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ITEM EX12

EXECUTIVE – 2 APRIL 2003

TREASURY MANAGEMENT STRATEGY FOR 2003/04

Report by Director for Business Support & County Treasurer

Introduction

  1. This report sets out a Treasury Management Strategy for the authority for the financial year 2003/04. The report covers background information which supports the Treasury Management Strategy and deals in detail with the Council’s Debt Management Strategy and daily cashflow. It also advises of the revised Chartered Institute of Public Finance and Accountancy (CIPFA) Code of Practice on Treasury Management in the Public Services.

  2. Regulations under the Local Government Act 2000 reserve the approval of any "… plan or strategy for the control of the authority’s borrowing …" to the full Council. This description applies to a substantial part of this report (the Debt Management Strategy in particular), which should accordingly be referred for comment to the Corporate Governance Scrutiny Committee for comment before the Executive makes a formal recommendation to Council, in accordance with the Budget and Policy Framework Procedure Rules set out in the Constitution.

    3. Revised Code of Practice for Treasury Management

  3. CIPFA has produced a revised Code of Practice for Treasury Management in the Public Services. The Code has been revised to reflect the increasing scale and complexity of treasury management activities and the demands placed on them, particularly with regard to risk management, performance management and the pursuit of best value and also, the increasing sophistication of money markets. The Code makes four key recommendations and these are set out in Annex 1.

  4. A draft revised Treasury Management Policy Statement, which meets the requirements of the CIPFA Code, is included at Annex 2 (download as .doc file). It proposes that the Executive be nominated as having overall responsibility for monitoring the implementation of treasury management policy and the Head of Finance be nominated as the relevant responsible officer for the execution and administration of treasury management activities. The Council already undertakes a large proportion of the revised requirements, but some work will be required to ensure full compliance. In particular the detailed treasury management practices recommended by the Code are currently being developed. If there is any need to change the strategy in 2003/04 this will be taken to the Executive as part of a Monthly Monitoring Report.

    5. Economic and Market Factors expected to impact on Interest Rates

  5. Short-Term Interest Rates. For the purposes of this report short-term interest rates are defined as being for 364 days or less.

  6. The Bank of England Monetary Policy Committee effectively determines the level of UK short-term interest rates. The Government has set the Bank of England an inflation target of 2½% (measured by the Retail Prices Index excluding mortgage interest). The underlying inflation rate has been slightly above this target for the past three months. Current predictions anticipate that inflation will remain above the 2½% target in the short term, although it will return to target in the medium term.

  7. During 2002/03 the UK bank base rate was cut from 4% to 3.75%. This last cut brought rates down to the lowest levels seen in the UK for almost fifty years. With uncertainty about the world economy running high and growth in Britain set to slow, the Bank of England is seen in the markets as likely to cut interest rates in the short term, although it is expected that there will be an overall rise by the end of the financial year 2003/04. The market predictions on short term interest rates are shown at Annex 3 (download as .doc file).

  8. The level for Long-Term Interest Rates is determined by short-term interest rates and expectations for inflation. Investors will only invest in longer term fixed interest bonds if they expect to receive a higher return than for shorter-term investments. Investors are reluctant to invest longer term if they fear inflation may rise because the value of their tied up capital will be eroded more quickly. Globally long term interest rates have fallen in the past few years due to the world central banks have taking a tough stance on controlling inflation.

  9. Due to uncertainty in the stock market, demand for 20-year plus UK long-term government stock (known as gilts) had increased in recent years, leading to a reduction in interest rates.

  10. However there is some optimism that the value of the stock market will increase by the end of the year. Also it is anticipated that the Chancellor will issue billions of pounds of government bonds over the next few years to fund increased public spending and this is expected to result in higher returns. These factors would point towards higher long-term interest rates.

    11. Forecast changes to the Council’s Debt Portfolio for the 2003/04 Financial Year

  11. The Council is allowed to borrow set amounts each year to finance its capital expenditure. Annex 4 (download as .doc file) gives the Council’s debt financing requirement for 2003/04. The notes to the annex provide details of the forecast composition of the County Council’s debt at 1 April 2003 showing that the major sources of funding is with the Public Works Loan Board (PWLB), which is a Government Agency.

