Treasury Management Strategy Statement, Minimum Revenue Provision Strategy and Annual Investment Strategy 2015/16

Transcription

1 Treasury Management Strategy Statement, Minimum Revenue Provision Strategy and Annual Investment Strategy 2015/16 Summary This report presents the suggested Treasury Management, Minimum Revenue Provision and Annual Investment Strategies for 2015/16, including risk management, prudential indicators, the borrowing requirement and investment strategy. Background information on the economic situation and the likely interest rate movements are included in the report, which informs the recommendations made. Portfolio Holder: Cllr R Standley, Leader of the Council Recommendation Cabinet is recommended to recommend to Council to: A. Approve the 2015/16 Treasury Management Strategy and Annual Investment Strategy; B. Set the Prudential and Treasury Indicators for 2015/16 as set out in Appendix B to this report; C. Approve the Specified and Non-specified Investments categories listed in Appendix C to this report; D. Approve that for the 2015/16 financial year the Council makes Minimum Revenue Provision in accordance with the Asset Life (Equal Instalment) Method for new capital expenditure; and E. Approve the updated Treasury Management Practices set out in Appendix E to this report. Reason To comply with: the Local Government Act 2003 and supporting regulations, the Council s Financial Procedure Rules, the CIPFA Treasury Management Code of Practice, the CIPFA Prudential Code for Capital Finance in Local Authorities and the Department for Communities and Local Government (DCLG) Guidance on Investments Introduction Background 1. The Council is required to operate a balanced budget, which broadly means that cash raised during the year will meet cash expenditure. Part of the treasury management operation is to ensure that this cash flow is adequately planned, with cash being available when it is needed. Surplus monies are invested in low risk counterparties or instruments commensurate with the Council s low risk appetite, providing adequate liquidity initially before considering investment return.

2 2. The second main function of treasury management is the funding of the Council s capital plans. These capital plans provide a guide to the borrowing need of the Council; essentially the longer term cash flow planning to ensure that the Council can meet its capital spending obligations. This management of longer term cash may involve arranging long or short term loans, or using longer term cash flow surpluses. On occasion any debt previously drawn may be restructured to meet Council risk or cost objectives. 3. The Chartered Institute of Public Finance and Accountancy (CIPFA) defines treasury management as: The management of the local authority s investments and 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. CIPFA Treasury Management in the Public Services Code of Practice and Cross-Sectoral Guidance Notes The CIPFA Treasury Management Code of Practice (the Code) was adopted by this Council on 20 February 2012 and this Council fully complies with its requirements. 5. The primary requirements of the Code are as follows: (a) Creation and maintenance of a Treasury Management Policy Statement which sets out the policies and objectives of the Council s treasury management activities; (b) Creation and maintenance of Treasury Management Practices which set out the manner in which the Council will seek to achieve those policies and objectives; (c) Receipt by the Full Council of an annual treasury management strategy report (including the annual investment strategy report) for the year ahead, a midyear review report (as a minimum) and an annual review report of the previous year; (d) Delegation by the Council of responsibilities for implementing and monitoring treasury management policies and practices and for the execution and administration of treasury management decisions; and (e) Delegation by the Council of the role of scrutiny of treasury management strategy and policies to a specific named body which in this Council is the Audit and Finance Committee. 6. The regulatory environment places responsibility on Members for the review and scrutiny of treasury management policy and activities. This report is therefore important in that respect, as it provides details of the strategy, policies and activities to be followed in the forthcoming year. This report is scrutinised by the Audit and Finance Committee prior to being submitted to Cabinet and Full Council for approval. 7. The Cabinet will receive a Treasury review each quarter as part of the Financial Management report, which is also reported to Audit and Finance Committee and Full Council.

3 8. This report covers: (a) The capital expenditure plans including the prudential indicators; (b) The minimum revenue provision policy which determines how residual capital expenditure is charged to revenue over time; (c) The treasury management strategy which sets out how investments and borrowings of the Council are to be organised and includes the treasury indicators; and (d) The annual investment strategy which determines the parameters within which investments will be managed. Treasury Management Strategy for 2015/16 9. The strategy for 2015/16 covers two main areas capital issues and treasury management issues. 10. The capital issues covered in the report include: (a) Capital expenditure plans; (b) Prudential indicators; and (c) The minimum revenue provision policy. 11. The treasury management issues covered in the report include: (a) The current treasury position; (b) Treasury indicators which limit the treasury risk and activities of the Council; (c) Prospects for interest rates; (d) The borrowing strategy; (e) Policy on borrowing in advance of need; (f) Debt rescheduling; (g) Investment strategy; (h) Creditworthiness policy; and (i) Policy on use of external service providers. 12. Additionally, this report includes an update to the Treasury Management Practices of the Council which set out the manner in which the Council seeks to achieve its treasury management policies and objectives and prescribe how it will control and manage its treasury management activities. Capital Plans and Prudential Indicators 2015/16 to 2017/ The Council s Prudential Indicators are set out in Appendix B and include the capital expenditure plans, capital financing requirement and indicators for affordability. 14. The Council s capital expenditure plans are the key driver of treasury management activity. The output of the capital expenditure plans is reflected in the prudential indicators, which are designed to assist members overview and confirm the affordability and sustainability of the capital expenditure plans.

