MEDWAY COUNCIL CABINET 9 JULY 2002 TREASURY MANAGEMENT OUTLOOK AND ADOPTION OF THE REVISED CIPFA CODE OF PRACTICE ON TREASURY MANAGEMENT

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1 MEDWAY COUNCIL CABINET 9 JULY 2002 TREASURY MANAGEMENT OUTLOOK AND ADOPTION OF THE REVISED CIPFA CODE OF PRACTICE ON TREASURY MANAGEMENT Portfolio Holder: Author: Councillor Alan Jarrett, deputy leader and finance portfolio Neil Davies, director of finance and corporate services 1. Summary 1.1 This report presents an outlook for the Council s treasury management position to 31 March It also details change in practice that will be necessary to adopt CIPFA s Treasury Management in the Public Services: Code of Practice Decision Issues 2.1 The Treasury Management outlook provides information to Members on the economic outlook and activities that are to occur this year. 2.2 The Council has previously adopted earlier versions of the CIPFA Treasury Management Code of Practice. CIPFA recommend that the revised version of the code is formally adopted by local authorities. This will require a change to Financial Rules in the Constitution and will require the approval of Council. 3. Treasury Management Outlook 3.1 The treasury management outlook details the anticipated activities of the treasury management function. Its production and submission to Cabinet is a requirement of the CIPFA Code of Treasury Management Practice. The outlook to 31 March 2003 takes account of advice from Sector, the Council s treasury management advisors. The outlook covers the following: the current treasury position; the prospects for interests rates; the treasury limits in force which will limit the treasury risk and activities of the Council; the Council s borrowing strategy; the Council s investment strategy; the extent of debt rescheduling opportunities;

2 4. Analysis of Total Loans and Investments Portfolio 4.1 The Council s loans and investments portfolio at 1 April 2002, is shown in the following table: 4.2 Table 1 Analysis of Total Loans & Investments Portfolio 31 March 2002 Long Term Borrowing Fixed rate funding PWLB Temporary Borrowing from the money market Principal Average Interest Rate of Return m m % Variable rate funding PWLB market Total Loans Total investments Table 2 Movements in the Credit Ceiling 1 April March 2002 (estimated) Total debt 31 March Add new borrowing 14.1 Less repayment of borrowing in year (1.6) Less capital receipts set aside to repay debt (1.5) Total Debt as at 31 March m Table 1 presents the actual borrowing that the Council has outstanding. Table 2 sets out the Council s credit ceiling. This is a notional estimate of the Council s level of debt and its calculation is laid down by statute. It is required by law and serves two purposes: it is the basis for calculating annual revenue contributions to the repayment of debt.

3 it is a major part of the Council s overall borrowing limit (see paragraph 4.4), as it measures the net indebtedness of the Council arising from historical capital transactions such as the setting aside of capital receipts. The level of actual borrowing and the credit ceiling are two different measures of Council indebtedness. The former may be higher than the credit ceiling. Treasury limits for 2002/ In accordance with Section 45 of the Local Government and Housing Act 1989, the Treasury limits set by full Council on February 2002 were: the Aggregate Credit limit comprising of 000 Credit ceiling 94,382 Temporary Revenue borrowing limit 20,228 Temporary capital Borrowing Limit 5,259 Approved Investments plus cash 85,508 Amount Specified as Directives NIL Less unapplied usable capital receipts 883 Total 204,494 the overall borrowing limit 200m the amount of the overall borrowing limit which may be outstanding by way of short-term borrowing 75m the maximum proportion of interest on borrowing which is subject to variable rate of interest 25% Prospects for interest rates 4.5 The following outlook for interest rates and the economy has been prepared using interest rate forecasts provided by treasury advisers and leading City experts. Economic background 4.6 September 11 could not have come at a worse time for the US economy, which had already been heading into recession due to a sharp contraction in high tech sector production. The attack ensured that the downturn gained further momentum and tipped the US into recession in quarters 3 and 4 of As America is the engine house of the world economy, this also pulled down the economies in Europe and worldwide trade and growth. This world downturn is likely to bottom in early 2002 and also unlikely to turn round quickly in the rest of In the UK growth did maintain a rate of growth of 2.5% in This was partly as a result of the Monetary Policy Committee (MPC) taking aggressive action to cut

