Contact: Paul Carey-Kent, Deputy Treasurer, 01962 847525

David Howells, Director of Corporate Services, 02380 644000 ext 203

1. Introduction

1.1 This report is set out in three parts relating to Treasury Management issues:

· Part A - Treasury Management Code of Practice

· Part B - Annual Treasury Management Strategy

· Part C - Prudential Code for capital finance

2. Part A - Treasury Management Code of Practice

2.1 The Authority's Financial Regulations are currently being reviewed and will ensure full compliance with the Chartered Institute of Public Finance and Accountancy's Code of Practice for Treasury Management in Local Authorities. In 2001 and 2002, CIPFA undertook a comprehensive review of the Code and has published a new version.

2.2 The new Code contains a number of key recommendations:

· public service bodies should have formal and comprehensive objectives, policies and practices, strategies and reporting arrangements for the management of treasury management activities

· the prime objectives should be the management and control of risk

· there is a need to pursue best value and use performance measures when appropriate

· financial regulations and treasury policy statements should be updated as suggested in the Code

· bodies should prepare a series of 12 treasury management practice notes (TMPs) on specified aspects of treasury management - these need not be subject to committee approval.

2.3 The new Code is a significant revision of CIPFA's earlier codes published in 1992 and 1996. It is more prescriptive about wordings to be used and issues to be covered in treasury policy statements and TMPs. However, the practical effect of the changes will be limited. The Treasurer's treasury management operation already complies fully with the spirit of the revised Code. In particular, treasury management staff have to work to a comprehensive internal code of practice that sets out objectives, dealing procedures and staff responsibilities.

Part B - Annual Treasury Management Strategy

3. Introduction

3.1 Under the Authority's Treasury Management Policy Statement set out in Appendix 1 the Finance and General Purposes Committee is responsible for:

· approving an annual Treasury Management Strategy. This strategy would include the raising of capital finance, the Management of the Authority's long-term debt portfolio and the investment of its surplus funds.

· approval of the Authority's Prudential Indicators.

4. Capital Finance and debt

4.1 Total capital expenditure in 2004/05 is estimated to be £863,000, all of which will be financed through borrowing.

4.2 Since the Authority was established, nine long-term fixed-rate loans totalling £3.25m have to date been taken from the Public Works Loan Board. (PWLB).

5. Interest rates and borrowing strategy

5.1 The Fire and Rescue Authority borrows for two main reasons:

· To finance capital expenditure (see 4.1).

· To meet short-term cash requirements, for example on days when salaries are paid.

5.2 The Authority borrows from two main sources:

· The Public Works Loans Board to finance capital expenditure, normally long-term at fixed interest rates.

· The County Council at variable rates based on local authority seven-day notice rates. This can be used to meet short-term cash requirements, or to finance capital expenditure when circumstances are appropriate.

5.3 Interest rates on the Authority's long-term debt portfolio from the PWLB currently range between 4.5% and 5.875%, and the weighted average rate is 4.94%. Current rates on fixed-rate PWLB loans range from 4.2% for one-year money to 4.85% for loans maturing in more than 25 years' time. Thus, current long-term rates remain at relatively low levels, despite a slight rising trend in recent weeks.

5.4 Some economic forecasters are suggesting that long-term rates will rise further over the next few months as borrowing by central government rises. However, no clear trend has yet developed. Base and other short-term rates are also expected to rise from their current level at around 3.75%, although most commentators do not expect them to rise any higher than 4.5% by March 2005.

5.5 Until now the Authority's borrowing strategy has been based on that of the County Council. For a number of years the County Council has borrowed long-term in small amounts, maintaining as far as possible the balance between long-term fixed-rate debt, which provides budget stability and protection against rising interest rates, and short-term temporary debt, which enables advantage to be taken of falling rates. It is suggested that this strategy should be retained by the Authority, with long-term fixed-rate borrowing only being considered when long-term rates stand at 5% or below.

6. Investment of surplus funds

6.1 In line with budget proposals the Authority aims to accumulate balances of £2m during 2004/05. £615,000 is expected to be received from the Constituent Authorities on 1 April and the government grant receipts are skewed towards the beginning of the financial year. However, during 2004/05, cashflow requirements will mean there is no scope for any direct external long term investment on the money markets. Thus, the Authority will invest all its surplus funds with the County Council, earning interest at the local authority seven-day notice rate.

