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Appendix J - Treasury Management Strategy

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Treasury Management Strategy 2021/22

Introduction

Treasury management is the management of the Council's cash flows, borrowing and investments, and the associated risks.

The Council has borrowed and invested substantial sums of money and is therefore exposed to financial risks including the loss of invested funds and the revenue effect of changing interest rates. The successful identification, monitoring and control of financial risk are therefore central to the Council's prudent financial management.

Treasury risk management at the Council is conducted within the framework of the Chartered Institute of Public Finance and Accountancy's Treasury Management in the Public Services - Code of Practice 2017 Edition (the CIPFA Code) which requires the Authority to approve a treasury management strategy before the start of each financial year. This report fulfils the Authority's legal obligation under the Local Government Act 2003 to have regard to the CIPFA Code.

Investments held for service purposes or for commercial profit are considered in a different report, the Investment Strategy (see Appendix K).

The current investment strategy is to seek to ensure sufficient liquidity so that longer term investment balances are available to fund future capital schemes such as the Harris Quarter Leisure Scheme and until the full financial impacts of Coronavirus are known.

Economic background

The impact on the UK from coronavirus, lockdown measures, the rollout of vaccines, as well as the new trading arrangements with the European Union will remain a major influence on the Council's treasury management strategy for 2021/22.

UK Consumer price Inflation was 0.3% for November 2020 year on year, down from 0.70% in the previous month. The most recent labour market data for the three months to October 2020 showed the unemployment rate rose to 4.9%.

Interest rate forecast: the forecast for the Bank Rate is 0.10% for the foreseeable future (see Table 1). Investment yields remain low due to the UK and global economic outlooks and are expected to remain low in the medium term.

Table 1 - Arlingclose Interest Rate Forecast

QUARTER ENDINGBANK RATE

INVESTMENT RATES

Borrowing rates

  3 MONTHS %5 YEAR %5 YEAR %20 YEAR %50 YEAR
March 20210.100.100.000.801.501.40
June 20210.100.100.000.801.501.40
September 20210.100.150.050.851.551.45
December 20210.100.150.100.901.551.45
March 20220.100.200.150.951.551.45
June 20220.100.200.201.001.601.50
September 20220.100.200.201.001.601.50
December 20220.100.200.201.001.651.55
March 20230.100.200.251.051.651.55
June 20230.100.200.251.051.651.55
September 20230.100.200.251.051.651.55
December 20230.100.200.251.051.701.60

 

Treasury Balances Forecast

On 31 December 2020, the Authority held £12.3m of borrowing and £63.9m of investments. This is set out in further detail in Table 2.

Table 2 - Existing Investment and Debt Portfolio Position at 31.12.20

External Borrowing
  • Public Works Loan Board - £1.9 mill
  • Bank Loans - £10.4 mill
  • Total External Borrowing - £12.3 mill
Treasury investments - Short Term
  • Banks (unsecured) - £9.8 mill*
  • Local Authorities  - £17.5 mill
  • Money Market Funds  - £16.6 mill
Treasury investments - Long Term - Other pooled funds
  • Cash Funds - £16.5 mill

  • Bond Funds - £3.5 mill

  • Total Treasury Investments - £63.9 mill

  • Net Lending (Investments less borrowing) - £51.6 mill

*This includes £2m in a green deposit investment to finance environmentally sustainable initiatives like renewable energy projects.

Forecast changes in these sums are shown in the balance sheet analysis in Table 3.

 

31.03.21

FORECAST £M

31.03.22

FORECAST £M

31.03.23

FORECAST £M

31.03.24

FORECAST £M

NOTES
Capital Financing Requirement (CFR)21.926.031.831.31
Less: Long Term Borrowing already taken(12.3)(12.3)(12.3)(12.3)2
Cumulative Borrowing Requirement9.613.719.519.03
Usable Reserves and Provisions at 31 March43.339.837.233.54
Working Capital7.05.05.05.05
Less: Internal Borrowing(9.6)(13.7)(19.5)(19.0)6
Cash available for Investment40.731.122.719.57

 

