Agenda item

The report set out the Treasury Management Policy and Strategy for 2019/20, which was in line with the Chartered Institute of Public Finance and Accountancy’s (CIPFA) revised Code of Practice.  The Strategy was based on the capital programme as presented to the Authority elsewhere on the agenda, and the financial implications were reflected in the revenue budget, also presented elsewhere on the agenda.

 

Statutory requirements

The Local Government Act 2003 (the Act) and supporting Regulations required the Authority to “have regard to” the 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 Authority’s capital investment plans were affordable, prudent and sustainable.  

 

This report fulfilled the Authority’s legal obligation under the Local Government Act 2003 to have regard to both the CIPFA Code and the Ministry of Housing, Communities and Local Government (MHCLG) Guidance.

 

Treasury Management Strategy for 2019/20

This Strategy Statement had been prepared in accordance with the CIPFA Treasury Management Code of Practice.  Accordingly, the Lancashire Combined Fire Authority's Treasury Management Strategy would be approved by the full Authority, and there would also be a mid-year and a year-end outturn report presented to the Resources Committee. In addition there would be monitoring and review reports to Members in the event of any changes to Treasury Management policies or practices.  The aim of these reporting arrangements was to ensure that those with ultimate responsibility for the treasury management function appreciated fully the implications of treasury management policies and activities, and that those implementing policies and executing transactions had properly fulfilled their responsibilities with regard to delegation and reporting.

 

The Treasury Management Strategy covered the following aspects of the Treasury Management function:-

 

·        Prudential Indicators which would provide a controlling framework for the capital expenditure and  treasury management activities of the Authority;

·        Current Long-term debt and investments;

·        Prospects for interest rates;

·        The Borrowing Strategy;

·        The Investment Strategy;

·        Policy on borrowing in advance of need.

 

Setting the Treasury Management Strategy for 2019/20

In setting the treasury management strategy the following factors needed to be considered as they might have a strong influence over the strategy adopted: economic forecasts, interest rate forecasts, the current structure of the Authority’s investment and debt portfolio and future capital programme and underlying cash forecasts.

 

Economic Context

The UK’s progress in negotiating its exit from the European Union (EU), together with its future trading arrangements, would continue to be a major influence on the economy in 2019/20. The latest (2018 Quarter 3) Gross Domestic Product (GDP) growth figures showed a year on year growth of 1.5%. It was anticipated that the growth would continue with the Bank of England, in its November Inflation Report, expecting GDP growth to average around 1.75% over the forecast horizon, providing the UK’s exit from the EU was relatively smooth.

 

The Bank of England remit included a 2% inflation (Consumer Price Index) target and it was slightly above this level at 2.1% in December 2018. The latest inflation report projected inflation to remain above the target for 2019/20, before reaching 2% at Q4 2021.

 

There were signs that there would be a slowing of world economic growth in 2019.  There was a continued risk of a developing trade war between US and China while the German economy grew by 1.5 per cent in 2018, the weakest rate since 2013. The World Bank forecast global economic growth would slow to 2.9 per cent with falls in the US, China and the Eurozone.

 

Following the Bank of England’s decision to increase Bank Rate to 0.75% in August, no changes to monetary policy had been made since.  However, the Bank expected that should the economy continue to evolve in line with its November forecast, further increases in Bank Rate would be required to return inflation to the 2% target.  The Monetary Policy Committee continued to reiterate that any further increases would be at a gradual pace and limited in extent.

 

Interest Rate Forecast and Prospects for Market Liquidity

Interest rate forecasts were made in the context of the overall economic position as outlined. The Bank of England last changed rates in August 2018 and it had maintained expectations for slow and steady rate rises however with the high level of uncertainty there was the possibility the next change in interest rates would be a reduction.  The latest forecast provided by Treasury Consultants Arlingclose Ltd was detailed in the report.

 

Current Treasury Portfolio Position

At the 31 December 2018 the debt outstanding was £2.0m with investments of £38.1m.  The level of investments represented the Authority’s cumulative surplus on the General Fund, the balances on other cash-backed earmarked reserves and a cash-flow balance generated by a surplus of creditors over debtors and by grant receipts in advance of payments. There was a net investment figure of £36.1m.

 

Borrowing and Investment Requirement

In the medium term the Authority borrowed for capital purposes only. The underlying need to borrow for capital purposes was measured by the Capital Financing Requirement (CFR), while usable reserves and working capital were the underlying resources available for investment. The table detailed in the report compared the estimated CFR to the debt which currently existed which gave an indication of the minimum borrowing or investment required throughout the period.  It also showed the estimated resources available for investment. An option was to use these balances to finance the expenditure rather than investing, often referred to as internal borrowing. The CFR forecast included the impact of the latest forecast of the funding of the Capital Programme which currently assumed there would be no borrowing.

