House of Commons - Communities and Local Government Committee

Local authority investments - Communities and Local Government Committee Contents

Memorandum by the Chartered Institute of Public Finance and Accountancy (LAI 13)

SUMMARY

The Chartered Institute of Public Finance and Accountancy (CIPFA) welcomes the opportunity to provide evidence to the Select Committee on local authority investments. CIPFA is one of the leading professional accountancy bodies in the UK and the only one which specialises in the public services. It is responsible for the education and training of professional accountants and for their regulation through the setting and monitoring of professional standards.

CIPFA has a key role in local authority treasury management. We are responsible for both the Prudential Code for Capital Finance and the Treasury Management Code which represent professional best practice in the area and which local authorities are required to follow under the 2003 Local Government Act. This is reinforced for CIPFA members through the Statement of Professional Practice with which all members are required to comply. CIPFA defines Treasury Management as:

"The management of the organisation's 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."

This clearly places risk management at the heart of all treasury management activities.

CIPFA firmly believes that professional treasury management has a key role in supporting the activities of local authorities in terms of value for money and management of risk. Our submission will set out our arguments for continuing and developing the current framework for treasury management and how CIPFA intends to support that framework moving forward.

We believe that the key focus of the enquiry should be around how the existing frameworks have been applied. General lessons to be learnt should be built into the development of treasury management practices moving forward. Should individual authorities have failed to properly follow policies and procedures then appropriate review and investigation should follow.

The key conclusions from our submission are:

— The overall framework for local authority treasury management remains based on sound principles. However the application of the Code should continue to be developed and strengthened in line with developing best practice and current work being carried out by CIPFA.

— No treasury management activity is without risk and determining what level of risk is acceptable should be at the heart of local authorities' treasury management policies. Treasury management policies should be designed to minimise the risk of capital loss but cannot eliminate it entirely.

— Clear governance arrangements are in place to ensure treasury management decisions are made in a public and transparent way with the full knowledge and approval of councils. Where individual authorities have not acted in accordance with the arrangements, procedures and protocols exist to deal with them.

— Greater regulatory control of local authority investments would be a response fraught with difficulties and potentially direct service implications and that the framework should continue to be based upon professional decision making, ensuring that local authorities have access to the best possible advice to assist them in this role.

CIPFA is happy to offer the Select Committee whatever assistance it is able in the consideration of local authority investments.

CONTEXT

1. Together Local Authorities in Great Britain manage around £63 billion of debt and £28 billion of investments. The table below shows a breakdown of local authority investments (a fuller breakdown can be found in Table 9, page 11 of the CIPFA Capital Finance and Treasury Management Statistics included with this submission). The investments at risk due to the collapse of the Icelandic Banks represent just over 3% of overall local authority deposits. The fact that this proportion is so low reflects local authorities' diversification of investment portfolios.

Table

EXTRACT FROM CIPFA CAPITAL FINANCE AND TREASURY MANAGEMENT STATISTICS 2006-07

As at 31 March 2007 £m	Externally Managed Funds	Cash deposits— banks/building societies	Other Internally Managed Funds	Total	Interest Earned
London	661	6,255	66	6,982	384
English Counties	465	4,891	129	5,485	283
English Districts	1,437	3,543	451	5,431	288
English Mets/Unitaries	518	4,139	401	5,058	326
Wales Unitaries	63	1,121	12	1,196	67
All England & Wales*	3,719	21,018	1,155	25,892	1,460
Scotland	438	1,147	380	1,965	93
Total	4,157	22,165	1,535	27,857	1,553

* Includes Joint Passenger Transport Authorities, Fire and Civil Defence Authorities, Waste Disposal
Authorities and Police Authorities

2. A marked trend in the last 20 years or so has been the increasing numbers of authorities that have become debt-free, mainly as a result of asset sales, notably council housing stock. This has led to more and more authorities being able to identify the existence of substantial amounts of core cash, and the development of their investment policies and practices to take advantage of the more permanent nature of their reserves.

3. However, the wider investment powers afforded by the 2004 investment guidance have not led to a widespread use of alternative instruments and, at 31 March 2008, over 90% of local authority cash investments were still represented by cash deposits with banks and building societies.

4. A key change over recent years has been the number of authorities holding both investments and debt. The Prudential Code allows for authorities to borrow reasonably in advance of planned capital expenditure to allow properly for certainty over project financing and management of interest rate risk. A large number of authorities, however, are in such a position for historical reasons and the costs of repaying debt and HRA financing determinations can act as a discouragement to the repayment of debt.