4 Minimum Revenue Provision Strategy 15. Capital expenditure is generally expenditure on assets which have a life expectancy of more than one year e.g. buildings, vehicles, machinery etc. It would be impractical to charge the entirety of such expenditure to revenue in the year in which it was incurred therefore such expenditure is spread over several years in order to try to match the years over which such assets benefit the local community through their useful life. The manner of spreading these costs is through an annual Minimum Revenue Provision (MRP). 16. The scheme of Minimum Revenue Provision ( MRP ) was set out in former regulations 27, 28 and 29 of the Local Authorities (Capital Finance and Accounting) (England) Regulations 2003 [SI 2003/3146, as amended] ( the 2003 Regulations ). This system has since been radically revised by the Local Authorities (Capital Finance and Accounting) (England) (Amendment) Regulations 2008 [SI 2008/414], ( the 2008 Regulations ) in conjunction with the publication by DCLG of statutory guidance on MRP (Third edition, February 2012). 17. The Council is legally obliged to have regard to the guidance, which is intended to enable a more flexible approach to assessing the amount of annual provision than was required under the previous statutory requirements. The guidance offers four main options under which MRP could be made, with an overriding recommendation that the Council should make prudent provision to redeem its debt liability over a period which is reasonably commensurate with that over which the capital expenditure is estimated to provide benefits. The requirement to have regard to the guidance therefore means that: (a) Although four main options are recommended in the guidance, there is no intention to be prescriptive by making these the only methods of charge under which a local authority may consider its MRP to be prudent; and (b) It is the responsibility of each authority to decide upon the most appropriate method of making a prudent provision, after having had regard to the guidance. 18. There is no requirement to charge MRP where the Capital Financing Requirement (CFR) is nil or negative at the end of the preceding financial year. There is no requirement on the Housing Revenue Account to make an MRP charge but there is a requirement for a charge for depreciation to be made although transitional arrangements are currently in place. 19. The Council implemented the new Minimum Revenue Provision (MRP) guidance in 2008/09, and will assess MRP for 2015/16 in accordance with the main recommendations contained within the guidance issued by the Secretary of State under section 21(1A) of the Local Government Act Option 1: Regulatory Method 20. Under the previous MRP regulations, MRP was set at a uniform rate of 4% of the adjusted CFR (i.e. adjusted for Adjustment A in relation to the

5 Housing Revenue Account to ensure consistency with previous Regulations) on a reducing balance method (which in effect meant that MRP charges would stretch into infinity). This historic approach must continue for all capital expenditure incurred in years before the start of this new approach. It may also be used for new capital expenditure up to the amount which is deemed to be supported through the Supported Capital Expenditure annual allocation. Option 2: Capital Financing Requirement Method 21. This is a variation on option 1 which is based upon a charge of 4% of the aggregate CFR without any adjustment for Adjustment A, or certain other factors which were brought into account under the previous statutory MRP calculation. The CFR is the measure of an authority s outstanding debt liability as depicted by their balance sheet. Option 3: Asset Life Method 22. This method may be applied to most new capital expenditure, including where desired that which may alternatively continue to be treated under options 1 or Under this option, it is intended that MRP should be spread over the estimated useful life of either an asset created, or other purpose of the expenditure. There are two useful advantages of this option: (a) Longer life assets e.g. freehold land can be charged over a longer period than would arise under options 1 and 2; and (b) No MRP charges need to be made until the financial year after that in which an item of capital expenditure is fully incurred and, in the case of a new asset, comes into service use (this is often referred to as being an MRP holiday ). This is not available under options 1 and There are two methods of calculating charges under option 3: (a) equal instalment method equal annual instalments; or (b) annuity method annual payments gradually increase during the life of the asset. Option 4: Depreciation Method 25. Under this option, MRP charges are to be linked to the useful life of each type of asset using the standard accounting rules for depreciation (but with some exceptions) i.e. this is a more complex approach than option 3. The same conditions apply regarding the date of completion of the new expenditure as apply under option 3. Minimum Revenue Provision Policy Statement 2015/ For capital expenditure incurred before 1 April 2008, the MRP policy will be to follow the existing practice outlined in former regulations (Option 1). This provides for an approximate 4% reduction in the borrowing need (CFR) each year. 27. The Council has evaluated the options for MRP policy in respect of capital expenditure incurred from 1 April 2008 and considers that the

6 Asset Life - Equal Instalment Method is the most appropriate for it to use. This provides for a reduction in the borrowing need over approximately the useful life of the asset. 28. Estimated life periods will be determined by the Chief Finance Officer. To the extent that expenditure is not on the creation of an asset and is of a type that is subject to estimated life periods that are referred to in the guidance, these periods will generally be adopted by the Council. However, the Council reserves the right to determine useful life periods and prudent MRP in exceptional circumstances where the recommendations of the guidance would not be appropriate. 29. As some types of capital expenditure incurred by the Council are not capable of being related to an individual asset, asset lives will be assessed on a basis which most reasonably reflects the anticipated period of benefit that arises from the expenditure. Also, whatever type of expenditure is involved, it will be grouped together in a manner which reflects the nature of the main component of expenditure and will only be divided up in cases where there are two or more major components with substantially different useful economic lives. 30. Repayments included in finance leases are applied as MRP.

