Treasury Management and Investment Strategy

Investment Strategy 2010/11 - 2012/13

29. Key Objectives - The Council’s investment strategy primary objectives are safeguarding the re-payment of the principal and interest of its investments on time first and ensuring adequate liquidity second – the investment return being a third objective.  Following the economic background above, the current investment climate has one over-riding risk consideration, that of counterparty security risk.  As a result of these underlying concerns officers are implementing an operational investment strategy which tightens the controls already in place in the approved investment strategy. 

30. Risk Benchmarking – A development in the revised Codes and the CLG consultation paper is the consideration and approval of security and liquidity benchmarks.  Yield benchmarks are currently widely used to assess investment performance.  Discrete security and liquidity benchmarks are new requirements to the Member reporting, although the application of these is more subjective in nature.  Additional background in the approach taken is attached at Annex B2.

31. These benchmarks are simple targets (not limits) and so may be breached from time to time, depending on movements in interest rates and counterparty criteria.  The purpose of the benchmark is that officers will monitor the current and trend position and amend the operational strategy depending on any changes.  Any breach of the benchmarks will be reported, with supporting reasons in the Mid-Year or Annual Report.

32. Security - The Council’s maximum security risk benchmark for the current portfolio, when compared to these historic default tables, is:

• 0.05% historic risk of default when compared to the whole portfolio.

33. Liquidity – In respect of this area the Council seeks to maintain:

• Bank overdraft - £0.5m
• Liquid short term deposits of at least £5m available with a week’s notice.
• Weighted Average Life benchmark is expected to be 0.1 years, with a maximum of 0.5 years.

34. Yield - Local measures of yield benchmarks are:

• Investments – Internal returns above the Bank of England  base rate

35. And in addition to that the security benchmark for each individual year is:

Note: This benchmark is an average risk of default measure, and would not constitute an expectation of loss against a particular investment. 

36. Investment Counterparty Selection Criteria - The primary principle governing the Council’s investment criteria is the security of its investments, although the yield or return on the investment is also a key consideration.  After this main principle the Council will ensure:

• It maintains a policy covering both the categories of investment types it will invest in, criteria for choosing investment counterparties with adequate security, and monitoring their security.  This is set out in the Specified and Non-Specified investment sections below.
• It has sufficient liquidity in its investments.  For this purpose it will set out procedures for determining the maximum periods for which funds may prudently be committed.  These procedures also apply to the Council’s prudential indicators covering the maximum principal sums invested. 

37. The Director of Finance and Corporate Services will maintain a counterparty list in compliance with the following criteria and will revise the criteria and submit them to Council for approval as necessary.  This criteria is separate to that which chooses Specified and Non-Specified investments as it provides an overall pool of counterparties considered high quality the Council may use rather than defining what its investments are. 

38. The rating criteria use the lowest common denominator method of selecting counterparties and applying limits.  This means that the application of the Council’s minimum criteria will apply to the lowest available rating for any institution.  For instance if an institution is rated by two agencies, one meets the Council’s criteria, the other does not, the institution will fall outside the lending criteria.  This is in compliance with a CIPFA Treasury Management Panel recommendation in March 2009 and the CIPFA Treasury Management Code of Practice.

39. Credit rating information is supplied by our treasury consultants on all active counterparties that comply with the criteria below.  Any counterparty failing to meet the criteria would be omitted from the counterparty (dealing) list.  Any rating changes, rating watches (notification of a likely change), rating outlooks (notification of a possible longer term change) are provided to officers almost immediately after they occur and this information is considered before dealing.  For instance a negative rating watch applying to a counterparty at the minimum Council criteria will be removed from the list, with all others being reviewed in light of market conditions.

40. The criteria for providing a pool of high quality investment counterparties (both Specified and Non-specified investments) is:

• Banks 1 - Good Credit Quality – the Council will only use banks which:

          i.   Are UK banks; and/or

          ii.  Are non-UK and domiciled in a country which has a minimum Sovereign long term

               rating of AAA

And have, as a minimum, the following Fitch, Moody’s and Standard and Poors credit ratings (where rated):

          i.      Short Term – F1

          ii.     Long Term – A

          iii.    Individual / Financial Strength – C (Fitch / Moody’s only)

          iv.    Support – 3 (Fitch only)

• Banks 2 – Guaranteed Banks with suitable Sovereign Support – In addition, the Council will use banks whose ratings fall below the criteria specified above if all of the following conditions are met:

(a) wholesale deposits in the bank are covered by a government guarantee;

(b) the government providing the guarantee is rated “AAA” by all three major rating agencies (Fitch, Moody’s and Standard & Poors); and

(c) the Council’s investments with the bank are limited to amounts and maturities within the terms of the stipulated guarantee.

