Treasury management strategy 2004/05

Report: 12
Date: 19 February 2004
By: Treasurer

Summary

This report sets out the Treasury Management Strategy recommended for 2004/05.

A. Recommendation

1. The strategy set out in this report for 2004/05 be approved

B. Supporting information

Background information

1. On 21 March 2002 the Metropolitan Police Authority formally adopted the key recommendations of CIPFA’s Code of Practice for Treasury Management in the Public Services as set out in Section 4 of that Code.

2. The Code requires that the MPA will receive an annual strategy and plan in advance of the year. This report is submitted in accordance with that requirement.

3. Investment activity has until now been subject to secondary legislation but the ODPM now intends that investment activity will be dealt with through guidance, issued by the Secretary of State under Section 15(1)(a) of the Local Government Act 2003. The guidance is still draft and under consultation with a proposed effective date of 1 April 2004. The guidance requires an Annual Investment Strategy that contains specific reference to the security and liquidity of investments. This report will incorporate those requirements.

4. Additionally under Part 1 of the Local Government Act 2003 local authorities are required by Regulation, effective 1 April 2004, to have regard to the Prudential Code for Capital Finance. The Prudential Code has introduced new requirements for how capital spending plans are considered and approved as part of an integrated treasury management strategy.

5. The Prudential Code also requires the Authority to set a number of Prudential Indicators some of which replace the borrowing limits and fixed/variable rate limits previously prescribed as part of the strategy statement. This report incorporates the relevant treasury management indicators which are set out at Appendix 1.

Strategic objectives

6. The objectives underpinning the strategy for 2004/05 are as follows:

• To undertake treasury management operations with primary regard for the security and liquidity of capital invested with reference to ODPM guidance.
• To minimise the cost of borrowing and to maximise the yield from investments consistent with the security and liquidity objectives identified above.
• To ensure that sufficient cash is available such that the MPA is able to discharge its financial obligations in accordance with approved spending plans.
• To undertake treasury management activity with regard to Prudential Code Indicators.

The investment strategy

7. At 1 April 2004 the MPA is estimated to have cash balances of approximately £260 million. This cash represents:

• Earmarked reserves, provisions and balances held to cover specific or general liabilities.
• Unapplied Capital receipts and grants pending payments in respect of capital projects.
• The net cashflow position of revenue income and expenditure including major creditors such as the Inland Revenue.

8. All cash balances will be invested in accordance with the Code of Practice and with regard to ODPM guidance which requires a prudent approach to the investment of temporarily surplus funds with priority given to security and liquidity. Under the guidance investments fall into two separate categories, either specified or non-specified investments, and there should be further regard to liquidity levels.

Specified investments

9. Specified investments offer high security and high liquidity and satisfy the conditions set out below:

• The investment is denominated in sterling and any payments or repayments in respect of the investment are payable in sterling only.
• The investment is not a long-term investment (has a maturity of less than one year).
• The investment does not involve the acquisition of share capital or loan capital in any body corporate.
• The investment is either:
  • made with the UK Government or a local authority or a parish or community council, or
  • made with a body or in an investment scheme which has been awarded a high credit rating by a credit rating agency

10. It is proposed that specified investments include the following institutions:

• UK local authorities
• Debt Management Account Deposit Facility
• Money Market Funds
• UK Banks, foreign banks registered in the UK and mutual building societies with a high credit rating

11. A high credit rating is interpreted as the Fitch Ratings Ltd criteria currently applied to the lending list. To be deemed highly rated the institution must satisfy at least the minimum of all three criteria:

• Long term credit rating A+
• Short term credit rating F1
• Individual rating C

12. Fitch Ratings Ltd e-mail credit rating amendments. If an amendment means an institution no longer meets the minimum requirement that institution is removed immediately from the counterparty lending list. Additionally Fitch Ratings Ltd publish monthly a comprehensive list of all ratings and this is compared to the current lending list providing additional assurance that no institution has fallen below the minimum criteria. Should an institution not on the counterparty list achieve the minimum rating that institution can then be added to the counterparty list.

Non-specified investments

13. Non-specified investments do not, by definition, meet the requirements of a specified investment. The ODPM guidance requires that greater detail is provided of the intended use of non-specified investments due to greater potential risk. It is proposed that the only type of non-specified investments undertaken are with mutual building societies that do not meet the specified criteria of section 11 above.

