Treasury Management Strategy Statement and Annual Investment Strategy
Argyll and Bute Council · 16 February 2023
Back to Policy and Resources Committee — 16 February 2023 and its agenda
Text extracted from the council's PDF. Layout and reading order may differ from the original.
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ARGYLL AND BUTE COUNCIL POLICY AND RESOURCES COMMITTEE FINANCIAL SERVICES 16 FEBRUARY 2023 TREASURY MANAGEMENT STRATEGY STATEMENT AND ANNUAL INVESTMENT STRATEGY 1. EXECUTIVE SUMMARY 1.1 The Council has adopted the Chartered Institute of Public Finance and Accountancy (CIPFA) Code of Practice on Treasury Management in Local Authorities. A requirement of the Code is for an annual Treasury Management Strategy Statement and Investment Strategy to be approved by Council for the forthcoming financial year. This report seeks Member’s approval of the proposed Treasury Management Strategy Statement and Annual Investment Strategy. The report also sets out the policy for the repayment of loans fund advances for 2023-24. 1.2 The draft Treasury Management Strategy Statement and Annual Investment Strategy will be presented to the: • Policy and Resources Committee on 16 February 2023 • Council on 23 February 2023 • Audit and Scrutiny Committee on 16 March 2023 • If required, Council on 27 April 2023, following recommendations from the Audit and Scrutiny Committee that need approval from Council. 1.3 The Council uses Link Treasury Services as its external treasury management advisors. The Council recognises that there is value in employing external providers of treasury management services in order to acquire access to specialist skills and resources. The Council will ensure that the terms of their appointment and the methods by which their value will be assessed are properly agreed and documented, and subject to regular review. 1.4 Section 2 of the attached document outlines the Council’s Capital Prudential and Treasury Indicators which Members are asked to approve. 1.5 In 2016 new regulations were enacted by the Scottish Parliament, the Local Authority (Capital Finance and Accounting) (Scotland) Regulations 2016, under which the Council is required to set out its policy for the statutory repayment of loans fund advances prior to the start of the financial year as detailed in section 2.6 of the strategy. The policy on repayment of loans fund advances in respect of capital expenditure by the Council is to ensure that the Council makes a prudent provision each year to pay off an element of the accumulated loans fund advances made in previous financial years. 1.6 A review of the Council’s loan fund advance repayments was undertaken in 2019-20 with advice from our external treasury management advisors. The review was undertaken to ensure the Council continues to make a prudent provision each year for the repayment of loans fund advances.
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1.7 1.8 The review considered new loans fund advances and historic loans fund advances to assess whether the repayment methodology was still the most prudent option. In doing so a revised policy on loans fund advance repayment profiling was introduced as follows: For all new loans fund advances the policy for repayment is: o Asset life method – loans fund advances will be repaid with reference to the life of an asset using a 5.1% annuity rate; o Funding / Income profile method – loans fund advances will be repaid by reference to an associated income stream using a 5.1% annuity rate. This would be utilised where the asset will generate income which can be used to repay the debt or as a result of spend to save schemes where again the savings can be used to repay the loans fund advances. During 2022-23 a decision was taken to repay three of our loans early to take advantage of a discount which was on offer. This has provided the Council with a one-off gain of £5.397m which will be transferred to the General Fund and can assist with budget pressures. 1.9 Section 3 of the document outlines the current actual external debt against the capital financing requirement highlighting any over or under borrowing. There is information on the interest rates projections and the borrowing strategy. 1.10 Section 4 of the document outlines the annual investment strategy. The Council’s investment priorities will be security first, liquidity second and then return. It explains the creditworthiness policy and the use of Link Treasury Services in this respect as well as the Country and Sector limits. 1.11 There are a number of appendices in Section 5. Some of this information has been provided by the Council’s external treasury management advisors. 2. RECOMMENDATIONS 2.1 It is recommended that Policy and Resources Committee refer to Council to: a) Approve the proposed Treasury Management Strategy Statement and Annual Investment Strategy and the indicators contained within. Note that the figures within the Strategy will be updated to reflect the budget decisions agreed at Council. b) Approve the continued use of the asset life method for the repayment of loan fund advances using a 5.1% annuity interest rate, with the exception of spend to save schemes where the funding/income profile method could be used. c) Approve the proposed asset repayment periods as detailed within section 2.7 of the Treasury Management Strategy Statement. d) Approve the ability to continue to use countries with a sovereign rating of AA- and above, as recommended by the Council’s external treasury management advisors.
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3. IMPLICATIONS 3.1 Policy – Sets the policy for borrowing and investment decisions. 3.2 Financial – An effective Treasury Management Strategy forms a significant part of the Council’s financial arrangements and its financial well-being. 3.3 Legal - None. 3.4 HR - None. 3.5 3.5.1 3.5.2 3.5.3 Fairer Scotland Duty – None. Equalities – None. Socio-Economic Duty – None. Islands Duty – None. 3.6 Climate Change – None. 3.7 Risk - This report does not require any specific risk issues to be addressed, however members will be aware that the management of risk is an integral part of the Council’s treasury management activities. 3.8 Customer Service - None. Kirsty Flanagan Executive Director/Section 95 Officer 9 February 2023 Policy Lead for Finance and Commercial Services: Councillor Gary Mulvaney APPENDICES Appendix 1 – Treasury Management Strategy Statement and Annual Investment Strategy 2023-24 For further information please contact: Anne Blue, Head of Financial Services anne.blue@argyll-bute.gov.uk
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1 Treasury Management Strategy Statement and Annual Investment Strategy 2023-2024
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2 1 INDEX 1 INTRODUCTION ............................................................................................................................ 3 1.1 Background ......................................................................................................................................................... 6 1.2 Treasury Management Reporting ...................................................................................................................... 6 1.3 Treasury Management Strategy for 2023/24 ..................................................................................................... 7 1.4 Training ............................................................................................................................................................. 8 1.5 Treasury management advisors ........................................................................................................................ 8 2 CAPITAL PRUDENTIAL AND TREASURY INDICATORS 2023/24 – 2025/26 ....................... 9 2.1 Capital Expenditure and Financing .................................................................................................................... 9 2.2 The Council’s Overall Borrowing Need (the Capital Financing Requirement) ............................................... 10 2.3 Liability Benchmark ........................................................................................................................................... 10 2.4 Core funds and expected investment balances .............................................................................................. 10 2.5 Limits to Borrowing Activity ............................................................................................................................... 12 2.6 Statutory repayment of loans fund advances ................................................................................................. 13 2.7 Asset Repayment Periods ............................................................................................................................... 13 3 TREASURY MANAGEMENT STRATEGY ............................................................................... 14 3.1 Current portfolio position ................................................................................................................................... 14 3.2 Prospects for interest rates ............................................................................................................................... 16 3.3 Investment and borrowing rates ....................................................................................................................... 17 3.4 Borrowing strategy ............................................................................................................................................ 17 3.5 Policy on borrowing in advance of need .......................................................................................................... 18 3.6 Debt rescheduling ............................................................................................................................................. 18 3.7 New financial institutions as a source of borrowing and/or types of borrowing .............................................. 19 3.7 Approved sources of long and short term borrowing ...................................................................................... 19 4 ANNUAL INVESTMENT STRATEGY ........................................................................................ 20 4.1 Investment policy .............................................................................................................................................. 20 4.2 Creditworthiness policy ..................................................................................................................................... 21 4.3 Country and sector limits .................................................................................................................................. 21 4.4 Investment strategy .......................................................................................................................................... 21 4.5 Investment risk benchmarking ......................................................................................................................... 23 4.6 End of year Investment Report ........................................................................................................................ 23 4.7 Policy on environmental, social and governance (E.S.G.) .............................................................................. 23 5 APPENDICES .............................................................................................................................. 24 Appendix 1 – Capital Prudential and Treasury Indicators 2023/24 – 2025/26 ..................................................... 24 Appendix 2 – Detailed Current Portfolio Position ................................................................................................... 27 Appendix 3 – Interest Rate Forecasts 2023 - 2026 and Commentary ................................................................. 28 Appendix 4 – Economic Background Provided by Link Treasury Services (at 08.12.22).................................... 29 Appendix 5 - Treasury Management Practice (TMP1) Permitted Investments .................................................... 32 Appendix 6 – Treasury Management Practice (TMP2) Credit and Counterparty Risk Management ................. 41 Appendix 7 – Creditworthiness policy .................................................................................................................... 47 Appendix 8 – Approved Countries for Investments (at 08.12.22) ......................................................................... 49 Appendix 9 – Treasury Management Scheme of Delegation ............................................................................... 50 Appendix 10 – The Treasury Management Role of the Section 95 Officer .......................................................... 51 Appendix 11 - Policy on environmental, social and governance (E.S.G) ............................................................ 53
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3 1 INTRODUCTION (Key Considerations) 2021 revised CIPFA Treasury Management Code and Prudential Code – changes which will impact on future TMSS/AIS reports and the risk management framework CIPFA published the revised Codes on 20th December 2021 and has stated that revisions need to be included in the reporting framework from the 2023/24 financial year. This Authority, therefore, has to have regard to these Codes of Practice when it prepares the Treasury Management Strategy Statement and Annual Investment Strategy, and also related reports during the financial year, which are taken to Full Council for approval. The revised Treasury Management Code requires all investments and investment income to be attributed to one of the following three purposes: - Treasury management Arising from the organisation’s cash flows or treasury risk management activity, this type of investment represents balances which are only held until the cash is required for use. Treasury investments may also arise from other treasury risk management activity which seeks to prudently manage the risks, costs or income relating to existing or forecast debt or treasury investments. Service delivery Investments held primarily and directly for the delivery of public services including housing, regeneration and local infrastructure. Returns on this category of investment which are funded by borrowing are permitted only in cases where the income is “either related to the financial viability of the project in question or otherwise incidental to the primary purpose”. Commercial return Investments held primarily for financial return with no treasury management or direct service provision purpose. Risks on such investments should be proportionate to an authority’s financial capacity – i.e., that ‘plausible losses’ could be absorbed in budgets or reserves without unmanageable detriment to local services. An authority must not borrow to invest primarily for financial return. The revised Treasury Management Code will require an authority to implement the following: - 1. Adopt a new liability benchmark treasury indicator to support the financing risk management of the capital financing requirement; this is to be shown in chart form for a minimum of ten years, with material differences between the liability benchmark and actual loans to be explained; 2. Long-term treasury investments, (including pooled funds), are to be classed as commercial investments unless justified by a cash flow business case; 3. Pooled funds are to be included in the indicator for principal sums maturing in years beyond the initial budget year; 4. Amendment to the knowledge and skills register for officers and members involved in the treasury management function - to be proportionate to the size and complexity of the treasury management conducted by each authority; 5. Reporting to members is to be done quarterly. Specifically, the Chief Finance Officer (CFO) is required to establish procedures to monitor and report performance against all forward-looking prudential indicators at least quarterly. The CFO is expected to establish a measurement and reporting process that highlights significant actual or forecast deviations
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4 from the approved indicators. However, monitoring of prudential indicators, including forecast debt and investments, is not required to be taken to Full Council and should be reported as part of the Authority’s integrated revenue, capital and balance sheet monitoring; 6. Environmental, social and governance (ESG) issues to be addressed within an authority’s treasury management policies and practices (TMP1). The main requirements of the Prudential Code relating to service and commercial investments are: - 1. The risks associated with service and commercial investments should be proportionate to their financial capacity – i.e. that plausible losses could be absorbed in budgets or reserves without unmanageable detriment to local services; 2. An authority must not borrow to invest for the primary purpose of commercial return; 3. It is not prudent for local authorities to make any investment or spending decision that will increase the CFR, and so may lead to new borrowing, unless directly and primarily related to the functions of the authority, and where any commercial returns are either related to the financial viability of the project in question or otherwise incidental to the primary purpose; 4. An annual review should be conducted to evaluate whether commercial investments should be sold to release funds to finance new capital expenditure or refinance maturing debt; 5. A prudential indicator is required for the net income from commercial and service investments as a proportion of the net revenue stream; 6. Create new Investment Management Practices to manage risks associated with non- treasury investments, (similar to the current Treasury Management Practices). An authority’s Annual Investment Strategy should include: - 1. The authority’s approach to investments for service or commercial purposes (together referred to as non-treasury investments), including defining the authority’s objectives, risk appetite and risk management in respect of these investments, and processes ensuring effective due diligence; 2. An assessment of affordability, prudence and proportionality in respect of the authority’s overall financial capacity (i.e. whether plausible losses could be absorbed in budgets or reserves without unmanageable detriment to local services); 3. Details of financial and other risks of undertaking investments for service or commercial purposes and how these are managed; 4. Limits on total investments for service purposes and for commercial purposes respectively (consistent with any limits required by other statutory guidance on investments); 5. Requirements for independent and expert advice and scrutiny arrangements (while business cases may provide some of this material, the information contained in them will need to be periodically re-evaluated to inform the authority’s overall strategy); 6. State compliance with paragraph 51 of the Prudential Code in relation to investments for commercial purposes, in particular the requirement that an authority must not borrow to invest primarily for financial return;
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5 As this Treasury Management Strategy Statement and Annual Investment Strategy deals solely with treasury management investments, the categories of service delivery and commercial investments should be addressed as part of the Capital Strategy report. However, as investments in commercial property have implications for cash balances managed by the treasury team, it will be for each authority to determine whether to add a high level summary of the impact that commercial investments have, or may have, if it is planned to liquidate such investments within the three year time horizon of this report, (or a longer time horizon if that is felt appropriate).