  12. The Council’s overall debt is projected to increase from £228 million at 1 April 2003 to £261 million at 31 March 2004, which is a net increase of £33 million. In addition to the net increase in debt the Council has £5 million of PWLB loans and £5 million of money market loans maturing, which will need to be replaced.

    13. Points to consider in formulating the Council’s Debt Management Strategy

  13. The Council should borrow long term and at fixed rates of interest when rates are "low" and borrow short term or at variable interest rates when rates are "high".

  14. The Council’s percentage of debt that is fixed is projected to increase from 93% to 95% between 1 April 2003 and 31 March 2004. At 1 April 1993 the debt was 52% fixed and 48% variable. The Council has progressively increased its level of fixed debt since the second half of the 1990’s, a period of rapidly falling interest rates.

  15. The maturity debt profile should be reasonably smooth to avoid having to replace large amounts of maturing debt in any future year. There is also the possibility of debt being repaid early if this can be achieved on favourable terms. Annex 5 (download as .doc file) gives a breakdown of the Council’s long-term debt by year of maturity. The longest period over which we can borrow from the PWLB is now 25 years.

    16. The Council’s Debt Management Strategy 2003/04

  16. The Council has a PWLB quota of £45.4 million in 2003/04, which is determined by credit approvals (£40.4 million) and maturing PWLB debt (£5 million). Credit approvals are the amount the Council can borrow in any one year to finance the capital programme (the notes to Annex 4 explain credit approvals in more detail).

  17. PWLB interest rates continue to be the cheapest source of borrowing available to local authorities. It is intended to take up the whole of the PWLB quota in 2003/04 and we continue to favour fixed interest loans in the 15-year plus period. Taking the whole quota in 2003/04 will increase the Council’s percentage of fixed debt from 93% to 95%. The Council’s agreed range of fixed debt is between 75% and 100%. It is recommended that this range continues.

  18. Opportunities to repay loans early will be taken if it is demonstrated that there are guaranteed savings and only where prematurely repaid debt is replaced with loans of a similar maturity period.

  19. The Council took £10m of Money Market Loans during the early 1990s and the final repayment (£5m) will be made in 2003/04. This will cause no problems for funding the Council’s Debt.

  20. From 2004/05 the government will implement a set of Prudential Guidelines to control Local Authority debt levels. This may give the Council power to borrow more money through unsupported credit approvals. It is not yet clear how the system will operate in detail, and I will report to the Executive when this has been established.

    21. Cashflow Management

  21. The Council’s internal balances include provisions, reserves, capital receipts unapplied and the difference between creditors and debtors. Where these balances are not required to fund the Council’s debts, they are lent out short term in the London wholesale money market for periods up to 364 days.

  22. The Council operates its own approved lending list, which is made up of financial institutions and other local authorities. Each institution is ascribed a maximum lending limit to ensure a spread of risk within the total lending portfolio. The Council subscribes to the Fitch IBCA credit rating service, which evaluates the credit worthiness of financial institutions and assigns them an individual rating. The Council only lends to top rated institutions, all of which are either authorised by the Bank of England or European Union to accept sterling deposits.

  23. The Bank of England determines the interest rates in the wholesale money market. Most independent City forecasts (Annex 3) (download as .doc file) are predicting the Bank will decrease short-term interests rates in the short term, but that they will increase by the end of 2003/04.

  24. The Council currently operates three call accounts, with LloydsTSB, Abbey National and Bank of Scotland, and these will continue to be used. A call account is where a cash deposit can be withdrawn with immediate notice. The operation of these accounts enables the smooth and efficient management of the Council’s day-to-day cash flow. The call accounts have maximum deposit limits of £15 million. The choice between the three accounts is dependant on the interest rates on offer.

    25. Alliance Capital

  25. In addition to the wholesale cash market local authorities may invest surplus funds in Certificates of Deposit, gilt-edged stock or Supranational bonds (e.g. World Bank). Few authorities invest directly in such instruments, since they have neither the time nor expertise to monitor performance in this area. Exposure is normally achieved by appointing a specialist external manager.

  26. Members will be aware that approval was received to appoint an external manager to manage up to £15 million in this way. This was done in order to diversify funds and to achieve higher returns on the Council’s surplus balances. Alliance Capital has been managing these funds since 28 August 2002, in a mixture of cash (70%) and gilts (30%). It should be noted that the performance on this type of investment needs to be viewed in the longer term and therefore it is too early to decide whether or not any additional sums of surplus cash should be invested with Alliance Capital. Their performance will continue to be monitored, and a review of the performance in 2002/03 will be included in a report to the Executive on Treasury Management Activity in 2002/03 on 24 June 2003.