7. Bank account

7.1 Work is now underway to have operable a separate bank account from 1 April 2004.

8. Part C - Prudential Code for capital finance

8.1 The Prudential Code for Capital Finance (the Code) in local authorities has now been approved and published by the Chartered Institute of Public Finance and Accountancy (CIPFA). It underpins the new prudential system for capital finance introduced in the Local Government Act 2003, replacing the current system of borrowing approvals and becomes effective from 1 April 2004. The executive summary of the Code is attached as Appendix 2.

8.2 The objective of the Code is to provide a framework for local authority capital finance that will ensure for individual authorities that:

a) capital expenditure plans are affordable

b) all external borrowing and other long-term liabilities are within prudent and sustainable levels

c) treasury management decisions are taken in accordance with professional good practice

and that in taking decisions in relation to (a) to (c) above the authority is:

d) accountable, by providing a clear and transparent framework

Further, the framework established by the Code should be consistent with and support:

e) local strategic planning

f) local asset management planning

g) prior options appraisal.

8.3 In exceptional circumstances the objective of the Code is to provide a framework that will demonstrate that there is a danger of not ensuring the above, so that the authority can take timely remedial action.

8.4 The framework of the Code is built around a set of prudential indicators which relate to:

· capital expenditure plans

· external debt

· treasury management

8.5 Appendix 3 summarises the indicators which the Authority needs to set on an estimated basis in approving the budget and capital programme and which will then be subject of monitoring during the year and approval at the year end.

8.6 In compiling these figures it is assumed that the capital programme will be approved and that vehicles will be finance through borrowing.

8.7 However the main purpose of this report is to give initial consideration to the Authority's framework for determining the level of borrowing in setting its capital programme in advance of the Authority considering its budget.

9. Outline of Prudential framework

9.1 The key element of the framework is the `capital financing requirement' - the potential borrowing level for capital purposes.

9.2 This indicator does not necessarily provide a straightforward signal as to the affordability, prudence and sustainability of capital investment plans. This will require an examination of the components of the capital financing requirement between:

· Government supported borrowing

· borrowing financed by virement from revenue budgets

· `temporary' unsupported borrowing pending the receipt of other capital resources eg capital receipts from a rationalisation project or a third party contribution

· any other unsupported borrowing - previously not possible

9.3 The report examines each of these in turn.

10. Policies underlying the setting of the capital financing requirement

Government supported borrowing

10.1 It is proposed that the policy of making maximum use of Government supported borrowing should be retained, subject to reviewing the affordability of any additional running costs associated with the proposed capital programme, as at present. This is on the assumption that the Government will provide either capital grants or (as for 2004/05) will continue to finance the cost of approved borrowing through the revenue support grant.

Borrowing financed by transfer from revenue budgets

10.2 One of the key objectives of the Code is to integrate more closely decisions on revenue and capital spending in support of corporate objectives. One way in which this can be achieved is to incur capital spending financed by unsupported borrowing. The financing costs can then be met by means of transfer from the revenue budget, so that the council tax impact is broadly neutral. It is proposed that the criteria for approval of unsupported borrowing financed in this way should cover:

· projects of an `invest to save' nature generating `cashable' savings in the efficiency plan or additional income sufficient to finance the borrowing costs

· projects which will result in the avoidance of at least an equivalent level of cost

10.3 Examples of the types of project that might fall within these criteria include:

· rationalisation/modernisation projects

· replacement of leasing of vehicles

10.4 Robust project appraisal is essential to ensuring that the business case for unsupported borrowing is soundly based.

10.5 It would also be possible to allow the costs of unsupported borrowing to be financed by virement from the revenue budget, even where the investment is not self-financing. But it is proposed that borrowing on this basis should only be approved if the virement is from a specific source and the policy of reduced spending in this area has been endorsed. A condition would be that no new spending bids could be put forward affecting a budget from which a virement had been approved, without that virement first having been reinstated.

10.6 In order to enable possible uses of unsupported borrowing financed by transfer from the relevant revenue budget, decisions also need to be taken on how the transfer process would operate. Having regard to the principles of prudence and sustainability and recognising the risks associated with the appraisal of cost savings and income generation, the following conditions are proposed:

· the repayment period to be limited to 10 years or any shorter period over which the investment is expected to yield benefits

· the interest rate to be set annually on the basis of prevailing long-term borrowing rates

· the revenue transfer to be calculated on an annuity basis, (ie interest and repayment costs set to total an equal annual payment), so that it does not have to be reviewed each year.