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6 1.1 Background The Council is required to operate a balanced budget, which broadly means that cash raised during the year will meet cash expenditure. Part of the treasury management operation is to ensure that this cash flow is adequately planned, with cash being available when it is needed. Surplus monies are invested in low risk counterparties or instruments commensurate with the Council’s low risk appetite, providing adequate liquidity initially before considering investment return. The second main function of the treasury management service is the funding of the Council’s capital plans. These capital plans provide a guide to the borrowing need of the Council, essentially the longer term cash flow planning to ensure that the Council can meet its capital spending obligations. This management of longer term cash may involve arranging long or short term loans, or using longer term cash flow surpluses. On occasion, when it is prudent and economic, any debt previously drawn may be restructured to meet Council risk or cost objectives. The contribution the treasury management function makes to the authority is critical, as the balance of debt and investment operations ensure liquidity or the ability to meet spending commitments as they fall due, either on day-to-day revenue or for larger capital projects. The treasury operations will see a balance of the interest costs of debt and the investment income arising from cash deposits affecting the available budget. Since cash balances generally result from reserves and balances, it is paramount to ensure adequate security of the sums invested, as a loss of principal will in effect result in a loss to the General Fund Balance. CIPFA defines treasury management as: “The management of the local authority’s borrowing, investments and cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks.” Whilst any commercial initiatives or loans to third parties will impact on the treasury function, these activities are generally classed as non-treasury activities, (arising usually from capital expenditure), and are separate from the day-to-day treasury management activities. 1.2 Treasury Management reporting The Council is required to receive and approve, as a minimum, three main reports each year, which incorporate a variety of policies, estimates and actuals. An Annual Treasury Management Strategy Statement (this report) – this is the first and most important report which is submitted to full Council before the start of the financial year. The Council approve this Strategy in February, after which the Audit and Scrutiny Committee have an opportunity to make comments and recommendations. If required the Strategy would then go back to Council in April to approve any amendments recommended by the Audit and Scrutiny Committee. The Strategy covers: The capital plans (including prudential indicators); A policy for the statutory repayment of debt, (how residual capital expenditure is charged to revenue over time); The Treasury Management Strategy (how the investments and borrowings are to be organised) including treasury indicators; and An Annual Investment strategy (the parameters on how investments are be to managed). A mid-year Treasury Management Review Report - this will update Members with the progress on the capital position, amending prudential indicators as necesssary and whether any policies require revision. Monitoring reports are submitted to each Policy and Resources Committee.
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7 An Annual Treasury Report – this provides details of a selection of actual prudential and treasury indicators and actual treasury operations compared to the estimates within the strategy. This report is presented to Council after the end of each financial year. Capital Strategy The CIPFA 2021 Prudential and Treasury Management Codes require all local authorities to prepare a capial strategy report, which will provide the following: a high-level overview of how capital expenditure, capital financing and treasury management activity contribute to the provision of services an overview of how the associated risk is managed the implications for future financial sustainability. The aim of this capital strategy is to ensure that all elected members on the full council fully understand the overall long-term policy objectives and resulting capital strategy requirements, governance procedures and risk appetite. The capital strategy was initially reported to members on 14 October 2021 and the decision taken that an updated strategy be presented to members in the early life of the new Council in 2022. During 2022 elected members were asked to set their priotities for the capital programme and an amended capital strategy has been prepared and will now go forward to full Council for approval. 1.3 Treasury Management Strategy for 2023/24 The strategy for 2023/24 covers two main areas: Capital issues the capital expenditure plans and the associated prudential indicators. the policy for statutory repayment of loans fund advances Treasury management issues the current treasury position; treasury indicators which limit the treasury risk and activities of the Council; prospects for interest rates; the borrowing strategy; policy on borrowing in advance of need; debt rescheduling; the investment strategy; creditworthiness policy; and policy on use of external service providers. These elements cover the requirements of the Local Government in Scotland Act 2003, the CIPFA Prudential Code, the CIPFA Treasury Management Code and Scottish Government loans fund repayment regulations and investment regulations, particularly Finance Circulars 5/2010 and 7/2016.
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8 1.4 Training The CIPFA Code requires the responsible officer to ensure that Members with responsibility for treasury management receive adequate training in treasury management. This especially applies to Members responsible for scrutiny (Audit and Scutiny Committee). Furthermore, pages 47 and 48 of the Code state that they expect “all organisations to have a formal and comprehensive knowledge and skills or training policy for the effective acquisition and retention of treasury management knowledge and skills for those responsible for management, delivery, governance and decision making. The scale and nature of this will depend on the size and complexity of the organisation’s treasury management needs. Organisations should consider how to assess whether treasury management staff and board/ council members have the required knowledge and skills to undertake their roles and whether they have been able to maintain those skills and keep them up to date. As a minimum, authorities should carry out the following to monitor and review knowledge and skills: Record attendance at training and ensure action is taken where poor attendance is identified. Prepare tailored learning plans for treasury management officers and board/council members. Require treasury management officers and board/council members to undertake self- assessment against the required competencies (as set out in the schedule that may be adopted by the organisation). Have regular communication with officers and board/council members, encouraging them to highlight training needs on an ongoing basis.” In further support of the revised training requirements, CIPFA’s Better Governance Forum and Treasury Management Network have produced a ‘self-assessment by members responsible for the scrutiny of treasury management’, which is available from the CIPFA website to download. The training needs of treasury management officers are periodically reviewed. A formal record of the training received by officers central to the Treasury function will be maintained. Similarly, a formal record of the treasury management/capital finance training received by members will also be maintained. 1.5 Treasury management consultants The Council uses Link Treasury Services as its external treasury management consultants. The Council recognises that responsibility for treasury management decisions remains with the organisation at all times and will ensure that undue reliance is not placed upon the services of our external service providers. All decisions will be undertaken with regards to all available information, including, but not solely, our treasury advisers. It also recognises that there is value in employing external providers of treasury management services in order to acquire access to specialist skills and resources. The Council will ensure that the terms of their appointment and the methods by which their value will be assessed are properly agreed and documented, and subjected to regular review.
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9 2 CAPITAL PRUDENTIAL AND TREASURY INDICATORS 2023/24 – 2025/26 The Council’s capital expenditure plans are the key driver of treasury management activity. The output of the capital expenditure plans are reflected in the prudential indicators, which are designed to assist Members’ overview and confirm capital expenditure plans. 2.1 Capital Expenditure and Financing This prudential indicator is a summary of the Council’s capital expenditure plans, both those agreed previously, and those forming part of the 2023/24 budget setting. The table below summarises the capital expenditure plans as outlined within the proposed capital plan 2023-26. Capital Expenditure 2021/22 2022/23 2023/24 2024/25 2025/26 £'000 Actual Estimate Estimate Estimate Estimate Executive Director - Douglas Hendry Education 7,798 7,155 6,970 2,226 2,219 Facility Services - Shared Offices 819 2,929 2,492 428 427 Major Projects/CHORD 11,598 4,558 1,351 0 0 Executive Director - Kirsty Flanagan ICT 1,538 1,289 1,258 771 768 Roads and Infrastructure 18,209 25,436 46,349 33,028 34,514 Development and Economic Growth 2,690 4,282 1,274 0 0 Live Argyll 324 560 1,106 428 427 Health and Social Care Partnership 0 628 1,920 428 427 Total 42,976 46,837 62,720 37,309 38,782 The table below summarises the above capital expenditure plans and how capital or revenue resources are financing them. Any shortfall of resources results in a funding borrowing need. (The financing need excludes other long-term liabilities, such as PFI and leasing arrangements, which already include borrowing instruments.) Capital Expenditure 2021/22 2022/23 2023/24 2024/25 2025/26 £'000 Actual Estimate Estimate Estimate Estimate Total Capital Expenditure 42,976 46,837 62,720 37,309 38,782 Financed by: Capital Receipts 835 500 1,195 350 400 Capital Grants 21,700 17,180 16,822 9,277 9,129 Capital Reserves 0 0 0 0 0 Revenue 735 21,402 1,593 1,331 0 Net Financing need for the year 19,706 7,755 43,110 26,351 29,253
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10 2.2 The Council’s Overall Borrowing Need (the Capital Financing Requirement) The 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 through a revenue or capital resource, will increase the CFR. The CFR does not increase indefinitely, as prudent annual repayments from revenue need to be made, called the Loan Fund Principal Repayment, which reflects the useful life of capital assets financed by borrowing. This charge reduces the CFR each year. From 1 April 2016, authorities may choose whether to use scheduled debt amortisation, (loans pool charges), or another suitable method of calculation in order to repay borrowing. The CFR includes any other long-term liabilities (e.g. PFI schemes, finance leases). Whilst these increase 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 £116.7m of such schemes within the CFR. The CFR projections are noted in the following table. 2021/22 2022/23 2023/24 2024/25 2025/26 £'000 Actual Estimate Estimate Estimate Estimate Capital Financing Requirement Opening CFR 294,752 307,100 304,498 372,359 386,984 Closing CFR 307,100 304,498 372,359 386,984 403,919 Movement in CFR 12,348 (2,602) 67,861 14,625 16,935 Movement in CFR represented by 2021/22 2022/23 2023/24 2024/25 2025/26 £'000 Actual Estimate Estimate Estimate Estimate Net financing need for the year (above) 19,706 7,755 43,110 26,351 29,253 Service Concessions Adjustment 36,038 0 0 Less scheduled debt Amortisation 7,358 10,357 11,287 11,726 12,318 Movement in CFR 12,348 (2,602) 67,861 14,625 16,935 2.3 Liability Benchmark A third and new prudential indicator for 2023/24 is the Liability Benchmark (LB). The Authority is required to estimate and measure the LB for the forthcoming financial year and the following two financial years, as a minimum. There are four components to the LB: -
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11 1 Existing loan debt outstanding: the Authority’s existing loans that are still outstanding in future years. 2 Loans CFR: this is calculated in accordance with the loans CFR definition in the Prudential Code and projected into the future based on approved prudential borrowing and planned Loans Fund advances/Loans Fund principal repayments. 3 Net loans requirement: this will show the Authority’s gross loan debt less treasury management investments at the last financial year-end, projected into the future and based on its approved prudential borrowing, planned Loans Fund principal repayments and any other major cash flows forecast. 4 Liability benchmark (or gross loans requirement): this equals net loans requirement plus short-term liquidity allowance. The graph below shows the four components for the Council: 2.4 Core Funds and Expected Investment Balances The 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.). Detailed below are estimates of the year-end balances for each resource and anticipated day-to-day cash flow balances. Year End Resources 2021/22 2022/23 2023/24 2024/25 2025/26 £'000 Actual Estimate Estimate Estimate Estimate Expected Investments 102,228 80,000 70,000 50,000 50,000
