Treasury Management strategy and Policy Statements and investment strategy 2011/12

Report: 4
Date: 14 March 2011
By: Treasurer

Summary

This report sets out the Treasury Management Strategy and Policy Statements and Investment Strategy recommended for 2011/12.

A. Recommendations

That members are invited to:

1. Approve the 2011/12 Treasury Management Strategy Statement and Investment Strategy set out in this report 2.
2. Approve the 2011/12 Treasury Management Policy Statement at Appendix 1

B. Supporting information

Background Information

1. The Chartered Institute of Public Finance and Accountancy’s Code of Practice for Treasury Management in Public Services (the CIPFA TM Code) and the Prudential Code require that the MPA adopts a Treasury Management Strategy Statement (TMSS), Treasury Management Policy Statement attached at Appendix 1 and Prudential Indicators on an annual basis. The TMSS also incorporates the Investment Strategy as required under the Communities and Local Government’s (CLG) Investment Guidance.

2. The Policy Statement 2011/12 defines the policies and objectives of the Authority’s treasury management activities and continues to adopt the roles and responsibilities as suggested in the KPMG review of Treasury Management in November 2008. These roles and responsibilities have been updated to reflect the current practice of the Finance and Resources Committee or relevant sub Committee approving changes to the lending list and the ability of the Treasurer to remove an institution from the lending list prior to formal approval by the next available committee. There is a requirement within the revised CIPFA Code to seek Full Authority approval for the Treasury Management Strategy Statement and Treasury Management Policy.

3. The MPA has adopted the CIPFA definition of treasury management and defines its 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.”

4. While no treasury management activity is without risk the MPA regards the successful identification, monitoring and control of risk to be an important and integral element of its treasury management activities. The objectives underpinning the TMSS for 2011/12, and the area of risk that the objective will control, are as follows:

• 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)

5. In line with the requirements of the Prudential Code the MPA formally adopted the CIPFA TM Code in March 2002. Changes arising from the revision of the Code, in November 2009, have been incorporated into treasury policies, procedures and practices.

Outlook for Interest Rates

6. Treasury management operations undertaken to meet the objectives set out at paragraph 4 must have regard to the prevailing economic climate. Following the credit freeze in the UK in 2007, brought on by extreme conditions following the collapse of Lehman Brothers in the USA and the freezing of Icelandic Bank assets, substantial financial assistance was provided by Central Banks and Governments, including the £200bn asset purchase facility implemented by the Bank of England. Minutes from a recent Bank of England Monetary Policy Committee’s meeting suggest a movement away from further Quantitative Easing. Despite Money Supply being weak and growth prospects remaining subdued the MPC have gravitated towards increasing rates in the New Year as global inflation continues to rise along with household inflation.

7. The economic interest rate outlook provided by the MPA’s treasury advisor, Arlingclose, is attached at Appendix 3. Although there has been a small rise in short term money market rates during the final quarter of 2010/11, the Official Bank Rate remains at 0.50%. While future interest rates are expected to rise from the current very low position the timing and extent of rises will be determined by a range of economic variables. The MPA will continue to monitor evolving market conditions, the impact on interest rates and the consequences for treasury management activity.

The Investment Strategy

8. CLG guidance on Local Government Investments requires that an Annual Investment Strategy is set. The MPA’s investment priorities within this strategy, in line with the objectives and risks set out above at paragraph 4, are as follows:

• the security of the invested capital;
• the liquidity of the invested capital;
• an optimum yield commensurate with security and liquidity

9. CLG guidance also requires that investments are categorised as ‘Specified’ or ‘Non Specified’, determined by the security and liquidity of the investment.

Specified Investments

10. Specified investments are those that offer high security and high liquidity and meet the following CLG criteria:

• sterling denominated
• a maximum maturity of one year
• meets the high credit quality as determined by the MPA, or is made with the UK government or a local authority or a parish or community council
• is not defined as capital expenditure, that is not loan capital or share capital in a body corporate

11. It is proposed that specified investments for use by the MPA are:

• Deposits in the Debt Management Account Deposit Facility administered by the Debt Management Office (DMO)
• Treasury Bills, both at auction and through the secondary market
• Deposits with other UK local authorities
• Deposits with banks and building societies
• AAA rated Money Market Funds with a Constant Net Asset Value (CNAV)