THE TREASURY MANAGEMENT FRAMEWORK

5. CIPFA plays a key role in the development of the treasury management framework for local authorities. The CIPFA Treasury Management Panel includes both practitioners and representatives from other key bodies to oversee the development of best practice guidance and advice, dissemination of knowledge and education and training. Collectively CIPFA technical panels aim to promote financial management and best practice throughout the public services. In addition the CIPFA Treasury Management Forum is a membership based organization that provides an extensive programme of workshops and bulletins to its member organisations.

6. Education and training is seen as a key requisite and to this end CIPFA has been instrumental in incorporating treasury management into the core CIPFA syllabus and working with the Association of Corporate Treasurers to introduce a new qualification in public sector treasury management. The qualification is currently under development and will be launched next spring.

7. At the heart of the framework for treasury management in local authorities is the CIPFA Treasury Management Code. The Code sets out the procedures and policies local authorities should follow in the organization and operation of their treasury management functions. The Treasury Management Code is given legislative weight by the Local Government Act 2003 and the adoption of the Treasury Management Code is a key requirement of the Prudential Code for Capital Finance.

8. CIPFA published Treasury Management in the Public Services: Code of Practice and Cross-sectoral Guidance Notes (The TM Code) in 2002. At the same time, it issued sector-specific guidance notes in respect of the main categories of public service organisations, including local authorities. These Guidance Notes were updated in 2006 and are currently in the process of being updated again. The original Treasury Management Code was published in the wake of the collapse of BCCI in July 1991 and included a response to many of the lessons learnt, especially around diversification of investments and governance arrangements.

9. The three key objectives of the Treasury Management Code are set out below. These are recommendations that authorities are required to adopt as part of their adoption of the Treasury Management Code.

XTRACT

FROM

REASURY

ANAGEMENT

ODE

Key Recommendation 1

Public service organisations should put in place formal and comprehensive objectives, policies and practices, strategies and reporting arrangements for the effective management and control of their treasury management activities.

Key Recommendation 2

Their policies and practices should make clear that the effective management and control of risk are prime objectives of their treasury management activities.

Key Recommendation 3

They should acknowledge that the pursuit of best value in treasury management, and the use of suitable performance measures, are valid and important tools for responsible organisations to employ in support of their business and service objectives; and that within the context of effective risk management, their treasury management policies and practices should reflect this.

10. It can clearly be seen that the primary objectives of the Treasury Management Code is the management and control of treasury management risks. Treasury management risks are many and varied but include interest rate, liquidity and counter-party risks. The Treasury Management Code is clear that treasury management returns should only be sought within the boundaries of an acceptable risk management policy.

11. The focus on risk in the Treasury Management Code is supported by the Investment Guidelines issued by the then Office of the Deputy Prime Minister in 2004. The Guidelines encourage forms of investment offering high security and liquidity. In essence, this is achieved by making a distinction between "specified" and "non-specified" investments, the latter being required to be subjected to greater scrutiny by authorities.

12. The Treasury Management Code also puts into place clear procedures for the governance of treasury management arrangements. Full Council is required before the start of each financial year to agree the Treasury Management Strategy which sets out the borrowing and lending criteria for the following year. The Treasury Management Strategy incorporates the requirements of the Investment Guidelines to produce an Annual Investment Strategy which sets out approved counterparties, the criteria by which they have been judged (including credit ratings) and limits on the type and value of investments that can be made.

13. The Treasury Management Code places a clear responsibility on the Chief Financial Officer to ensure that systems exist to deliver proper financial administration and control, and a framework for overseeing and reviewing the treasury management function. As a minimum there is a requirement for an annual monitoring report to councillors on treasury management functions, in practice many authorities report more regularly.

14. Where there is non compliance with the Treasury Management Code, clear redress exists; whether through audit powers (including the ability to make a public interest report) and CIPFA's own code of ethics. The Statement of Professional Practice applies to individual CIPFA members. Whilst the Treasury Management Code applies to organizations, non-compliance with the Treasury Management Code by a CIPFA member whilst employed by, or undertaking work for, an organisation that has adopted the Code may be considered as a material factor in any disciplinary action under the Institutes by-laws.

15. A fuller description of the treasury management framework, with a particular emphasis on its response to risk, is included at Annex A to this submission. Also included at Annex B is an extract of relevant sections of the Treasury Management Code and Cross Sectoral Guidance Notes to aid the Select Committee in assimilating those sections with particular relevance to the current enquiry.