 

CIPFA’s Prudential Code for Capital Finance in Local Authorities recommended that the Authority’s total debt should be lower than its highest forecast CFR over the next 3 years. However, the report showed that the level of loans was above the CFR at 31/3/18. This was the result of the Authority adopting a policy of setting aside additional Minimum Revenue Provision (MRP) in order to generate the cash to repay loans either on maturity or as an early repayment.  Rather than having a need for borrowing it was estimated the Authority had an underlying need to invest although the available balances were forecast to reduce.  Although the Authority did not have plans for new borrowing it currently held £2.0m of loans as part of its strategy for funding previous years' capital programmes.

 

Borrowing Strategy

Although it was unlikely that borrowing would be required in 2019/20 it was still best practice to approve a borrowing strategy and a policy on borrowing in advance of need.  In considering a borrowing strategy the Authority needed to make provision to borrow short term to cover unexpected cash flow shortages or to cover any change in the financing of its Capital Programme.

 

Therefore the approved sources of long-term and short-term borrowing were:

 

·        Public Works Loan Board;

·        UK local authorities;

·        any institution approved for investments; 

·        any other bank or building society authorised by the Prudential Regulation Authority to operate in the UK;

·        UK public and private sector pension funds. 

 

In the past the Authority had raised all of its long-term borrowing from the Public Works Loan Board, but it continued to investigate other sources of finance, such as local authority loans, and bank loans, that may be available at more favourable rates.

 

Policy on Borrowing in Advance of Need

In line with the existing policy the Authority would not borrow more than or in advance of need purely in order to profit from the investment of the extra sums borrowed. However advance borrowing might be taken if it was considered that current rates were more favourable than future rates and that this advantage outweighed the cost of carrying advance borrowing. Any decision to borrow in advance would be considered carefully to ensure value for money could be demonstrated and that the Authority could ensure the security of such funds and relationships.

 

Debt Restructuring

The Authority’s debt had arisen as a result of prior years' capital investment decisions. It had not taken any new borrowing out since 2007 as it had been utilising cash balances to pay off debt as it matured, or when deemed appropriate with the Authority making early payment of debt. The anticipated holding of debt at 31 March 2019 was £2.0m. All the debt was from the Public Works Loans Board (PWLB) and was all at fixed rates of interest (4.5%), repayable on maturity. This debt was taken out in 2007 when base rate was 5.75% and when the Authority was earning 5.84% return on its investments. Given the high interest rates payable on these loans, relative to current interest rates, we had again reviewed opportunities for debt repayment/restructuring.

 

The level of penalty applicable on early repayment of loans now stood at £0.9m.  Outstanding interest payable between now and maturity was £1.6m which gave a gross saving of £0.7m.

 

However, any early repayment meant that cash balances available for investment would be reduced and hence interest receivable would also be reduced. The extent of which was dependent upon future interest rates. It was estimated that if the interest rate on investments was at 1.25% over the remaining period of the loan then repaying the loans now would be broadly neutral. 

 

If returns on investments over the next 20 years exceed 1.25% then it was financially disadvantageous to pay off the loans, if interest rate averaged less than 1.25% then it was financially advantageous. It was noted that other than during the current financial crisis, interest rates had never been at such a low rate. If, as seemed likely, interest rates proved to be higher than this then the early repayment of debt resulted in a worse overall financial position.

 

It was also noted that whilst the capital budget did not show any additional borrowing being required in the next 5 years, it did not include any allowance for relocating SHQ. This project was currently on hold and should the Authority decide to proceed with the relocation it would need to take out additional borrowing to meet the costs.

 

Investment Strategy

At 31st December 2018 the Authority held £38.1m invested funds, representing income received in advance of expenditure plus existing balances and reserves.  In the past 12 months, the Authority’s investment balance had ranged between £28.5m and £48.3m. The variation arose principally due to the timing of the receipt of government grants. It was anticipated that similar levels would be maintained in the forthcoming year.

 

Both the CIPFA Code and the CLG Guidance required the Authority to invest its funds prudently, and to have regard to the security and liquidity of its investments before seeking the highest rate of return, or yield.  The Authority’s objective when investing money was to strike an appropriate balance between risk and return, minimising the risk of incurring losses from defaults and the risk receiving unsuitably low investment income.  Therefore in line with the guidance the Treasury Management Strategy was developed to ensure the Fire Authority would only use very high quality counterparties for investments.  The Authority may invest its surplus funds with any of the counterparties outlined in the report, subject to the cash and time limits shown. 

 

The investment in LCC as part of the call account arrangement was excluded from the limits shown in the report as the balance on this account was dependent upon short term cash flows and therefore did not have a limit.                                       

 

Whilst the investment strategy had been amended to allow greater flexibility with investments any decision as to whether to utilise this facility would be made based on an assessment of risk and reward undertaken jointly between the Director of Corporate Services and LCC Treasury Management Team, and consideration of this formed part of the on-going meetings that took place throughout the year.

