Agenda item

The Director of Corporate Services presented the report that set out the Treasury Management Policy and Strategy for 2020/21.

 

Statutory Requirements

The Local Government Act 2003 (the Act) and supporting Regulations required the Authority to “have regard to” the Chartered Institute of Public Finance and Accountancy (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 2020/21

The 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 have properly fulfilled their responsibilities with regard to delegation and reporting.

 

The Authority had adopted reporting arrangements in accordance with the requirements of the Code as set out in the report.

 

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

 

•        Prudential Indicators which will 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 2020/21

In setting the treasury management strategy the: economic forecasts, interest rate forecasts, the current structure of the investment and debt portfolio and the future capital programme and underlying cash forecasts were considered.

 

Economic Context

The UK economy had been affected by concerns over the world economy, in particular the trade war between the USA and China, and the uncertainty arising from the UK's exit from the European Union. The Bank of England set its monetary policy to achieve the government’s target of keeping inflation at 2%. The latest inflation rate was measured by the Consumer Prices Index as 1.5%. In the short term, the Bank of England had to balance the target of low inflation with supporting economic growth and jobs. As a result, the base rate had remained at 0.75% throughout 2019 with the last movement being a 0.25% increase in August 2018.

 

The Bank of England monetary policy committee met on 19 December 2019 with the committee’s latest projections for activity and inflation being set out in the November Monetary Policy Report and assumed an orderly transition to a free trade agreement between the United Kingdom and the European Union. UK Gross Domestic Product growth was projected to pick up, supported by the reduction of Brexit-related uncertainties, an easing of fiscal policy and a modest recovery in global growth. With demand growth outstripping the subdued pace of supply growth, excess demand and domestic inflationary pressures were expected to build gradually. Consumer Prices Index inflation was projected to rise slightly above the 2% target towards the end of the forecast period.  

 

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.

 

The latest forecast of long-term interest rates as provided by Treasury Consultants Arlingclose Ltd was shown in the report. 

 

Current Treasury Portfolio Position

At the 31 December 2019 the debt and investments balances were: -

 

Debt	Principal £m	%
Fixed rate loans from the Public Works Loan Board	2.000	100%
Variable rate loans		-
	2.000	100%
Investments
Variable rate investments with Lancashire County Council	29.575	85.5
Fixed rate investments	10.000	14.5
	39.575	100%

 

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 £37.575m.

 

Borrowing and Investment Requirement

In the medium term LCFA 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 in the report compared the estimated CFR to the debt which currently existed.

 

The CFR forecast included the impact of the latest forecast of the funding of the Capital Programme which currently assumed that there would be no borrowing until 2022/23. It also included a voluntary MRP in 2019/20 to take the future loans element of the MRP to nil.

 

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 three years. However, the table in the report showed that the level of loans was above the CFR, which 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.   The table also indicated that rather than having a need for borrowing it was estimated that 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

The draft Capital Programme implied there may be a requirement to use borrowing to fund the capital programme in the later years. At this stage it was unlikely that borrowing would be required in 2020/21. However, 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.

 

In the past the Authority had raised all of its long-term borrowing from the Public Works Loan Board, but if long term borrowing was required other sources of finance, such as local authority loans, and bank loans, would be investigated that may be available at more favourable rates. This was especially the case as in October 2019 the PWLB announced that its loan rates would be increased to be 1.8% above the rate of Gilts rather than 0.8% as it was, at the time.

 

Short term borrowing if required would most likely be taken from other local authorities.

 

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 and UK public and private sector pension funds.

 

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 may 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.

 

In determining whether borrowing would be undertaken in advance of need the Authority would: Ensure that there was a clear link between the capital programme and the maturity profile of the existing debt portfolio which supported the need to take funding in advance of need; Ensure the on-going revenue liabilities created, and the implications for the future plans and budgets had been considered; Evaluate the economic and market factors that might influence the manner and timing of any decision to borrow; Consider the merits and demerits of alternative forms of funding and; Consider the alternative interest rate bases available, the most appropriate periods to fund and repayment profiles to use.

 

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 2020 was £2.0m. All the debt was from the Public Works Loans Board (PWLB) at fixed rates of interest and repayable on maturity. This debt was taken out in 2007 when the 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 £1.131m.

 

Outstanding interest payable between now and maturity was £1.497m. Giving a gross saving of £0.366m.

 

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 interest rate on investments was at 1.1% over the remaining period of the loan then repaying the loans now would be broadly neutral.  If they were higher, then lost investment interest would exceed the interest saving on repayment and if they were lower then lost investment returns would be lower than the saving on repayment.