16. CIPFA believes that the underlying principles on which the Treasury Management Code is based remain sound. CIPFA keeps the Code and its associated guidance under review through the work of the Treasury Management Panel and will continue to do so. Updated guidance notes for local authorities were due to be published at the end of 2008 but these have been held back so that the lessons to be learned from the current situation can be incorporated. It is intended to issue these guidance notes during Spring 2009.

CIPFA TREASURY MANAGEMENT DEVELOPMENTS

17. CIPFA looks to continually improve professional financial management in local authorities; part of this is the support it provides to professionals undertaking treasury management functions. CIPFA's support for treasury management has been highlighted by recent developments including the 2007 change to accounting for financial instruments.

18. Fundamentally, in a treasury management context, it is recognised that active management is key to delivering good results. This requires the recognition, understanding, measurement and management of treasury risks. In turn, this means that local authorities need to be armed with the requisite knowledge, tools and techniques to undertake these tasks. CIPFA's current risk management agenda is about making sure that everything possible is done to make sure that local authorities are equipped to the best of their ability to manage treasury management risk effectively. CIPFA has recently issued a paper that was the culmination of a piece of work the CIPFA Treasury Management Panel had been carrying out on extending the risk management techniques used by local authorities. It incorporated earlier discussion papers on the use of benchmarking and proposals for a treasury management "tool-kit".

19. A key strand to the ongoing development of treasury management skills will be the development of education and training including current working with the Association of Corporate Treasurers on the introduction of a joint qualification for treasury management in the public services. The introduction of the new qualification will be a major advance in developing local authorities own in-house expertise in this arena. In addition strategic treasury management is intended to be covered in the toolkit being developed to assist Directors of Finance in the public sector as part of an existing project by CIPFA to strengthen the role across the whole of the public services.

20. The current agenda is aimed at continuing the development of treasury management in the public sector which was begun with the issue of the Treasury Management Code and continued with the Prudential Code.

LOCAL AUTHORITIES' USE OF EXTERNAL ADVICE

21. There has been a growing tendency for local authorities to employ external advisers and consultants, often for the purpose of a general treasury management advisory service. Local Authorities place varying levels of reliance on the advice of these advisers depending upon their own level of internal skills and knowledge. CIPFA has a clear role as part of its risk management and educational agendas of equipping individuals within local authorities with the skills to act as knowledgeable clients in such situations. This is a role that is supported by the treasury management advisers themselves.

22. In addition local authorities place a degree of reliance on the ratings given to financial institutions by credit rating agencies such as Moodys, Fitch and Standard and Poor. Whilst local authorities will continue to use other sources of information they have available, an approach encouraged by CIPFA itself, and despite recent criticisms about the agencies response to changing financial climates, it should be recognised that the ratings agencies remain a key accepted view of an organizations financial standing and it is unlikely that local authorities themselves would have the resources or knowledge to carry out their own detailed credit analysis. CIPFA understands that the FSA is working with other agencies internationally to review the role and regulation of such agencies. CIPFA fully supports the need for such a review and the FSAs role.

REVIEW OF LOCAL AUTHORITY INVESTMENTS

23. CIPFA fully supports the Select Committee in its review of local authority investments in the light of the Icelandic banks collapse and we welcome the wider emphasis on the review of local authority investments. We hope that in previous sections of this submission we have shown that the principles underlying local authority treasury management are sound. The production of Annual Investment Strategies and Treasury Management Strategies has placed treasury management at the heart of council decision making and ensured that all councillors are aware of the policies and practices of their councils. Individual local authorities, as part of these strategies, are required to set out their treasury management policy on acceptable risk.

24. Local authorities play a key role in wholesale money markets and their impact on market liquidity is seen as vital in the current economic climate. It should also be recognized that the £1.6bn earned in interest by English, Scottish and Welsh local authorities annually is used in support of services. Any reduction in that income would result in further pressure on local authority budgets at a time when authorities are faced with difficult decisions about service and council tax levels. It should be noted that at present the only 'secure' counterparty investment open to local authorities is through the Debt Management Office's deposit facility which pays much lower rates of interest or government stocks which have an underlying price risk unless held to maturity.

25. CIPFA would strongly urge against a greater role for Government in local authority investment. It should be noted that when BCCI failed it was on the then Government approved lending list. The current Investment Guidance provides a framework in which authorities are required to exercise professional judgment over the individual institutions to which they lend. Any increased regulation would result in the Government needing to reach a conclusion on the financial standing of individual financial institutions, a role that is clearly beyond its current remit. Any failure in those institutions would be laid at the door of Government who would be unable to argue against guaranteeing individual deposits.