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12 2.5 Limits to Borrowing Activity The operational boundary: This is the limit beyond which external debt is not normally expected to exceed. In most cases, this would be a similar figure to the CFR, but may be lower or higher depending on the levels of actual debt and the ability to fund under-borrowing by other cash resources. Operational Boundary 2021/22 2022/23 2023/24 2024/25 2025/26 £'m Actual Actual Estimate Estimate Estimate Debt 188 190 263 278 300 Other long term liabilities 119 115 109 110 105 Total 307 305 372 388 405 The authorised limit for external debt. This is a key prudential indicator and represents a control on the maximum level of borrowing. This represents a legal limit beyond which external debt is prohibited, and this limit needs to be set or revised by the full Council. It reflects the level of external debt which, while not desired, could be afforded in the short term, but is not sustainable in the longer term. a) The authorised limits for external debt for the current year and two subsequent years are the legislative limits determined under Regulation 6(1) of the Local Authority (Capital Finance and Accounting) (Scotland) Regulations 2016. b) The Council is asked to approve the following authorised limit: Authorised Limit 2021/22 2022/23 2023/24 2024/25 2025/26 £'m Actual Actual Estimate Estimate Estimate Debt 193 195 268 283 305 Other long term liabilities 122 118 112 113 108 Total 315 313 380 396 413
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13 2.6 Statutory repayment of loans fund advances The Council is required to set out its policy for the statutory repayment of loans fund advances prior to the start of the financial year. The repayment of loans fund advances ensures that the Council makes a prudent provision each year to pay off an element of the accumulated loans fund advances made in previous financial years. A variety of options are provided to Councils so long as a prudent provision is made each year. A review of the Council’s loan fund advances was undertaken during 2019-20 to ensure the Council continues to make a prudent provision each year for the repayment of loans fund advances. For all new loans fund advances the policy for the repayment is:- 1. Asset life method – loans fund advances will be repaid with reference to the life of an asset using a 5.1% annuity rate; 2. Funding / Income profile method – loans fund advances will be repaid by reference to an associated income stream. The annuity rate applied to current loans fund repayments is based on historic interest rates over a 15 year period ensuring that a prudent rate is used. The current rate is 3.41%, however it is still considered prudent to use the average historic rate at this time. 2.7 Asset Repayment Periods Using the asset life method, the Council is required to ensure that the debt is repaid over a period that is reasonably commensurate with that over which the capital expenditure provides benefits. The table below details the repayment period that applies for each asset type. Asset Type Repayment Period (Years) Land (including cemeteries) 100 Road Structures - Bridges, Retaining Walls, Sea Walls, Flood Defences 60 Piers and Harbours - Major Structural Work 60 Piers and Harbours - Medium Term Works e.g painting/cathodic protection 20 Piers and Harbours - Limited Lifespan Improvements 10 Roads and Footways 20 Street Lighting 30 Vehicles & Plant 7 IT Equipment 5 Major Regeneration Works (Public Realm etc) 60 New Builds including Schools 60 Buildings - Electrical 40 Buildings - Plant 20 Buildings - Roofing 35 Buildings - Windows & External Doors 20 Buildings - Structural 25
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14 3 TREASURY MANAGEMENT STRATEGY The capital expenditure plans set out in Section 2 provide details of the service activity of the Council. The treasury management function ensures that the Council’s cash is organised in accordance with the the relevant professional codes, so that sufficient cash is available to meet this service activity. This will involve both the organisation of the cash flow and, where capital plans require, the organisation of approporiate borrowing facilities. The strategy covers the relevant treasury / prudential indicators, the current and projected debt positions and the Annual Investment Strategy. 3.1 Current portfolio position The Council’s treasury portfolio position at 31 March 2022 and at 31 December 2022 are shown below for both borrowing and investments. A more detailed analysis of the above table showing actual investments placed with individual counterparties can be found in Appendix 2. Actual Actual Current Current 31.3.22 31.3.22 31.12.22 31.12.22 Treasury investments £000 % £000 % Banks 70,117 63% 51,921 50% Building Societies - rated 0 0% 0 0% Local Authorities 17,500 16% 42,500 41% Money Market Funds 19,600 18% 4,700 5% Certificates of Deposit 0 0% 0 0% Third Party Loans 3,789 3% 3,694 4% Total managed in house 111,006 100% 102,815 100% Bond Funds 0 0% 0 0% Property Funds 0 0% 0 0% Total managed externally 0 0% 0 0% Total Treasury Investments 111,006 100% 102,815 100% Treasury external borrowing PWLB 118,145 66% 84,273 58% LOBOs 39,255 22% 39,255 27% Market 10,000 6% 10,000 7% Special 10 0% 8 0% Temporary Borrowing 10,500 6% 10,540 7% Local Bonds 24 0% 18 0% Total External Borrowing 177,934 100% 144,094 100% Net Treasury Investments / (Borrowing) (66,928) (41,279) TREASURY PORTFOLIO
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15 The Council’s forward projections for borrowing, are summarised below. The table shows the actual external debt (the treasury management operations), against the underlying capital borrowing need (the Capital Financing Requirement - CFR), highlighting any over or under borrowing. 2021/22 2022/23 2023/24 2024/25 2025/26 £'000 Actual Estimate Estimate Estimate Estimate External Debt Debt as 1st April 168,805 177,934 142,158 176,154 221,135 Change in Debt (In Year) 9,129 (35,776) 33,996 44,981 39,997 Other long-term liabilities (OLTL) at 1st April 121,524 118,931 114,088 108,971 109,191 Change in OLTL (In Year) (2,593) (4,843) (5,117) 220 (4,938) Actual gross debt at 31st March 296,865 256,246 285,125 330,326 365,385 The Capital Financing Requirement 307,100 304,498 372,359 386,984 403,919 Under / (Over) borrowing 10,235 48,252 87,234 56,658 38,534 The figures in the above tables include an allowance for the introduction of IFRS16 – Leasing which is being introduced in the 24/25 financial year, having been deferred in December 2021. The change requires local authorities to account for leased assets previously treated as operating leases (off balance sheet) as finance leases (on balance sheet), which increases capital expenditure and the gross debt required to finance them. Work is underway to identify and evaluate the operating leases affected and, in the meantime, the figures used in the calculations above represent a high level estimate of the potential impact on the Council’s Capital Financing Requirement. The following graph shows the the CFR compared to the expected net debt in each of the years and the under / (over) borrowed position, also shown is the Council’s authorised limit for debt and it’s operational boundary (see paragraph 2.4 above.
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16 Within 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 gross debt 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 2022/23 and the following two financial years. This allows some flexibility for limited early borrowing for future years, but ensures that borrowing is not taken for revenue or speculative purposes. The Section 95 Officer reports that the Council complied with this prudential indicator in the current year and does not envisage difficulties for the future. This view takes into account current commitments, existing plans, and the proposals in this budget report. 3.2 Prospects for interest rates The Council has appointed Link Treasury Services as its treasury advisor and part of their service is to assist the Council to formulate a view on interest rates. Link provided the following forecasts on 8th December 2022. These are forecasts for certainty rates, gilt yields plus 80 bps. Additional notes by Link on this forecast table: -
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17 Our central forecast reflects a view that the Monetary Policy Committee (MPC) will be keen to demonstrate its anti-inflation credentials by delivering a succession of rate increases. This has happened throughout 2022, but the new Government’s policy of emphasising fiscal rectitude will probably mean Bank Rate does not now need to increase to further than 4.5%. Further down the road, we anticipate the Bank of England will be keen to loosen monetary policy when the worst of the inflationary pressures have lessened – but that timing will be one of fine judgment: cut too soon, and inflationary pressures may well build up further; cut too late and any downturn or recession may be prolonged. The CPI measure of inflation will peak at close to 11% in Q4 2022. Despite the cost-of-living squeeze that is still taking shape, the Bank will want to see evidence that wages are not spiralling upwards in what is evidently a very tight labour market. Wage increases, excluding bonuses, are currently running at 5.7%. Regarding the plan to sell £10bn of gilts back into the market each quarter (Quantitative Tightening), this has started but will focus on the short to medium end of the curve for the present. This approach will prevent any further disruption to the longer end of the curve following on from the short-lived effects of the Truss/Kwarteng unfunded dash for growth policy. In the upcoming months, our forecasts will be guided not only by economic data releases and clarifications from the MPC over its monetary policies and the Government over its fiscal policies, but the on-going conflict between Russia and Ukraine. (More recently, the heightened tensions between China/Taiwan/US also have the potential to have a wider and negative economic impact.) On the positive side, consumers are still estimated to be sitting on over £160bn of excess savings left over from the pandemic so that will cushion some of the impact of the above challenges. However, most of those are held by more affluent people whereas lower income families already spend nearly all their income on essentials such as food, energy and rent/mortgage payments. Link Treasury Services have also provided commentary in relation to interest rates and this is included within Appendix 3. 3.3 Investment and borrowing rates Yield curve movements have become less volatile under the Sunak/Hunt government. PWLB 5 to 50 years Certainty Rates are, generally, in the range of 3.75% to 4.50%. The medium to longer part of the yield curve is currently inverted (yields are lower at the longer end of the yield curve compared to the short to medium end). We view the markets as having built in, already, nearly all the effects on gilt yields of the likely increases in Bank Rate and the poor inflation outlook but markets are volatile and further whipsawing of gilt yields across the whole spectrum of the curve is possible. The current margins over gilt yields are as follows: -. PWLB Standard Rate is gilt plus 100 basis points (G+100bps) PWLB Certainty Rate is gilt plus 80 basis points (G+80bps) PWLB HRA Standard Rate is gilt plus 100 basis points (G+100bps) PWLB HRA Certainty Rate is gilt plus 80bps (G+80bps) Local Infrastructure Rate is gilt plus 60bps (G+60bps) Borrowing for capital expenditure. Our long-term (beyond 10 years) forecast for Bank Rate stands at 2.5%. As all PWLB certainty rates are now above this level, borrowing strategies will need to be reviewed in that context. Better value can generally be obtained at the shorter end of the curve and short-dated fixed LA to LA monies should be considered. Temporary borrowing rates are likely, however, to remain near Bank Rate and may also prove attractive whilst the market waits for inflation, and therein gilt yields, to drop back later in 2023.
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18 While this authority will not be able to avoid borrowing to finance new capital expenditure, to replace maturing debt and the rundown of reserves, there will be a cost of carry, (the difference between higher borrowing costs and lower investment returns), to any new borrowing that causes a temporary increase in cash balances. 3.4 Borrowing strategy The Council is currently maintaining an under-borrowed position. This means that the capital borrowing need, (the Capital Financing Requirement), has not been fully funded with loan debt as cash supporting the Council’s reserves, balances and cash flow has been used as a temporary measure. This strategy is prudent as medium and longer dated borrowing rates are expected to fall from their current levels once prevailing inflation concerns are addressed by tighter near-term monetary policy. That is, Bank Rate increases over the remainder of 2022 and the first half of 2023. Against this background and the risks within the economic forecast, caution will be adopted with the 2023/24 treasury operations. The Section 95 Officer will monitor interest rates in financial markets and adopt a pragmatic approach to changing circumstances: if it was felt that there was a significant risk of a sharp FALL in borrowing rates, then borrowing will be postponed. if it was felt that there was a significant risk of a much sharper RISE in borrowing rates than that currently forecast, fixed rate funding will be drawn whilst interest rates are lower than they are projected to be in the next few years. Any decisions will be reported to the appropriate decision-making body at the next available opportunity. 3.5 Policy on borrowing in advance of need The Council will not borrow more than, or in advance of, its needs purely in order to profit from the investment of the extra sum borrowed. Any decision to borrow in advance will be within forward approved Capital Financing Requirement estimates, and will be considered carefully to ensure that value for money can be demonstrated and that the Council can ensure the security of such funds. Risks associated with any borrowing in advance activity will be subject to prior appraisal and subsequent reporting through the mid-year or annual reporting mechanism. 3.6 Debt rescheduling Rescheduling of current borrowing in our debt portfolio is unlikely to occur as there is still a very large difference between premature redemption rates and new borrowing rates, In 2022, there was a window of opportunity, due to the volatility of interest rates, to repay some of its borrowing early to take advantage of a discount on repayment. Rescheduling of remaining borrowing in our debt portfolio is not currently planned for in 2023/24. However, the Council may consider rescheduling debt if an opportunity arises and it is prudent to do so in terms of cash balances held and anticipated future interest rates. If rescheduling was done, it will be reported to the appropriate Committee at the earliest meeting following its action.
