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Treasury Management Policy

Encompassing Liability Management Policy and Investment Management Policy

Status: Approved by the Council on 29 July 2009. Amended 28 June 2010, and further amended on 27 September 2011.
Reference: P09-008

Treasury Management Policy (full version) (54 pages 183KB PDF)

The following is an abridged version of the full policy covering its key elements.

Broad Philosophy

The Council's philosophy on the conduct of its treasury activities is to ensure that the risks associated with such activity are properly identified, quantified and managed to ensure it meets its statutory obligations, and that there is minimal negative impact on the council arising from such risks.

This Treasury Management Policy (TMP) sets out the Council's objectives, policies, strategies and monitoring procedures to ensure that its responsibilities in terms of the Liability Management Policy and Investment Policy are carried out in accordance with its statutory obligations. The policy has been revised and updated for this Community Plan.

Objectives

The objectives of the Council in respect to the TMP are essentially in three parts - the Council's Perpetual Investment Fund, its other pure commercial and semi-commercial investments and its normal treasury management involved in its borrowing, short-term investment and financial market risk management (this part in total referred to as other treasury activity).

Objectives for Perpetual Investment Fund

The Council's broad objectives in relation to the basis for and management of the Perpetual Investment Fund are:

1. The founding principle of the fund

The founding principle of the fund is to at least maintain the real capital of the fund as a sustainable perpetual investment fund.

2. Fund investment style

The fund investment style shall operate as:

A pure investment style. The investments are made on purely commercial terms.
A direct investment style. The Council chooses to mandate a commercially focussed board to undertake the investment management role.
A prudent, commercial, diversified portfolio investment style and asset allocation, which manages risk to meet the obligations under the founding principle.

3. Fund goals

The key measurable goal of Taranaki Investment Management Limited (TIML) is to at least maintain the real value of the initial settled capital of the PIF over a perpetual timeframe;
TIML seeks to deliver a return to meet the obligations of the founding principles and a sustainable release to the shareholder.

4. Management of the fund

TIML shall undertake the investment and management of the fund;
TIML shall provide services required under a contract between the parties;
TIML will recommend and the PIF will provide release payments per the contract and as calculated in the release rule adopted by the council and based on recognised and evolving best practice models (currently the "Yale" model).
TIML will operate as an independent, commercial and accountable body based in New Plymouth that:
: Takes a direct investment role.
: Has regard to the maintenance of the council's credit rating.
: Manages its ongoing management costs within a level not exceeding 0.6 per cent of the fund value, plus direct investing costs.

The Council has contractually mandated TIML, a 100 per cent Council-owned company, to manage the fund to meet these objectives by making investment decisions and determining investment policy in the best interests of the fund, including the exercise of all rights in respect of any voting securities that form part of the fund.Return to top

Objectives for other pure commercial and semi-commercial investments

To manage the investments, and enhancing the returns and the value of the investments over the long-term.
To identify, quantify and manage the risks associated with the investments.
To regularly review the investments and determine whether the value of any investment has been maximised, or could potentially reduce, and if appropriate, to dispose of the investment in the most cost effective and efficient manner.
For the semi-commercial investments to modify the pure commercial rationale with broader community outcomes (if applicable) that could be contributed to by holding the investment in question.

Objectives for other treasury activity

To prudently, effectively and efficiently manage all risks associated with other treasury activity.
To fully comply with the council's statutory financial obligations.
To ensure that appropriate funding is in place to meet current and ongoing commitments of the Council.
To ensure that the Council receives and maintains the highest possible credit rating commensurate with its financial strength and nature of its operations.
To develop and maintain professional relationships with financial institutions, investors and rating agencies.
To manage such investments within the Council's strategic objectives; invest surplus cash in liquid and creditworthy investments.
To arrange and structure long-term funding at the lowest achievable funding margin while also optimising flexibility and spread of debt maturities.
To minimise the Council's exposure to adverse interest rate movements.
To monitor, evaluate and report treasury performance.
To monitor and report on financing/borrowing covenants and ratios under the obligations of security/lending arrangements.
To monitor and report on financial ratios and limits stated within this policy.
To ensure adequate internal controls exist to protect council's financial assets and to prevent unauthorised transactions

In meeting the above objectives for other treasury activity, the Council is a risk averse entity, and does not wish to seek risk from these activities. Interest rate risk, liquidity risk, funding risk and credit risk are risks the Council seeks to manage, not capitalise on. Accordingly activity that may be construed as speculative in nature is expressly forbidden.

Liability Management Policy

In broad terms the Council will have two types of liabilities: current liabilities and term liabilities.

Current liabilities

Current liabilities reflect those obligations, expressed in monetary terms, that the Council has to meet within a relatively short space of time - at a maximum within the next 12 months. For day to day obligations for its operational and capital expenditure, the Council's policy is to pay such in full (or to the full extent of any contractual obligations) by the due date. This eliminates any credit exposure or risk.

Current liabilities can include the maturing portions of any term liabilities that will be due for repayment within the following 12 months. As there are specific policy provisions for term liabilities (as opposed to the more common current liabilities like trade creditors) it is more appropriate to deal with these as part of the term liabilities' policies.