 

It was also noted that the draft capital budget potentially required additional borrowing in 2023/24 and 2024/25. Given the penalties it was considered beneficial to retain these loans.

 

In relation to debt restructuring County Councillor O’Toole commented that, as guardians of public money he did not think the Authority should borrow without good need to borrow.

 

Investment Strategy

At 31^st December 2019 the Authority held £39.575m 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 £27.7m and £48.0m. 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 MHCLG 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 as set out in the report. 

 

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 base 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, longer term loans had been placed with UK local authorities to enhance the interest earned. To this end at the following investments were already impacting 2020/21.

 

Start Date	End Date	Principal	Rate	Interest 2020/21
18/10/18	19/10/20	£5,000,000	1.15	£31,664
10/12/19	10/06/21	£5,000,000	1.20	£60,000
20/04/20	20/04/22	£5,000,000	1.45	£68,726

 

Consideration was given fixing further investments if the maturity fit with estimated cash flows and the rate was considered to be attractive. This would continue to be reviewed. Current rates payable by other local authorities indicated by brokers were:

 

3-month investment	0.85%
6-month investment	0.90%
12-month investment	1.00%

 

The overall combined amount of interest earned on Fixed/Call balances as at 31st December 2019 was £0.257m on an average balance of £37.5m at an annualised rate of 0.91%. This compared favourably with the benchmark 7?day LIBID rate which averages 0.57% over the same period, and was 0.16% 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: The CLG Guidance defined specified investments as 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:

•     the UK Government,

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

•     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 are domiciled in the UK or a foreign country with a sovereign rating of AA+ or higher.

 

Non-Specified Investments: were any investment not meeting the definition of a specified investment was classed as non-specified.  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 below.

 

The Authority prepared daily cash flow forecasts to determine the maximum period for which funds may prudently be committed.  The forecast was compiled on a pessimistic basis, with receipts under-estimated and payments over-estimated to minimise the risk of the Authority being forced to borrow on unfavourable terms to meet its financial commitments. Limits on long-term investments were set by reference to the Authority’s medium-term financial plan and cash flow forecast.

 

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 2020/21 in accordance with guidance issued by the Secretary of State under section 21(1A) of the Local Government Act 2003.  

 

The Authority had made a voluntary MRP in 2019/20 and it was anticipated that the MRP on loans will be nil in 2020/21 this will be the case until capital expenditure was financed by borrowing.

 

Whilst the Authority had no unsupported borrowing, nor had any plans to take out any unsupported borrowing in 2020/21 it was prudent to approve a policy relating to the MRP that would apply if circumstances changed.  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. This would be based on a straightforward straight–line calculation to set an equal charge to revenue over the estimated life of the asset. Estimated life periods would be determined under delegated powers. To the extent that expenditure was not on the creation of an asset and is of a type that was subject to estimated life periods that were referred to in the guidance, these periods would generally be adopted by the Authority.  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. 

 

As some types of capital expenditure incurred by the Authority were not capable of being related to an individual asset, asset lives would be assessed on a basis which most reasonably reflected the anticipated period of benefit that arose from the expenditure.  Also, whatever type of expenditure was involved, it would be grouped together in a manner which reflected the nature of the main component of expenditure and would only be divided up in cases where there were two or more major components with substantially different useful economic lives.

 

Assets held under a PFI contract 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.

 

Revenue Budget

The capital financing budget currently showed that income received exceeded expenditure. This excluded the PFI and Finance lease payments, which were included in other budgets. Based on the Strategy outlined then the proposed budgets for capital financing were:

 

	2020/21	2021/22	2022/23	2023/24
	£m	£m	£m	£m
Interest payable	0.090	0.090	0.090	0.090
MRP	0.010	0.010	0.010	0.010
Interest receivable	(0.322)	(0.297)	(0.322)	(0.347)
Net budget	(0.222)	(0.197)	(0.222)	(0.247)

 

Prudential Indicators for 2019/20(revised) to 2022/23 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 table in the report set out the debt and investment-related indicators which provided the framework for the Authority’s proposed borrowing and lending activities over the coming three 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 leases. However, from 1 April 2020 accounting standards were changing in relation to recording leases. In effect, more leases were likely to be included on the balance sheet and therefore would be included against the other long term liabilities indicators. At this stage work was on-going to quantify the impact of the change and therefore the other long-term liabilities limits may be subject to change.

 

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 (MRP) calculation as set out in the report as now presented; and

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