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19 3.7 New financial institutions as a source of borrowing and / or types of borrowing Currently the PWLB Certainty Rate is set at gilts + 80 basis points for both HRA and non-HRA borrowing. However, consideration may still need to be given to sourcing funding from the following sources for the following reasons: Local authorities (primarily shorter dated maturities out to 3 years or so – still cheaper than the Certainty Rate). Financial institutions (primarily insurance companies and pension funds but also some banks, out of forward dates where the objective is to avoid a “cost of carry” or to achieve refinancing certainty over the next few years). Our advisors will keep us informed as to the relative merits of each of these alternative funding sources. 3.8 Approved Sources of Long and Short term Borrowing A list of approved sources of long and short term borrowing is shown below: On Balance Sheet Fixed Variable PWLB √ √ Municipal bond agency √ √ Local authorities √ √ Banks √ √ Pension funds √ √ Insurance companies √ √ UK Infrastructure Bank √ √ Market (long-term) √ √ Market (temporary) √ √ Market (LOBOs) √ √ Stock issues √ √ Local temporary √ √ Local Bonds √ Local authority bills √ √ Overdraft √ Negotiable bonds √ √ Internal (capital receipts & revenue balances) √ √ Commercial paper √ Medium Term Notes √ Finance leases √ √
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20 4 ANNUAL INVESTMENT STRATEGY 4.1 Investment policy The Council’s investment policy implements the requirements of the Local Government Investments (Scotland) Regulations 2010, (and accompanying Finance Circular 5/2010), and the CIPFA Treasury Management in Public Services Code of Practice and Cross Sectoral Guidance Notes 2021, (“the Code”) and CIPFA Treasury Management Guidance Notes 2021. The above regulations and guidance place a high priority on the management of risk. The Council’s investment priorities will be security first, liquidity second and then return. This authority has adopted a prudent approach to managing risk and defines its risk appetite by the following means: 1. Minimum acceptable credit criteria are applied in order to generate a list of highly creditworthy counterparties. This also enables diversification and thus avoidance of concentration risk. The key ratings used to monitor counterparties are the short term and long-term ratings. 2. Other information: ratings will not be the sole determinant of the quality of an institution; it is important to continually assess and monitor the financial sector on both a micro and macro basis and in relation to the economic and political environments in which institutions operate. The assessment will also take account of information that reflects the opinion of the markets. To achieve this consideration the Council will engage with its advisors to maintain a monitor on market pricing such as “credit default swaps” and overlay that information on top of the credit ratings. 3. Other information sources used will include the financial press, share price and other such information pertaining to the financial sector in order to establish the most robust scrutiny process on the suitability of potential investment counterparties. 4. This Authority has defined the list of types of investment instruments that the treasury management team are authorised to use. There are two lists in Appendix 5 under the categories of ‘specified’ and ‘non- specified’ investments.Lending limits, (amounts and maturity), for each counterparty will be set through applying the matrix table in Appendix 7. 5. Transaction limits are set for each type of investment in Appendix 5. 6. This authority will set a limit for the amount of its investments which are invested for longer than 365 days, (see paragraph 4.4). 7. Investments will only be placed with counterparties from countries with a specified minimum sovereign rating, (see paragraph 4.3). 8. All investments will be denominated in sterling. 9. As a result of the change in accounting standards for 2021/22 under IFRS 9, this authority will consider the implications of investment instruments which could result in an adverse movement in the value of the amount invested and resultant charges at the end of the year to the General Fund. However, this authority will also pursue value for money in treasury management and will monitor the yield from investment income against appropriate benchmarks for investment performance, (see paragraph 4.4). Regular monitoring of investment performance will be carried out during the year.
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21 4.2 Creditworthiness policy The Council recognises the vital importance of credit-worthiness checks on the counterparties it uses for investments. This Council applies the creditworthiness service provided by Link Treasury Services. This service employs a sophisticated modelling approach utilising credit ratings from the three main credit rating agencies - Fitch, Moody’s and Standard and Poor’s. The credit ratings of counterparies are supplemented with the following further overlays: credit watches and credit outlooks from credit rating agencies; CDS spreads to give early warning of likely changes in credit ratings; sovereign ratings to select counterparties from only the most creditworthy countries. Further explanation of the approach for creditworthiness used by Link Treasury Services is found in Appendix 7. UK banks – ring fencing The largest UK banks, (those with more than £25bn of retail / Small and Medium-sized Enterprise (SME) deposits), are required, by UK law, to separate core retail banking services from their investment and international banking activities. This is known as “ring-fencing”. Whilst smaller banks with less than £25bn in deposits are exempt, they can choose to opt in. Ring-fencing is a regulatory initiative created in response to the global financial crisis. It mandates the separation of retail and SME deposits from investment banking, in order to improve the resilience and resolvability of banks by changing their structure. In general, simpler, activities offered from within a ring- fenced bank, (RFB), will be focused on lower risk, day-to-day core transactions, whilst more complex and “riskier” activities are required to be housed in a separate entity, a non-ring-fenced bank, (NRFB). This is intended to ensure that an entity’s core activities are not adversely affected by the acts or omissions of other members of its group. While the structure of the banks included within this process may have changed, the fundamentals of credit assessment have not. The Council will continue to assess the new-formed entities in the same way that it does others and those with sufficiently high ratings, (and any other metrics considered) will be considered for investment purposes. 4.3 Country and sector limits The Council has determined that it will only use approved counterparties from the UK and from countries with a minimum sovereign credit rating of AA- from Fitch. The list of countries that qualify using this credit criteria as at the date of this report are shown in Appendix 8. This list will be added to, or deducted from, by officers should ratings change in accordance with this policy. 4.4 Investment strategy In-house funds: Investments will be made with reference to the core balance and cash flow requirements and the outlook for short-term interest rates (i.e. rates for investments up to 24 months). Greater returns are usually obtainable by investing for longer periods. While cash balances are required in order to manage the ups and downs of cash flow, where cash sums can be identified that could be invested for longer periods, the value to be obtained from longer term investments will be carefully assessed. If it is thought that Bank Rate is likely to rise significantly within the time horizon being considered, then consideration will be given to keeping most investments as being short term or variable. Conversely, if it is thought that Bank Rate is likely to fall within that time period, consideration will be given to locking in higher rates currently obtainable, for longer periods.
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22 Investment returns expectations The current forecast shown in Appendix 3, includes a forecast for Bank Rate to reach 4.5% in Q2 2023. The suggested budgeted investment earnings rates for returns on investments placed for periods up to about three months during each financial year are as follows.: Average earnings in each year 2022/23 (remainder) 3.95% 2023/24 4.40% 2024/25 3.30% 2025/26 2.60% 2026/27 2.50% Years 6 to 10 2.80% Years 10+ 2.80% As there are so many variables at this time, caution must be exercised in respect of all interest rate forecasts. Inter-local authority lending and borrowing rates have also declined due to the surge in the levels of cash seeking a short-term home at a time when many local authorities are probably having difficulties over accurately forecasting when disbursements of funds received will occur or when further large receipts will be received from the Government. Investment treasury indicator and limit These limits are set with regard to the Council’s liquidity requirements and to reduce the need for early sale of an investment, and are based on the availability of funds after each year-end. The Council is asked to approve the treasury indicator and limit: 2023/24 2024/25 2025/26 20 20 20 5 5 0Current investments as at 31-12-22 in excess of 1 year maturing each year Principal sums invested for longer than 365 days £m Maximum principal sums invested for longer than 365 days For its cash flow generated balances, the Council will seek to utilise its business reserve instant access and notice accounts, money market funds and short-dated deposits (overnight to 100 days).
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23 4.5 Investment risk benchmarking This Council will use an investment benchmark to assess the investment performance of its investment portfolio of SONIA (Sterling Overnight Interest Average).This benchmark will be used from 1st April 2022 and replaces 7 day LIBID. 4.6 End of year Investment Report At the end of the financial year, the Council will report on its investment activity as part of its Annual Treasury Report. 4.7 Policy on environmental, social and governance (E.S.G.) The Council’s policy on environmental, social and governance (E.S.G) can be found in appendix 11.
