APPENDIX F Treasury Strategy

Appendix 2: Treasury Management Strategy Statement, MRP Strategy and Annual Investment Strategy 2012/13

Recommendations to be incorporated in main report

• Approve the Treasury Strategy and Prudential Indicators
• Note that the Pension Fund cash will be managed in accordance with this strategy
• Approve the Treasury Management Policy Statement attached as Annex1
• Approve the MRP policy
• Approve the proposed methodology for apportioning debt between the HRA and General Fund under the new HRA self-financing regime and agree to the Council proceeding with a two-pool method of managing debt in the future.
• Note the Director of Corporate Finance and Audit will implement the strategy under existing delegated powers.

Introduction

1. The Council is required to operate a balanced budget, which broadly means that cash raised during the year will meet cash expenditure. To assist this objective, the Council operates a Treasury Management Function which incorporates the management of the Council’s cash flows, lending and borrowing activities and the management of the risks associated with the activities. The treasury management function also aids the planning of the funding of the Council’s capital programme.

1.1The Local Government Act 2003 (the Act) and supporting regulations requires the Council to ‘have regard to’ the Chartered Institute of Public Finance and Accountancy’s (CIPFA) Prudential Code and the CIPFA Treasury Management Code of Practice to set Prudential and Treasury Indicators for the next three years to ensure that the Council’s capital investment plans are affordable, prudent and sustainable.

1.2The Act therefore requires the Council to set out its treasury strategy for borrowing and to prepare an Annual Investment Strategy (as required by Investment Guidance subsequent to the Act and included as paragraph 13 of this report); this sets out the Council’s policies for managing its investments and for giving priority to the security and liquidity of those investments.

1.3The Department of Communities and Local Government has issued investment guidance which came into effect from 1 April 2010. The Council’s investment strategy is compliant with the CLG guidance.

1.4The CIPFA Code of Practice on Treasury Management (revised November 2011) was adopted by Full Council in the meeting on the 9 March 2010. This strategy report complies with the revised Code of Practice.

1.5The key requirements of the Code are as follows:

• Creation and maintenance of a Treasury Management Policy Statement which sets out the policies and objectives of the Council’s treasury management activities. The Treasury Management Policy is re attached for approval as Annex1.
• Creation and maintenance of Treasury Management Practices which set out the manner in which the Council will seek to achieve those policies and objectives.
• Receipt by the full council of an annual Treasury Management Strategy Statement - including the Annual Investment Strategy and Minimum Revenue Provision Policy - for the year ahead ( this report fulfils this requirement), a Mid-year Review Report and an Annual Report (stewardship report) covering activities during the previous year.
• 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. The scheme of delegation is attached as Annex 2
• Delegation by the Council of the role of scrutiny of treasury management strategy and policies to a specific named body. For this Council the delegated body is the Audit Committee.

1.6As outlined above the London Borough of Ealing fully complies with the requirements of the revised 2011 code and takes seriously its role in managing the risks associated with this function. In this regard the Council’s investment governance process has recently been streamlined with the introduction of a treasury risk and investment board, which meets regularly to support the Director of Corporate Finance and Audit in the execution of his delegated powers. This has enabled more timely assessment, discussion and response to emerging investment risks.

Treasury Management Strategy for 2012/13

1. The fallout from the credit crunch and the ensuing European sovereign debt crises has continued to dominate financial markets in 2011/12.

2.1The proposed Treasury management Strategy and Policy for the remainder of 2011/12 and 2012/13 follows the Council’s policy on investments of “safety first, returns second” in this regard officers have temporarily suspended the use of Money Market Funds, and a number of UK Banks as the risks and likely impact of the sovereign debt crises has continued to escalate. Currently investments are placed with the Government’s Debt Management Office Account and other Local Authorities, which represents a much scaled down counterparty lending list. The lending list is constantly under review.

2.2The strategy proposed in this report will assist the Council in providing as much safety as possible in the Council’s Treasury Management activities and allow the borrowing necessary to finance the capital programme. The strategy is consistent with the proposed capital programme and revenue budget dealt with elsewhere on the agenda and aims to secure investment income on the Council’s general cash balances with the minimum risk possible. As will be clear from the recent events globally and nationally, it is impossible in practical terms to eliminate all credit risk but this Council seeks to be as prudent as possible.

