Treasury management

Report: 12
Date: 20 July 2000
By: Treasurer

Summary

To present for approval the Treasury Management Policy Statement and the Treasury Management Strategy for 2000/01.

A. Supporting information

Introduction

1. At its meeting on 10 July 2000 the Authority formally adopted the CIPFA Code of Practice on Treasury Management. This Committee’s terms of reference include the approval, in relation to treasury management, of the Authority’s policy and annual strategy, and receiving reports on performance.

Purpose of the Code

2. The purpose of the Code at a strategic level is to:

1. Support the quality and status of treasury management in local authorities.
2. Provide guidance on the proper practices to be employed for treasury management.

3. At an operational level guidance is provided to chief financial officers of local authorities regarding:

1. Allocation of responsibility among the relevant staff.
2. The balance between security/risk and the rate of return.
3. Effective management of risk.
4. Reconciliation of the need for rapid decisions on dealing with the need to be accountable for the use of delegated authority.
5. Mechanisms to satisfy the statutory obligations placed upon the monitoring officer (Clerk) and chief finance officer (Treasurer).
6. Best practice at reporting at various levels in the authority.
7. Performance measurement.

Policy statement and annual strategy

4. The Code requires the preparation and approval of a Treasury Management Policy Statement and a Treasury Management Strategy for the year ahead. The documents prepared for the MPA are attached at Appendices A and B respectively.

The Treasury Management Policy Statement

5. The Policy Statement sets out the policy framework within which treasury management operations are to be undertaken. It is a standing document subject to review from time to time.

The Treasury Management Strategy for 2000/01

6. The Strategy for 2000/01 sets out how investment and borrowing operations are to be managed in this year within the framework established in the Policy Statement. It also addresses legislative requirements to determine specific issues of financial policy for the ensuing year.

B. Recommendations

It is recommended that:

1. The Treasury Management Policy Statement be approved (Appendix A).
2. The Treasury Management Strategy for 2000/01 be approved (Appendix B).

C. Financial implications

Borrowing costs and investment income are reflected in the approved budget for 2000/01.

D. Review arrangements

The Committee will receive quarterly reports on treasury management performance. The Treasurer will keep the annual strategy under review reporting to members as appropriate. The strategy for 2001/02 will be presented for approval in March 2001. The Policy Statement will be kept under review and any material changes brought to the Committee for approval.

E. Background papers

The following is a statutory list of background papers (under the Local Government Act 1972 S.100 D) which disclose facts or matters on which the report is based and which have been relied on to a material extent in preparing this report. They are available on request to either the contact officer listed above or to the Clerk to the Police Authority at the address indicated on the agenda.

• CIPFA Code of Practice on Treasury Management

F. Contact details

The authors of this report are Peter Martin and Brendon Arnold.

For information contact:

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

Appendix A: MPA Treasury Management Policy Statement introduction and purpose

1. For many years local authorities, and more recently, police authorities, have successfully managed the cash balances that need to be held for operational and strategic purposes and debt assumed for purposes of financing capital expenditure. Such management has generally been to the benefit of national and local tax payers and stakeholders in the local communities which these authorities serve.

2. The management of treasury operations in the local authority sector is undertaken in line with guidance set out in the CIPFA Code of Practice for Treasury Management in Local Authorities ('the Code'). This Code, which is endorsed by the Home Office Code of Practice on Financial Management for Police Authorities, is recommended for adoption by the Metropolitan Police Authority (MPA) on this agenda. The Code recommends that each authority gives formal approval to a treasury management policy statement.

3. The Treasury Management Policy Statement set out in this report will provide a framework within which treasury management is undertaken, and the application of that policy in each year will be addressed through the preparation of an annual Treasury Management Strategy. For 2000/01 only, the Strategy will apply to the period 3 July 2000 to 31 March 2001, reflecting the shortened accounting period arising from the establishment of the MPA under the Greater London Authority Act 1999.