7 Current Portfolio Position 31. The Council s treasury portfolio position at 31/12/2014 comprised: Investment Portfolio Internally Managed Funds at 31 December 2014 Investment Term Deposits - UK Banks and Building Societies Maturity Date Investment Period: Days Rate of Return Benchmark Return Lloyds Bank Plc 2,000,000 02/01/ % 0.370% Nationwide Building Society 4,000,000 02/01/ % 0.580% Barclays Treasury Direct 4,000,000 12/02/ % 0.580% Other Local Authorities Salford City Council 2,000,000 19/01/ % 0.430% Dumfries & Galloway Council 2,000,000 23/01/ % 0.370% Staffordshire Moorlands District Council 1,000,000 05/02/ % 0.370% Dumfries & Galloway Council 2,000,000 23/02/ % 0.430% Mid Suffolk District Council 1,000,000 13/03/ % 0.430% Birmingham City Council 2,000,000 17/03/ % 0.430% Kings Lynn & West Norfolk Borough Council 1,000,000 23/03/ % 0.430% Eastleigh Borough Council 3,000,000 08/04/ % 0.430% Money Market Funds Public Sector Deposit Fund 4,000,000 Call % 0.350% Business Reserve Accounts Natwest 95 Day Notice Liquidity 2,000, Day Notice % 0.430% Natwest Business Reserve 2,000,000 Call % 0.350% Lloyds Bank Plc Interest Bearing Current Account 4,000,000 n/a % 0.350% Overall 36,000, % 0.422%

8 Loan Type Borrowing Position as at 31/12/2014 Maturity Date Principal Interest Rate PWLB Fixed Rate Maturity Loan 18/05/2015 1,000, % PWLB Fixed Rate Maturity Loan 28/03/2016 2,282, % PWLB Fixed Rate Maturity Loan 04/08/2016 1,000, % PWLB Fixed Rate Annuity Loan 28/02/ , % PWLB Fixed Rate Maturity Loan 28/03/2019 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2020 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2021 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2022 2,282, % PWLB Fixed Rate Maturity Loan 04/08/2024 1,000, % PWLB Fixed Rate Maturity Loan 04/08/2025 1,000, % PWLB Fixed Rate Maturity Loan 28/03/2027 2,282, % PWLB Fixed Rate Maturity Loan 18/05/ , % PWLB Fixed Rate Maturity Loan 28/03/2028 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2029 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2030 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2031 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2032 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2033 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2034 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2035 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2036 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2037 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2038 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2039 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2040 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2041 2,282, % PWLB Fixed Rate Maturity Loan 28/03/2042 2,282, % % 52,446, %

9 Borrowing 32. The Prudential Indicators set out in Appendix B show the gross actual external debt position at 31 March 2014 and the net debt position at 31 March 2014 with forward projections of both. 33. Within the prudential indicators there are a number of key indicators to ensure the Council operates its activities within well defined limits. One of these is to ensure that the Council s gross debt does not, except in the short term, exceed the total of the Capital Financing Requirement (CFR) in the preceding year plus the estimates of any additional CFR for 2015/16 and the following two financial years. This allows some flexibility for limited early borrowing for future years but ensures that borrowing is not undertaken for revenue purposes. 34. The Chief Finance Officer reports that the Council complied with this prudential indicator in the current year and does not envisage difficulties for the future. This view takes into account current commitments, existing plans and the proposals in the current budget cycle. Treasury Indicators: Limits to Borrowing Activity 35. The operational boundary is the limit beyond which external debt is not normally expected to exceed. 36. It is a statutory duty under Section 3 of the Act and supporting regulations, for the Council to determine and keep under review how much it can afford to borrow. The amount so determined is termed the Affordable Borrowing Limit. In England and Wales the Authorised Limit represents the legislative limit specified in the Act. 37. The Council must have regard to the Prudential Code when setting the Authorised Limit, which essentially requires it to ensure that total capital investment remains within sustainable limits and, in particular, that the impact upon its future council tax and council rent levels is acceptable. 38. Whilst termed an Affordable Borrowing Limit, the capital plans to be considered for inclusion incorporate financing by both external borrowing and other forms of liability, such as credit arrangements. 39. The Operational Boundary and the Authorised Limit are to be set, on a rolling basis, for the forthcoming financial year and two successive financial years; details can be found in Appendix B to this report. 40. Separately, the Council is also limited to a maximum HRA CFR through the HRA self-financing regime details of this maximum limit are also set out in Appendix B. Prospects for Interest Rates 41. The Council has appointed Capita Asset Services as treasury adviser to the Council and part of their service is to assist the Council to formulate a view on interest rates. The following table and commentary gives the Capita Asset Services central view; this is based on their latest information release dated 5 January 2015.

