Treasury management and investment strategy 2007/08

Report: 11
Date: 15 February 2007
By: Acting Director of Resources on behalf of the Commissioner and the Treasurer

Summary

This report sets out the Treasury Management and Investment Strategy recommended for 2007/08.

A. Recommendations

Members are invited to approve the 2007/08 Treasury Management and Investment Strategy set out in this report.

B. Supporting information

Background Information

1. On 21 March 2002 the Metropolitan Police Authority (MPA) formally adopted the key recommendations of the Chartered Institute of Public Finance and Accountancy’s (CIPFA) 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 introduced 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 recommended relevant treasury management indicators set out at Appendix 1.

Strategic Objectives

6. The objectives underpinning the strategy for 2007/08 are as follows:

• To undertake treasury management operations with primary regard for the security and liquidity of capital invested.
• 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 2007 the MPA is estimated to have cash balances of approximately £175 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 guidance, which requires a prudent approach to the investment of temporarily surplus funds with priority given to security and liquidity. Under this 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 guidance requires that greater detail is provided of the intended use of non-specified investments due to greater potential risk. Two types of non-specified investment are currently used:

• investments undertaken with mutual building societies that do not meet the specified criteria of section 11 above
• investments that have a maturity greater than one year

14. Most 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.

15. Long-term investment of £40 million has been undertaken (this is the ceiling for longer term investments agreed by MPA full authority on 30 March 2006) and it is proposed that we maintain a maximum of £ 80 million that can be placed in non-specified investments. To confirm this will be the maximum of the combined balances of non-rated building societies and long-term investmentscontinuing current practice.

Liquidity of Investments

16. Each investment decision is made with regard to cash flow requirements resulting in a range of maturity periods within the investment portfolio. The majority of investments made are short-term (a maturity of less than one year) with a limit of £40 million for long-term investments (recognised as non-specified investments as described at paragraph13 and 15 above). To cover short-term commitments and to further assist cash flow planning we shall continue to maintain two instant access accounts with Royal Bank of Scotland (RBS) and Halifax Bank of Scotland (HBOS) providing a maximum combined balance of £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 Chartered Institute of Public Finance and Accountancy (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 in instant access accounts 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. As previously described at section 15 this limit was set at £40 million by the full Authority on 30 March 2006. The average balance of long-term investments during 2006-07 was £40 million.

Maturity structure of borrowing

At 31 March 2007 the MPA debt portfolio is estimated to be £57.34 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 2007

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 26% of the portfolio. As the size of debt reduces because no new borrowing has been undertaken the amount of debt maturing in any one year becomes proportionately large (although in cash terms the amount remains the same). The recommended maturity structure of borrowing at Appendix 1 reflects the maturity profile of the 15 loans in the portfolio.

External Debt

24. The Finance Committee today is also considering the Draft Capital Programme 2007-08 to 2009-10 Progress Report which includes the recommendation to approve a capital spending programme for 2007-08 of £180.7 million of which £60.2 million is unsupported.

25. In deciding the policy for undertaking new borrowing consideration is given to MPA cash flow, which represents both capital cash and revenue cash, and whether to raise funds externally. In view of the likely size of cash balances and the planned capital programme, which includes the escalation of the estates strategy, it is proposed that external long term borrowing, limited to £30m, could be undertaken this year to finance the programme. The timing of borrowing, if undertaken, will be determined by cash flow requirements and prevailing interest rates. This can be done within the existing headroom allowed under the prudential code indicator for the external debt operational boundary.

26. To allow for the possibility that capital expenditure not included in the capital programme may be approved during 2007-08 it is proposed that the option to undertake external long term borrowing to fund this expenditure is allowed, subject to prior approval by the Treasurer. This would need to be contained within the existing prudential code limits to ensure affordability. Any increases in the external borrowing limit would require the Authority’s approval. Similarly the timing of such borrowing will be determined by cash flow requirements and prevailing interest rates.

27. The prudential code requires that two limits for external debt are set and the treasury management strategy will have regard to these. The operational boundary of £138 million is the maximum position for external debt (see Appendix 1). and includes provision for additional long-term borrowing and operational management such as short-term borrowing to cover temporary revenue requirements and represents the most likely, prudent but not worst-case scenario. Separate agreement from the Authority will be sought in advance for any proposed borrowing where the operational boundary would exceed £110 million with separate consultation also taken in advance with the GLA.

28. The Treasury Management Prudential Code indicators will be monitored monthly with an update provided in the six month stewardship report to Finance Committee.

Abbreviations

CIPFA

Chartered Institute of Public Finance and Accountancy

HBOS 

Halifax Bank of Scotland

ILMCS 

Inner London Magistrates Courts Service

ILPS 

Inner London Probation Service

RBS 

Royal Bank of Scotland

C. Race and equality impact

Consideration is given to the requirements of the Race Relations (Amendment) Act through the Metropolitan Police Service (MPS) Environmental Strategy whereby environmental liabilities and risks arising from MPS financial investments are investigated.

D. Financial implications

The budgetary assumptions discussed in this report are consistent with those in the MPA budget proposals for 2007/08.

E. Background papers

None

F. Contact details

Report author: Simon Hart, Acting Director of Finance Services, MPS.

For more information contact:

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

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