4 interest rates and stimulate growth. The manufacturing sector has been badly hit by the world downturn but the economy overall has been supported by strong growth in Government expenditure, consumer demand and borrowing, retail sales and by a buoyant housing market. The consumer sector has been fuelled by a strong growth in net household income. The World Trade Centre attack has not directly impacted on domestic consumer confidence although there has been an indirect effect through lower US and world growth which has dented manufacturing and financial services sector confidence and profitability. The prospect for interest rates 4.8 The Monetary Policy Committee (MPC) has been able to reduce base rates as inflationary pressure has been limited. Inflationary pressures in 2002 are expected to be very muted and it could even fall below 1.5%. This will make it difficult for the MPC to start raising the base rate until later in the year. The MPC is also concerned at the increase in consumer and corporate borrowing which means that they will be cautious about raising rates too fast or too far as this could precipitate a sharp cut back in expenditure to meet interest payments on debt. 4.9 The recovery in the US economy in 2002 is expected to be weak and slow; in particular, there is not expected to be any sharp recovery from the steep falls in production in the high tech sector. This will mean that world growth recovery will also be weak and so create an overall weak international backdrop for MPC base rate decisions. As the downturn in the US is likely to continue it is expected that UK base rates will not increase quickly, only rising to 4.5%. The consensus among City analysts is that the base rate is expected to remain at this rate throughout The prospect for long-term interest rates 4.10 Public Works Loan Board (PWLB) rates fell in the second half of 2001 due to the down turn in America, which was then compounded by the terrorist attacks. PWLB rates have now recovered with year lower quota rates at around 5.00%- 5.25%. These rates are expected to remain stable throughout Government finances have been undermined by the world economic downturn which has depressed corporate profitability and hence Government income from, for example, corporation tax. This will lead to an increase in government borrowing which is therefore likely to put some upward pressure on interest rates on government debt. There may be additional pressure on government debt interest rates from pension funds, due to the accounting changes. Accounting changes have generated pressure on pension funds to buy fixed income bonds, primarily corporate bonds in preference to holding equities and has also led to a reduction in pension fund holdings of government debt in Capital Borrowing and the Borrowing Portfolio Strategy 4.11 Based upon the prospects for interest rates outlined above, there are a number of strategy options available. The opinion is that short term rates will continue to be cheaper than long-term fixed rate borrowing for most of 2002/03. However with short-term rates expected to rise to match longer term fixed rates, the differential will narrow over time. The interest rate market has been volatile during 2001 and

5 should be much less so during 2002 provided that there are no further major terrorist attacks. This expectation provides a variety of options: The main sensitivities of the forecast are likely to be the following: an unexpected sharp rise in long and short term rates. If growth accelerates above trend there would be a greater rise in all rates. In this event the portfolio position will be re-appraised with the likely action that fixed rate funding will be drawn whilst interest rates are relatively cheap Against this economic background and prospects for interest rates the Council s strategy towards investments and borrowing is as follows: INVESTMENTS Investments held by the Fund Managers 4.13 The Council s fund managers believe that UK base rates will rise at some stage during 2002/03 but not for some time. They are cautiously optimistic that there will be opportunities for good returns in 2002/03. Predictions for returns in 2002/03 are as follows: Central case 5.00%-5.25% Best case 5.50% Worst Case 4.75% (The current budget is based on a rate of return of 5.5%.) 4.14 There is a requirement to draw down funds from the fund managers to meet the Council s cash requirements. As at the 31 st March 2002 the fund managers held 92.8m. This differs from the figure in Table 1 since that includes small levels of in house investment. Our requirement for cash in 2002/03 to manage the Council s cash flow is a net disinvestments of approximately 20m For 2001/02 the Council enjoyed a 15m cash windfall which has now ended. This temporary situation resulted from the payment to the Council by a number of power stations of business rates in January In the autumn this was paid to Central Government as part of the normal claw back arrangements for the payment of business rates. From this date the Council has borrowed short-term from the markets since these rates have been more preferential. It is not appropriate to adopt this approach on a longer-term basis and therefore funds must now be withdrawn from the fund managers. The balance of the cash requirement of 5m ( 20m- 15m) represents the use of reserves to support both the capital and revenue budget The cash drawdown recommended is, therefore, 20m, with a drawdown from both fund managers. This will result in both holding similar amounts of approximately 36m. This drawdown of funds is planned to occur in August.

