Treasury management and investment strategy 2005/06

Report: 08
Date: 7 April 2005
By: Treasurer

Summary

This report sets out the Treasury Management and Investment Strategy recommended for 2005/06.

A. Recommendation

That the strategy set out in this report for 2005/06 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. Additionally, guidance issued 1 April 2004 by the Secretary of State under Section 15(1)(a) of the Local Government Act 2003, requires an Annual Investment Strategy that contains specific reference to the security and liquidity of investments. This report will incorporate those requirements.

4. Furthermore 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 and this report incorporates the relevant treasury management indicators, which are set out at Appendix 1.

Strategic Objectives

6. The objectives underpinning the strategy for 2005/06 are as follows:

• To undertake treasury management operations with primary regard for the security and liquidity of capital invested with reference to the Office for the Deputy Prime Minister (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 2005 the MPA is estimated to have cash balances of approximately £275 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 made up to 31 March 2005 are short term having a maturity of less than one year. The Prudential Code does permit long-term investments and we propose that limited longer-term investment to a maximum of £30 million can be undertaken.

16. As contingency to cover short-term commitments and to assist cash flow planning we shall continue to maintain two instant access reserve accounts, with combined balances up to £80 million.

Treasury Management Prudential Code Indicators

17. 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 21 March 2002.

Interest Rate Exposures

18. 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 95% 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 95% range and variable interest rate exposures within a 5% to 30% range.

19. 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%.

20. 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 £80 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. Limited longer-term investments to a ceiling of £30 million is proposed.

Maturity structure of borrowing

21. At 31 March 2005, the MPA debt portfolio is forecast to total £85.84 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 2005

22. 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.

23. Loans totalling £15 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

24. The Capital Programme 2005-06 includes an estimate of the borrowing requirement of £70.65 million in support of the ongoing capital programme, including C3i, and borrowing in support of the 1st and 2nd phases of the Step Change Programme.

25. 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 four 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 2006 is predicted to be £70.84 million.

26. 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 £116 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 2005/06.

E. Background papers

• None

F. Contact details

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

For more information contact:

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

Appendix 1

Treasury Management Prudential Indicators for the Metropolitan Police Authority

Treasury Management Indicators

• Net outstanding principal – limits in interest rate exposure

This indicator reflects the requirement specified under the Code, however the outstanding principal payable and receivable from external loans and investments is exceedingly weighted towards investment: £113 million external borrowing and £366 million investment in 2003/04. Both of these balances will gradually reduce, to about £70 million and £250 million respectively by 2006/07. It is therefore proposed that for operational treasury management purposes two discretionary indicators are approved as follows:

• Gross outstanding borrowing

• Gross outstanding investment

• Maturity structure of borrowing – upper and lower limits

• Principal sums invested for periods longer than 364 days

The authority has no investments with an initial term longer than 364 days. However, the authority may wish to consider some limited longer-term investment and a ceiling of £30 million is proposed

• The MPA has adopted the CIPFA Code of Practice for Treasury Management in Public Services

External Debt Indicators

• Authorised limit for external debt

This is the maximum amount that the authority allows itself to borrow in each year. The Treasurer reports that these Authorised Limits are consistent with the authority’s current commitments, existing plans and the proposals in the budget report for capital expenditure and financing, and with its approved treasury management policy statement and practices. They are based on the estimate of the most likely, prudent but not worst-case scenario, with in addition sufficient headroom over and above this to allow for operational management, for example unusual cash movements. Risk analysis and risk management strategies have been taken into account, as have plans for capital expenditure and estimates of cashflow requirements.

• Operational boundary for external debt

The proposed Operational Boundary for external debt is based on the same estimates as the Authorised Limit but reflects directly the estimate of the most likely, prudent, but not worst case scenario, without the additional headroom included within the Authorised Limit to allow for example for unusual cash movements and equates to the maximum of external debt projected by this estimate.

• Actual external debt

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