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24 5 APPENDICES Appendix 1 – Capital Prudential and Treasury Indicators 2023/24 – 2025/26 1. Affordability Prudential Indicators The 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: 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. 2021/22 2022/23 2023/24 2024/25 2025/26 % Actual Estimate Estimate Estimate Estimate Ratio 5.24% 4.91% 4.37% 4.40% 4.43% The estimates of financing costs include current commitments and the proposals in this budget report. 2. Maturity structure of borrowing The purpose of this indicator is to restrain the activity of the treasury function within certain limits, thereby managing risk and reducing the impact of any adverse movement in interest rates. However, if this is set to be too restrictive it will impair the opportunities to reduce costs/ improve performance. The indicator is “Maturity structure of borrowing”. These gross limits are set to reduce the Council’s exposure to large fixed rate sums falling due for refinancing and are required for upper and lower limits. The Council is asked to approve the following treasury indicator and limits Lower Upper 0% 30% 0% 30% 0% 30% 0% 40% 10 years to 20 years 0% 100% 20 years to 30 years 0% 100% 30 years to 40 years 0% 100% 40 years to 50 years 0% 100% 0% 100% Maturity structure of fixed interest rate borrowing 2023/24 12 months to 2 years 2 years to 5 years Under 12 months 5 years to 10 years 50 years and above . The interest rate exposure in respect of the Council’s external debt will be monitored on an ongoing basis by keeping the proportion of variable interest rate debt at an appropriate level given the total amount of external debt and the interest rate environment within which the Council is operating. When interest rates
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25 are increasing the Council will look to move to fixed rate borrowing and if interest rates are likely to fall then the level of variable rate borrowing will be increased to minimise future interest payments. 2022/23 2023/24 2024/25 2025/26 Upper Upper Upper Upper 195% 190% 190% 190% 60% 60% 60% 60% % Interest rate exposure Limits on fixed interest rates based on net debt Limits on variable interest rates based on net debt
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26 Appendix 2 – Detailed Current Portfolio Position Actual Actual Current Current 31.3.22 31.3.22 31.12.22 31.12.22 Treasury investments £000 % £000 % Banks Clydesdale Bank 5,117 5% 6,921 7% Bank of Scotland 0 0% 0 0% Goldman Sachs 10,000 9% 0 0% Qatar National Bank 5,000 5% 0 0% Commonwealth Bank of Australia 0 0% 0 0% Santander 5,000 5% 0 0% ANZ Banking Group/London 0 0% 10,000 10% Close Brothers 15,000 14% 2,500 2% First Abu Dhabi Bank 10,000 9% 15,000 15% AL Rayan Bank 10,000 9% 5,000 5% Toronto Dominion Bank 5,000 5% 5,000 5% National Bank of Kuwait 5,000 5% 7,500 7% 70,117 63% 51,921 50% Local Authorities London Borough of Croydon 7,500 7% 5,000 5% Rotherhan Metropolitan Borough Council 7,500 7% 0 0% Thurrock Borough Council 0 0% 10,000 10% Cheshire West & Chester Council 2,500 2% 2,500 2% Cambridgeshire County Council 0 0% 5,000 5% Spelthorn Borough Council 0 0% 5,000 5% Slough Borough Council 0 0% 10,000 10% Barnsley Metropolitian Borough Council 0 0% 5,000 5% 17,500 16% 42,500 41% DMADF (H.M.Treasury) 0 0% 0 0% Money Market Funds BNP Paribas Inticast Fund 10,000 9% 4,700 5% Federated 0 0% 0 0% CCLA 9,600 9% 0 0% AVIVA 0 0% 0 0% 19,600 18% 4,700 5% Third Party Loans Argyll Community Housing Association 2,410 2% 2,344 2% Fyne Homes 0 0% 0 0% West Highland Housing Accociation Ltd 837 1% 814 1% The Port Ellen Station 50 0% 44 0% Hubco Sub Debt 492 0% 492 0% 3,789 3% 3,694 4% Total Treasury Investments 111,006 100% 102,815 100% TREASURY PORTFOLIO
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27 Actual Actual Current Current 31.3.22 31.3.22 31.12.22 31.12.22 Treasury external borrowing Local Authorities 0 0% 0 0% PWLB 118,145 66% 84,273 58% LOBOs Commerzbank Finance & Covered Bonds S.A. 13,000 7% 13,000 9% FMS Wertmanagement 5,255 3% 5,255 4% Bayerische Landesbank 21,000 12% 21,000 15% 39,255 22% 39,255 27% Market Barclays (formerly LOBO) 10,000 6% 10,000 7% 10,000 6% 10,000 7% Special Prudential assurance co 10 0% 8 0% 10 0% 8 0% Temporary Borrowing 10,500 6% 10,540 7% Local Bonds 24 0% 18 0% Total External Borrowing 177,934 100% 144,094 100% Net Treasury Investments / (Borrowing) (66,928) (41,279)
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28 Appendix 3 – Interest Rate Forecasts 2023 - 2025 and Commentary Provided by Link Treasury Services (08.12.22) PWLB forecasts are based on PWLB certainty rates. Link Group Interest Rate View 08.11.22 Dec-22 Mar-23 Jun-23 Sep-23 Dec-23 Mar-24 Jun-24 Sep-24 Dec-24 Mar-25 Jun-25 Sep-25 Dec-25 BANK RATE 3.50 4.25 4.50 4.50 4.50 4.00 3.75 3.50 3.25 3.00 2.75 2.50 2.50 3 month ave earnings 3.60 4.30 4.50 4.50 4.50 4.00 3.80 3.30 3.00 3.00 2.80 2.50 2.50 6 month ave earnings 4.20 4.50 4.60 4.50 4.20 4.10 3.90 3.40 3.10 3.00 2.90 2.60 2.60 12 month ave earnings 4.70 4.70 4.70 4.50 4.30 4.20 4.00 3.50 3.20 3.10 3.00 2.70 2.70 5 yr PWLB 4.30 4.30 4.20 4.10 4.00 3.90 3.80 3.60 3.50 3.40 3.30 3.20 3.10 10 yr PWLB 4.50 4.50 4.40 4.30 4.20 4.00 3.90 3.70 3.60 3.50 3.40 3.30 3.20 25 yr PWLB 4.70 4.70 4.60 4.50 4.40 4.30 4.10 4.00 3.90 3.70 3.60 3.50 3.50 50 yr PWLB 4.30 4.40 4.30 4.20 4.10 4.00 3.80 3.70 3.60 3.40 3.30 3.20 3.20
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29 Appendix 4 – Economic Background Provided by Link Treasury Services (at 08.12.22) Against a backdrop of stubborn inflationary pressures, the easing of Covid restrictions in most developed economies, the Russian invasion of Ukraine, and a range of different UK Government policies, it is no surprise that UK interest rates have been volatile right across the curve, from Bank Rate through to 50-year gilt yields, for all of 2022. Market commentators’ misplaced optimism around inflation has been the root cause of the rout in the bond markets with, for example, UK, EZ and US 10-year yields all rising by over 200bps since the turn of the year. The table below provides a snapshot of the conundrum facing central banks: inflation is elevated but labour markets are extra-ordinarily tight, making it an issue of fine judgment as to how far monetary policy needs to tighten. UK Eurozone US Bank Rate 3.0% 1.5% 3.75%-4.00% GDP -0.2%q/q Q3 (2.4%y/y) +0.2%q/q Q3 (2.1%y/y) 2.6% Q3 Annualised Inflation 11.1%y/y (Oct) 10.0%y/y (Nov) 7.7%y/y (Oct) Unemployment Rate 3.6% (Sep) 6.6% (Sep) 3.7% (Aug) Q2 of 2022 saw UK GDP revised upwards to +0.2% q/q, but this was quickly reversed in the third quarter, albeit some of the fall in GDP can be placed at the foot of the extra Bank Holiday in the wake of the Queen’s passing. Nevertheless, CPI inflation has picked up to what should be a peak reading of 11.1% in October, although with further increases in the gas and electricity price caps pencilled in for April 2023, and the cap potentially rising from an average of £2,500 to £3,000 per household, there is still a possibility that inflation will spike higher again before dropping back slowly through 2023. The UK unemployment rate fell to a 48-year low of 3.6%, and this despite a net migration increase of c500k. The fact is that with many economic participants registered as long-term sick, the UK labour force actually shrunk by c£500k in the year to June. Without an increase in the labour force participation rate, it is hard to see how the UK economy will be able to grow its way to prosperity, and with average wage increases running at 5.5% - 6% the MPC will be concerned that wage inflation will prove just as sticky as major supply-side shocks to food and energy that have endured since Russia’s invasion of Ukraine on 22nd February 2022. Throughout Q3 Bank Rate increased, finishing the quarter at 2.25% (an increase of 1%). Q4 has seen rates rise to 3% in November and the market expects Bank Rate to hit 4.5% by May 2023. Following a Conservative Party leadership contest, Liz Truss became Prime Minister for a tumultuous seven weeks that ran through September and December. Put simply, the markets did not like the unfunded tax-cutting and heavy spending policies put forward by her Chancellor, Kwasi Kwarteng, and their reign lasted barely seven weeks before being replaced by Prime Minister Rishi Sunak and Chancellor Jeremy Hunt. Their Autumn Statement of 17th November gave rise to a net £55bn fiscal tightening, although much of the “heavy lifting” has been left for the next Parliament to deliver. However, the markets liked what they heard, and UK gilt yields have completely reversed the increases seen under the previous tenants of No10/11 Downing Street.
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30 Globally, though, all the major economies are expected to struggle in the near term. The fall below 50 in the composite Purchasing Manager Indices for the UK, US, EZ and China all point to at least one if not more quarters of GDP contraction. In November, the MPC projected eight quarters of negative growth for the UK lasting throughout 2023 and 2024, but with Bank Rate set to peak at lower levels than previously priced in by the markets and the fiscal tightening deferred to some extent, it is not clear that things will be as bad as first anticipated by the Bank. The £ has strengthened of late, recovering from a record low of $1.035, on the Monday following the Truss government’s “fiscal event”, to $1.20. Notwithstanding the £’s better run of late, 2023 is likely to see a housing correction of some magnitude as fixed-rate mortgages have moved above 5% and affordability has been squeezed despite proposed Stamp Duty cuts remaining in place. In the table below, the rise in gilt yields, and therein PWLB rates, through the first half of 2022/23 is clear to see. However, the peak in rates on 28th September as illustrated in the table covering April to September 2022 below, has been followed by the whole curve shifting ever lower. PWLB rates at the front end of the curve are generally over 1% lower now whilst the 50 years is over 1.75% lower. After a shaky start to the year, the S&P 500 and FTSE 100 have climbed in recent weeks, albeit the former is still 17% down and the FTSE 2% up. The German DAX is 9% down for the year. CENTRAL BANK CONCERNS – NOVEMBER 2022
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31 At the start of November, the Fed decided to push up US rates by 0.75% to a range of 3.75% - 4%, whilst the MPC followed a day later by raising Bank Rate from 2.25% to 3%, in line with market expectations. EZ rates have also increased to 1.5% with further tightening in the pipeline. Having said that, the press conferences in the US and the UK were very different. In the US, Fed Chair, Jerome Powell, stated that rates will be elevated and stay higher for longer than markets had expected. Governor Bailey, here in the UK, said the opposite and explained that the two economies are positioned very differently so you should not, therefore, expect the same policy or messaging. Regarding UK market expectations, although they now expect Bank Rate to peak within a lower range of 4.5% - 4.75%, caution is advised as the Bank of England Quarterly Monetary Policy Reports have carried a dovish message over the course of the last year, only for the Bank to have to play catch-up as the inflationary data has proven stronger than expected. In addition, the Bank’s central message that GDP will fall for eight quarters starting with Q3 2022 may prove to be a little pessimistic. Will the £160bn excess savings accumulated by households through the Covid lockdowns provide a spending buffer for the economy – at least to a degree? Ultimately, however, it will not only be inflation data but also employment data that will mostly impact the decision-making process, although any softening in the interest rate outlook in the US may also have an effect (just as, conversely, greater tightening may also).
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32 Appendix 5 - Treasury Management Practice (TMP1) Permitted Investments This Council approves the following forms of investment instrument for use as permitted investments as set out in table 1. Treasury risks All the investment instruments in table 1 are subject to the following risks: - Credit and counter-party risk: this is the risk of failure by a counterparty (bank or building society) to meet its contractual obligations to the organisation particularly as a result of the counterparty’s diminished creditworthiness, and the resulting detrimental effect on the organisation’s capital or current (revenue) resources. There are no counterparties where this risk is zero although AAA rated organisations have the highest, relative, level of creditworthiness. Liquidity risk: this is the risk that cash will not be available when needed. Whilst it could be said that all counterparties are subject to at least a very small level of liquidity risk as credit risk can never be zero, in this document, liquidity risk has been treated as whether or not instant access to cash can be obtained from each form of investment instrument. However, it has to be pointed out that while some forms of investment e.g. gilts, CDs, corporate bonds can usually be sold immediately if the need arises, there are two caveats: - a. Cash may not be available until a settlement date up to three days after the sale b. There is an implied assumption that markets will not freeze up and so the instrument in question will find a ready buyer. The column in table 1 headed as ‘market risk’ will show each investment instrument as being instant access, sale T+3 = transaction date plus 3 business days before you get cash, or term i.e. money is locked in until an agreed maturity date. Market risk: this is the risk that, through adverse market fluctuations in the value of the principal sums an organisation borrows and invests, its stated treasury management policies and objectives are compromised, against which effects it has failed to protect itself adequately. However, some cash rich local authorities may positively want exposure to market risk e.g. those investing in investment instruments with a view to obtaining a long-term increase in value. Interest rate risk: this is the risk that fluctuations in the levels of interest rates create an unexpected or unbudgeted burden on the organisation’s finances, against which the organisation has failed to protect itself adequately. This authority has set limits for its fixed and variable rate exposure in its Treasury Indicators in this report. All types of investment instrument have interest rate risk except for the following forms of instrument which are at variable rate of interest (and the linkage for variations is also shown). Legal and regulatory risk: this is the risk that the organisation itself, or an organisation with which it is dealing in its treasury management activities, fails to act in accordance with its legal powers or regulatory requirements, and that the organisation suffers losses accordingly.