6 Dresdner/Morley 4.17 One of the Council s two cash fund managers, Dresdner RCM (DRCM), sold its local authority cash management unit to Morley Fund Management in June Around 50 local authorities are affected by the change. Until now, Morley have only managed investments for a handful of local authorities. Having said this, however, Morley are a very large cash fund manager with 43bn under management Their investment style appears to be a close fit with that of DRCM s and they also appear adequately resourced. Recently, Morley has not been tendering for local authority cash management as their fee structure was not conducive (generally requiring a minimum fund size of 20m). This would not be an issue with the DRCM client base and would enable Morley to offer comparable fees In terms of a performance record Morley has been running local authority cash funds for only a short period of time (just over one year) and have at present two local authority cash fund clients. In respect of performance over this period of time i.e. last financial year, their return was very similar to DRCM s and in what was a difficult market was placed close to the average return amongst their peers Existing fund managers within DRCM will not be transferring. It is DRCM s and Morley s intention that both client directors (Jennie Gilbert and John Luke) will transfer over to the new group. The aim is that this process will be completed by September. The director of finance and corporate services will be meeting with Morley and will subsequently review whether the Council will wish to retender for fund management services. Temporary Investments managed by the Councils own Treasury Team 4.21 The money market yield curve is currently anticipating a rising base rate for the next year but has a considerable way to go in fully pricing in increases in interest rates. The Council maintains only minimal in-house investments. Investments are made with reference to cash flow requirements. The Council views that the markets expectation for base rates is too low and investments will be kept short, with a view to enabling returns to be compounded more frequently by re-investing as rates rise All investments will be made in accordance with the approved investment regulations (1990) and with the institutions identified in the Councils approved counter party investment list. 5. Debt Rescheduling 5.1 The Council has opportunities to reschedule both its own debt portfolio and that held by Kent County Council relating to local government reorganisation. Rescheduling the Medway Debt Portfolio 5.2 Any debt rescheduling is likely to take place when interest rates are anticipated to be at their most advantageous. The situation will be continually monitored in order

7 to take advantage of any perceived anomalies in the yield curve. The reasons for rescheduling will include: the generation of cash savings at minimum risk to enhance the balance of the long term portfolio. i.e. to amend the maturity profile and/or the balance of volatility All rescheduling will be reported to the Cabinet and then the Support Services Overview and Scrutiny Committee at the meeting following its action. Local Government Reorganisation Debt 5.3 Discussions are currently taking place with Kent County Council regarding options to reduce the cost of this debt. 6. Adoption of CIPFA s Treasury Management in the Public Services: Code of Practice The CIPFA Code of Practice on Treasury Management in Local Authorities was last updated in 1996 and has been substantially revised in 2001 in order to reflect developments since then. The Institute has revised the code for the following reasons: the increasing size and complexity of the public services treasury management activities and demands placed on them, particularly with regard to effective risk management, by performance measurement and pursuit of best value the growth of cross sectoral partnerships the volatility and sophistication of the financial and money markets 6.2 In addition, various versions of the code have been issued over time for different sectors in the public service field and it was felt that these should be consolidated into one document encompassing common principles but allowing for variations in their workings as appropriate to each sector. 6.3 The code requires that a report be submitted to the Council setting out four clauses which should be formally passed in order to approve adoption of the new version of the code. The Council will in addition receive each year the following reports:- Annual strategy and plan in advance of the year; and Annual report after its close 6.4 The new code also requires each organisation to draw up a much truncated and more strategic treasury management policy statement (TMPS) incorporating the three clauses shown at Appendix 1 and a revised definition of treasury management activities. 6.5 The 1996 code required chief finance officers to draw up a treasury systems document to cover how treasury management activities are actually implemented. The new code has laid out a framework of treasury management practices (TMP) to replace this and to incorporate parts of the previous approach taken by the Council. The code does not require this TMP to be approved by the Council. Further details on the TMP are given at Appendix 2.

8 6.6 CIPFA recommends that public service organisations adopt as part of their standing orders, financial rules which include the following four clauses. Cabinet is therefore asked to adopt the resolutions detailed below: 1) The Council adopts the key recommendations of CIPFA s Treasury Management in the Public Services: code of practice (the code) 2001 as described in Section 4 of that code (see Appendix 3). 2) Accordingly, the Council will create and maintain, as the cornerstones for effective treasury management. - a Treasury Management Policy Statement (TMPS) stating the policies and objectives of its treasury management - suitable Treasury Management Practices (TMP) setting out the manner in which the organisation will seek to achieve those policies and objectives, and prescribing how it will manage and control those activities. 3) The Cabinet will receive reports on its treasury management policies, practices and activities including as a minimum, an annual strategy and plan in advance of the year, and an annual report after its close, in the form of prescribed in its TMP. 4) That the Cabinet delegates responsibility for the execution and administration of treasury management decisions to the Director of Finance and Corporate Services who will act in accordance with the organisation s policy statement and TMP and if a CIPFA member, to CIPFA s Standard of Professional Practice Treasury Management. Support Services Overview and Scrutiny Committee will monitor treasury management policies and practices, including performance. 7. Financial and legal Implications 7.1 There are no direct financial or legal implications that arise directly from the report. Those that do are built into the budget for 2002/ Recommendations i) That Members note the treasury management outlook report. ii) That Cabinet recommends the Council adopts the key recommendations of CIPFA s Treasury Management in the Public Services: code of practice (the code) 2001 as described in Section 4 of that code (see appendix 3). iii) Accordingly, the Council will create and maintain, as the cornerstones for effective treasury management: - a Treasury Management Policy Statement (TMPS) stating the policies and objectives of its treasury management