10 Bank PWLB Borrowing Rates % Rate % (including certainty rate adjustment) 5 year 25 year 50 year Jan Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Capita Asset Services have provided the following commentary on the reasons for this latest update to the interest rates forecast: (a) The plunge in the price of oil has been the major surprise of the last three months. This will reduce inflation and stimulate the economies of oil importing countries. (b) There is a downside to the plunge in oil prices in terms of a sharp increase in the risk of emerging country debt default and emerging country oil producing corporate defaults. This could have a knock on effect on western banks that have lent to these areas and to hedge, pension and investment funds which have been wrong footed by holding debt or equities in these areas. (c) Greece: the anti EU and anti austerity party Syriza is likely to be the strongest party in the general election on 25 th January. However, the Eurozone has put in place sufficient firewalls that a Greek exit would have little direct impact on the rest of the EZ and the Euro. The indirect effect is more problematic to quantify as such an election result would be likely to strengthen support for anti EU and anti austerity political parties in many EU countries. Italy is the greatest risk as it has the third biggest debt mountain in the world and has shown little progress so far in undertaking fundamental reforms to improve the competitiveness of the economy. (d) UK GDP growth forecasts have recently been more subdued although growth will still remain strong, but not as strong as previously expected.

11 (e) The political risks around the UK general election in May 2015 have increased with the likely result now being very hard to predict. (f) A combination of the above factors has caused us to put back the start of increases in Bank Rate from Q to Q4 with knock on delays on increases in following years. (g) We have also had to bring our short term PWLB forecasts down to reflect current abnormally low levels which are unsustainably low. However, how quickly or slowly they will unwind is very hard to predict. 43. The one area of resoundingly good news over the last three months has been that the American economy is well on track to making a full recovery from the financial crash. GDP growth rates (annualised) for Q2 and Q3 of 4.6% and 5.0% have been stunning and hold great promise for strong growth going forward and for further falls in unemployment. It is therefore confidently predicted that the Fed will start on the first increase in the Fed rate by the middle of In contrast, the surge in UK growth during 2014 appears to have diminished (Q1 0.7%, Q2 0.9%, Q3 0.7%) and the year on year rate has subsided from 3.2% in Q2 to 2.6% in Q3. Forward indicators are also revealing some cooling of prospects going forward, though this remains strong growth by UK standards, but not as strong as previously forecast. 44. In consequence, it is now the US which is most likely to be putting central rates up before the UK. The prospects for the UK are somewhat mixed. The hoped for rebalancing of the economy towards greater reliance on exports is not happening and the UK faces an uphill struggle with its main trading partner, the EU now expected to resort to full blown quantitative easing (QE) early in 2015 in order to stimulate the economy to rise above near stagnation. However, UK consumer confidence is still buoyant although the housing market looks as if it is also cooling with house price rises and new mortgage approvals both subsiding. UK consumers are obviously benefiting from the fall in the oil price with overall inflation falling to 1.0% in November, the lowest rate since September It is also forecast to stay around the same level for the best part of a year. 45. Nevertheless, the beneficial effect of the fall in oil prices will fall out after twelve months, so inflation will rise as a result after then, although it is still expected to remain at or near 2%. What this does mean, however, is that average wage increases are likely to exceed inflation for the coming year and so increase the disposable income of consumers. This, in turn, will underpin domestic demand and support GDP growth. Looking further forward, whichever political party or coalition comes to power after the general election in May 2015 will still have to decide what balance of government spending cuts and / or tax increases will be needed to bring the public sector net borrowing deficit down. This will likely mean an erosion of overall consumer disposable income although further falls in unemployment will counteract some of this effect. The Bank of England therefore faces an incredibly delicate task of balancing the pros and cons of when to start on increasing Bank Rate, especially knowing that