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33 Controls on treasury risks Credit and counter-party risk: this authority has set minimum credit criteria to determine which counterparties and countries are of sufficiently high creditworthiness to be considered for investment purposes. See paragraphs 4.2 and 4.3. Liquidity risk: this authority has a cash flow forecasting model to enable it to determine how long investments can be made for and how much can be invested. Market risk: this authority purchases Certificates of Deposit (CD’s), as they offer a higher rate of return than depositing in the DMADF. They are usually held until maturity but in exceptional circumstances, they can be quickly sold at the current market value, (which may vary from the purchase cost), if the need arises for extra cash at short notice. Their value does not usually vary much during their short life. Interest rate risk: this authority manages this risk by having a view of the future course of interest rates and then formulating a treasury management strategy accordingly which aims to maximise investment earnings consistent with control of risk or alternatively, seeks to minimise expenditure on interest costs on borrowing. See paragraph 4.4. Legal and regulatory risk: this authority will not undertake any form of investing until it has ensured that it has all necessary powers and complied with all regulations. Unlimited investments Regulation 24 states that an investment can be shown in table 1 as being ‘unlimited’ in terms of the maximum amount or percentage of the total portfolio that can be put into that type of investment. However, it also requires that an explanation must be given for using that category. The authority has given the following types of investment an unlimited category: - Debt Management Agency Deposit Facility. This is considered to be the lowest risk form of investment available to local authorities as it is operated by the Debt Management Office which is part of H.M. Treasury i.e. the UK Government’s sovereign rating stands behind the DMADF. It is also a deposit account and avoids the complications of buying and holding Government issued treasury bills or gilts. High credit worthiness banks and building societies. See paragraph 4.2 for an explanation of this authority’s definition of high credit worthiness. While an unlimited amount of the investment portfolio may be put into banks and building societies with high credit worthiness, the authority will ensure diversification of its portfolio ensuring that no more than £20m of the total portfolio can be placed with UK banks and £15m in any single non UK bank institution or group at any one time.
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34 Objectives of each type of investment instrument Regulation 25 requires an explanation of the objectives of every type of investment instrument which an authority approves as being ‘permitted’. Deposits The following forms of ‘investments’ are actually more accurately called deposits as cash is deposited in an account until an agreed maturity date or is held at call. Debt Management Agency Deposit Facility. This offers the lowest risk form of investment available to local authorities as it is effectively an investment placed with the Government. It is also easy to use as it is a deposit account and avoids the complications of buying and holding Government issued treasury bills or gilts. As it is low risk it also earns low rates of interest. However, it is very useful for authorities whose overriding priority is the avoidance of risk. The longest period for a term deposit with the DMADF is 6 months. Term deposits with high credit worthiness banks and building societies. See paragraph 4.2 for an explanation of this authority’s definition of high credit worthiness. This is the most widely used form of investing used by local authorities. It offers a much higher rate of return than the DMADF (dependent on term). The authority will ensure diversification of its portfolio of deposits ensuring that no more than £20m of the total portfolio can be placed with any UK bank and £15m with any single non UK bank institution or group. In addition, longer-term deposits offer an opportunity to increase investment returns by locking in high rates ahead of an expected fall in the level of interest rates. At other times, longer-term rates can offer good value when the markets incorrectly assess the speed and timing of interest rate increases. This form of investing therefore, offers a lot of flexibility and higher earnings than the DMADF. Where it is restricted is that once a longer-term investment is made, that cash is locked in until the maturity date. Call accounts with high credit worthiness banks and building societies. The objectives are as for term deposits above but there is instant access to recalling cash deposited. This generally means accepting a lower rate of interest than that which could be earned from the same institution by making a term deposit. Some use of call accounts is highly desirable to ensure that the authority has ready access to cash when needed to pay bills. Fixed term deposits with variable rate and variable maturities (structured deposits). This line encompasses ALL types of structured deposits. There has been considerable change in the types of structured deposits brought to the market over the last few years, some of which are already no longer available. In view of the fluidity of this area, this is a generic title for all structured deposits so as to provide councils with greater flexibility to adopt new instruments as and when they are brought to the market. However, this does mean that members ought to be informed as to what instruments are presently under this generic title so that they are aware of the current situation, and that they are informed and approve of intended changes in an appropriate manner. Collateralised deposits. These are deposits placed with a bank which offers collateral backing based on specific assets. Examples seen in the past have included local authority LOBOs, where such deposits are effectively lending to a local authority as that is the ultimate security.
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35 DEPOSITS WITH COUNTERPARTIES CURRENTLY IN RECEIPT OF GOVERNMENT SUPPORT / OWNERSHIP These banks offer another dimension of creditworthiness in terms of Government backing through either partial or full direct ownership. The view of this authority is that such backing makes these banks attractive institutions with whom to place deposits, and that will remain our view if the UK sovereign rating were to be downgraded in the coming year. Term deposits with high credit worthiness banks which are fully or semi nationalised. As for term deposits in the previous section, but Government full, (or substantial partial), ownership, implies that the Government stands behind this bank and will be deeply committed to providing whatever support that may be required to ensure the continuity of that bank. This authority considers that this indicates a low and acceptable level of residual risk. Fixed term deposits with variable rate and variable maturities (structured deposits). This line encompasses ALL types of structured deposits. There has been considerable change in the types of structured deposits brought to the market over the last few years, some of which are already no longer available. In view of the fluidity of this area, this is a generic title for all structured deposits so as to provide councils with greater flexibility to adopt new instruments as and when they are brought to the market. However, this does mean that members ought to be informed as to what instruments are presently covered under this generic title so that they are aware of the current situation, and that they are informed and approve of intended changes in an appropriate manner. COLLECTIVE INVESTMENT SCHEMES STRUCTURED AS OPEN ENDED INVESTMENT COMPANIES (OEICS) Government liquidity funds. These are the same as money market funds (see below) but only invest in government debt issuance with highly rated governments. Due to the higher quality of underlying investments, they offer a lower rate of return than MMFs. However, their net return is typically on a par with the DMADF, but with instant access. Money Market Funds (MMFs). ). MMFs are regulated under The European Money Market Fund Regulation (EU) 2017/1131. The Regulation was implemented in full on 21 March 2019. They typically carry a AAA money fund rating and can be priced using the following methods. Constant Net Asset Value (CNAV), Low Volatility Net Asset Value (LVNAV) and Variable Net Asset Value (VNAV). The majority of MMFs are priced using the LVNAV pricing method, which allows for constant pricing in normal market conditions. They are highly diversified, using many forms of money market securities including types which this authority does not currently have the expertise or capabilities to hold directly. However, due to the high level of expertise of the fund managers and the huge amounts of money invested in MMFs, and the fact that the weighted average maturity (WAM) cannot exceed 60 days, MMFs offer a combination of high security, instant access to funds, high diversification and competitive rates of return compared to equivalent instant access facilities. They are particularly advantageous in falling interest rate environments as they are actively managed giving the opportunity to lock in investments earning higher rates of interest than might be available in the market. MMFs also help an authority to diversify its own portfolio as e.g., a £2m investment placed directly with HSBC is a 100% risk exposure to HSBC whereas £2m invested in a MMF may end up with say £10,000 being invested with HSBC through the MMF. For authorities particularly concerned with
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36 risk exposure to banks, MMFs offer an effective way of minimising risk exposure while still delivering superior rates of return available through the DMADF. Ultra short dated bond funds. Ultra short dated bond funds. These funds are similar to MMFs and can carry a AAA bond fund rating. Due to the longer dated nature of the assets they invest in the funds use a VNAV pricing method meaning the price will move up and down inline with market movements. They aim to achieve a higher yield and to do this either take longer term credit risk by using floating rate notes or by investing in longer durations, which means their assets are more volatile. Typically, these funds can have weighted average maturities of up to 360 days and weighted average life’s beyond 5 years. Their primary objective is to firstly generate a competitive total return, whilst preserving capital. They therefore carry a higher level of risk than MMFs and correspondingly have the potential to earn higher returns than MMFs. Gilt funds. These are funds which invest only in U.K. Government gilts. They offer a lower rate of return than bond funds but are highly rated both as a fund and through investing only in highly rated government securities. They offer a higher rate of return than investing in the DMADF but they do have an exposure to movements in market prices of assets held. Bond funds. These can invest in both government and corporate bonds. This therefore entails a higher level of risk exposure than gilt funds and the aim is to achieve a higher rate of return than normally available from gilt funds by trading in non- government bonds. SECURITIES ISSUED OR GUARANTEED BY GOVERNMENTS The following types of investments are where an authority directly purchases a particular investment instrument, a security, i.e. it has a market price when purchased and that value can change during the period the instrument is held until it matures or is sold. The annual earnings on a security is called a yield i.e. it is normally the interest paid by the issuer divided by the price you paid to purchase the security unless a security is initially issued at a discount e.g. treasury bills. Treasury bills. These are short-term bills, (up to 18 months but usually 9 months or less), issued by the Government and so are backed by the sovereign rating of the UK. The yield is higher than the rate of interest paid by the DMADF and another advantage compared to a time deposit in the DMADF is that they can be sold if there is a need for access to cash at any point in time. However, there is a spread between purchase and sale prices so early sales could incur a net cost during the period of ownership. Gilts. These are longer-term debt issuance by the UK Government and are backed by the sovereign rating of the UK. The yield is higher than the rate of interest paid by the DMADF and another advantage compared to a time deposit in the DMADF is that they can be sold if there is a need for access to cash at any point in time. However, there is a spread between purchase and sale prices so early sales may incur a net cost. Market movements that occur between purchase and sale may also have an adverse impact on proceeds. The advantage over Treasury bills is that they generally offer higher yields the longer it is to maturity (for most periods) if the yield curve is positive. Bond issuance issued by a financial institution which is explicitly guaranteed by the UK Government e.g. National Rail. This is similar to a gilt due to the explicit Government guarantee.
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37 Sovereign bond issues (other than the UK govt) denominated in Sterling. As for gilts but issued by other nations. Use limited to issues of nations with at least the same sovereign rating as for the UK. Bonds issued by Multi Lateral Development Banks (MLDBs). These are similar to c. and e. above but are issued by MLDBs which are typically guaranteed by a group of sovereign states e.g. European Bank for Reconstruction and Development. SECURITIES ISSUED BY CORPORATE ORGANISATIONS The following types of investments are where an authority directly purchases a particular investment instrument, a security, i.e. it has a market price when purchased and that value can change during the period the instrument is held until it is sold. The annual earnings on a security is called a yield i.e. is the interest paid by the issuer divided by the price you paid to purchase the security. These are similar to the previous category but corporate organisations can have a wide variety of credit worthiness so it is essential for local authorities to only select the organisations with the highest levels of credit worthiness. Corporate securities are generally a higher risk than government debt issuance and so earn higher yields. a. Certificates of deposit (CDs). These are shorter-term securities issued by deposit taking institutions (mainly financial institutions). They are negotiable instruments, so can be sold ahead of maturity and also purchased after they have been issued. However, that liquidity can come at a price, where the yield could be marginally less than placing a deposit with the same bank as the issuing bank. b. Commercial paper. This is similar to CDs but is issued by commercial organisations or other entities. Maturity periods are up to 365 days but commonly 90 days. c. Corporate bonds. These are (long term) bonds (usually bearing a fixed rate of interest) issued by a financial institution, company or other non-government issuer in order to raise capital for the institution as an alternative to issuing shares or borrowing from banks. They are generally seen to be of a lower creditworthiness than government issued debt and so usually offer higher rates of yield. d. Floating rate notes. These are bonds on which the rate of interest is established periodically with reference to short-term interest rates. OTHER Property fund. This is a collective investment fund specialising in property. Rather than owning a single property with all the risk exposure that means to one property in one location rising or falling in value, maintenance costs, tenants actually paying their rent / lease etc, a collective fund offers the advantage of diversified investment over a wide portfolio of different properties. This can be attractive for authorities who want exposure to the potential for the property sector to rise in value. However, timing is critical to entering or leaving this sector at the optimum times of the property cycle of rising and falling values. Typically, the minimum investment time horizon for considering such funds is at least 3-5 years.