Definitions

4. 'Treasury management' is defined in the Code as: " The management of the local authority's cash flows, its borrowings and its investments, the management of the associated risks, and the pursuit of optimum performance or return consistent with those risks"

5. This policy statement shall operate within the following general principles:

1. To undertake treasury management operations with primary regard for the security of capital invested.
2. To minimise the cost of borrowing and to maximise the return on investments subject to (i) above.
3. To ensure that sufficient cash is available such that the MPA is able to discharge its obligations as determined in its general financial strategy.

Responsibilities within the treasury management function

6. The Treasurer to the MPA is responsible for securing treasury management including loans and investments. As set out in Section 31 of the Financial Management Code of Practice the Treasurer may ask the Force Finance Director to undertake or procure the daily management of loans and investments work, following a decision made by the police authority.

7. The following options exist for provision of this work:

1. Recruit a new team to work directly to the Treasurer
2. Place funds with external cash managers and retain a scaled down in house treasury management function.
3. Delegate responsibility to the Director of Resources of the MPS whose Finance Directorate has been undertaking Treasury Management operations on the required scale and to the required technical standard prior to the establishment of the MPA.

8. It is proposed in this statement that the MPS Finance Directorate shall continue to exercise the Treasury Management function under delegation from the Treasurer. This recommendation is made against the backdrop of the Best Value review of the Finance Directorate that is scheduled for 2002/03, when alternative options for provision can be considered in detail. It is also possible that, within this period, the Greater London Authority may seek a review of generic functions, such as treasury management, across the GLA and the functional bodies. In view of these impending developments, which will need to be considered in due course, it is not proposed at this time to explore options (i) or (ii).

Investment of strategic and short term surplus cash

9. The investment of funds is not a local authority function (except in relation to trust and pension funds) but the legislation recognises that local authorities hold cash balances and Part IV of the Local Government and Housing Act 1989 provides for the Secretary of State to prescribe approved investments.

Approved investments and restrictions

10. The following restrictions shall apply:

1. The purchase of equities, the use of derivatives, or any other form of speculation in the money markets is not permitted.
2. Investments are confined to instruments denominated in sterling.
3. Investments are restricted to the following instruments, all of which have been prescribed as approved investments by the Secretary of State:
   1. UK Treasury Bills.
   2. Deposits (or certificates of deposit) with the Bank of England or authorised institutions (i.e. banks regulated by the Bank of England under the Banking Act 1987).
   3. Deposits (or certificates of deposit) with, or shares in, UK mutual building societies.
   4. Short term loans to UK local authorities.

11. Investments in cash are restricted to period of less than one year.

The dealing operation

12. Investment operations are conducted in accordance with the London Code of Conduct, which governs the relationship and standards of brokers and principals in the wholesale (financial) markets, as promulgated by the Financial Services Authority.

13. With the exception of the purchase of Treasury Bills, investments are made through a number of authorised money brokers whose activities are regulated by the Financial Services Act 1986 and whose names appear on the Bank of England list of money market institutions. In addition deposits can be made directly with the MPA's bankers. The selection criteria for placing funds directly with the bankers will be:

1. The competitiveness of the rates quoted against rates available in the money market.
2. The availability of placement opportunities in the money markets where unforeseen or small scale dealing is required later in the business day.

14. The objective of using a number of authorised brokers and a range of investment options with the bankers is to obtain a competitive rate of return and to avoid the risk of lower returns through placing higher levels of business with specific brokers. The appointment or removal of the money brokers is undertaken by the Finance Directorate in consultation with the Treasurer. The performance of brokers is monitored and reviewed monthly.

15. Treasury Bills are purchased through the MPA's bankers from HM Treasury.

Management of risk

16. A List of Approved Organisations for Investment (The 'Lending List') is maintained by the Treasury Team. The Lending List for 2000/01, together with investment limits and the relevant credit rating criteria, is shown at Appendix 1. This is continuously updated to reflect amendments to credit ratings, and where prudence indicates that a given institution should be suspended or removed. Although the fullest interpretation of the regulations made under the 1989 Act would allow a wider range of financial institutions to be used, at the time of writing this is not necessary to meet operational requirements. It should be noted that a lending limit is not assigned to the National Westminster Bank plc. This is because the assignment of such a limit would be inappropriate and impracticable for the MPA's bankers.