Notes to Table 3

  1. The CFR is the amount the Authority needs to borrow for a capital purpose. The CFR increases when Prudential Borrowing is used to finance the capital programme. The Authority's capital expenditure plans are the key driver of treasury management activity and are summarised in the Capital Strategy Report.
  2. This is the amount of debt that the Authority has already borrowed.
  3. This is the cumulative amount of new borrowing that is required to finance the Capital Programme. The timing of new borrowing will be determined by the profile of capital expenditure and the availability of Internal Borrowing (Note 7).
  4. This line represents the amount of usable reserves, balances and provisions which are available as cash. The forecast changes to the amount of usable reserves and provisions are determined by the drawdown of reserves, balances and provisions as estimated in the Financial Forecast Update 2020/21 to 2024/25 and the Capital Programme.
  5. Working Capital is a temporary surplus in day to day cash. The current balance represents an estimate of cash held at 31 March 2021 pending the outcome of NNDR appeals and cash held on behalf of the Collection Fund (being Preston City Council, the County Council, the Police Authority and the Fire Authority).
  6. Internal Borrowing occurs when the Authority uses its own cash resources to finance capital expenditure rather than new external borrowing. This is a prudent approach when investment returns are low. The amounts shown are the cumulative amount of borrowing required for each year.  Over the life of this forecast, the total amount of internal borrowing is £19.0m by 2024.
  7. This is the forecast amount of cash available for investment after allowing for the funding of Internal Borrowing.

The underlying need to borrow for capital purposes is measured by the Capital Financing Requirement (CFR), while usable reserves and working capital are the underlying resources available for investment. The Authority's current strategy is to maintain borrowing and investment, below their underlying levels, sometimes known as internal borrowing.

The Authority has an increasing CFR due to the capital programme. The cash available for investing reduces as reserves are drawn down, working capital is depleted and internal borrowing is used to fund the Capital Programme.

CIPFA's Prudential Code for Capital Finance in Local Authorities recommends that the Authority's total debt should be lower than its highest forecast CFR over the next three years. Table 3 shows that the Authority expects to comply with this recommendation during 2021/22.

The budget for investment income in 2021/22 is £0.18m at an average interest rate of 1.2% and the budget for debt interest paid in 2021/22 is £0.59m based on an average debt portfolio of £12.3m at an average interest rate of 4.8%. If actual levels of investments and borrowing, or actual interest rates, differ from those forecast, performance against budget will be correspondingly different.

Borrowing Strategy

The Authority currently holds £12.3m of loans as part of its strategy for funding previous years' capital programmes.

The Treasury Balances Forecast in Table 3 shows that the Authority does not expect to need to borrow in 2021/22. The Authority may however borrow to pre-fund future years' requirements, providing this does not exceed the authorised limit for borrowing of £22.3m.

Objectives

The Authority's chief objective when borrowing money is to strike an appropriately low risk balance between securing low interest costs and achieving certainty of those costs over the period for which funds are required. The flexibility to renegotiate loans in the event that the Council's long-term plans change is a secondary objective.

Strategy

Given the significant cuts to public expenditure and in particular to local government funding, the Council's borrowing strategy continues to address the key issue of affordability. With short-term interest rates currently much lower than long-term rates, it is likely to be more cost effective in the short-term to either use internal resources, or to borrow short-term loans instead.

By doing so, the Council is able to reduce borrowing costs and reduce overall treasury risk.

The benefits of internal borrowing will be monitored regularly and this strategy will be reviewed if the outlook for borrowing rates indicates a significant risk of a rise in borrowing rates, with the outcome that external loans may be taken whilst borrowing rates are relatively cheap. 

The Council may borrow short-term to cover unexpected cash flow movements.

The Council has previously raised some of its long-term borrowing from the PWLB but will consider long-term loans from other sources including banks, pensions and local authorities and will consider the possibility of issuing bonds and similar instruments in order to lower interest costs.

PWLB loans are no longer available to local authorities who are planning to buy investment assets primarily for yield and the Council intends to avoid this activity in order to retain access to PWLB loans.

The Council is legally obliged to set an affordable borrowing limit (also termed the authorised limit for external debt) each year. In line with statutory guidance, a lower "operational boundary" is also set as a warning level should debt approach the limit.