    27. New Flexible Investment Options for Local Authorities

  27. From April 2002, local authorities have been given wider investment powers. There are now two additional means of investing the Council’s surplus funds and it is considered that it would be in the Council’s interests to add these facilities to the approved list of investments. These facilities are described below.

    28. (i) Money Market Funds

  28. Money Market Funds are shared investment funds run by many of the commercial financial companies. They work by pooling together the investments from a range of participating organisations and then placing short-term loans with a variety of companies. Technically investors hold units in the Fund, but in practice the Fund operates like an instant access account, with the facility of investing or withdrawing money at a few hours’ notice. Investments are only made with those companies that are triple A rated by at least one of the major credit rating agencies. By bringing together a large number of smaller investments, these funds will typically be able to achieve very competitive rates. In addition, by spreading the pooled investment funds across a range of companies, these funds will be able to minimise the level of risk.

  29. Money Market Funds will be a useful addition to the approved list of investments. They produce a return which is comparable with other very short term investments and they are of the very highest credit limit. For this reason, it is proposed that there is a limit of £15 million for each Fund. Since all Funds operate in a similar way, it is proposed that the Head of Finance be delegated to select one fund initially that will provide the most administratively effective service to the Council.

    30. (ii) Debt Management Account

  30. The second new service that is now available to local authorities is a deposit-taking service from the Debt Management Office, which is an executive agency of HM Treasury. This service will take deposits for fixed periods and will be suitable for amounts that can be placed for several weeks or months. The Debt Management Account will also be triple A rated, since it will be based on the Government’s own ‘sovereign’ credit rating. We would also be able to deposit smaller amounts than in a Money Market Fund. Again, since this is a very low risk investment, it is recommended that there is a limit of £15 million for investment in this account.

    31. Revision of the County Council’s Approved Lending List

  31. Some institutions have been removed from the list since last year under delegated powers for technical reasons or minor credit downgradings. The remaining institutions on the list meet the County Council’s credit rating criteria in full. There are no proposals to add further institutions to the list.

  32. The total average lending to date on a daily basis in 2002/03 has been £33.5m. There is a range of choice available to ensure a suitable diversification in depositing our surplus cash safely as follows:

    1. a lending list comprising major banks and building societies with appropriate lending limits for each institution;

    2. three call accounts, of £15 million;

    3. in 2002/03 we advanced £15m to Alliance Capital for them to invest in alternative financial investments;

    4. in 2003/04 we will be adding both a Money Market Fund and the Debt Management Account to our lending list with limits of £15m on each.

    Overall Summary

  33. The Authority’s Treasury Management Strategy 2003/04 may be summarised as follows:

    1. take up the maximum PWLB quota of £45.4 million to finance the capital programme;

    2. continue to monitor interest rates to ensure that we borrow from the PWLB at the most advantageous rate;

    3. continue to monitor the performance of Alliance Capital;

    4. expand our short-term investment options by using new low risk areas available to local authorities, namely Money Market Funds and Debt Management Account;

    5. implement the revised CIPFA Code of Practice on Treasury Management in the Public Services.

    RECOMMENDATIONS

  34. The Executive is RECOMMENDED to:

          1. adopt the key recommendations of CIPFA’s Code of Practice for Treasury Management in the Public Services, as set out in Annex 1 to the report;

          2. adopt the Treasury Management Policy Statement attached at Annex 2 (download as .doc file);

          3. subject to (d) below, endorse the proposals set out in the report:

            4. (i) to keep the range for fixed interest debt at 75 to 100%;

            (ii) to add a Money Market Fund to the approved list of investments with a limit of up to £15 million and to delegate the selection of a Fund to the Head of Finance; and

            (iii) to add the Debt Management Account to the approved list of investments with a limit of up to £15 million;

          4. refer the report to the Corporate Governance Scrutiny Committee for comments, particularly in respect of the proposed strategy for the control of the Council’s borrowing, with a view to making a recommendation on the strategy to the June 2003 Council.

CHRIS GRAY
Director for Business Support & County Treasurer

Background Papers: Nil

Contact Officer: Mike Petty Tel: Oxford 815622

March 2003

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