2.3A mid year update report on Treasury Management in 2011/12 went to Full Council on 31 January 2012 and Audit Committee on 25 January 2012.

2.4The proposed strategy for 2012/13 is based upon treasury officers’ views on interest rates, supplemented with leading market forecasts provided by the Council’s treasury advisors, Sector.

2.5The strategy report covers:

• update on Pension Fund cash/Treasury limits and current portfolio position
• treasury and prudential indicators which will limit the treasury risk and activities of the Council
• MRP Policy
• economic background and prospects for interest rates
• borrowing strategy and policy on borrowing in advance of need
• debt rescheduling
• the current treasury position
• recommendations for pooling of debt following self financing
• annual investment strategy
• credit worthiness policy
• policy for use of external advisors
• treasury budget
• policy for use if external advisors

Pension Fund Cash

2.6The Council’s arrangement for Pension Fund cash changed from 1 April 2011 to meet the requirements of CLG regulations. A separate bank account is operated for the Pension Fund and Pension fund cash is now invested separately from the Councils in Special Interest Bearing Account (SIBA) with RBS.

2.7Pension Fund transactions still flow through the council’s bank account and any surplus of income over expenditure is intermittently transferred to the separate bank account, from where investments are made.

2.8Cash will be transferred to fund managers to rebalance the fund, when cash trigger levels set within the Pension Fund investment strategy are reached.

2.9The Council is still responsible for managing the Pension Fund cash in accordance with this Treasury Management Strategy.

Balanced Budget Requirement

3It is a statutory requirement under Section 33 of the Local Government Finance Act 1992, for the Council to produce a balanced budget. In particular, Section 32 requires a local authority to calculate its budget requirement for each financial year to include the revenue costs that flow from capital financing decisions. This, therefore, means that increases in capital expenditure must be limited to a level whereby increases in charges to revenue from: -

1. increases in interest charges caused by increased borrowing to finance additional capital expenditure, and
2. any increases in running costs from new capital projects are limited to a level which is affordable, prudent and sustainable within the projected income of the Council for the foreseeable future.

Treasury Limits for 2012/13 to 2014/15

4It 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.

4.1The 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’.

4.2Whilst 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. The Authorised Limit is to be set, on a rolling basis, for the forthcoming financial year and two successive financial years, details of the Authorised Limit can be found in the prudential indicator table in paragraph 6.

Current Portfolio Position

5The Council’s treasury portfolio position at 09/01/2012 comprised:

Prudential Indicators

6The 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.

6.1Ealing’s Prudential and Treasury Management Indicators for the period 2010-14 are set out below.

6.2The benefit of the indicators will be derived from monitoring them over time rather than from the absolute value of each. The indicators are not intended to be used as comparators between councils. A reporting process has been established, with a half-yearly report to Full Council to highlight any significant deviations from expectations. Once determined, the indicators can be amended, subject to reporting to Council for approval.

6.3The figures used for the later years are necessarily broad estimates, including the level of Government support beyond 2012-13. Such estimates can and will be revised, as more firmed up information become available.

6.4The Council’s capital expenditure plans are the key driver of treasury management activity. The output of the capital expenditure plans is reflected in prudential indicators, which are designed to assist member’s overview and confirm capital expenditure plans.

6.5Capital Expenditure. This prudential Indicator is a summary of the Council’s capital expenditure plans, both those agreed previously, and those forming part of this budget cycle. Members are asked to approve the capital expenditure forecasts:

6.6Other long term liabilities. The above financing need excludes other long term liabilities, such as PFI and leasing arrangements which already include borrowing instruments.

6.7 The table below outlines the above capital expenditure plans and how these plans are proposed to be financed by capital or revenue resources. Any shortfall of resources results in a funding need i.e. borrowing.