12 many consumers are still heavily indebted and very vulnerable to increases in borrowing rates. 46. A further factor affecting financial markets and the confidence of UK producers is the increase in political risk. The UK faces a general election where the outcome looks very hard to predict as to the knock-on effects on the UK economy. 47. As for the MPC, their last minutes appeared to show a consolidation of support for holding off on increasing Bank Rate due to the fall in inflation caused by the fall in oil prices. They will also be focusing in 2015 on how quickly wage inflation increases and said it needed to pick up further in order to meet the 2% inflation target. This resulted in financial market investors pushing back their bets on the timing of the next interest rate hike to late 2015 / early Our view has also shifted in this forecast to a first increase in Q rather than Q Capita Asset Services Forward View 48. Economic forecasting remains difficult with so many external influences weighing on the UK. Our Bank Rate forecasts (and also MPC decisions) will be liable to further amendment depending on how economic data transpires over Forecasts for average earnings beyond the three year time horizon will be heavily dependent on economic and political developments. Major volatility in bond yields is likely to endure as investor fears and confidence ebb and flow between favouring more risky assets i.e. equities, or the safe haven of bonds. 49. The overall longer run trend is for gilt yields and PWLB rates to rise, due to the high volume of gilt issuance in the UK, and of bond issuance in other major western countries. Increasing investor confidence in eventual world economic recovery is also likely to compound this effect as recovery will encourage investors to switch from bonds to equities. 50. The overall balance of risks to economic recovery in the UK is currently evenly balanced. Only time will tell just how long this current period of strong economic growth will last; it also remains exposed to vulnerabilities in a number of key areas. 51. We would, however, remind clients of the view that we have expressed in our previous interest rate revision newsflashes of just how unpredictable PWLB rates and bond yields are at present. We are experiencing exceptional levels of volatility which are highly correlated to geo-political and sovereign debt crisis developments. 52. As there are significant potential risks from the Eurozone and from financial flows from emerging markets in particular, caution must be exercised in respect of all interest rate forecasts at the current time. The general expectation for an eventual trend of gently rising gilt yields and PWLB rates is expected to remain unchanged, as market fundamentals will focus on the sheer volume of UK gilt issuance (and also US Treasury issuance) and the price of those new debt issues. Negative (or positive) developments in the EZ sovereign debt crisis could significantly impact safe-haven flows of investor money into UK, US and German bonds and produce shorter term movements away from our central forecasts.

13 53. The current economic outlook and structure of market interest rates and government debt yields have several key treasury management implications: (a) As for the Eurozone, concerns in respect of a major crisis subsided considerably in However, the downturn in growth and inflation during the second half of 2014, and worries over the Ukraine situation, Middle East and Ebola, have led to a resurgence of those concerns as risks increase that it could be heading into deflation and a triple dip recession since Sovereign debt difficulties have not gone away and major concerns could return in respect of individual countries that do not dynamically address fundamental issues of low growth, international lack of competitiveness and the need for overdue reforms of the economy (as Ireland has done). It is, therefore, possible over the next few years that levels of government debt to GDP ratios could continue to rise to levels that could result in a loss of investor confidence in the financial viability of such countries. Counterparty risks therefore remain elevated. This continues to suggest the use of higher quality counterparties for shorter time periods; (b) Investment returns are likely to remain relatively low during 2015/16 and beyond; (c) Borrowing interest rates have been volatile during 2014 as alternating bouts of good and bad news have promoted optimism, and then pessimism, in financial markets. During July to October 2014, a building accumulation of negative news has led to an overall trend of falling rates. The policy of avoiding new borrowing by running down spare cash balances has served well over the last few years. However, this needs to be carefully reviewed to avoid incurring higher borrowing costs in later times, when authorities will not be able to avoid new borrowing to finance new capital expenditure and/or to refinance maturing debt; (d) There will remain a cost of carry to any new borrowing which causes an increase in investments as this will incur a revenue loss between borrowing costs and investment returns. Borrowing Strategy 54. The Council is currently maintaining an under-borrowed position. This means that the capital borrowing need (the Capital Financing Requirement), has not been fully funded with loan debt as cash supporting the Council s reserves, balances and cash flow has been used as a temporary measure. This strategy is prudent as investment returns are low and counterparty risk is relatively high. 55. Against this background and the risks within the economic forecast, caution will be adopted with the 2015/16 treasury operations. The Chief Finance Officer will monitor interest rates in financial markets and adopt a pragmatic approach to changing circumstances, reporting any decisions to Cabinet at the next available opportunity. The main

14 sensitivities of the forecast are likely to be the two scenarios noted below. (a) If it was felt that there was a significant risk of a sharp FALL in long and short term rates e.g. due to a marked increase of risks around relapse into recession or of risks of deflation then long term borrowing will be postponed and potential rescheduling from fixed rate funding into short term borrowing will be considered; (b) If it was felt that there was a significant risk of a much sharper RISE in long and short term rates than currently forecast, perhaps arising from a greater than expected increase in the anticipated rate to US tapering of asset purchases or in world economic activity or a sudden increase in inflation risks, then the portfolio position will be re-appraised with the likely action that fixed rate funding will be drawn whilst interest rates are still lower than they will be in the next few years. 56. The Council s borrowing strategy will give consideration to new borrowing in the following order of priority: (a) The cheapest borrowing will be internal borrowing by running down cash balances and foregoing interest earned at continuing low rates. However, in view of the overall forecast for long term borrowing rates to increase over the next few years, consideration will also be given to weighing the short term advantage of internal borrowing against potential long term costs if the opportunity is missed for taking market loans at long term rates which will be higher in future years; (b) PWLB borrowing for periods under 10 years where rates are expected to be significantly lower than rates for longer periods. This offers a range of options for new borrowing which will spread debt maturities away from a concentration in longer dated debt; (c) Long term fixed rate market loans at rates significantly below PWLB rates for the equivalent maturity period (where available) and to maintaining an appropriate balance between PWLB and market debt in the debt portfolio; and (d) PWLB variable rate loans for up to 10 years. Treasury Management Limits on Activity 57. There are three debt related treasury activity limits. The purpose of these is to restrain the activity of the treasury function within certain limits, thereby managing risk and reducing the impact of any adverse movement in interest rates. However, if these are set to be too restrictive they will impair the opportunities to reduce costs and/or improve performance. These limits are set out in Appendix B and comprise: (a) Upper Limit on Variable Interest Rate Exposure: This sets a maximum limit for variable interest rates based upon the debt position net of investments.