14. The majority of building societies do not provide credit ratings to the credit rating agencies (so cannot be classed as specified investments) and inclusion on the lending list and individual lending limit has hitherto been determined by asset size. It is proposed that we continue current practice and select the top twenty building societies, determined by asset size, and set a maximum of £80 million that can be placed in total with non-specified societies.

Liquidity of investments

15. Each investment decision is made with regard to cash flow requirements resulting in a range of maturity periods within the investment portfolio. All investments are short term having a maturity of less than one year and there is no proposal to change this approach (although the Prudential Code does allow long term investments). We propose to maintain two instant access reserve accounts, with combined balances up to £60 million, as contingency to cover short-term liabilities.

Treasury Management Prudential Code Indicators

16. 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 including the adoption of the CIPFA code of Practice for Treasury Management in Public Services approved by this committee on 21st March 2002.

Interest rate exposures

17. The purpose of the prudential indicators that set the upper limits on fixed interest rate and variable interest rate exposures is to set ranges that will limit exposure to interest rate movement. On the one hand fixed rate borrowing and investment can contribute to reducing uncertainty but on the other variable interest rates give flexibility that can assist in enhancing performance. The indicator required by the prudential code considers the net position of borrowing and investment. The upper limit on fixed rate exposure of 90% and variable rate of 30% on net principal sums (set out at Appendix 1) means fixed interest rate exposure can be managed within the 70% to 90% range and variable interest rate exposures within a 10% to 30% range.

18. To assist operational treasury management purposes two discretionary indicators have been selected, setting upper and lower limits for interest rate exposure on gross borrowings and on gross investments (see Appendix 1). These indicators give an upper limit for variable rate borrowing of 15% and for investments of 40%.

19. The prudential code also identifies the risk inherent in the maturity structure of an investment portfolio that there may be a requirement to realise an investment before it reaches final maturity. To address this risk we have a policy of maintaining up to £60 million on call and cannot foresee that early maturity of a fixed term deposit would be necessary. As an additional measure the prudential code requires that a limit is set for sums that are invested for periods longer than 364 days, to limit over commitment and further reduce the need of early maturity. While there is no current proposal to invest beyond 364 days the Authority may wish to consider some longer-term investments in future years and a ceiling of £30 million is proposed.

Maturity structure of borrowing

20. At 31 March 2004 the MPA debt portfolio is forecast to total £104.47 million. This includes debt held on behalf of the former Inner London Magistrates’ Courts Service (ILMCS) and the former Inner London Probation Service (ILPS). The breakdown between the three services is shown in Table 1.

Table 1: Outstanding debt at 31 March 2004

21. The Greater London Magistrates’ Courts Authority and the National Probation Service have an obligation to reimburse the MPA for costs incurred in discharging the debt of ILMCS and ILPS respectively. Currently the Courts and Probation services make annual repayments to the MPA of 4% of the balance of debt outstanding plus interest charges.

22. Loans totalling £18.6 million are due for repayment during the year representing nearly 18% of the portfolio. This is in line with the recommended maturing structure of borrowing prudential indicator which sets an upper limit of 20% for debt maturing within 12 months.

External debt

23. The Capital Programme 2004-05 includes an estimate of the borrowing requirement of £44.6 million in support of the ongoing capital programme, including C3i, and borrowing in support of the 1st phase of the Step Change Programme.

24. In deciding the policy for new borrowing consideration is given to the cash flow of the MPA, which represents both capital cash and revenue cash, and whether to raise funds externally. In view of the size of cash balances the strategies for the preceding three financial years have determined that no new external long-term borrowing is undertaken and it is proposed that this policy is maintained. Considering the current maturity structure external debt at 31 March 2005 is predicted to be £85.87 million.

25. With regard to external debt the prudential code requires that two limits are set and the treasury management strategy will have regard to these. The operational boundary of £179.7 million equates to the maximum position for external debt (see Appendix 1). This includes provision for operational management such as short-term borrowing to cover temporary revenue requirements and represents the most likely, prudent but not worst case scenario.

C. Equality and diversity implications

There are no equality and diversity implications arising from this report.

D. Financial implications

The budgetary assumptions discussed in this report are consistent with those in the MPA budget proposals for 2004/05.

E. Background papers

None.

F. Contact details

Report author: Stephen Skirten, Treasury Manager, Exchequer Services, MPS.

For more information contact:

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

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