee meeting of 13 September 2010 reviewed 1st quarter treasury management operations. This half year report provides a review of the 1st and 2nd quarters combined but also provides Members with a separate summary overview of 2nd quarter activity.

3. Activity throughout the period has been undertaken in line with the 2010/11 Treasury Management Strategy Statement, approved by Finance and Resources Committee on 18 March 2010. Members are reminded that the 2010/11 approved counterparty list for investments was extended combining increased opportunities with lower individual limits with the aim of spreading risk amongst a wider range of institutions.

4. Members are also provided with a statement of assurance by the Treasurer and Director of Finance about 2nd quarter treasury management activities. This is attached at Appendix 4.

2nd Quarter 2010/11 summary overview

5. The following is a summary of 2nd quarter treasury management activity:

• Average cash balances invested £210m
• Debt Management Office (DMO) portfolio balance at 7%. Call money balance 26%, held with Royal Bank of Scotland (RBS) and Lloyds Banking Group (HBOS)
• Notional limit of £30m with RBS exceeded once by £8m for one night, due to late in the day receipt of funds. The excess funds were on lent the following day
• There were 102 investments with four UK banks, four foreign banks, one building society, the DMO and one local authority
• Investment income of £0.334m at a return of 0.63%
• Cash flow, borrowing requirements and the funding of the capital programme were kept under constant review. No new borrowing was undertaken during the period
• One part maturing EIP loan of £250k was repai

Half-Year Review 2010/11

6. The following is a review of treasury management activity for the period 1 April to 30 September 2010 combining the 1st quarter review previously presented to the Resources and Productivity Sub Committee with the 2nd quarter activity summarised at paragraph 5 above.

Average Investment Balances

7. The average size of the investment portfolio during the first six months of 2010/11 was £158m. 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.

8. The structure of the portfolio continues to reflect the investment instruments selected for investment purposes as defined by the 2010/11 Treasury Management strategy. Appendix 1 provides an analysis of average investment balances for each counter-party sector. Funds in the two call accounts represent 33% of the portfolio. These call account funds in addition to the 22% invested with other UK banks, 8% with the Nationwide Building Society, 5% with the DMO and 3% with local authorities means that 71% of the portfolio is invested within the UK. Non UK Banks represent the balance of 29%. This continues to highlight the opportunities to invest with a wider selection of banks as determined in the 2010/11 Treasury Management Strategy and in particular reducing the need to place funds with the DMO.

9. There were 158 deposits made during the first six months of 2010/11 (this does not include call money activity). Overall these deposits were made with three UK banks, four foreign banks, Nationwide building society, the DMO and one local authority, a total of ten institutions. The average size of investments was £14.9m and the average term 14 days. The average term of investments includes three one year deposits during the period.

Income on Investments

10. Income on the investment portfolio for the first six months of 2010/11 was £0.523m at a return of 0.68%. Appendix 1 shows the rate of return and the income received by market sector. The call money account return is 1% and continues to show the most attractive return while also providing liquidity. The DMO is still the lowest rate of return at 0.25% for the period, but as described in paragraph 8 above, reliance on this sector has reduced and now accounts for only 5% of the portfolio.

11. Interest received on investments during the six months was £0.523m against a budget of £0.8m. Due to anticipated future interest rates and cash balances the estimated outturn for 2010/11 is currently maintained to budget of £0.8m.

Borrowing

12. In line with Treasury Management Policy the MPA Treasurer takes the decision on external borrowing ensuring compliance with the CIPFA Treasury Management Code of Practice. The Treasurer gives the approval for borrowing having reviewed the options available with MPS finance staff and treasury advisors Arlingclose. Full consideration is given to short term cash flow requirements and the ability of the MPA to meet its liabilities and the long term position of borrowing to support the capital programme.

13. In line with the 2010/11 borrowing strategy additional external borrowing was undertaken in May 2010. All borrowing was fixed rate and undertaken with the Public Loans Board (PWLB). Table 1 below provides details of the new loans raised.

Table 1 - 2010/11 new loans raised with the PWLB

14. The new borrowing of £45m detailed at Table 1, less the repayment of principal of Equal Instalment of Principal (EIP) loans of £0.8m, gives an outstanding portfolio balance of £166.15m at 30 September 2010. All debt is with the PWLB of which £151.15m is fixed rate and £15m variable rate.