26. At present local authority investment decisions are guided by the advice of professional brokers and advisers and within markets regulated by the FSA . In addition the Bank of England monitors market activity and the impact of the wholesale money markets on the wider economy. Greater Government regulation of local authority investments is likely to leave it in danger of assuming a regulatory role within these markets.

27. CIPFA has always been clear that its own role is to promote professional best practice and provide advice to authorities on treasury management frameworks. CIPFA's independence is key to this role and we are clear that we cannot advise on individual investment decisions. As a professional institute our role is not to become involved in FSA regulated activities or act as a quasi regulator.

28. It is clear that the key source of help local authorities are currently seeking from the Government is access to capitalisation directives to allow them to spread any losses arising from the Icelandic banks collapse over more than one years revenue account. CIPFA welcomes the recent announcement from Communities and Local Government to help local authorities manage the accounting implications of money at risk and avoid the consequent immediate impact on the council tax. A key feature of local authority access to capital markets is that they are informed investors and are expected to balance and manage the risks that are present in any treasury management activity.

29. CIPFA has a key role in driving forward the treasury management agenda and in ensuring that any lessons from recent events are learnt and as such it is committed to working with the Government, devolved administrations, the auditors and market regulators. Once these lessons have emerged and the future shape of capital markets becomes clear we will ensure that the Treasury Management Code and Guidance reflect any necessary changes. We believe that the risk management agenda we are currently pursuing will continue the development of best practice started with the Treasury Management Code and will continue to work with Government to ensure that the Investment Guidelines maximize the opportunities for local authorities to make appropriate investments within clearly defined risk boundaries.

30. We look forward to working with the Select Committee to take advantage of an opportune moment to review local authority investment practices and build upon and develop the existing strong framework within which treasury management occurs.

Annex A

BACKGROUND TO LOCAL AUTHORITY TREASURY MANAGMENT

THE CIPFA TREASURY MANAGEMENT CODE

31. In 2002, CIPFA published Treasury Management in the Public Services: Code of Practice and Cross-sectoral Guidance Notes (The TM Code). At the same time, it issued sector-specific guidance notes in respect of the main categories of public service organisations, including local authorities. These Guidance Notes were updated in 2006 and are currently in the process of being updated again.

THE LEGAL STATUS OF THE TREASURY MANAGEMENT CODE

32. The legal status of the TM Code in England and Wales derives from regulations issued under the Local Government Act 2003, which explicitly require authorities to have regard to the TM Code. In Scotland, SSI No 229 requires local authorities to have regard to the CIPFA Prudential Code and, hence, to adopt the TM Code.

33. The TM Code and the Prudential Code are closely linked. All authorities in the UK are required to have regard to the Prudential Code when setting limits to the level of their affordable borrowing under section 3(5) of the Local Government Act 2003 (in England and Wales), or their capital expenditure under section 35 of the Local Government in Scotland Act 2003 (in Scotland). The first prudential indicator in the Prudential Code in respect of treasury management is the adoption of the TM Code.

34. The relationship between the TM Code and CIPFA's Standards of Professional Practice (September 2002) (the SoPP) should be noted. The SoPP states that:

"The SoPP applies to individual CIPFA members, whereas the TM Code applies to any organisation that has adopted it as part of its standing orders, financial regulations or other formal documents appropriate to its circumstances. Non-compliance with the TM Code by a CIPFA member whilst employed by, or undertaking work for, an organisation that has adopted the TM Code may be considered as a material factor in any disciplinary action under the Institute's bye-laws.''

Disciplinary action can include suspension or expulsion from the institute and loss of the professional status.

THE TREASURY MANAGEMENT POWERS OF LOCAL AUTHORITIES

35. Local authorities' treasury management activities are prescribed by statute. The sources of their powers are, in England and Wales, the Local Government Act 2003 (the 2003 Act), and in Scotland, the Local Government in Scotland Act 2003 (the 2003 Scotland Act). The provisions of these Acts simplified past complexities and clarified particular uncertainties under previous legislation.

36. Essentially, a local authority may borrow or invest for any purpose relevant to its functions, under any enactment, or "for the purpose of the prudent management of its financial affairs".