17. Overall limits are also imposed for market sectors to maintain a balanced portfolio. These are reviewed as required throughout the financial year.

18. Treasury Practice Notes are prepared by the Finance Directorate as required where market conditions or other indicators suggest changes to these arrangements. These documents are approved by senior managers in the Finance Directorate in consultation with the Treasurer.

Delegation and security

19. The scheme of delegation to be used in the Treasury Management function at an operational level is set out in the Treasury Systems Document. The scheme operates with the principle of separation between:

1. Policy formulation and review.
2. The dealing operation.
3. The recording and administrative functions.
4. Independent reconciliation.

Recording

20. Records are maintained to demonstrate compliance with the Treasury Systems Document, the Code and relevant legislative constraints.

Reporting

21. The Treasury Team is responsible for generating monthly and year end reports on treasury activities for senior management and the Treasurer. During each financial year the Treasurer shall table at meetings of the MPA or a suitable committee (i) a Treasury Management Strategy (ii) Quarterly Financial Reports on Treasury Operations, and (iii) an Annual Review.

Capital financing and borrowing

Powers and limits
22. The MPA has general powers to borrow under section 43 of the Local Government and Housing Act 1989 for any purpose relevant to its statutory functions. In common with all local authorities in England and Wales the MPA is required to set an external borrowing limit before the start of each financial year. All borrowing operations undertaken are to comply with Part IV of the Local Government and Housing Act 1989. The context within which borrowing shall be undertaken is set out in the annual Treasury Management Strategy.

Short term borrowing
23. The MPA does not presently have a requirement to engage in regular short term borrowing. However, from time to time, large receipts, such as grant disbursed by central government, are not received in a timely manner. In these circumstances it is possible that on an exceptional basis temporary borrowing may be required. The MPA also has small overdraft facilities with its bankers to provide flexibility in day to day operations.

General management of long term borrowing operations
24. Decisions on borrowings are approved by senior managers in the Finance Directorate and are undertaken in consultation with the Treasurer. Such decisions shall be made with regard to the following:

1. The need to borrow.
2. Consideration of any options that might be available.
3. The need to maintain a balance of fixed and variable rate loans. The proportion of interest payable at variable rates may not exceed 10%. This proportion is subject to review in the Treasury Management Strategy.
4. The need to maintain a maturity profile that avoids exposing the Metropolitan Police Fund to replacing a high level of maturing debt in any given year, when interest rates may be relatively high. The proportion of debt needing to be replaced in any one year should not normally exceed 15%.
5. A view of current, and future movements, in interest rates.

25. Loans are negotiated directly with the Public Works Loans Board (PWLB) or with commercial banks through money brokers. The detailed proposals to be operated within this policy framework are set out in the annual Treasury Management Strategy.

Security arrangements for negotiation of loans
26. As for investment operations, the scheme of delegation to be used for borrowing operations is set out in the Treasury Systems Document, a working manual used by the Treasury Team in day-to-day operations. The system operates with the principle of separation between:

1. Policy formulation and review, and
2. The undertaking of borrowing operations, recording and administrative functions.

Recording
27. Records are maintained to demonstrate compliance with the Treasury Systems Document, the Code and relevant legislative constraints.

Appendix 1: The lending list to be used for MPA Treasury Operations 2000/01

1. Counter-party lending limits

1.1 The lending limits for those counter-parties other than local authorities are shown in the attached schedule. Local authority counter-parties, which do not have credit ratings, are assigned lending limits based on 5 Bands (see below).

1.2 No counter-party, with the exception of the National Westminster Bank (the MPA's bankers) may have a lending limit which exceeds £20 million.

1.3 The local authorities to which lending may take place are:

1. County Councils in England
2. Shire District Councils in England
3. Metropolitan District Councils
4. London Borough Councils
5. All Purpose ('unitary') Authorities in England
6. All Purpose ('unitary')Authorities in Wales
7. All Purpose ('unitary') Authorities in Scotland
8. Metropolitan and Non-Metropolitan Police Authorities
9. Metropolitan and Non-Metropolitan Fire Authorities
10. The Greater London Authority and its functional bodies
11. The Common Council of the City of London and the Council of the Isles of Scilly.
12. Joint Waste Disposal Authorities.
13. Joint Passenger Transport Authorities.