The Council’s Borrowing Need (the Capital Financing Requirement)

6.8The second prudential indicator is the Council’s Capital Financing Requirement (CFR). The CFR is simply the total historic outstanding capital expenditure which has not yet been paid for from either revenue or capital resources. It is essentially a measure of the Council’s underlying borrowing need. Any capital expenditure above, which has not immediately been paid for, will increase the CFR

6.9Following accounting changes the CFR includes any other long term liabilities (e.g. PFI schemes, finance leases) brought onto the balance sheet. Whilst this increases the CFR, and therefore the Council’s borrowing requirement, these types of scheme include a borrowing facility and so the Council is not required to separately borrow for these schemes. The Council currently has (£117.5m) of such schemes that forms part of the CFR.

6.10The Council is asked to approve the CFR projections below:

6.11Under the capital finance regulations, local authorities are permitted to borrow up to three years in advance of need. This Council will only consider borrowing in advance of need if market conditions indicate that it is the best course of action. One of the reasons for borrowing in advance is to take advantage of and lock in low long term interest rates. There is a short term carry cost to borrowing in advance of need as currently investment rates are considerably lower than long term borrowing rates. This will be evaluated before any decision is taken to borrow in advance of need.

6.12Borrowing in advance of need also increases the level of temporary investments and thus increases the exposure to loss of investment principal. However, the Council has put in place a prudent methodology to minimise this risk.

MRP Policy Statement

6.13The Council is required to pay off an element of the accumulated General Fund capital spend each year (the CFR) through a revenue charge (the minimum revenue provision - MRP), although it is also allowed to undertake additional voluntary payments if required (voluntary revenue provision - VRP).

6.14 CLG Regulations have been issued which require the full Council to approve an MRP Statement in advance of each year. A variety of options are provided to councils, so long as there is a prudent provision. The Council is recommended to approve the following MRP Statement.

6.15For capital expenditure incurred before 1 April 2008 or which in the future will be Supported Capital Expenditure, the MRP policy will be:

• Existing practice - MRP will follow the existing practice outlined in former CLG regulations (option 1); This option provide for an approximate 4% reduction in the borrowing need (CFR) each year.
• From 1 April 2008 for all unsupported borrowing (including PFI and finance leases) the MRP policy will be:

• Asset Life Method – MRP will be based on the estimated life of the assets, in accordance with the proposed regulations (this option must be applied for any expenditure capitalised under a Capitalisation Direction) (option 3); This option provides for a reduction in the borrowing need over approximately the asset’s life.
• Repayments included in annual PFI or finance leases are applied as MRP.

The Use of the Councils Resources and the Investment Position

6.18The application of resources (capital receipts, reserves etc.) to either finance capital expenditure or other budget decisions to support the revenue budget will have an ongoing impact on investments unless resources are supplemented each year from new sources (asset sales etc.). Outlined below are estimates of the year end balances on investments balances.

Affordability Prudential Indicators

6.19The previous sections cover the overall capital and control of borrowing prudential indicators, but within this framework prudential indicators are required to assess the affordability of the capital investment plans. These provide an indication of the impact of the capital investment plans on the Council’s overall finances. The Council is asked to approve the following indicators:

6.20Actual and estimates of the ratio of financing costs to net revenue stream. This indicator identifies the trend in the cost of capital (borrowing and other long term obligation costs net of investment income) against the net revenue stream.

6.21The estimates of financing costs include current commitments and the proposals in this budget report.

Estimates of the incremental impact of capital investment decisions on council tax

6.22This indicator identifies the revenue costs associated with proposed changes to the three year capital programme recommended in this budget report compared to the Council’s existing approved commitments and current plans. The assumptions are based on the budget, but will invariably include some estimates, such as the level of Government support, which are not published over a three year period.

Incremental impact of capital investment decisions on the band D council tax

Incremental Impact of Capital Investment Decisions on Housing Rent (Unsupported Borrowing)

6.23Within the prudential indicators there are a number of key indicators to ensure that the Council operates its activities within well defined limits. One of these is that the Council needs to ensure that its total debt, net of any investments, does not, except in the short term, exceed the total of the CFR in the preceding year plus the estimates of any additional CFR for 2012/13 and the following two financial years (shown as net borrowing above). This allows some flexibility for limited early borrowing for future years, but ensures that borrowing is not undertaken for revenue purposes.