37. They are not constrained by law in the types of investments they may make or the investment instruments they may use. However, in England and Wales, they are in practice constrained by ODPM (now CLG) and National Assembly for Wales guidance (the 2004 investment guidance), which encourages forms of investment offering high security and liquidity. In essence, this is achieved by making a distinction between "specified" and "non-specified" investments, the latter (in particular including equity-type investments) being required to be subjected to greater scrutiny by authorities, and being defined as capital expenditure, the effect of which, if used, is to reduce an authority's scope for funding capital projects. There is an exemption if shares and bonds are acquired through collective investment schemes, such as unit trusts, because such funds spread and reduce risk, while allowing easy access to cash. Although similar provisions do not exist in Scotland, best accepted practice is to invest in secure and liquid investments.

38. The Local Authorities (Capital Finance and Accounting) (Amendment) (England) Regulations 2007 (SI 2007/573) have been issued, which added Real Estate Investment Trusts (REITs) to the list of investments which are exempted from the requirement for local authorities in England to define them as capital expenditure.

REPORTING ON TREASURY MANAGEMENT ACTIVITIES

39. Local authorities are required to report on their treasury management activities by virtue of the provisions of the TM Code, the Prudential Code, the 2004 investment guidance, and the 2007 SORP. The key features of each are listed below and, although they represent four separate requirements, in practice local authorities combine them into a single, co-ordinated, reporting process.

The TM Code

40. TMP6 recommends that local authorities should, as a minimum, report annually to the full council on their treasury management strategy and plan, before the start of the year, and prepare an annual report on the performance, effects of decisions taken and borrowings executed, and circumstances of non-compliance with their policies, after the year-end. The cross-sectoral guidance notes additionally suggest interim reporting of treasury management activities.

The Prudential Code

41. The Prudential Code requires local authorities to set and revise the estimates and limits, and to publish actuals, in respect of those items described in section 5 of these guidance notes. It requires the estimates and limits to be approved and revised by the same body that sanctions the authority's budget. In respect of the treasury management indicators, the Prudential Code requires them to be considered together with the annual treasury management strategy and plan, and the annual post-year-end report. It requires the chief finance officer to establish the reporting and monitoring processes, and to integrate the Prudential Code's requirements into the overall financial planning process. The current review of the Prudential Code is anticipated to result in the requirements of paragraph 13 of that Code concerning the reporting of treasury management indicators (reproduced in the appendix to these guidance notes) becoming part of the provisions of the TM Code.

Investment Guidance

42. The guidance recommends that authorities produce an Annual Investment Strategy (AIS), approved and, if necessary, amended by the full council (or closest equivalent level) to be made publicly available, that sets out the policies for managing investments and for giving priority to the security and liquidity of those investments. In particular, the AIS should state the authority's policy on the use of credit ratings, the procedures for determining and limiting the use of higher risk investments, and for the liquidity of investments.

EXTERNAL SERVICE PROVIDERS

43. Local authorities have extensive relationships with financial and money market practitioners in their banking, borrowing and capital/project financing activities, as well as in their cash investment functions. These include bankers, brokers, advisers, consultants and fund managers.

44. These relationships are managed proactively in order to secure the optimum benefit for an authority. They are subjected to regular review and, in accordance with standing orders, to formal invitations to tender for services, to ensure best value is to be obtained.

45. Particular attention is paid to the question of potential conflicts of interest, and to establishing the degree of objectivity and independence which authorities are entitled to expect from advice given and transactions executed by external service providers.

Annex B

EXTRACTS FROM THE CIPFA TREASURY MANAGEMENT CODE

The following extracts summarise the Treasury Management Codes approach to managing risk in investments and the controls it expects local authorities to have in place around their treasury management activities. These extracts are included to assist the Select Committee in identifying the key sections relating to local authority investments. A full copy of the Treasury Management Code and Local Authority Guidance Notes are included with this submission.

KEY RECOMMENDATIONS OF THE TREASURY MANAGEMENT CODE

Key Recommendation 1

Key Recommendation 2

Their policies and practices should make clear that the effective management and control of risk are prime objectives of their treasury management activities.

Key Recommendation 3

Key Recommendation 4

In order to achieve the above, organisations should:

1. adopt the four clauses in Section 5 of this Code;

2. adopt a treasury management policy statement, as recommended in Section 6; and

3. follow the recommendations in Section 7 concerning the creation of TMPs.