10.7 Based on an interest rate of 5% and a period of 10 years an annuity factor of 13% is generated. This would mean that a revenue budget transfer (or saving) of £130,000 would be required to finance unsupported borrowing of £1m.

`Temporary' unsupported borrowing

10.8 The Code provides the scope for accommodating capital expenditure which will eventually be financed from capital receipts or other capital contributions, but in the short-term from unsupported borrowing, providing the cost of `bridging' is affordable. This would supplement the existing alternatives of meeting the initial investment from within capital programme limits or by drawing upon earmarked reserves.

10.9 The cost of bridging could be borne either by:

· a contribution from the revenue budget to meet the temporary financing costs - calculated on a minimum revenue provision basis for each year of the bridging period

· rolling up interest so that the eventual capital receipt used to repay debt takes account of the financing costs of bridging.

10.10 Such investment might be necessary for example on a large scale if the Authority was able to generate sufficient capital receipts from its land holdings to finance the redevelopment of headquarters.

Other unsupported borrowing

10.11 The use of unsupported borrowing as a means of integrating decisions on capital and revenue spending or as a means of temporary `bridging', can operate within a framework in which the costs of unsupported borrowing have to be accommodated within existing revenue and capital budgets, as set out in paragraphs 10.1 to 10.10 above.

10.12 However the Code also provides an opportunity for the Authority to consider whether to set a larger capital programme than it would be able to under current capital controls, by supplementing revenue contributions to capital with unsupported borrowing.

10.13 Government borrowing approvals or PFI schemes would remain preferable as both bring revenue budget support. However, it is anticipated that future private finance investment (PFI) schemes will require a minimum package of around £20m. This would create difficulties for schemes such as likely Hampshire-only fire station building programmes (suggesting that regional approaches may be necessary if a PFI route is to be pursued).

10.14 The cost of financing unsupported borrowing without the requirement for cost savings or additional income would result in higher future council taxes than would otherwise be required. It is the issue of determining what (if any) use is made of long-term unsupported borrowing that lies at the heart of the principles in the Code of affordability, prudence and sustainability. It is intended to made sure that any such trade-off between current investment and future levels of council tax is made on a prudent basis. This requirement is covered by indicators 1 to 8 set out in Appendix 3.

11. Conclusions

11.1 There are a number of arguments for giving priority to developing the use of the new flexibilities which the Code provides to integrate capital and revenue decision making and to facilitate invest to save initiatives, but to be cautious about use of unsupported borrowing as a means of supplementing the capital programme:

· the Authority already has some capacity to generate capital receipts, mainly from the disposal of land.

· other pressures on the council tax are likely to provide little scope for even small increases in council tax to finance unsupported borrowing

· there is also a danger that if authorities make immediate and extensive use of general unsupported borrowing that the Government will either make use of the reserve power to set borrowing limits or perhaps more likely will use this as an opportunity to reduce Government support for capital expenditure.

12. European Convention on Human Rights and the Human Rights Act 1998.

12.1 The proposals within this report are compatible with the provisions of the European Convention on Human Rights and the Human Rights Act 1998.

Recommendations

That it be recommended that the Authority:

1. approve the Treasury Management Policy statement set out in Appendix 1.

2. approve the policies set out in paragraph 10 of the report as the basis of the Authority's prudential framework for capital finance.

3. approve the financial indicators set out in Appendix 3.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

Published works.

Documents which disclose exempt or confidential information as defined in the Act.

TITLE FILE

Fire - Budget 2004/05 General papers

Appendix 1

Treasury management policy statement

Policies and objectives

The Authority defines its treasury management activities as:

· the management of the Authority'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.

The Authority regard the successful identification, monitoring and control of risk to be the prime criteria by which the effectiveness of its treasury management activities will be measured. Accordingly, the analysis and reporting of treasury management activities will focus on their risk implications for the Authority.

The Authority acknowledges that effective treasury management will provide support towards the achievement of its business and service objectives. It is therefore committed to the principles of achieving best value in treasury management, and to employing suitable performance measurement techniques, within the context of effective risk management.