Table 4 - Prudential Indicators: Authorised limit and Operational Boundary for External Debt

Authorised Limit - maximum external debt

  • 2020/21 limit (£m) - 22.3
  • 2021/22 limit (£m) - 22.3
  • 2022/23 limit (£m) - 22.3
  • 2023/24 limit (£m) - 22.3

Operational Boundary - total external debt

  • 2020/21 limit (£m) - 14.3
  • 2021/22 limit (£m) - 14.3
  • 2022/23 limit (£m) - 14.3
  • 2023/24 limit (£m) - 14.3

Sources of borrowing

The approved sources of long-term and short-term borrowing are:

  • HM Treasury's PWLB lending facility (formerly the Public Works Loan Board)
  • Any institution approved for investments (see below)
  • Any other bank or building society authorised to operate in the UK
  • Any other UK public sector body
  • UK public and private sector pension funds (except Lancashire County Pension Fund as it is the Council's own pension fund)
  • Capital market bond investors
  • UK Municipal Bonds Agency plc and other special purpose companies created to enable local authority bond issues

Other sources of debt finance: In addition, capital finance may be raised by the following methods that are not borrowing, but may be classed as debt liabilities:

  • Leasing
  • Hire purchase
  • Sale and leaseback and similar arrangements

All decisions on borrowing will be reported to the Cabinet Member for Resources in the Quarterly Treasury Management Report.

Investment Strategy

The Council holds significant invested treasury funds, representing income received in advance of expenditure, monies held on behalf of the Collection Fund (Lancashire County Council, the Police and Crime Commissioner for Lancashire and Lancashire Combined Fire Authority) plus balances and reserves held.

Objectives

The CIPFA Code requires the Authority to invest its treasury 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 is to strike an appropriate balance between risk and return, minimising the risk of incurring losses from defaults and the risk of receiving unsuitably low investment income.

Negative interest rates

The Covid-19 pandemic has increased the risk that the Bank of England will set the Bank Rate at or below zero. As investments cannot pay negative income, negative rates will be applied by reducing the value of investments.

In this event, security will be measured as receiving the contractually agreed amount at maturity, even though this may be less that the amount originally invested.

Strategy

Whilst the Council explores the regeneration strategy for the Harris Quarter, the Council will continue to adopt a prudent approach to investment management to ensure that cash balances are readily available to fund the Harris Quarter Leisure scheme and the response to the Covid-19 pandemic.

It is a requirement that the Council's investments follow the government guidance on local government investments and the CIPFA Treasury Management Code of Practice.

To comply with this, the Council must prioritise security, liquidity and yield in that order.

The Council has declared a climate change emergency to tackle the drivers and impact of climate change. The Council recognises that it may further enhance its efforts through its investments decisions.

Ethical investing is an approach to investing which considers values as well as returns but at the present time there is no financial regulation and different investment managers take different approaches making the information provided inconsistent, subjective, and difficult to compare.

Regulators are beginning to introduce measures to standardise how companies report their environmental impact.

The UK Financial Conduct Authority is considering introducing a set of principles to help firms deliver reliable and sustainable investment products that will help investors make better informed choices. Until that time, the Council will consider ethical investments opportunities as they arise but they must first meet all statutory investment guidance considerations.

Approved counterparties: The Authority may invest its surplus funds with any of the counterparty types in Table 5 below, subject to the cash limits (per counterparty) and the time limits shown.

Table 5 - Approved investment counterparties and limits

Investment Type / Minimum Credit

Rating (Note 1)

Banks Unsecured

(Note 2)

Banks Secured

(Note 3)

Government

(Note 4)

UK Governmentn/an/a

£ Unlimited 50 years

UK Treasury Billsn/an/a

£13m in Total for 6 months

UK Local Authoritiesn/an/a

£5m each for 1 year

Investment Rated A

£2m each for 6 months

£4m each for 1 yearn/a
UK Unrated Building Societies (Note 5)£1m each (maximum of £2m) for 3 months
Money Market Funds (Note 6)£3m per Fund
Cash Plus Funds (Note 6)£6m per Fund (£20m in Total)
Bond Funds (Note 6)£5m in Total
Multi Asset Funds (Note 7)£5m per Fund (£10m in Total)

Property Funds and Real Estate Investment Trusts (Note 7)

£5m in Total

Registered Providers (Preston area) (Note 8)

£5m in Total for 5 years
Any other organisation (Note 9)£100k each for 5 years

This table must be read in conjunction with the notes below.