In framing these recommendations, CIPFA acknowledges the difficulties of striving for effective risk management and control, whilst at the same time pursuing best value. This Code does not seek to be prescriptive about how this issue should be handled, particularly since it covers such a wide variety of organisations. However, where appropriate, the sector-specific guidance notes give suitable advice. CIPFA recognises that no two organisations in the public services are likely to tackle this issue in precisely the same manner; but success in this area of treasury management is likely to be viewed, especially in best value terms, as an indicator of a strongly performing treasury management function.

CIPFA considers that the report by the Treasury and Civil Service Committee of the House of Commons on the BCCI closure is still pertinent, wherein it was stated that:

"In balancing risk against return, local authorities should be more concerned to avoid risks than to maximise returns." Paragraph 58, Second Report, December 1991

It is CIPFA's view that throughout the public services the priority is to protect capital rather than to maximise return. The avoidance of all risk is neither appropriate nor possible. However, a balance must be struck with a keen responsibility for public money.

CLAUSES TO BE FORMALLY ADOPTED

CIPFA recommends that all public service organisations adopt, as part of their standing orders, financial regulations, or other formal policy documents appropriate to their circumstances, the following four clauses.

"1. This organisation adopts the key recommendations of CIPFA's Treasury Management in the Public Services: Code of Practice (the Code), as described in Section 4 of that Code.

2. Accordingly, this organisation will create and maintain, as the cornerstones for effective treasury management:

— a treasury management policy statement, stating the policies and objectives of its treasury management activities

— suitable treasury management practices (TMPs), setting out the manner in which the organisation will seek to achieve those policies and objectives, and prescribing how it will manage and control those activities.

The content of the policy statement and TMPs will follow the recommendations contained in Sections 6 and 7 of the Code, subject only to amendment where necessary to reflect the particular circumstances of this organisation. Such amendments will not result in the organisation materially deviating from the Code's key recommendations.

3. This organisation (ie full board/council) will receive reports on its treasury management policies, practices and activities, including, as a minimum, an annual strategy and plan in advance of the year, and an annual report after its close, in the form prescribed in its TMPs.

4. This organisation delegates responsibility for the implementation and monitoring of its treasury management policies and practices to [note 1], and for the execution and administration of treasury management decisions to [note 2], who will act in accordance with the organisation's policy statement and TMPs and, if he/she is a CIPFA member, CIPFA's Standard of Professional Practice on Treasury Management."

THE TREASURY MANAGEMENT POLICY STATEMENT

CIPFA RECOMMENDS THAT AN ORGANISATION'S TREASURY MANAGEMENT POLICY STATEMENT ADOPTS THE FOLLOWING FORMS OF WORDS TO DEFINE THE POLICIES AND OBJECTIVES OF ITS TREASURY MANAGEMENT ACTIVITIES:

HIS

ORGANISATION

DEFINES

ITS

TREASURY

MANAGEMENT

ACTIVITIES

MANAGEMENT

THE

ORGANISATION

CASH

FLOWS

ITS

BANKING

MONEY

MARKET

AND

CAPITAL

MARKET

TRANSACTIONS

THE

EFFECTIVE

CONTROL

THE

RISKS

ASSOCIATED

WITH

THOSE

ACTIVITIES

AND

THE

PURSUIT

OPTIMUM

PERFORMANCE

CONSISTENT

WITH

THOSE

RISKS

HIS

ORGANISATION

REGARDS

THE

SUCCESSFUL

IDENTIFICATION

MONITORING

AND

CONTROL

RISK

THE

PRIME

CRITERIA

WHICH

THE

EFFECTIVENESS

ITS

TREASURY

MANAGEMENT

ACTIVITIES

WILL

MEASURED

CCORDINGLY

THE

ANALYSIS

AND

REPORTING

TREASURY

MANAGEMENT

ACTIVITIES

WILL

FOCUS

THEIR

RISK

IMPLICATIONS

FOR

THE

ORGANISATION

HIS

ORGANISATION

ACKNOWLEDGES

THAT

EFFECTIVE

TREASURY

MANAGEMENT

WILL

PROVIDE

SUPPORT

TOWARDS

THE

ACHIEVEMENT

ITS

BUSINESS

AND

SERVICE

OBJECTIVES

THEREFORE

COMMITTED

THE

PRINCIPLES

ACHIEVING

BEST

VALUE

TREASURY

MANAGEMENT

AND

EMPLOYING

SUITABLE

PERFORMANCE

MEASUREMENT

TECHNIQUES

WITHIN

THE

CONTEXT

EFFECTIVE

RISK

MANAGEMENT

TREASURY MANAGEMENT PRACTICES

TMP1 Risk management

General statement

"The responsible officer will design, implement and monitor all arrangements for the identification, management and control of treasury management risk, will report at least annually on the adequacy/suitability thereof, and will report, as a matter of urgency, the circumstances of any actual or likely difficulty in achieving the organisation's objectives in this respect, all in accordance with the procedures set out in TMP6 Reporting requirements and management information arrangements. In respect of each of the following risks, the arrangements which seek to ensure compliance with these objectives are set out in the schedule to this document."