15 (b) (c) Upper Limit on Fixed Interest Rate Exposure: This is similar to the previous indicator and sets a maximum limit for fixed interest rates. Maturity Structure of Borrowing: These gross limits are set in order to reduce the Council s exposure to large fixed rate sums falling due for refinancing. Policy on borrowing in advance of need 58. The Council will not borrow more than or in advance of its needs purely in order to profit from the investment of the extra sums borrowed. Any decision to borrow in advance will be within forward approved Capital Financing Requirement estimates, and will be considered carefully to ensure value for money can be demonstrated and that the Council can ensure the security of such funds. 59. Risks associated with any borrowing in advance activity will be subject to prior appraisal and subsequent reporting through the in-year or annual reporting mechanism. Debt Rescheduling 60. As short term borrowing rates will be considerably cheaper than longer term rates, there are likely to be significant opportunities to generate savings by switching from long term debt to short term debt. However, these savings will need to be considered in the light of their short term nature and the likely cost of refinancing those short term loans, once they mature, compared to the current rates of longer term debt in the existing debt portfolio. Any such rescheduling and repayment of debt is likely to cause a flattening of the Council s maturity profile as in recent years there has been a skew towards longer dated PWLB. 61. The reasons for any rescheduling to take place will include: (a) the generation of cash savings and / or discounted cash flow savings; (b) helping to fulfil the strategy outlined above; and (c) to enhance the balance of the portfolio (amend the maturity profile and/or the balance of volatility). 62. Consideration will also be given to the potential for making savings by running down investment balances to repay debt prematurely as short term rates on investments are likely to be lower than rates paid on current debt. 63. All rescheduling will be discussed with the Portfolio Holder for Finance and reported to the Cabinet, at the earliest meeting following its action.

16 Annual Investment Strategy Investment Policy 64. The Council will have regard to the DCLG s Guidance on Local Government Investments ( the Guidance ) and the 2011 revised CIPFA Treasury Management in Public Services Code of Practice and Cross Sectoral Guidance Notes ( the CIPFA TM Code ). The Council s investment priorities are, in order of importance: (a) the security of capital; and (b) the liquidity of its investments. 65. The Council will also aim to achieve the optimum return on its investments commensurate with proper levels of security and liquidity. The risk appetite of this Council is low in order to give priority to security of its investments. 66. The borrowing of monies purely to invest or on lend and make a return is unlawful and this Council will not engage in such activity. 67. In order to minimise risk to investments, the Council applies minimum acceptable credit criteria in order to generate a list of highly creditworthy counterparties which also enables diversification and thus avoidance of concentration risk. 68. Continuing regulatory changes in the banking sector are designed to see greater stability, lower risk and the removal of expectations of Government financial support should an institution fail. This withdrawal of implied sovereign support is anticipated to have an effect on ratings applied to institutions. This will result in the key ratings used to monitor counterparties being the Short Term and Long Term ratings only. Viability, Financial Strength and Support Ratings previously applied will effectively become redundant. This change does not reflect deterioration in the credit environment but rather a change of method in response to regulatory changes. 69. As with previous practice, ratings will not be the sole determinant of the quality of an institution and it is important to continually assess and monitor the financial sector on both a micro and macro basis and in relation to the economic and political environments in which institutions operate. The assessment will also take account of information that reflects the opinion of the markets. To this end the Council will engage with its advisers to maintain a monitor on market pricing such as credit default swaps and overlay that information on top of the credit ratings. 70. Other information sources used will include the financial press, share price and other such information pertaining to the banking sector in order to establish the most robust scrutiny process on the suitability of potential investment counterparties 71. Investment instruments identified for use in the financial year are listed in Appendix C under the Specified and Non-Specified Investments categories. Following evaluation of the Council s cash balances and cash flows, it is deemed necessary to implement some modest