Notes to Table 5

  1. Credit rating: Investment limits are set by reference to the lowest published long-term credit rating from a selection of external rating agencies. However, investment decisions are never made solely based on credit ratings, and all other relevant factors including external advice will be taken into account.
  2. Banks unsecured: Includes accounts, deposits, certificates of deposit and unsecured bonds with banks and building societies. These investments are subject to the risk of credit loss via a bail-in should the regulator determine that the bank is failing or likely to fail. See below for arrangements relating to operational bank accounts.
  3. Banks secured: Includes covered bonds, reverse repurchase agreements and other collateralise arrangements with banks and building societies. These investments are secured on the bank's assets, which limits the potential losses in the unlikely event of insolvency, and means that they are exempt from bail-in. Where there is no investment specific credit rating, but the collateral upon which the investment is secured has a credit rating, the higher of the collateral credit rating and the counterparty credit rating will be used to determine cash and time limits.
  4. Government: Includes loans, bonds and bills issued or guaranteed by national governments, regional and local authorities and multilateral development banks. These investments are not subject to bail- in, and there is generally a lower risk of insolvency. Investments with the UK Central Government may be made in unlimited amounts as a contingency in the event of a crisis.
  5. Building Societies: The Building Societies regulatory framework and insolvency regime means that in the unlikely event of a Building Society liquidation, the Authority's deposits would be paid out in preference to retail depositors. Most Building Societies do not have a credit rating, therefore, a credit analysis will be undertaken by Treasury Advisor's Arlingclose which will determine a preferred list of Building Societies with whom to invest.
  6. Pooled Funds: These Funds are shares in diversified investment vehicles which invest in any of the investment types above (Notes 2 to 4), plus equity shares and property. These funds provide wide diversification, together with the services of a professional Fund Manager. The Money Market Funds offer same-day liquidity and very low volatility and are used as an alternative to instant access bank accounts. There is no sector limit applying to Money Market Funds although the Council will take care to diversify its liquid investments over a variety of providers to ensure The Cash Plus and Bond Funds may be used for investments for a longer period and the value of these investments may change in line with market prices but offer enhanced returns over the longer term. These funds have no defined maturity date but are available for withdrawal after a short notice period.
  7. Multi-Asset and Property Funds: Multi-Asset funds are similar to the funds outlined in Note 6 and invest in a combination of cash, bonds, equity and property to diversify risk and enhance return. These funds will only be introduced and used following a review of the risks and rewards which would be first reported to the Cabinet Member of Resources. Property funds offer enhanced returns over the longer term, but are more volatile in the short term. These allow the Council to diversify into asset classes other than cash without the need to own and manage the underlying investments. These funds have no defined maturity date, but are more suitable to a minimum investment period of at least three to five years. As with property funds, Real Estate Investment Trusts offer enhanced returns over the longer term but are more volatile in terms of share price and the underlying value of the property.
  8. Registered providers: These are longer term loans or bonds that are secured or guaranteed on the assets of Registered Providers of Social Housing. These bodies are highly regulated by the Homes and Communities Agency and are likely to receive government support if needed.
  9. Other organisation: This is subject to an external credit assessment and specific advice from the Council's treasury management adviser.
  10. Foreign Countries: Investments with institutions domiciled in foreign countries rated AA+ or higher will be limited to £2m per foreign country. This limit does not apply to Pooled Funds as these funds spread their investments over many countries in order to reduce risk.
  11. Operational bank accounts: The Council's own bank account which is used for all of the Council's operational activities will have a minimum credit rating of BBB- and assets greater than £25 billion. The Bank of England has stated that in the event of failure, banks with assets greater than £25 billion are more likely to be bailed-in than made insolvent, increasing the chance of the Council maintaining operational continuity.   The balances in the Council's own bank account will ideally    be kept below

    £1m. Due to cash flow fluctuations this limit may be exceeded on occasion and if the limit is exceeded for more than three working days the Section 151 Officer will review.

  12. Risk assessment and credit ratings: Credit ratings are obtained and monitored by the Council's treasury advisers, who will notify changes in ratings as they occur. Where a credit rating agency announces that a counterparty of the Council is on review for a possible credit rating downgrade (so that it may fall below the approved rating criteria), then only investments that can be withdrawn on the next working day will be made until the outcome of the review is announced. This policy will not apply to credit rating 'negative outlooks' which indicate a long-term trend rather than an imminent change of credit rating.

  13. Other information on the security of investments: Credit ratings are not the only predictors of investment default. Other information is also used to assess the credit quality of counterparties. This information includes credit default swap prices, financial statements, potential government support and reports in the financial press. This information is analysed by the Council's treasury advisors and no investments will be made with an organisation if there are doubts about its credit quality, even though it may meet the credit rating criteria.

