Agenda item

The Director of Corporate Services / Treasurer presented the report that set out the Treasury Management Policy and Strategy for 2021/22.

 

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 2021/22

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 had 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 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 2021/22

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 impact on the UK from coronavirus, lockdown measures, the rollout of vaccines, as well as the new trading arrangements with the European Union (EU), would remain major influences on the Authority’s treasury management strategy for 2021/22.

 

The Bank of England (BoE) maintained Bank Rate at 0.10% in December 2020 and Quantitative Easing programme at £895 billion having extended it by £150 billion in the previous month. The BoE also forecast the economy would now take until Q1 2022 to reach its pre-pandemic level rather than the end of 2021 as previously forecast.

 

UK Consumer Price Inflation (CPI) for November 2020 registered 0.3% year on year, down from 0.7% in the previous month.

 

Interest Rate Forecast and Prospects for Market Liquidity

The treasury management consultant Arlingclose was forecasting that BoE Bank Rate would remain at 0.1% until at least the first quarter of 2024. The risks to this forecast were judged to be to the downside as the BoE and UK government continued to react to the coronavirus pandemic and the new EU trading arrangements.  Members considered the latest forecast as presented in the report.  It was noted that the Authority could borrow at 80 basis points above the gilt yield, for example a fixed interest rate to borrow PWLB money for 10 years would be 1.05%, 0.25% plus 0.80%.

 

Current Treasury Portfolio Position

At the 31 December 2020 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	24.110	61.6
Fixed rate investments	15.000	38.4
	39.110	100%

 

The level of investment 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 £37.110m.

 

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, this gave an indication of the borrowing required. 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 table in the report gave an indication of the minimum borrowing or investment requirement through the period.

 

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 in the next three years. A voluntary MRP was made 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 at 31.3.20. 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.   The table 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 in the next three years it did currently hold £2.0m of loans as part of its strategy for funding previous years' capital programmes. The draft capital programme, reported elsewhere on the agenda, identified a borrowing requirement in 2025/26.

 

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 extremely unlikely that borrowing would be required in 2021/22. 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. 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 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 has 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 2021 was £2.0m. All the debt was from the Public Works Loans Board (PWLB) and was all at fixed rates of interest and was 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, the opportunities for debt repayment/restructuring had again been reviewed.

 

The level of penalty applicable on early repayment of loans now stood at £1.180m.

 

Outstanding interest payable between now and maturity was £1.407m.

 

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 were at 0.7% over the remaining period of the loan then repaying the loans now would be broadly neutral. 

 

It was noted that the capital budget allowed for additional borrowing within the next 5 years. Current long-term borrowing rates were 1.67% for a 25-year loan and 1.49% for a 50-year loan, both of which exceed the breakeven position noted above. Hence given the penalties it was considered beneficial to retain these loans.

 

Investment Strategy

At 31^st December 2020 the Authority held £39.110m invested funds, representing income received in advance of expenditure plus existing balances and reserves.  During the year the Authority’s investment balance had ranged between £28.6m and £52.0m. 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.

 

Regarding the risk of investing with another local authority, only a very few authorities have their own credit rating.  Any lender to a local authority had protection, under statute, by way of a first charge on the revenues of that authority. No local authority had ever defaulted to date and this also may be an indication of security. However, following the downgrade of the UK credit rating by the rating agencies those local authorities with a rating saw a reduction in their ratings. Therefore, consideration had been given to reducing the risk associated with the investment with other local authorities. Arlingclose, the County Council's Treasury Management advisor, stated they were "comfortable with clients making loans to UK local authorities for periods up to two years, subject to this meeting their approved strategy. For periods longer than two years we recommend that additional due diligence is undertaken prior to a loan being made."  On that basis it was proposed that the investments to local authorities be limited as follows:

 

	Maximum individual investment (£m)	Maximum total investment (£m)	Maximum period
Up to 2 years	5	30	2 years
Over 2 years	5	25	10 years

                                       

The investment in LCC as part of the call account arrangement was excluded from the above limits. The balance on that 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 base rate, this is currently 0.10%. 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 2021/22.

 

Start Date	End Date	Principal	Rate	Interest 2021/22
10/12/19	10/06/21	£5,000,000	1.20	£11,506
20/04/20	20/04/22	£5,000,000	1.45	£72,500
24/04/20	25/04/22	£5,000,000	1.45	£72,500

 

Consideration was given to 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. Suggested rates payable by other local authorities indicated were:

 

3 month investment	0.05-0.11%
6 month investment	0. 05-0.15%
12-month investment	0.12-0.28%
3-year investment	0.53-0.68%
4-year investment	0.62-0.77%

 

The overall combined amount of interest earned on Fixed/Call balances as at 31st December 2020 was £0.197m on an average balance of £42.6m at an annualised rate of 0.61%. This compared favourably with the benchmark 7 day LIBID rate which averaged 0.12% over the same period, and was 0.51% above the current bank rate.

 

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 2021/22 in accordance with guidance issued by the Secretary of State under section 21(1A) of the Local Government Act 2003.  

 

The Authority made a voluntary MRP in 2019/20 and it was anticipated that the MRP on loans would be nil in 2021/22 this would 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 2021/22 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 was 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 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.

 

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 the proposed budget 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)	(0.175)	(0.075)	(0.060)
Net budget	(0.222)	(0.075)	0.025	0.040

 

Although the MRP requirement was currently nil the budget included a provision for making a charge either due to incurring a small amount of borrowing or to make a voluntary MRP to offset against future requirements.

 

Prudential Indicators for 2020/21(revised) to 2023/24 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, accounting standards were likely to change 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.

 

In response to a question raised by County Councillor O’Toole, the Director of Corporate Services confirmed that all the Authority’s investments were with other local authorities.

 

RESOLVED – That the Authority:

 

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

ii)            Agreed the Minimum Revenue Provision calculation as now presented; and

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