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38 Table 1: permitted investments in house This table is for use by the in house treasury management team. 1.1 Deposits * Minimum Credit Criteria / colour banding Liquidity risk Market risk Max % of total investments Max. maturity period Debt Management Agency Deposit Facility -- term no 100 6 months Term deposits – local authorities -- term no 100 2 years Call accounts – banks and building societies Yellow Purple Blue Orange Red Green No Colour instant no 100 Up to 5 yrs Up to 2 yrs Up to 1 yr Up to 1 yr Up to 6 mths Up to 100 days Not for use Term deposits – banks and building societies Yellow Purple Blue Orange Red Green No Colour term no 100 Up to 5 yrs Up to 2 yrs Up to 1 yr Up to 1 yr Up to 6 mths Up to 100 days Not for use Fixed term deposits with variable rate and variable maturities: - Structured deposits. Green term no 50 2 years Collateralised deposit (see note 1) UK sovereign rating term no 50 1 year Note 1. As collateralised deposits are backed by e.g. AAA rated local authority LOBOs, this investment instrument is effectively a AAA rated investment 1.2 Deposits with counterparties currently in receipt of government support / ownership * Minimum Credit Criteria / colour banding Liquidity risk Market risk Max % of total investments Max. maturity period UK part nationalised banks Blue term no 100 1 Year Banks part nationalised by high credit rated (sovereign rating) countries – non UK UK Sovereign Rating or Blue term no 100 1 Year Fixed term deposits with variable rate and variable maturities: - Structured deposits Green term yes 100 1 Year
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39 1.3 Collective investment schemes structured as Open Ended Investment Companies (OEICs) * Minimum Fund Rating Liquidity risk Market risk Max % of total investments Max. maturity period 1a. Money Market Funds CNAV AAA instant No see note 1 100 1 Year 1b. Money Market Funds LVNAV AAA Instant to T+5 No see note 1 100 1 Year 1c. Money Market Funds VNAV AAA instant to T+5 No see note 1 100 1 Year 2. Ultra short dated bond funds with a credit score of 1.25 AAA T+1 to T+5 yes 100 1 Year 3. Ultra short dated bond funds with a credit score of 1.5 AAA T+1 to T+5 yes 100 1 Year 4. Bond Funds AAA T+2 or longer yes 100 1 Year 5. Gilt Funds UK sovereign rating T+2 or longer yes 100 1 Year Note 1. The objective of MMFs is to maintain the net asset value but they hold assets which can vary in value. However, the credit rating agencies require the fluctuation in unit values held by investors to vary by almost zero. 1.4 Securities issued or guaranteed by governments * Minimum Credit Criteria Liquidity risk Market risk Max % of total investments Max. maturity period Treasury Bills UK sovereign rating Sale T+1 yes 100 1 Year UK Government Gilts UK sovereign rating Sale T+1 yes 100 1 Year Bond issuance issued by a financial institution which is explicitly guaranteed by the UK Government e.g. National Rail UK sovereign rating Sale T+3 yes 100 1 Year Sovereign bond issues (other than the UK govt) AAA Sale T+1 yes 80 1 Year Bonds issued by multilateral development banks AAA Sale T+1 yes 80 1 Year
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40 1.5 Securities issued by corporate organisations * Minimum Credit Criteria Liquidity risk Market risk Max % of total investments Max. maturity period Certificates of deposit issued by banks and building societies Green Sale T+0 yes 50 2 Years Commercial paper other Green Sale T+0 yes 20 2 Years Floating rate notes Green Sale T+0 yes 20 2 Years Corporate Bonds other Green Sale T+3 yes 20 2 Years Accounting treatment of investments. The accounting treatment may differ from the underlying cash transactions arising from investment decisions made by this Council. To ensure that the Council is protected from any adverse revenue impact, which may arise from these differences, we will review the accounting implications of new transactions before they are undertaken. 1.6 Other * Minimum Credit Criteria / fund rating Liquidity risk Market risk Max % of total investments Max. maturity period Property funds -- T+4 yes 100 5 Years
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41 Appendix 6 – Treasury Management Practice (TMP2) Credit and Counterparty Risk Management The following table is for use by the Treasury team and is a list of current counterparties. However, the use of counterparties depends on credit ratings and the Council may stop using certain counterparties and may stop using certain counterparties and/or decide to use alternative counterparties within its permitted investments. If for unavoidable short term operation reasons, limits are breached this will be communicated to management immediately. The Monitoring of Investment Counterparties - The status of counterparties will be monitored regularly. The Council receives credit rating and market information from Link Treasury Services, including when ratings change, and counterparties are checked promptly. On occasion ratings may be downgraded when an investment has already been made. The criteria used are such that a minor downgrading should not affect the full receipt of the principal and interest. Any counterparty failing to meet the criteria will be removed from the list immediately by the Section 95 Officer, and if required new counterparties which meet the criteria will be added to the list. Type of Investment Treasury Risks Mitigating Controls Council Limits Common Good Limits Cash type instruments a. Deposits with the Debt Management Account Facility (UK Government) (Very low risk) This is a deposit with the UK Government and as such counterparty and liquidity risk is very low, and there is no risk to value. Deposits can be between overnight and 6 months. Little mitigating controls required. As this is a UK Government investment the monetary limit is unlimited to allow for a safe haven for investments. £unlimited, maximum 6 months. £unlimited, maximum 6 months. b. Deposits with other local authorities or public bodies (Very low risk) These are considered quasi UK Government debt and as such counterparty risk is very low, and there is no risk to value. Liquidity may present a problem as deposits can only be broken with the agreement of the counterparty, and penalties can apply. Little mitigating controls required for local authority deposits, as this is a quasi UK Government investment. Non- local authority deposits will follow the approved credit rating criteria. £unlimited, maximum 2 year. Limit of £10m per local Authority or public body £unlimited, maximum 2 years.
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42 Type of Investment Treasury Risks Mitigating Controls Council Limits Common Good Limits Deposits with other non-local authority bodies will be restricted to the overall credit rating criteria. c. Money Market Funds (MMFs) – CNAV/LVNAV/VNAV(Low to very low risk) Pooled cash investment vehicle which provides very low counterparty, liquidity and market risk. These will primarily be used as liquidity instruments. Funds will only be used where the MMFs has a “AAA” rated status from either Fitch, Moody’s or Standard and Poor’s. £15m per fund 100% d. Ultra short dated bond funds (low risk) Pooled cash investment vehicle which provides very low counterparty, liquidity and market risk. These will primarily be used as liquidity instruments. Funds will only be used where the have a “AAA” rated status from either Fitch, Moody’s or Standard and Poor’s. £15m per fund 100% e. Call account deposit accounts with financial institutions (banks and building societies) (Low risk depending on credit rating) These tend to be low risk investments, but will exhibit higher risks than categories (a), (b) and (c) above. Whilst there is no risk to value with these types of investments, liquidity is high and investments can be returned at short notice. The counterparty selection criteria approved above restricts lending only to high quality counterparties, measured primarily by credit ratings from Fitch, Moody’s and Standard and Poor’sDay to day investment dealing with this criteria will be further strengthened by use of additional market intelligence. As shown in the counterparty section criteria above. As shown in the counterparty section criteria above. f. Term deposits with financial institutions (banks and building societies) (Low to medium risk depending These tend to be low risk investments, but will exhibit higher risks than categories (a), (b) and (c) above. Whilst there is no risk to value with these types of investments, liquidity is low and term deposits can only be The counterparty selection criteria approved above restricts lending only to high quality counterparties, measured primarily by credit ratings from Fitch, Moody’s and Standard and Poor’s. Day to day investment dealing with this criteria will be further strengthened by use of additional market intelligence. As shown in the counterparty section criteria above. As shown in the counterparty section criteria above.
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43 Type of Investment Treasury Risks Mitigating Controls Council Limits Common Good Limits on period & credit rating) broken with the agreement of the counterparty, and penalties may apply. g. Government Gilts and Treasury Bills (Very low risk) These are marketable securities issued by the UK Government and as such counterparty and liquidity risk is very low, although there is potential risk to value arising from an adverse movement in interest rates (no loss if these are held to maturity. Little counterparty mitigating controls are required, as this is a UK Government investment. The potential for capital loss will be reduced by limiting the maximum monetary and time exposures. £10m maximum 1 year. 100% maximum 1 year. h. Certificates of deposits with financial institutions (Low risk) These are short dated marketable securities issued by financial institutions and as such counterparty risk is low, but will exhibit higher risks than categories (a), (b) and (c) above. There is risk to value of capital loss arising from selling ahead of maturity if combined with an adverse movement in interest rates (no loss if these are held to maturity). Liquidity risk will normally be low. The counterparty selection criteria approved above restricts lending only to high quality counterparties, measured primarily by credit ratings from Fitch, Moody’s and Standard and Poor’s. Day to day investment dealing with this criteria will be further strengthened by the use of additional market intelligence. £10m per counterparty maximum 1 year. 20% maximum 1 year. i. Structured deposit facilities with banks and building societies (escalating rates, de- escalating rates etc.) (Low to medium risk These tend to be medium to low risk investments, but will exhibit higher risks than categories (a), (b) and (c) above. Whilst there is no risk to value with these types of investments, liquidity is very low and investments can only be broken with the agreement The counterparty selection criteria approved above restricts lending only to high quality counterparties, measured primarily by credit ratings from Fitch, Moody’s and Standard and Poor’s. Day to day investment dealing with this criteria As shown in the counterparty section criteria above. As shown in the counterparty section criteria above.
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44 Type of Investment Treasury Risks Mitigating Controls Council Limits Common Good Limits depending on period & credit rating) of the counterparty (penalties may apply). will be further strengthened by the use of additional market intelligence. j. Corporate bonds (Medium to high risk depending on period & credit rating) These are marketable securities issued by financial and corporate institutions. Counterparty risk will vary and there is risk to value of capital loss arising from selling ahead of maturity if combined with an adverse movement in interest rates. Liquidity risk will be low. The counterparty selection criteria approved above restricts lending only to high quality counterparties, measured primarily by credit ratings from Fitch, Moody’s and Standard and Poor’s. . Corporate bonds will be restricted to those meeting the base criteria. Day to day investment dealing with this criteria will be further strengthened by the use of additional market intelligence. £5m and maximum 1 year. £20% and maximum 1 year. Other types of investments a. Investment properties These are non-service properties which are being held pending disposal or for a longer term rental income stream. These are highly illiquid assets with high risk to value (the potential for property prices to fall or for rental voids). In larger investment portfolios some small allocation of property based investment may counterbalance/compliment the wider cash portfolio. Property holding will be re-valued regularly and reported annually with gross and net rental streams. £10m 20%. b. Loans to third parties, including soft loans These are service investments either at market rates of interest or below market rates (soft loans). These types of investments may exhibit credit risk and are likely to be highly illiquid. Each third party loan requires Member approval and each application is supported by the service rational behind the loan and the likelihood of partial or full default. £10m and maximum 5 years. 10% and maximum 5 years.