    When deteriorating financial market conditions affect the creditworthiness of all organisations, as happened in 2008 and 2020, this is not generally reflected in credit ratings, but can be seen in other market measures. In these circumstances, the Council will restrict its investments to those organisations of higher credit quality and reduce the maximum duration of its investments to maintain the required level of security. The extent of these restrictions will be in line with prevailing financial market conditions. If these restrictions mean that insufficient commercial organisations of high credit quality are available to invest the Authority's cash balances, then the surplus will be deposited with the UK Government via the Debt Management Office or invested in government treasury bills for example, or with other local authorities. This will cause a reduction in the level of investment income earned, but will protect the principal sum invested.

  14. Liquidity management: The Council uses a detailed daily cash flow forecast to determine the maximum period for which funds may prudently be committed. The forecast is compiled on a prudent basis to minimise the risk of the Council being forced to borrow on unfavourable terms to meet its financial commitments. Limits on long-term investments are set by reference to the Council's medium-term financial plan and cash flow forecast.

    The Council spreads its liquid cash over a number of providers (eg. Bank accounts and money market funds) to ensure that access to cash is maintained in the event of operational difficulties at any one provider.

Treasury Management Indicators

The Authority measures and manages its exposures to treasury management risks using the following indicators.

Maturity structure of borrowing: This indicator is set to control the Authority's exposure to refinancing risk. The upper and lower limits on the maturity structure of borrowing will be:

Table 6 - Maturity Structure of Debt

  • Under 12 months - Lower Limit 0% - Upper Limit 40%
  • 12 months to 2 years - Lower Limit 0% - Upper Limit 50%
  • 2 years to 5 years - Lower Limit 0% - Upper Limit 50%
  • 5 years to 10 years - Lower Limit 0% - Upper Limit 60%
  • 10 years and above - Lower Limit 0% - Upper Limit 100%

No lower limit is set in order to allow flexibility when managing the debt portfolio in the current economic conditions.

Table 7 - Limits for Investments over 364 Days

Principal sums invested for periods longer than a year: This limit is set to ensure adequate liquidity of investments and is the maximum amount of funds the Council will invest longer term.

Limit for investments over 364 days

  • 2021/22 - £8.3 mil
  • 2022/23 - £8.3 mil
  • 2023/24 - £8.3 mil

Security - the exposure to credit risk is monitored by measuring the average credit rating of its investment portfolio with a target rating of A-.

Liquidity - the Authority will manage its cashflow so as not to go overdrawn.

Yield - the benchmark for returns on investments is the Sterling Overnight Index Average (SONIA).  Actual investment returns are monitored against budget.

There are a number of additional items that the Council is obliged to include in the Treasury Management Strategy.  These are:

  • Policy on use of financial derivatives - the Council will only use financial derivatives (such as swaps, forwards, futures and options) where it can be clearly demonstrated to reduce the level of financial risks that the Council is exposed to. Embedded derivatives, including those present in pooled funds and forward starting transactions, will not be subject to this policy, although the risks they present will be managed in line with the overall treasury risk management strategy.
  • In line with the CIPFA Code, the Council will seek external advice and will consider that advice before entering into financial derivatives to ensure that it fully understands the implications.

Other Options Considered

The CIPFA Code does not prescribe any particular treasury management strategy for local authorities to adopt. The Section 151 Officer, having consulted the Cabinet Member for Resources, believes that the above strategy represents an appropriate balance between risk management and cost effectiveness. Some alternative strategies, with their financial and risk management implications, are listed below.

Alternative

Impact on income and expenditure

Impact on risk management

Invest in a narrower range of counterparties and/or for shorter times

Interest income may be lower

Lower chance of losses from credit related defaults, but any such losses may be greater

Invest in a wider range of counterparties and/or for longer times

Interest income may be higher

Increased risk of losses from defaults and reduced liquidity

Borrow additional sums at long- term fixed interest rates

Debt interest costs will rise; this is unlikely to be offset by higher investment income

Higher investment balance leading to a higher impact in the event of a default; however long- term interest costs may be more certain

Borrow short-term or variable loans instead of long-term fixed rates

Debt interest costs will initially be lower

Increases in debt interest costs will be broadly offset by rising investment income in the medium term, but long-term costs may be less certain

Reduce level of borrowing

Penalties for repaying debt early will significantly impact on Revenue budgets

Long-term interest costs may be less certain

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