12. The MPA, with the guidance and assistance of treasury advisors Arlingclose, will continue to maintain a counterparty list that is high credit quality. This assessment will include credit ratings from the three rating agencies and a range of other indicators to build up a comprehensive picture of credit strength at a sovereign and institution level and will include the following:

• Counterparty credit rating long term minimum A+ (Fitch) A1 (Moody’s) A+ (S&P)
• Counterparty credit rating short term minimum F1 (Fitch) P-1 (Moody’s) A-1 (S&P)
• Sovereign credit rating minimum AA+
• Credit Default Swaps (CDS)
• Sovereign support mechanisms / potential support from a well resourced parent institution
• Share prices (where quoted)
• Macroeconomic indicators
• Corporate developments, news and articles and market sentiment

These criteria include those recommended by KPMG in their review of MPA treasury management considered by Finance and Resource Committee in February 2009.

13. Applying these criteria Arlingclose have recommended that sovereign states whose banks can be included are Australia, Canada, Finland, France, Germany, Netherlands and Sweden. The banks within these states and within the UK that meet the high credit quality criteria for institutions are included in the recommended counterparty list at Appendix 4. Compared with the 2010/11 counterparty list there are four new banks shown in bold print. These additional opportunities will enable the further spreading of risk amongst a wider range of institutions.

14. The recommended lending limit for each counterparty is also shown at Appendix 4. These limits provide sufficient opportunity to make investments when large scale grants or other funding is received. The existing £35m individual limit for UK banks, approved by Finance and Resources Committee on 16 December 2010 as an amendment to 2010/11 strategy, is unchanged. The recommended individual limits for non UK banks remains at £20m with an increased sector limit to £120m to reflect the additional banks.

15. The notional individual limit for the MPA banker RBS is also proposed to be £35m, in line with other UK banks, but is noted on Appendix 4 as having no counterparty limit. Occasionally very late receipts, such as the capital receipt from the sale of a building, will be received into the current account. Late funds cannot be placed elsewhere and will remain within RBS until the next working day and a “no limit” assignment to RBS allows for this. When the notional limit with RBS is exceeded it is reported to the Resources and Productivity sub Committee as part of quarterly updates.

15. The investment decision for placing surplus funds must consider cash flow requirements. The cyclical nature of MPA large scale receipts and payments and average cash balances results in investments having a range of short-term maturity periods. CLG guidance recommends that procedures are in place to determine the maximum periods for which funds may prudently be committed, with specific reference to funds committed for more than 365 days. It is not proposed at this stage that the MPA will invest funds for more than 365 days so will not set a limit in this regard. The maximum maturity term for investments is 364 days and this particular Prudential Code indicator is included at Appendix 2.

16. Money Market Funds provides the MPA with access to pooled funds that invest in highly diversified and high credit quality investments. Arlingclose recommend a number of AAA rated money market funds that will provide security, high liquidity and a return commensurate with that level of security and liquidity. Arlingclose currently recommend fourteen of these AAA rated funds and the MPA will consider these for placing funds with an individual limit of £20m and a sector limit of £50m. Although these options are available indications are that current practice will continue with liquidity and a relatively high return achieved from UK bank call accounts.

17. Local authorities are included as counterparties although the MPA has placed only limited funds with this sector. It is proposed to continue this approach and if opportunities arise that match MPA requirements these will be considered. The counterparty limit assigned to a local authority is based on the authority’s budget and ranges from £2m to £20m.

Non-specified Investments

18. Non-specified investments do not, by definition, meet the requirements of a specified investment. These would include investments undertaken with mutual building societies that do not meet the specified criteria or investments that have a maturity term greater than one year. It is not proposed that the MPA should undertake any non-specified investments.

Summary of recommended changes to the investment strategy

19. To assist members Table 1 below compares the key components of the proposed 2011/12 investment strategy with the 2010/11 strategy. Although the addition of four banks should increase opportunities there is no guarantee that in practice the selected banks will actively take funds in line with MPA requirements. Money market funds tend to be low yielding but do provide a small marginal return over low yielding DMO deposits.