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45 Type of Investment Treasury Risks Mitigating Controls Council Limits Common Good Limits c. Shareholdings in a local authority company These are service investments which may exhibit market risk and are likely to be highly illiquid. Each equity investment in a local authority company requires Member approval and each application will be supported by the service rational behind the investment and the likelihood of loss. 50% 20% d. Non-local authority shareholdings These are non-service investments which may exhibit market risk, be only considered for longer term investments and will be likely to be liquid. Any non-service equity investment will require separate Member approval and each application will be supported by the service rational behind the investment and the likelihood of loss. 5% 100% e. Loans to third parties as part of the Council’s Empty Homes Strategy These are service investments either at market rates of interest or below market rates (soft loans). These types of investments may exhibit credit risk and are likely to be highly illiquid. Each third party loan requires Section 95 Officer approval and each application is supported by the service rational behind the loan and the likelihood of partial or full default. Each funding request will be accompanied by financial projections and be subject to an assessment of the project and borrower. £1.5m and a maximum of 10 years. N/A f. Loans to third parties as part of the Council’s SHF Front Funding Facility These are service investments either at market rates of interest or below market rates (soft loans). These types of investments may exhibit credit risk and are likely to be highly illiquid. Each third party loan requires Section 95 Officer approval and each application is supported by the service rational behind the loan and the likelihood of partial or full default. Each funding request will be accompanied by financial projections and be subject to an assessment of the project and borrower. £5m and a maximum of 3 years. N/A
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46 Type of Investment Treasury Risks Mitigating Controls Council Limits Common Good Limits g. Loans to third parties as part of the Council’s Long Term Loan Funding to RSL’s These are service investments either at market rates of interest or below market rates (soft loans). These types of investments may exhibit credit risk and are likely to be highly illiquid. Each third party loan requires Section 95 Officer approval and each application is supported by the service rational behind the loan and the likelihood of partial or full default. Each funding request will be accompanied by financial projections and be subject to an assessment of the project and borrower. £5m and a maximum of 30 years. N/A h. Hub Co sub debt These are non-service investments which may exhibit market risk, be only considered for longer term investments and will be likely to be highly illiquid. Any non-service equity investment will require separate Member approval and each application will be supported by the service rational behind the investment and the likelihood of loss. £10m N/A i. Investment in a project run by a Local Authority or Local Authority Joint Committee These are investments which may exhibit market risks and will only be considered for medium to longer term investments Each investment requires approval by the Section 95 Officer up to £250,000, and, above this level, member approval. Each application will be supported by the service rationale behind the investment and the likelihood of loss. £10m N/A
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47 Appendix 7 – Creditworthiness policy Service and Information provided by Link Treasury Services This Council applies the creditworthiness service provided by Link Treasury Services. This service employs a sophisticated modelling approach utilising credit ratings from the three main credit rating agencies - Fitch, Moody’s and Standard and Poor’s. The credit ratings of counterparties are supplemented with the following overlays: Credit watches and credit outlooks from credit rating agencies Credit Default Swaps (CDS) spreads to give early warning of likely changes in credit ratings Sovereign ratings to select counterparties from only the most creditworthy countries. This modelling approach combines credit rates, credit watches and credit outlooks in a weighted scoring system which is then combined with an overlay of CDS spreads for which the end product is a series of colour coded bands which indicate the relative creditworthiness of counterparties. These colour codes are used by the Council to determine the suggested duration of investments. Based on the Link Treasury Services approach, the Council will therefore use counterparties within the following durational bands: Yellow 5 years* Dark pink 5 years for Ultra short dated bond funds with a credit score of 1.25 Light pink 5 years for Ultra short dated bond funds with a credit score of 1.5 Purple 2 years Blue 1 year (only applies to nationalised or semi nationalised UK banks) Orange 1 year Red 6 months Green 100 days No colour Not to be used *The yellow colour category is for UK Government debt, or its equivalent, money market funds and collateralised deposits where the collateral is UK Government debt. The Link creditworthiness service uses a wider array of information other than just primary ratings. Furthermore, by using a risk weighted scoring system, it does not give undue preponderance to just one agency’s ratings. Typically, the minimum credit ratings criteria the Council use will be a short-term rating (Fitch or equivalents) of F1 and a long-term rating of A-. There may be occasions when the counterparty ratings from one rating agency are marginally lower than these ratings but may still be used. In these instances, consideration will be given to the whole range of ratings available, or other topical market information, to support their use. All credit ratings will be monitored at least weekly. The Council is alerted to changes to ratings of all three agencies through its use of the Link creditworthiness service.
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48 if a downgrade results in the counterparty / investment scheme no longer meeting the Council’s minimum criteria, its further use as a new investment will be withdrawn immediately. in addition to the use of credit ratings the Council will be advised of information in movements in Credit Default Swap spreads against the iTraxx European Senior Financials benchmark and other market data on a daily basis via its Passport website, provided exclusively to it by Link. Extreme market movements may result in downgrade of an institution or removal from the Council’s lending list. Sole reliance will not be placed on the use of this external service. In addition this Council will also use market data and market information, information on government support for banks and the credit ratings of that supporting government. No more than £20m can be invested with each UK bank and £15m each with any non UK bank. The Council will place overnight and call deposits with the Council’s bankers irrespective of credit rating. The Council’s Bankers currently have a credit rating which allows deposits of up to £20m to be placed with them for up to 100 days. Deposits can be placed with Local Authorities and other public sector bodies for a period up to 2 years. The Council can invest an unlimited amount of money with the Debt Management Agency Deposit Facility (operated by the Debt Management Office which is part of HM Treasury). The longest period for a term deposit with the DMADF is 6 months. Creditworthiness. Significant levels of downgrades to Short and Long-Term credit ratings have not materialised since the crisis in March 2020. In the main, where they did change, any alterations were limited to Outlooks. However, more recently the UK sovereign debt rating has been placed on Negative Outlook by the three major rating agencies in the wake of the Truss/Kwarteng unfunded tax-cuts policy. Although the Sunak/Hunt government has calmed markets, the outcome of the rating agency reviews is unknown at present, but it is possible the UK sovereign debt rating will be downgraded. Accordingly, when setting minimum sovereign debt ratings, this Authority will not set a minimum rating for the UK CDS prices Although bank CDS prices, (these are market indicators of credit risk), spiked upwards during the days of the Truss/Kwarteng government, they have returned to more average levels since then. However, sentiment can easily shift, so it will remain important to undertake continual monitoring of all aspects of risk and return in the current circumstances. Link monitor CDS prices as part of their creditworthiness service to local authorities and the Authority has access to this information via its Link-provided Passport portal.
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49 Appendix 8 – Approved Countries for Investments (08-12-22) This list is based on those countries which have sovereign ratings of AA- or higher (we show the lowest rating from Fitch, Moody’s and S&P) and also, (except - at the time of writing - for Hong Kong, Norway and Luxembourg), have banks operating in sterling markets which have credit ratings of green or above in the Link credit worthiness service. AAA Australia Denmark Germany Netherlands Norway Singapore Sweden Switzerland AA+ Canada Finland U.S.A. AA Abu Dhabi (UAE) France AA- Belgium Qatar U.K.
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50 Appendix 9 – Treasury Management Scheme of Delegation The Council Overall responsibility for Treasury Management Strategy. Adoption of Treasury Policy Statements. Receive an Annual Report and other reports on the Treasury Management Operation and on the exercise of delegated treasury management powers. The Policy and Resources Committee Responsibility for the overall investment of money under the control of the Council. Keeping under review the level of borrowing. Approval of Annual Strategy Statement. Receiving and reviewing reports on treasury management policies, practices and activities. Approval of Treasury Policy Statements. Implementation and monitoring of Treasury Management Policies and Practices. The Audit and Scrutiny Committee Review the overall internal and management control framework related to the treasury function. Review internal and external audit reports related to treasury management. Review provision in the internal and external audit plans to ensure there is adequate audit coverage of treasury management. Monitor progress with implementing recommendations in internal and external audit reports. Reviewing the treasury management policy and procedures and making recommendations to the responsible body.
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51 Appendix 10 – The Treasury Management Role of the Section 95 Officer Section 95 Officer: Recommending clauses, treasury management policy/practices for approval, reviewing the same regularly, and monitoring compliance. Submitting regular treasury management policy reports. Suubmitting budgets and budget variations. Receiving and reviewing management information reports. Reviewing the performance of the treasury management function. Ensuring the adequacy of treasury management resources and skills, and the effective division of responsibilities within the treasury management function. Ensuring the adequacy of internal audit, and liaising with external audit. Recommending the appointment of external service providers. Reviewing and considering risk management in terms of treasury activities. preparation of a capital strategy to include capital expenditure, capital financing, non- financial investments and treasury management, with a long term timeframe ensuring that the capital strategy is prudent, sustainable, affordable and prudent in the long term and provides value for money ensuring that due diligence has been carried out on all treasury and non-financial investments and is in accordance with the risk appetite of the authority ensure that the authority has appropriate legal powers to undertake expenditure on non-financial assets and their financing ensuring the proportionality of all investments so that the authority does not undertake a level of investing which exposes the authority to an excessive level of risk compared to its financial resources ensuring that an adequate governance process is in place for the approval, monitoring and ongoing risk management of all non-financial investments and long term liabilities provision to members of a schedule of all non-treasury investments including material investments in subsidiaries, joint ventures, loans and financial guarantees ensuring that members are adequately informed and understand the risk exposures taken on by an authority ensuring that the authority has adequate expertise, either in house or externally provided, to carry out the above creation of Treasury Management Practices which specifically deal with how non- treasury investments will be carried out and managed, to include the following: - o Risk management (TMP1 and schedules), including investment and risk management criteria for any material non-treasury investment portfolios; o Performance measurement and management (TMP2 and schedules), including methodology and criteria for assessing the performance and success of non-treasury investments; o Decision making, governance and organisation (TMP5 and schedules), including a statement of the governance requirements for decision making in relation to non-treasury investments; and arrangements to ensure that
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52 appropriate professional due diligence is carried out to support decision making; o Reporting and management information (TMP6 and schedules), including where and how often monitoring reports are taken; o Training and qualifications (TMP10 and schedules), including how the relevant knowledge and skills in relation to non-treasury investments will be arranged. The nominated Elected Member (Policy Lead for Finance and Commercial Services) Acting as spokesperson for treasury management. Taking a lead for elected Members in overseeing the operation of the treasury function. Review the treasury management policy, strategy and reports. Support and challenge the development of treasury management.
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53 Appendix 11 – Policy on environmental, social and governance (E.S.G.) This Council is supportive of the Principles for Responsible Investment (www.unpri.org) and will seek to bring ESG (environmental, social and governance) factors into the decision- making process for investments. Within this, the Council is also appreciative of the Statement on ESG in Credit Risk and Ratings which commits signatories to incorporating ESG into credit ratings and analysis in a systemic and transparent way. The Council uses ratings from Fitch, Moody’s and Standard & Poor’s to support its assessment of suitable counterparties. Each of these rating agencies is a signatory to the ESG in credit risk and ratings statement, which is as follows: “We, the undersigned, recognise that environmental, social and governance (ESG) factors can affect borrowers’ cash flows and the likelihood that they will default on their debt obligations. ESG factors are therefore important elements in assessing the creditworthiness of borrowers. For corporates, concerns such as stranded assets linked to climate change, labour relations challenges or lack of transparency around accounting practices can cause unexpected losses, expenditure, inefficiencies, litigation, regulatory pressure and reputational impacts. At a sovereign level, risks related to, inter alia, natural resource management, public health standards and corruption can all affect tax revenues, trade balance and foreign investment. The same is true for local governments and special purpose vehicles issuing project bonds. Such events can result in bond price volatility and increase the risk of defaults. In order to more fully address major market and idiosyncratic risk in debt capital markets, underwriters, credit rating agencies and investors should consider the potential financial materiality of ESG factors in a strategic and systematic way. Transparency on which ESG factors are considered, how these are integrated, and the extent to which they are deemed material in credit assessments will enable better alignment of key stakeholders. In doing this the stakeholders should recognise that credit ratings reflect exclusively an assessment of an issuer’s creditworthiness. Credit rating agencies must be allowed to maintain full independence in determining which criteria may be material to their ratings. While issuer ESG analysis may be considered an important part of a credit rating, the two assessments should not be confused or seen as interchangeable. With this in mind, we share a common vision to enhance systematic and transparent consideration of ESG factors in the assessment of creditworthiness.” For short term investments with counterparties, this Council utilises the ratings provided by Fitch, Moody’s and Standard & Poor’s to assess creditworthiness, which do include analysis of ESG factors when assigning ratings. The Council will continue to evaluate additional ESG-related metrics and assessment processes that it could incorporate into its investment process and will update accordingly. This Council will not invest in companies whose core activities pose a risk of serious harm to individuals or groups, or whose activities are inconsistent with the Council’s mission and values e.g.: a. Human rights abuse (e.g., slave or child labour, political oppression) b. Activities that damage the environment by extraction of fossil fuels, destruction of habitat, or creation of pollutants c. Socially harmful activities (e.g., tobacco, gambling) d. Manufacture of weapons