15. Expenditure on the debt portfolio during the first six months was £3.142m. A summary of the period’s expenditure on the debt against the 2010/11 budget of £3.6m is provided at Appendix 2. As reported in the 1st Quarter update to the Resources and Productivity Committee in June 2010 the estimated outturn for 2010/11, based on the current level of external debt (£166.15m), continues to show an emerging budget pressure of approximately £2m. Options are currently being considered for dealing with this pressure as part of a review of the wider MPS budget.

16. The 2010/11 borrowing strategy included provision to borrow £90m and careful consideration must be given to decisions about the untaken balance of £45m. Indications are that cash balances will fall towards the end of the 3rd quarter 2010/11 and there may be further pressure resulting from future strategic decisions about the use of reserves. Furthermore the timing of borrowing must consider the prevailing and predicted market conditions and it could be advantageous to schedule new borrowing before possible rate increases even though the cash flow requirement may be later in the year. However with regard to the additional revenue expenditure resulting from new borrowing, which will add to the budget pressure mentioned above at paragraph 14, alternative options are being considered such as borrowing short term from the market for a few days until the cash position is restored or the further use of variable rate loans from the PWLB. This latter option needs to be seen in the context of the appropriate prudential code indicator and this is addressed at paragraph 26 below. All options around cash flow and borrowing will be closely monitored by the MPS treasury team, the Treasurer and Arlingclose.

Interest rate movement and investment performance for 2010/11

17. During the first six months of 2010/11 the Bank of England maintained base rate at 0.5%. Although this keeps short term rates low (around 0.6% for one month), we continued to see a positive yield curve (upward sloping indicating higher future rates) with money market rates around 1.90% for one year compared with base rate of 0.5%.

18. Performance is monitored against British Bankers Association (BBA) LIBID rate, which is the rate at which banks are willing to pay for borrowing from other banks. The MPA return of 0.68% compares with BBA LIBID (1 week) of 0.44% and BBA LIBID (1 month) of 0.50%. The higher MPA return is attributable to the return received on the call accounts, the three longer term deposits with higher yields and lower balances with the DMO.

Risk assessment and compliance

19. All investment and borrowing activity has been undertaken within the guidelines and objectives set out in current treasury management policy and strategy. Liquidity has been maintained to ensure that obligations have been discharged. All investments were compliant with the requirements of the strategy and achieved a rate of return consistent with the opportunities available.

20. Using information supplied by rating agencies, Reuters and financial updates from Arlingclose the lending list is monitored to ensure all institutions met the required minimum credit quality criteria. Furthermore, the institutions on the 2010/11 lending list, as set out in the strategy, are all adopted from the list of institutions recommended as suitable by Arlingclose.

21. Without any significant increase to risk, but to increase the opportunities available for investment and reduce further the funds placed with the DMO, some minor adjustments to the lending list are being proposed. The individual lending limit assigned to each institution is currently £30m for each of the five UK banks and Nationwide Building Society. Increasing the individual limit for these institutions by £5m to £35m will provide additional investment capacity of £30m. It is recommended that members approve a £5m increase to the individual lending limit for the five UK banks and the Nationwide Building Society.

22. Additionally members are asked to approve the addition of Clydesdale Bank to the lending list. Clydesdale is a UK bank, with its own banking licence, and is wholly owned subsidiary of National Australia Bank (NAB), which is one of the non UK banks on the lending list. Clydesdale Bank is on Arlingclose’s list of recommended institutions. Arlingclose have advised they are comfortable with the MPA placing investments with Clydesdale Bank for up to one year, but the actual term of investment will be determined by cash flow requirements. It is recommended that members approve the addition of Clydesdale Bank to the MPA investment counterparty lending list.

Treasury management Prudential Code indicators

23. 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 2010/11 and the following two years were presented as part of the 2010/11 treasury management strategy.

24. The indicators for borrowing are presented at Appendix 3. This includes the maturity profile of the debt portfolio at 30 September 2010, so includes the £45m new borrowing as set out above at Table 1.

26. The prudential code indicators that refer to gross outstanding borrowing set out the upper and lower limits for fixed rate and for variable rate borrowing. The existing portfolio of £166.15m includes £15m at variable rate, which is 9% and within the prudential code limit of 15%. To provide sufficient flexibility to consider further variable rate borrowing, as discussed at paragraph 16 above, the upper limit for variable rate borrowing should be increased. It is recommended that members approve an increase to the upper limit on variable rate exposure for borrowing from 15% to 30%.