Table 1: Summary of 2010/11 and proposed 2011/12 investment strategy

Borrowing Strategy

20. New borrowing of £45m, in fixed rate maturity loans, was undertaken in 2010/11. Repayments of £1.6m Equal Instalment of Principal (EIP) loans were made during the year resulting in external debt on 1 April 2011 of £165.35m. The £45m of external borrowing undertaken is less than the £110m borrowing (supported and unsupported) identified to fund the 2010/11 capital programme. The cash flow position was such that further external borrowing was not required at this stage, in part due to the slippage in the capital programme. Early indications are that expenditure and funding of not less than £40m will slip into 2011/12 to be added to the programme for that year, so there may be a need to take this sum as external debt.

21. The draft borrowing and capital spending plan 2011/12 to 2017/18, considered by Finance Resources Committee on 17 February 2011, set out the proposed funding position that supports the capital programme including borrowing. An extract of this is set out below at Table 2. The decision to take up £68m of external loans during 2011/12, in addition to any borrowing requirement that has been carried forward from 2010/11, will be determined by cash flow. The current cash flow forecast, which includes provision for capital expenditure as set out in the capital programme, is that external short or long term borrowing to support the cash position will need to be undertaken during quarter 1 of 2011/12.

Table 2: Proposed Borrowing (Supported and Unsupported) to Fund the Capital Programme 2011/12 to

22. This report also includes at Appendix 2 the Prudential Code indicators relevant to treasury management activity. Members are reminded that the authorised limit and operational boundary are significantly higher than the actual level of external debt. (The level of external debt of £165.35m against the 2011/12 operational boundary indicator of £428.74m). This is the result of past decisions to fund borrowing internally, and not negotiate external loans, resulting in the MPA being significantly under borrowed.

23. While cash flow requirements will be a significant factor in determining when future external borrowing is undertaken, estimated future interest rates will also be closely monitored. It may be advantageous to schedule any new loans before anticipated rate increases. It is permissible under the prudential code to borrow in advance of need (up to the level of the Capital Financing Requirement (CFR)) with the cash forming part of invested balances until the related capital expenditure is incurred.
24. The outlook for interest rates, cash flow predictions and the options available for external loans will be closely monitored by MPS Treasury team, the Treasurer and Arlingclose. It is proposed at this stage, to reflect the possible slippage from the 2010/11 programme and the capital programme for 2011/12 that new external borrowing of £108m is approved, with the timing of borrowing determined by the factors discussed above.

Treasury Management Prudential Code Indicators

25. The Prudential Code has a key role in capital finance decisions with objectives that ensure capital investment plans are affordable, prudent and sustainable. The prudential indicators specific to treasury management are designed to ensure that treasury management is carried out in accordance with good professional practice. Prudential Code Indicators are set out in Appendix 2.

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 2011/12 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 proposed strategy for 2011-12 increases opportunities for the placing of funds with 4 new counterparties; this is expected to increase potential interest receipts by £0.2m as funds are moved away from the DMO. Income budget for 2011-12 is £1m.

Legal Implications

1. Under Section 1 of the Local Government Act 2003, the MPA as local authority defined under s23 of that Act, may borrow money for any purpose relevant to its functions under any enactment, or for the purpose of the prudent management of its financial affairs.

2. The Mayor is required under s3 of the Local Government Act 2003 to determine how much money the GLA and each functional body (which includes the MPA) can afford to borrow. In complying with this duty, Regulation 2 of the Local Authorities (Capital Finance and Accounting)(England) Regulations 2003 requires the Mayor to have regard to the Prudential Code for Capital Finance in Local Authorities when determining how much the MPA can afford.

3. The MPA’s standing orders provide the Treasurer, as the s127 officer, is responsible for the proper administration of the MPA’s financial affairs. Part F of the MPA’s standing orders also requires the Treasurer to report to the Authority, or designated committee of the Authority, on treasury management operations on a quarterly basis.
4. As is indicated in paragraph 1 of section B an investment strategy statement must be completed as part of risk management and good Governance. The report is submitted in compliance with TMSS and CLG requirements in this regard.

5. Any further legal implications relating to the proposed capital programme will be reflected in the final report to the Authority on the capital programme in March 2010.

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 2011/12 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 2011/12 and includes regular review, reporting and scrutiny of treasury management activity.

D. Background papers

None

E. Contact details

Report authors: Bob Atkins, Treasurer, MPA

For more information contact:

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

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