• Banks 3 – Eligible Institutions - the organisation is an Eligible Institution for the HM Treasury Credit Guarantee Scheme initially announced on 13 October 2008, with the necessary short and long term ratings required in Banks 1 above.  These institutions have been subject to suitability checks before inclusion, and have access to HM Treasury liquidity if needed.
• Banks 4 – The Council’s own banker for transactional purposes if the bank falls below the above criteria, although in this case balances will be minimised in both monetary size and time.
• Bank Subsidiary and Treasury Operations – the Council will use these where the parent bank has the necessary ratings outlined above.

• Building Societies – the Council will use all Societies which:

         i.  meet the ratings for banks outlined above

• Money Market Funds – AAA
• UK Government (including gilts and the DMADF)
• Local Authorities, Parish Councils etc
• Supranational institutions

41. Country and sector considerations - Due care will be taken to consider the country, group and sector exposure of the Council’s investments.  In part the country selection will be chosen by the credit rating of the Sovereign state in Banks 1 above.  In addition:

• no more than 10% will be placed with any non-UK country at any time;
• limits in place above will apply to Group companies;
• Sector limits will be monitored regularly for appropriateness.

42. Use of additional information other than credit ratings – Additional requirements under the Code of Practice now require the Council to supplement credit rating information.  Whilst the above criteria relies primarily on the application of credit ratings to provide a pool of appropriate counterparties for officers to use, additional operational market information will be applied before making any specific investment decision from the agreed pool of counterparties.  This additional market information (for example Credit Default Swaps, negative rating watches/outlooks) will be applied to compare the relative security of differing investment counterparties.

43. Time and Monetary Limits applying to Investments - The time and monetary limits for institutions on the Council’s Counterparty List are as follows (these will cover both Specified and Non-Specified Investments):

44. The proposed criteria for Specified investments are shown in Annex B1 for approval.

45. In the normal course of the Council’s cash flow operations it is expected that the Specified investments will be utilised for the control of liquidity as this category allows for short term investments. 

46. The use of longer term instruments (greater than one year from inception to repayment) will fall in the Non-specified investment category.  These instruments will not be used by the Council.

47. Economic Investment Considerations - Expectations on shorter-term interest rates, on which investment decisions are based, show likelihood of the current 0.5% Bank Rate remaining flat but with the possibility of a rise in mid-2010.  The Council’s investment decisions are based on comparisons between the rises priced into market rates against the Council’s and advisers own forecasts.  

48. There is an operational difficulty arising from the current banking crisis. There is currently little value investing longer term unless credit quality is reduced.  Whilst some selective options do provide additional yield uncertainty over counterparty creditworthiness suggests shorter dated investments would provide better security.

49. The criteria for choosing counterparties set out above provide a sound approach to investment in “normal” market circumstances.  Whilst Members are asked to approve this base criteria above, under the exceptional current market conditions the Director of Finance and Corporate Services may temporarily restrict further investment activity to those counterparties considered of higher credit quality than the minimum criteria set out for approval.  These restrictions will remain in place until the banking system returns to “normal” conditions.  Similarly the time periods for investments will be restricted.

50. Examples of these restrictions would be the greater use of the Debt Management Deposit Account Facility (DMADF – a Government body which accepts local authority deposits), Money Market Funds, guaranteed deposit facilities and strongly rated institutions offered support by the UK Government.  The credit criteria have been amended to reflect these facilities.

Sensitivity to Interest Rate Movements

51. Future Council accounts will be required to disclose the impact of risks on the Council’s treasury management activity.  Whilst most of the risks facing the treasury management service are addressed elsewhere in this report (credit risk, liquidity risk, market risk, maturity profile risk), the impact of interest rate risk is discussed but not quantified.   The following table highlights the estimated impact of a 1% increase/decrease in all relevant interest rates to the estimated treasury management costs/income for next year.  That element of the debt and investment portfolios which are of a longer term, fixed interest rate nature will not be affected by interest rate changes.

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