9 - suitable Treasury Management Practices (TMP) setting out the manner in which the organisation will seek to achieve those policies and objectives, and prescribing how it will manage and control those activities. iv) That the Cabinet will receive reports on its treasury management policies, practices and activities including as a minimum, an annual strategy and plan in advance of the year, and an annual report after its close, in the form of prescribed in its TMP. v) That the Cabinet delegates responsibility for the execution and administration of treasury management decisions to the Director of Finance and Corporate Services who will act in accordance with the organisation s policy statement and TMP and if a CIPFA member, to CIPFA s Standard of Professional Practice Treasury Management. Support Services Overview and Scrutiny Committee will monitor treasury management policies and practices, including performance. 9. Reasons for decision 9.1 In line with best practice the Council should continue to comply with the CIPFA Code of Treasury Management Practice. This report seeks adoption of the revised code. Appendices Appendix 1 Treasury Management Policy Statement Appendix 2 Treasury Management Practices Appendix 3 CIPFA s Treasury Management in the Public Sector 2001 Sections 4 and 5 Background papers CIPFA Code of Practice Treasury Management in the Public Services Files held by officers within the financial planning division. Report author Jenny Spick, financial and capital investment strategy manager Telephone: jenny.spick@medway.gov.uk

10 Appendix 1 Treasury Management Policy Statement This Council defines the policies and objectives of its treasury management activities as follows: 1. Treasury management activities are as follows: The management of the authority s cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks. 2. The Council regards the successful identification; monitoring and control of risk to be the prime criteria by which the effectiveness of its treasury management activities will be measured. Accordingly, the analysis and reporting of treasury management activities will focus on their risk implications for the organisation. 3. The Council acknowledges that effective treasury management will provide support towards the achievement if its business and service objectives. It is therefore committed to the principles of achieving best value in treasury management and to employing suitable performance measurement techniques, within the context of effectiveness risk management.

11 Appendix 2 Treasury Management Practices The Council has prepared the following treasury management practices to which schedules have been included to specifying the systems and routines used. TMP 1 TMP 2 TMP 3 TMP 4 TMP 5 TMP 6 TMP 7 TMP 8 TMP 9 TMP 10 TMP 11 TMP 12 Treasury Risk Management this defines how the Council will design, implement and monitor all arrangements for the identification, management and control of treasury management risk. Best Value and performance measurement This defines that the Council is committed to the pursuit of best value in its treasury management activities and will use performance methodology in support of that aim. Decision-making and analysis This defines how the Council will maintain records of its treasury management decisions. Approved instruments, methods and technique This defines the instruments, methods and techniques that will be used to undertake treasury management activities. Organisation, clarity and segregation of responsibilities and dealing arrangements this lays out how the operation of the treasury management function will be organised. Reporting requirements and managing information arrangements this details the reporting arrangements for treasury management activities and policies. Budgeting, accounting and audit arrangements the definition of the annual budget for treasury management, including those items required by statute or regulation. Cash and cash flow management the requirement that all cash unless required to be held by statute e.g. trust funds will be the responsibility of the responsible officer who is the Director of Finance and Corporate Services. Money laundering the definition of arrangements that will be taken to ensure the Council is not affected by money laundering. Staff training and Qualifications This statement contains a commitment to the training of treasury staff so that they are fully equipped to undertake the duties and responsibilities allocated to them. Use of external service providers this sets out the Council s approach to the use of employing external providers of treasury management services in order to acquire access to specialist skills and resources. Corporate Governance this contains a commitment to perform treasury activities with transparency and openness. It also states that the Council will adopt and implement the recommendations of the CIPFA code.

12 Appendix 3 Section 4 of Treasury Management in the Public Services: Code of Practice The Code makes four key recommendations. Key Recommendation 1 Public Service organisations should put in place formal and comprehensive objectives, policies and practices, strategies and reporting arrangements for the effective management and control of their treasury management activities. Key Recommendation 2 Their policies and practices should make clear that the effective management and control of risk are prime objectives of their treasury management activities. Key Recommendation 3 They should acknowledge that the pursuit of best value in treasury management, and the use of suitable performance measures, are valid and important tools for responsible organisations to employ in support of their business and service objectives; and that within the context of effective risk management, their treasury management policies and practices should reflect this. Key Recommendation 4 In order to achieve the above, organisations should: 1. adopt the four clauses in Section 5 of this code(see below) 2. adopt a treasury management policy statement (as recommended in Section 6, see appendix 1 of this report) 3. follow the recommendations in Section 7 concerning the creation of TMPs (see appendix 2 of this report).

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