1.4 Local Authority counter-parties are placed in one of five Bands based principally on an assessment of the resources available to a given counter-party. The availability of resources is measured by the Standard Spending Assessment (in Scotland Grant Aided Expenditure) issued to each authority by central government. The SSA/GAE Threshold is the minimum value required for assignment of a given lending limit.

Band (1): Lending Limit £20 million
SSA/GAE Threshold: £600 million

Band (2): Lending Limit £15 million
SSA/GAE Threshold: £400 million

Band (3): Lending Limit £10 million
SSA/GAE Threshold: £200 million

Band (4): Lending Limit £5 million
SSA/GAE Threshold: £100 million

Band (5): Lending Limit £2 million
SSA/GAE Threshold: £4 million

2. Sector limits

2.1 The following Sector Limits shall apply:

1. UK Incorporated Institutions authorised under the Banking Act 1987 to accept deposits in the United Kingdom. Sector Limit: £60 million - in order to allow operational flexibility this sector limit may be exceeded by up to £10 million on any single occasion as long as the additional funds are placed overnight.
2. UK Local Authorities Sector Limit: £60 million
3. Mutual Building Societies Sector Limit £60 million.
4. Treasury Bills No Sector Limit is used

3. Credit ratings

3.1 The credit ratings used are produced by Fitch IBCA.

3.2 Ratings are used for banks. The ratings which a bank must possess are listed below. If the rating for any institution falls below this minimum that institution will be immediately suspended or removed.

Banks:
Short Term = F1
Long Term = A
Individual = B
Support = 2

3.3 The mutual building society sector is not presently fully rated (Fitch IBCA has rates for 7 of the 14 societies listed). It is planned that a rating schema for this sector will be adopted when the sector becomes fully rated. Reference is made to such information as is available with the possibility of suspension or removal from the lending list in the event of a negative rating alert. Presently however, there is no requirement for a mutual building society to be the recipient of a credit rating for inclusion on the lending list.

The following are guideline ratings where a society is rated.

Mutual Building Societies:
Short Term = F1
Long Term = A
Individual = B
Support = 4

The definitions pertaining to these ratings are as follows:

1. Short Term - F1
   Indicates the strongest capacity for timely payment of financial commitments; may have an added '+' to denote a particularly strong credit feature.
   Comment: All current banks are rated at "F1+".
   All current building societies holding a rating are rated at "F1".
2. Long Term - A
   High Credit Quality
   'A' ratings denote a low expectation of credit risk. The capacity for timely payment of financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to changes in circumstances or in economic conditions than is the case for higher ratings.
   Comment: All current banks are rated at least "AA-".
   3 of current building societies are rated "A+" or higher.
3. Individual - B
   A strong institution. There are no major concerns regarding the institution. Characteristics may include strong profitability and balance sheet integrity, franchise, operating environment or prospects.
   Comment: 3 of the 10 banks are currently rated higher.
   1 of the 14 building societies is rated higher.
4. Support - 2
   An institution for which, in the opinion of the credit rating agency, state support would be forthcoming, even in the absence of a legal guarantee. This could be, for example, because of the bank's importance to the economy or its historic relationship with the authorities.
   Comment: 3 of the 10 banks are currently rated "1".
5. Support - 4
   An institution for which support is likely but not certain.
   Comment: 1 of the 7 rated building societies is rated higher.

Schedule

Appendix B: MPA Treasury Management Strategy for 2000/01

Introduction

1. This report:

1. Outlines a proposed strategy for the management of the Authority's long term debt portfolio during 2000/01 in the light of expected interest rate trends over the next year and beyond.
2. Recommends limits on total external borrowing, temporary borrowing and the proportion of interest payable at rates variable by the lender, to be submitted for approval to the Authority as required by Section 45 of the Local Government and Housing Act 1989.
3. Reviews arrangements for the investment of the Authority's cash balances.