 

Currently all of the Authority's investments were with other local authorities. The Authority currently had access to a call (instant access) account with a local authority, which paid bank rate, this was currently 0.75%. Each working day the balance on the Authority's current account was invested to ensure that the interest received on surplus balances was maximised. 

 

In addition a longer term loans had been placed with a UK local authority as outlined in the report.

 

Consideration would be given to fixing further investments if the maturity fit with estimated cash flows and the rate was considered to be attractive.

 

The overall combined amount of interest earned on Fixed/Call balances as at 31st December 2018 was £0.3m on an average balance of £38.3m at an annualised rate of 0.90%. This compared favourably with the benchmark 7 day LIBID which averaged 0.48% over the same period, and is 0.15% above the current bank rate.

 

Specified and Non-specified investments

The legislative and regulatory background to treasury management activities required the Authority to set out its use of “specified” and “non-specified” investments.  Specified Investments as defined by the CLG Guidance were those:-

 

·        denominated in pound sterling,

·        due to be repaid within 12 months of arrangement,

·        not defined as capital expenditure by legislation, and invested with one of:

o   the UK Government,

o   a UK local authority, parish council or community council, or

o   a body or investment scheme of “high credit quality”.

 

The Authority defined “high credit quality” organisations as those having a credit rating of A+ or higher that were domiciled in the UK or a foreign country with a sovereign rating of AA+ or higher.

 

Non-specified investment was any investment not meeting the definition of a specified investment.  The Authority did not intend to make any investments denominated in foreign currencies, nor any that were defined as capital expenditure by legislation, such as company shares.  Non-specified investments would therefore be limited to long-term investments, i.e. those that were due to mature 12 months or longer from the date of arrangement, and investments with bodies and schemes not meeting the definition on high credit quality.

 

The Authority may lend or invest money using any of the following instruments:-

 

• interest-bearing bank accounts,
• fixed term deposits and loans,
• callable deposits where the Authority may demand repayment at any time (with or without notice),
• certificates of deposit,
• bonds, notes, bills, commercial paper and other marketable instruments, and

 

Investments may be made at either a fixed rate of interest, or at a variable rate linked to a market interest rate, such as LIBOR, subject to the limits on interest rate exposures.

 

Minimum Revenue Provision (MRP)

Under Local Authority Accounting arrangements the Authority was required to set aside a sum of money each year to reduce the overall level of debt. This sum was known as the Minimum Revenue Provision (MRP).

 

The Authority would assess their MRP for 2018/19 in accordance with guidance issued by the Secretary of State under section 21(1A) of the Local Government Act 2003. 

 

It was proposed to continue to utilise the Capital Financing Requirement (CFR) Method. This provided for a charge of 4% of the value of fixed assets, as measured on the balance sheet, for which financing provision had not already been made.  The Authority may make a voluntary MRP depending upon the overall financial position and the Director of Corporate Services would have the authority to authorise a voluntary MRP.

 

Whilst the Authority had no unsupported borrowing, nor had any plans to take out any unsupported borrowing it needed to approve a policy relating to the MRP that would apply if this were not the case. As such in accordance with the Local Government Act 2003, the MRP on any future unsupported borrowing would be calculated using the Asset Life Method.  However, the Authority reserved the right to determine useful life periods and prudent MRP in exceptional circumstances where the recommendations of the guidance would not be appropriate. 

 

Assets held under PFI contracts and finance leases formed part of the Balance Sheet. This had increased the overall capital financing requirement and on a 4% basis the potential charge to revenue. To prevent the increase the guidance permitted a prudent MRP to equate to the amount charged to revenue under the contract to repay the liability. In terms of the PFI schemes this charge formed part of the payment due to the PFI contractor.

 

Prudential Indicators for 2018/19 (revised) to 2021/22 in respect of the Combined Fire Authority's Treasury Management Activities

In accordance with its statutory duty and with the requirements of the Prudential Code for Capital Finance and the CIPFA Code for Treasury Management, the Combined Fire Authority produced each year a set of prudential indicators which regulated and controlled its treasury management activities.

 

The report detailed the debt and investment-related indicators which provided the framework for the Authority’s proposed borrowing and lending activities over the coming 3 years.  These indicators would also be approved by members as part of the Capital Programme approval process along with other capital expenditure-related indicators, but needed to be reaffirmed and approved as part of this Treasury Management Strategy.

 

It was noted that contained within the external debt limits, there were allowances for outstanding liabilities in respect of the PFI schemes and finance leases for operational vehicles and photocopiers.

 

RESOLVED:- That the Authority:-

i)     Approved the revised Treasury Management Strategy, including the Prudential Indicators, as set out in the report now presented;

ii)    Agreed the Minimum Revenue Provision calculation as set out in the report as now presented; and

iii)   Agreed the Treasury Management Policy Statement as now presented.