[5] credit and counterparty risk management

"This organisation regards a prime objective of its treasury management activities to be the security of the principal sums it invests. Accordingly, it will ensure that its counterparty lists and limits reflect a prudent attitude towards organisations with whom funds may be deposited, and will limit its investment activities to the instruments, methods and techniques referred to in TMP4 Approved instruments, methods and techniques and listed in the schedule to this document. It also recognises the need to have, and will therefore maintain, a formal counterparty policy in respect of those organisations from which it may borrow, or with whom it may enter into other financing arrangements."

TMP4 Approved instruments, methods and techniques

"This organisation will undertake its treasury management activities by employing only those instruments, methods and techniques detailed in the schedule to this document, and within the limits and parameters defined in TMP1 Risk management."

TMP6 Reporting requirements and management information arrangements

"This organisation will ensure that regular reports are prepared and considered on the implementation of its treasury management policies; on the effects of decisions taken and transactions executed in pursuit of those policies; on the implications of changes, particularly budgetary, resulting from regulatory, economic, market or other factors affecting its treasury management activities; and on the performance of the treasury management function.

As a minimum, the organisation (ie full board/council) will receive:

— an annual report on the strategy and plan to be pursued in the coming year

— an annual report on the performance of the treasury management function, on the effects of the decisions taken and the transactions executed in the past year, and on any circumstances of non-compliance with the organisation's treasury management policy statement and TMPs."

TMP11 Use of external service providers

"This organisation recognises the potential value of employing external providers of treasury management services, in order to acquire access to specialist skills and resources. When it employs such service providers, it will ensure it does so for reasons which will have been submitted to a full evaluation of the costs and benefits. It will also 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. And it will ensure, where feasible and necessary, that a spread of service providers is used, to avoid over reliance on one or a small number of companies. Where services are subject to formal tender or re-tender arrangements, legislative requirements will always be observed. The monitoring of such arrangements rests with the responsible officer, and details of the current arrangements are set out in the schedule to this document."

TMP12 Corporate governance

"This organisation is committed to the pursuit of proper corporate governance throughout its businesses and services, and to establishing the principles and practices by which this can be achieved. Accordingly, the treasury management function and its activities will be undertaken with openness and transparency, honesty, integrity and accountability.

This organisation has adopted and has implemented the key recommendations of the Code. This, together with the other arrangements detailed in the schedule to this document, are considered vital to the achievement of proper corporate governance in treasury management, and the responsible officer will monitor and, if and when necessary, report upon the effectiveness of these arrangements."

EXTRACTS FROM THE CIPFA TREASURY MANAGEMENT CROSS SECTORAL GUIDANCE NOTES

RISK MANAGEMENT

— well documented records of the standing of third parties it does or may deal with, and continuous access to independent sources of advice and information on the same

All public service organisations need to be alert to the prospect of the third parties it deals with being unable or unwilling to fulfil their contractual responsibilities, especially as a result of failure to maintain their credit status. This applies not only to contracts relating to capital financing and investment, but also to those concerned with the increasing reliance placed by public service organisations on outsourcing. Issues for which organisations should have policies in place in relation to credit risk are listed in the suggested schedules in Section 2 of these guidance notes. As a general rule, however, a sound diversification policy, in terms of both the commercial lenders and the borrowers an organisation may deal with, should be the guiding principle, in order to avoid over reliance on a small number of third parties.

DECISION-MAKING AND ANALYSIS IN THE PUBLIC SERVICES

CIPFA gives the following general guidance on the issues to be considered in connection with various aspects of an organisation's treasury management activities, and which an organisation should demonstrate it has considered.

In respect of every decision made the organisation should:

— above all, be clear about the nature and extent of the risks to which the organisation may become exposed

— be certain about the legality of the decision reached and the nature of the transaction, and that all authorities to proceed have been obtained

— be content that the documentation is adequate both to deliver the organisation's objectives and protect the organisation's interests, and to deliver good housekeeping

— ensure that third parties are judged satisfactory in the context of the organisation's creditworthiness policies, and that limits have not been exceeded

— be content that the terms of any transactions have been fully checked against the market, and have been found to be competitive.