Background

2. The Financial Management Code of Practice requires that all loans and investments should be arranged in line with best practice as embodied in the CIPFA Code of Practice on Treasury Management ('the Code'). Treasury Management in the Metropolitan Police Service has been undertaken in line with the Code in the years preceding the creation of the MPA. Accompanying reports on this agenda invite formal adoption of the Code by the Metropolitan Police Authority and set out the proposed Treasury Management Policy Statement as a policy framework within which Treasury operations are to be conducted in line with the requirements of the Code. The formulation of the annual Treasury Management Strategy presented in this report is also a requirement of the Code.

Strategic objectives

3. The objectives underpinning the strategy for 2000/01 are as follows:

1. To undertake treasury management operations with primary regard for the security of capital invested.
2. To minimise the cost of borrowing and to maximise the return on investments subject to (i) above.
3. To ensure that sufficient cash is available such that the MPA is able to discharge its obligations as determined in its general financial strategy.
4. To maintain cash balances at a prudent level.

Interest rates

4. Interest rates movements are reviewed continuously using informed comment appearing in the financial press, brokers advice sheets and with regard to financial and economic indicators. Investment and borrowing operations are undertaken accordingly.

The investment portfolio

5. The MPA holds cash invested in approved investments as specified in regulations made under the Local Government and Housing Act 1989. At 3 July 2000 this figure is expected to be in the region of £200 million. The cash represents:

1. Amounts due to major creditors such as the Inland Revenue and the Contributions Agency.
2. Working Cash Balances representing sums held to cover for cash movements incurred during normal business activities.
3. Earmarked Reserves, Provisions and Balances held to cover specific or general liabilities.

6. The investment portfolio earns a return for the MPA. The Treasury Management Policy Statement sets out the policy framework. Specifically in 2000/01 it is proposed that the portfolio be held as follows:

1. Deposits with the Bank of England or authorised institutions.
2. Short term loans to UK local authorities.
3. Short term loans to mutual building societies.
4. UK Treasury Bills.

7. Overall limits are imposed for three of these market sectors, with the aim of maintaining a balanced portfolio. The Sector Limits are currently set at £60 million for each of sectors (i)-(iii). There is no limit on the value of Treasury Bills which may be held reflecting the very low risks associated with these instruments. Changes to these Sector Limits, as with other amendments to operational practice, are made through the preparation of Treasury Practice Notes which are approved by senior management in consultation with the Treasurer.

8. The range of authorised institutions, meaning banks regulated by the Bank of England under the Banking Act 1987, is larger than the number of such institutions appearing on the Lending List. This is because (i) only institutions with very high credit ratings are currently included and (ii) the use of this smaller pool does not presently inhibit treasury operations.

Long term borrowing

9. Reference to Appendix 1 shows that at 3 July 2000 the MPA holds a debt portfolio of £147 million. This includes the whole of the debt held by the Receiver including that undertaken in respect of the Inner London Magistrates' Courts Service and the Inner London Probation Service prior to inception of the MPA. These services have an obligation to reimburse the MPA for costs incurred in discharging the debt held at 2 July. The mean rate of interest currently paid on the whole of the portfolio (including the 2% held as variable rate debt) is 6.39%. Loans have been taken out over a number of years for the purpose of financing new capital expenditure or re-financing maturing loans taken out for the same purpose. It follows that, given the variations in interest rates noted when individual loans were taken, the portfolio is composed of loans taken at different points in time, at different rates of interest.

Re-scheduling

10. During 2000/01 it is proposed that re-scheduling operations are considered in order to take advantage of limited opportunities that may arise to reduce the mean rate of interest payable on the portfolio. In making such decisions, reference will be made to the penalties associated with early redemption of loans, to ensure that the operations undertaken do not result in higher costs being incurred by the MPA. It is expected that all such re-scheduling arrangements will be undertaken with the Public Works Loans Board which normally offers loans at attractive rates of interest compared with those available from commercial lenders. However, the possibility of using commercial lenders is not excluded.