Landsbanki update

27. The first hearing of Landsbanki test cases in the Reykjavik District Court took place on 30 April 2010. This was a procedural hearing about how the case is to be conducted, rather than a hearing on the merits of local authorities’ claims. The Landsbanki winding up board has agreed to refer all the non-test cases to court, which is positive as it should facilitate the earliest possible resolution of matters for all authorities with exposure to Landsbanki. The appointed legal advisors working with the Local Government Association (LGA) are currently preparing to file written submissions in relation to non test case authorities which includes the MPA.

C. Other organisational and community implications

Equality and Diversity Impact

1. Consideration is given to the requirements of equality legislation through the 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.

Consideration of MET Forward

2. The Treasury Management Strategy 2010/11 defines MPA treasury management activities as ‘the management of the organisation’s investments and cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks.”

3. The achievement of optimum performance from treasury management activities, by maximising yield from cash balances invested and minimising the cost of borrowing while effectively controlling associated risk, supports the objective of achieving better value for money.

Financial Implications

4. The financial implications have been discussed in the report. The 2010/11 estimated outturn for interest on investments is to budget at £0.8m. The 2010/11 estimated outturn for expenditure on the current debt portfolio of £166.15m is £6.7m, an emerging pressure of £2m against budget once a corresponding increase in Loan Charges Grant is allowed for. This is due to the scheduling of new loans with the full year cost having been recognised in future years but not the partial in year impact. Any additional borrowing during 2010/11 will add to this pressure but alternatives to long term borrowing to cover cash flow shortfalls are being considered. Options for dealing with this budget pressure are being examined as part of the wider review of the MPS budget.

Legal Implications

5. This is a financial monitoring report primarily for information only.

6. The Treasurer’s responsibilities are set out in the Financial Regulations under Part E of the MPA standing orders. In accordance with those standing orders, the Treasurer is responsible for advising the Authority on all matters relating to treasury management, investments and borrowing, and for ensuring that treasury management arrangements are in compliance with the CIPFA Code of Practice for Treasury Management in Local Authorities. This report fulfils this requirement.

7. The Resources and Productivity sub-committee has authority in accordance with its terms of reference to receive and review the MPS Treasury Management report on a quarterly basis. The report will also be referred to the Finance & Resources Committee for final approval as the recommendations have significant financial implications.

Environmental Implications

8. There are no direct environmental impacts arising from the treasury management activity discussed in this report. However the MPA ethical investment policy seeks to avoid the investment of funds in organisations whose core activity contributes to significant negative environmental impacts the MPA will not invest funds in any organisation involved in animal testing, the fur trade and blood sports.

9. It should be noted that the MPS Corporate Social Responsibility (CSR) Strategy is currently awaiting review by the MPA. This Strategy takes into account a broader scope of issues than the current MPS Environmental Strategy, extending also to social/ethical and economic issues. Consequently, the "Environmental Implications" section will, in due course, be replaced by a section that addresses these broader issues.

10. With this in mind, there are no corporate social responsibility issues directly arising from this report. The consideration of environmental, social/ethical and economic issues arising from MPS investment is appropriately directed by the MPA ethical investment policy.

Risk Implications

11. The risks associated with treasury management activity are addressed by the CIPFA Code of Practice and set out in Treasury Management Practices. Furthermore the Treasury Management Strategy 2010/11 sets objectives to identify, monitor and control risk. Specifically the objectives and the associated areas of risk covered are:

• To undertake treasury management operations with regard for the security of capital invested (Credit and Counterparty Risk)
• To ensure that sufficient cash is available such that the MPA is able to discharge its financial obligations in accordance with approved spending plans (Liquidity Risk)
• To minimise the cost of borrowing and to maximise the yield from investments consistent with the security and liquidity objectives identified above (Market or Interest Rate Risk)
• To minimise the amount of borrowing to be replaced at any one time by maintaining an evenly spread maturity profile (Refinancing Risk)
• To undertake treasury management activity with regard to Prudential Code Indicators (All areas of Risk)

Roles and responsibilities for treasury management are clearly established and set out in the Treasury Management Policy Statement 2010/11 and includes regular review, reporting and scrutiny of treasury management activity.

D. Background papers

None

E. Contact details

Report authors: Paul Daly, Director of Exchequer Services, MPS

For more information contact:

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

Appendix 4

Treasury Management 1 2nd Quarter 2010/11

Certificate of assurance

We confirm that the Treasury management report for the second quarter of 2010/11 is an accurate record of the treasury management activity of the Metropolitan Police Authority for the period ended 30 September 2010 and that all activity has been undertaken in accordance with the agreed policies and strategy.

Bob Atkins - Treasurer, MPA

Nick Rogers - Director of Finance, MPS

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