In respect of investment decisions, the organisation should:

— consider the optimum period, in the light of cash flow availability and prevailing market conditions

— consider the alternative investment products and techniques available, especially the implications of using any which may expose the organisation to changes in the value of its capital.

USE OF EXTERNAL SERVICE PROVIDERS

There are substantial numbers of service providers available to support the treasury management activities of public service organisations.

Perhaps the most active and long-standing of these have been the money-broking companies, whose role it is to act as intermediaries, making introductions between the prospective parties to transactions.

It is not the role of brokers to provide advice on the creditworthiness of those organisations to which public service organisations may lend. They may provide information already in the public domain, but may not interpret it. The use of brokers is a matter for local decision. But it is considered good practice, if their services are used, to ensure that business is spread between a reasonable number of them, and certainly no fewer than two. And it is not uncommon for their services to be the subject of a competitive tendering process every few years.

Direct dealing with principals is a not uncommon feature of treasury management in the public services which, if nothing else, can provide a useful check on brokers' performance.

There has also been a growing tendency for public service organisations to employ external advisers and consultants, often for the purposes of a general treasury management advisory service, but also for specific purposes, such as the securing and structuring of funding and for partnership arrangements. These, too, should be the subject of regular competitive tendering.

Further, many public service organisations employ the services of external investment managers to help manage their surplus cash and, where relevant, their pension fund, trust fund or endowment fund assets.

CIPFA advises all organisations using the services of external service providers to document comprehensively the arrangements made with them.

Corporate Governance

The Code recommends that public service organisations state their commitment to embracing the principles of corporate governance in their treasury management activities, notably openness and transparency.

It is CIPFA's view that:

— adoption of the principles and policies promoted in the Code and in these guidance notes will in itself deliver the framework for demonstrating openness and transparency in an organisation's treasury management function;

— publication of and free access to information about an organisation's treasury management transactions and other public documents connected with its treasury management activities will further assist in achieving this end;

— establishing clear treasury management policies, the separation of roles in treasury management and the proper management of relationships both within and outside the organisation will establish the integrity of the function;

— robust treasury management organisational structures, together with well-defined treasury management responsibilities and job specifications, will enhance accountability; and

— equality in treasury management dealings, absence of business favouritism and the creation of keen competition in treasury management will lay the groundwork for fairness.

The following paragraphs further emphasise the practices that CIPFA believes an organisation should employ to ensure the principles of corporate governance are successfully implemented.

Procedural responses

The policies and strategies of treasury management should link clearly to the organisation's other key policies and strategies. In the management of risk, in particular, treasury risk management should be an integral part of its overall risk management processes, culminating in a well-defined, organisation-wide strategy for the control of risk and contingency planning.

The management and administration of treasury management should be robust, rigorous and disciplined. Over the years, some of the most significant examples of treasury mismanagement, in both the public services and the private sector, have resulted from procedural indiscipline. This has frequently been as a result of a failure to apply otherwise well-documented management and administration systems, or through failures in transmission, documentation or deal recording processes.

Reporting arrangements should be applied so as to ensure that those charged with responsibility for the treasury management policy have all the information necessary to enable them to fulfil openly their obligations; and that all stakeholders are fully apprised of and consulted on the organisation's treasury management activities on a regular basis.

The procedures for monitoring treasury management activities through audit, scrutiny and inspection should be sound and rigorously applied, with an openness of access to information and well-defined arrangements for the review and implementation of recommendations for change.

The application and interpretation of performance data should be clear, concise and relevant to the organisation's treasury management activities.

Stewardship responsibilities

The responsible officer should ensure that systems exist to deliver proper financial administration and control, and a framework for overseeing and reviewing the treasury management function.

As regards a control framework, an organisation's formal policy documents should define clearly procedures for monitoring, control and internal check.

With regard to delegation, it is vitally important that those involved in the implementation of treasury management policies and the execution of transactions are unambiguously empowered to undertake their tasks, and that reporting lines are well-defined.

An organisation's adoption of and adherence to the Code should be widely broadcast, as should the principles of the Code and the method of its application in the organisation.

The organisation's procedures for reviewing the value of the treasury management function, and the implementation of opportunities for improvement, should be both continuous and open to examination.

SUGGESTED SCHEDULES TO ACCOMPANY AN ORGANISATION'S STATEMENT OF ITS TREASURY MANAGEMENT PRACTICES (EXTRACT)