17 increases to the counterparty limits in order to maximise available return whilst prioritising the security and liquidity of the Council s investments. Changes to Credit Rating Methodology 72. As outlined in the creditworthiness policy section below, the Council applies the creditworthiness service provided by Capita Asset Services. An element of this service relies on credit ratings from the three main rating agencies; some changes to which are taking place this year as explained below. 73. The main rating agencies (Fitch, Moody s and Standard & Poor s) have, through much of the financial crisis, provided some institutions with a ratings uplift due to implied levels of sovereign support. More recently, in response to the evolving regulatory regime, the agencies have indicated they may remove these uplifts. This process may commence during 2014/15 and / or 2015/16. The actual timing of the changes is still subject to discussion, but this does mean immediate changes to the credit methodology are required. 74. It is important to stress that the rating agency changes do not reflect any changes in the underlying status of the institution or credit environment, merely the implied level of sovereign support that has been built into ratings through the financial crisis. The eventual removal of implied sovereign support will only take place when the regulatory and economic environments have ensured that financial institutions are much stronger and less prone to failure in a financial crisis. 75. Both Fitch and Moody s provide standalone credit ratings for financial institutions. For Fitch, it is the Viability Rating, while Moody s has the Financial Strength Rating. Due to the future removal of sovereign support from institution assessments, both agencies have suggested going forward that these will be in line with their respective Long Term ratings. As such, there is no point monitoring both Long Term and these standalone ratings. 76. Furthermore, Fitch has already begun assessing its Support ratings, with a clear expectation that these will be lowered to 5, which is defined as A bank for which there is a possibility of external support, but it cannot be relied upon. With all institutions likely to drop to these levels, there is little to no differentiation to be had by assessing Support ratings. 77. As a result of these rating agency changes, the credit element of Capita Asset Services future methodology will focus solely on the Short and Long Term ratings of an institution. Rating Watch and Outlook information will continue to be assessed where it relates to these categories. This is the same process for Standard & Poor s that has always been taken, but a change to the use of Fitch and Moody s ratings. Furthermore, CDS prices will continue to be utilised as an overlay to ratings in the new methodology. Creditworthiness Policy 78. This Council uses the creditworthiness service provided by Capita Asset Services. This service employs a sophisticated modelling approach with

18 credit ratings from the three main credit rating agencies. The credit ratings of counterparties are supplemented with the following overlays: (a) credit watches and credit outlooks from credit rating agencies; (b) Credit Default Swap (CDS) spreads to give early warning of likely changes in credit ratings; and (c) Sovereign ratings to select counterparties from only the most creditworthy countries. 79. This modelling approach combines credit ratings, credit watches, credit outlooks and CDS spreads in a weighted scoring system for which the end product is a series of colour code bands which indicate the relative creditworthiness of counterparties. These colour codes are also used by the Council to determine the duration for investments and are therefore referred to as durational bands. The Council is satisfied that this service now gives a much improved level of security for its investments. It is also a service which the Council would not be able to replicate using in house resources. 80. The Council will therefore use counterparties within the following durational bands: (a) Yellow 5 years 1 (b) Dark pink 5 years for Enhanced money market funds (EMMFs) with a credit score of 1.25 (c) Light pink 5 years for Enhanced money market funds (EMMFs) with a credit score of 1.5 (d) Purple 2 years (e) Blue 1 year (only applies to nationalised or semi nationalised UK Banks) (f) Orange 1 year (g) Red 6 months (h) Green 100 days (i) No colour not to be used 81. The creditworthiness service provided by Capita Asset Services uses a wider array of information than just primary ratings and by using a risk weighted scoring system, does not give undue preponderance to just one agency s ratings. 82. All credit ratings will be monitored daily. The Council is alerted to changes to ratings of all three agencies through its use of the Capita Asset Services creditworthiness service. 83. If a downgrade results in the counterparty/investment scheme no longer meeting the Council s minimum criteria, its further use as a new investment will be withdrawn immediately. 1 Please note the yellow colour category is for UK Government Debt or its equivalent, money market funds and collateralised deposits where the collateral is UK Government Debt.

19 84. In addition to the use of Credit Ratings the Council will be advised of information in movements in Credit Default Swap against the itraxx benchmark and other market data on a weekly basis. Extreme market movements may result in downgrade of an institution or removal from the Councils lending list. 85. Sole reliance will not be placed on the use of this external service. In addition this Council will also use market data and information, information on sovereign support for banks and the credit ratings of that supporting government. Country Limits 86. The Council has determined that it will only use approved counterparties from countries outside the UK with a minimum sovereign credit rating of AAA from Fitch Ratings (or equivalent from other agencies if Fitch does not provide). The list of countries that qualify using this credit criteria as at the date of this report are shown in appendix D. This list will be added to or deducted from by officers should ratings change in accordance with this policy. The Council has also set a maximum amount of 3 million in any country outside the UK. Investment Strategy - In-house managed funds 87. Investments will be made with reference to the core balance and cash flow requirements and the outlook for short-term interest rates (i.e. rates for investments up to 12 months). 88. For its cash flow generated balances, the Council will seek to utilise its bank current account, deposit reserve accounts and short-dated deposits (overnight to 100 days) in order to benefit from the compounding of interest. 89. Bank rate is currently forecast to remain unchanged at 0.5% before starting to rise from quarter 4 of Bank rate forecasts for financial year ends are: (a) 2015/ % (b) 2016/ % (c) 2017/ % 90. These are revised forecasts issued in January 2015 based on putting back the forecast of a first interest rate rise to Q4 of 2015 instead of Q Further detailed interest rate forecasts are shown in Appendix A to this report. 92. Based on this latest interest forecast, it is suggested that the Council should budget for 0.40% on investments placed during the financial year and this has been fed into budget forecasts. Investment Treasury Indicator and Limit 93. The Council is required to set a limit for the total principal funds invested for greater than 364 days. This is set with regard to the Council s liquidity requirements and to reducing the need for early sale of an investment, and is based on the availability of funds after each year-end. Details are set out in Appendix B to this report.