Responsibilities

The responsible committee for treasury management matters will be the Authority's Finance and General Purposes Committee. It will consider all reports submitted by the Treasurer and have specific responsibility for:

· approving an annual treasury management strategy; this strategy will cover the raising of capital finance, the management of the Authority's long-term debt portfolio and the investment of its surplus funds, and will focus on the minimisation of risk

· considering the annual report by the Treasurer on the exercise of treasury management activities delegated to him

· approving the Prudential Code indicators

· The policy on the appointment of external managers or contractors for the management of the treasury function.

The Authority will delegate authority to the Treasurer for the determination of operating parameters, monitoring procedures and reporting arrangements for all treasury management matters. In particular, the Treasurer, consulting with the Chief Fire Officer where appropriate will have delegated responsibility for:

· the formulation of treasury management strategies for the approval of Finance and General Purposes Committee

· the day to day management of the Authority's bank balances

· the determination of approved methods of raising capital finance

· the determination of criteria for, and the maintenance and monitoring of, an approved list of organisations to which the Authority can lend. Limits are to be maintained on investments outstanding at any one time with organisations on the approved list

· the formulation and maintenance of treasury management practice notes (TMPS), as recommended in CIPFA's Code.

Appendix 3

Prudential indicators 2004/05

Indicators based on estimates must be prepared for the forthcoming financial year and the following two years. Those based on actuals have been calculated for 2002/03 using the Authority's accounts. The year 2003/04 has been included for completeness on an estimated basis.

Key indicators of affordability

1. Estimates of the ratio of financing costs to net revenue stream

2003/04 0.56%

2004/05 0.84%

2005/06 1.04%

2006/07 1.39%

Note: These indicators show a sharp increase due to the age of the Authority combined with starting debt free.

2. Actual ratio of financing costs to net revenue stream

2002/03 0.58%

3. Estimates of the incremental impact of capital investment decisions on the council tax

Council Tax Band D (£)

2004/05 0.04

2005/06 0.24

2006/07 0.73

Full year 1.42

Indicators for prudence

4. Net borrowing and capital financing requirement ie over the medium term net external borrowing must not exceed the capital financing requirement (see below)

"The Authority will not exceed the capital financing requirement".

Indicators for capital expenditure

5. Estimates of total capital expenditure

2003/04 £1,299,000

2004/05 £863,000

2005/06 £2,737,000

2006/07 £5,249,000

6. Actual total capital expenditure

2002/03 £1,290,000

7. Estimates of the capital financing requirement at the year end (similar to the current credit ceiling)

31 March 2004 £4,440,000

31 March 2005 £5,133,000

31 March 2006 £7,671,000

31 March 2007 £12,638,000

8. Actual capital financing requirement

31 March 2003 £3,820,000

Indicators for external debt

9. Authorised limit for external debt (ie borrowing plus other long-term liabilities)

10. Operational boundary for external debt (ie borrowing plus other long-term liabilities)

Note: the operational boundary should be the Authority's estimate of the most likely and prudent scenario, whereas the authorised limit should provide headroom for unexpected or unusual cash movements.

11. Actual external debt

31 March 2003 £3,867,000

Treasury management

12. Adoption of the CIPFA Code of Practice for Treasury Management in the Public Services

This will be included in the new financial regulations when they are presented to the Authority.

13. Upper limits on fixed rate exposures, either in terms of interest payable or principal outstanding

2003/04 £12,544,000

2004/05 £12,775,000

2005/06 £15,512,000

2006/07 £20,761,000

14. Upper limits on variable rate exposures

2003/04 £9,911,000

2004/05 £10,142,000

2005/06 £12,879,000

2006/07 £18,128,000

15. Upper and lower limits on the maturity structure of fixed rate borrowing (ie borrowing maturing during each stipulated period as a percentage of total fixed rate borrowing at the start of the period).

Note: stipulated periods are: under 12 months; between 12 and 24 months; between 24 months and 5 years; between 5 and 10 years; and 10 years and above.

Upper limit (%) Lower Limit (%)

Under 12 months 80 0
12-24 months 21 0
24 months - 5 years 21 0
5 years -10 years 21 0
10 years and beyond 100 25

16. Upper limit on total principal sums invested for periods longer than 364 days

2003/04 Nil

2004/05 Nil

2005/06 Nil

2006/07 Nil