The medium term position

11. It is expected that cash balances will be sufficient in 2000/01 to allow all liabilities falling due to be discharged. For this reason, it is proposed that new borrowing will only be undertaken in line with credit approvals issued by the Home Office to finance new capital expenditure. In the event that these assumptions should require review, it is proposed that the MPA's borrowing limits (see paragraph 16) are set at a higher level than is implied by the current borrowing proposals. The following table sets out a three year forecast for outstanding debt for each year until 31 March 2003 (including debt attributable to the Inner London Magistrates Court Service and Inner London Probation Service):

Forecast movements in long term debt 2000/01 to 20002/03

12. The table shows that over the three year period to March 2003 a decrease in net external long term borrowing of £13.2 million is expected of which £9.3 million relates to repayments by the Inner London Magistrates Courts and Probation Services. The timing of these repayments has yet to be confirmed and the position will be kept under review throughout 2000/01.

The structure of the debt portfolio

13. The Treasury Management Policy Statement ('Policy Statement') requires that a balance should be maintained in the portfolio between debt taken at fixed and variable rates of interest. Fixed rate debt means that interest costs are more stable and less vulnerable to changes in interest rates. Conversely variable rate debt is sensitive to changes in interest rates and allows savings to be made when interest rates fall, but leads to increased costs when they rise.

14. At the start of the financial year on 3 July 2000 some 2% of the loans portfolio will be held at variable interest rates. It is recognised that the overall proportion of the debt portfolio held at variable rates is low. Given that interest rates are expected to peak in the second half of 2000, consideration will be given to taking on new variable rate debt during the latter half of 2000/01. It is proposed that the proportions of fixed and variable rate debt be kept under review and the proportion of variable rate debt moved towards a figure of up to 10 % of the portfolio value as market conditions allow. This limit reflects that set down in the Policy Statement.

15. The Policy Statement also requires that the proportion of the portfolio maturing in any one year should not exceed 15% of the total. As shown in Appendix 1, the current position is consistent with this recommendation, with the exception of 2004/05 when 15.6% of the portfolio will mature. This exception is not a cause for concern. However it is suggested that the portfolio would benefit from some re-structuring to bring about a greater consistency in the level of debt maturing in each year. This approach will be adopted in the small scale borrowing operations expected to be undertaken during 2000/01 and will also be applied in the event of the debt re-scheduling proposals referred to in paragraph 10.

Borrowing limits

16. Under Section 45 of the 1989 Local Government and Housing Act, in common with the generality of local authorities, the MPA is required to set borrowing limits for the year ahead, as follows:

1. A Maximum Borrowing Limit, representing the total borrowing limit within which both short and long term borrowing operations must be constrained. It is recommended that this figure be set at £260 million (See Appendix 2).
2. A Short Term Borrowing Limit, representing the maximum short-term borrowing (for less than one year) which may be outstanding at any time. It is recommended that the MPA should set this limit at £100 million, in order to provide operational flexibility in the event that significant items of income, such as Government Grants, are received late.
3. A Variable Rate Limit that constrains the value of debt held at variable rates of interest. It is recommended that this limit be set at £15 million (around 10%).

Recommendations

17. It is recommended that

1. The strategy set out in this report be approved for 2000/01:
2. The objectives set out in paragraph 3 are adopted.
3. Movements in interest rates be closely monitored.
4. Limited re-scheduling operations are undertaken to reduce the mean rates of interest payable on the portfolio where this can be done in line with value for money principles (paragraph 10).
5. Borrowing in 2000/01 be undertaken to the value of borrowing approvals issued by the Home Office and that maturing debt should not be replaced (paragraph 11) and that this approach should be periodically reviewed.
6. That consideration be given to increase the proportion of variable rate loan as indicated by market conditions (paragraph 14).
7. That the portfolio be re-structured within new borrowing or re-scheduling operations to achieve greater consistency in the level of debt that matures between years (paragraph 15).
8. That the borrowing limits set out in paragraph 16 are adopted.

Appendix 2: Calculation of the External Borrowing Limit for the MPA in 2000/01

Note: figures are calculated to the nearest whole number 

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