20 End of year investment report 94. At the end of the financial year, the Council will report on its investment activity as part of its Annual Treasury Report to full Council. Treasury Management Practices 95. In accordance with the CIPFA Treasury Management Code, the Council has an existing framework of twelve Treasury Management Practices (TMPs) to set out the manner in which the Council will seek to achieve its treasury management policies and objectives and to prescribe how it will control and manage its treasury management activities. 96. The Council s TMPs have been updated to reflect existing management structures, procedures and controls. The updated TMPs are set out in Appendix E to this report for approval, and remain fully compliant with the CIPFA Treasury Management Code. Policy on the use of external service providers / treasury management consultants 97. The Council uses Capita Asset Services, Treasury Solutions as its external treasury management advisers. 98. The Council recognises that responsibility for treasury management decisions remains with the organisation at all times and will ensure that undue reliance is not placed upon our external service providers. Council officers are clear between what constitutes information and what constitutes advice. 99. The Council also recognises that there is value in employing external providers of treasury management services in order to acquire access to specialist skills and resources. The Council will ensure that the terms of their appointment and the methods by which their value will be assessed are properly agreed and documented, and subjected to regular review. Training 100. The CIPFA Code requires the responsible officer to ensure that members with responsibility for treasury management receive adequate training in treasury management. This especially applies to members responsible for scrutiny. The Audit and Finance Committee received treasury management training on 29 th September 2014 and further training will be arranged as required The training needs of treasury management officers are periodically reviewed. Scheme of Delegation 102. The Council has approved a Scheme of Delegation. This is attached as Appendix F. Role of the Section 151 Officer 103. The Council has approved the role of the Section 151 Officer (Chief Finance Officer) in relation to treasury management. This is attached as Appendix G.

21 Corporate Management Team Advice 104. Cabinet is recommended to recommend to Council to: (a) (b) (c) (d) (e) Approve the 2015/16 Treasury Management Strategy and Annual Investment Strategy; Set the Prudential and Treasury Indicators for 2015/16 as set out in Appendix B to this report; Approve the Specified and Non-specified Investments categories listed in Appendix C to this report; Approve that for the 2015/16 financial year the Council makes Minimum Revenue Provision in accordance with the Asset Life (Equal Instalment) Method for new capital expenditure; and Approve the updated Treasury Management Practices set out in Appendix E to this report. Financial Implications 105. The strategy proposed in this report, together with the interest rates forecast, are in line with the assumptions made when the 2015/16 budget was prepared. The costs of treasury operations, debt management expenses and investment income are included in the 2015/16 budget. Legal Implications 106. The Local Government Act 2003 and supporting regulations requires the Council to have regard to the Prudential Code and to set Prudential Indicators for the next three years to ensure that the Council s capital investment plans are affordable, prudent and sustainable. The Council also has to 'have regard' to the DCLG s Guidance on Local Government Investments ( the Guidance ) issued in April 2010 and CIPFA s Revised Treasury Management in Public Services Code of Practice 2011 and Cross Sectoral Guidance Notes ( the CIPFA TM Code ). Human Resources Implications 107. None arising directly from this report. Other Implications 108. The Treasury Strategy has been formulated to minimise risk. Credit ratings and other market intelligence are used and counterparty limits also assist to assess and mitigate risk. The adoption of the revised CIPFA Treasury Management Code also embeds risk management further into treasury management operations.

22 Other Implications Applies? Other Implications Applies? Human Rights No Equalities and Diversity No Crime and Disorder No Consultation No Environmental No Access to Information No Sustainability No Exempt from publication No Risk Management Yes Director: Trevor Scott, Director of Governance and Corporate Services Proper Officer: Steven Linnett, Chief Finance Officer Report Contact Gillian Taberner, Finance Manager Accounting & Control Officer: Telephone Number: address: Appendices: A Interest Rate Forecasts B Prudential and Treasury Indicators C Specified and Non-specified Investments D Approved countries for investment E Treasury Management Practices F Treasury Management Scheme of Delegation G Treasury Management Role of the Section 151 Officer Background Papers: None

23 Appendix A Interest Rate Forecasts Appendix A: Interest Rate Forecasts 1. Detailed forecasts provided by Capita Asset Services on 5 January The PWLB rates and forecast shown below have taken into account the 20 basis point certainty rate reduction effective as of the 1st November 2012.