Term liabilities

Term liabilities cover obligations of the Council which in general terms are not immediately payable, i.e. not due within the following 12 months. Public debt is the most common example but long-term lease obligations or deferred settlements may also be included in this section.

As part of its new Treasury Management Policy the Council has included specific borrowing (debt) management policies to address the various issues involved. The Council is a risk averse entity and does not wish to seek risk from its borrowings. Interest rate risk, liquidity risk and credit risk are risks that the Council seeks to manage, not capitalise on. Speculative activity is forbidden.

Philosophy

The Council's policy on borrowing is based on three key elements:

1. Borrowings must be maintained at a "prudent" level.

2. Borrowings provide a basis to achieve intergenerational equity.

3. Borrowings must be undertaken efficiently and in accordance with the council's liability management policy.

Power to borrow

The Council borrows as it considers appropriate. The Council approves borrowing in general terms during the Community Plan and Annual Plan processes and delegates authority to officers to raise the approved borrowing during the year concerned. Return to top

Limits on borrowing

Borrowings will be managed within the following limits:


Net external debt[1] not to exceed	20% of equity
Net external debt not to exceed	135% of total revenue[2]
Pre-tax Funds Flow from Operations (FFO)[3] to exceed net interest expense by at least	2.5 times
Net interest expense on external debt (debt secured under debenture) as a percentage of total revenue to be less than	10%
Net interest expense on external debt as a percentage of total annual rates income (debt secured under debenture) to be less than	20%
Liquidity (term debt plus commited loan facilities plus cash or cash equivalents) over projected peak net debt levels over the next 12 months, to be at least	110%

[1] Revenue is defined as earnings from rates, government grants and subsidies, user charges, interest, dividends, financial and other revenue. For the purposes of the limits above total revenues do not include realised or unrealised gains/losses arising from the PIF, as the revenue flow to the Council from that Fund is managed through a Release Rule that smoothes the revenue impact of such value-based variations over time, therefore making such variations less relevant to the ratios being measured. The revenue released to the Council under the Release Rule is included in total revenues.

[2] Net external debt = gross debt (aggregate borrowings of the council, including any capitalised finance leases, and financial guarantees provided to third parties) less any cash or near cash treasury investments held from time to time.

[3] FFO = total revenues, less capital receipts and other non recurring revenues; less total expenditure net of any capital payments and non recurring expenditure; plus depreciation and increase in provisions.

Security for lenders

The Council has a debenture registered in favour of Perpetual Trust Limited, representing the interests of all lenders to or in the Council. The debenture is a floating debenture but provides the lenders with a specific charge over the rates revenue of the Council.

Types of borrowing

The Council has a variety of borrowing sources available, and will utilise the most appropriate and cost effective source from time to time, as determined by management.

Other sources of financing will from time to time be offered to the council. Management is authorised to assess and utilise such financing sources as it so determines, but within the general constraints laid down in terms of the Treasury Management Policy.

Future borrowings and allocation of loan charges

In 2009/10 the Council proposes borrowing $7.56 million to balance the funding required for its capital expenditure programme.

All activities requiring new capital collectively contribute to the need to borrow. Consequently, it would be inequitable to attribute the cost of new debt to particular activities using capital and not to others.

The Council centralises all borrowings (including existing debt outstanding) for the purpose of internal accounting. With the exception of those activities that have been financially "ring-fenced" (water supply, waste disposal, solid waste disposal and stormwater) debt servicing costs incurred at the corporate level are charged to each activity on the basis of the proportion of long-term assets held by that operating unit, to the total long-term assets of the council. The assets include long term investments.

The mechanism to charge each activity is by way of a cost of capital charge set at a level to recover the actual costs involved.

The capital charge to other activities is included in the Management of Investments and Funding activity.

New borrowings proposed are:

2009/10 = $7.56m
2010/11 = $9.50m
2011/12 = $14.47m

Risk management

There are six main areas of risk the Liability Management Policy addresses: liquidity risk, interest rate risk, credit risk, funding risk, foreign exchange risk and operational risk.Return to top

Liquidity risk

The Council is exposed to liquidity risk in that due to unforeseen events or circumstances it may not be able to meet its day to day commitments, including debt maturities.

The Council's objective is to always be in a position to meet its day to day commitments, to maintain its reputation and prevent any financial loss occurring, whilst ensuring that the level of cash balances are minimised in accordance with good cash flow management practices.

The Council is a highly credit-rated borrower and should always be in a position to raise additional funds if, and when, required. Accordingly, the greatest risk facing the council is that of a major disruption, either to the financial markets as a whole or from a natural disaster affecting the district or region, which results in a severe disruption to the Council's day to day revenues. To safeguard the Council against such risks the following guidelines have been adopted:

Maintain a disaster recovery fund of not less than $600,000.
Retain membership of the Local Authority Protection Programme (LAPP).

Interest rate risk

Interest rate risk is the risk that investment returns or funding costs (due to adverse movements in market interest rates) will materially exceed or fall short of adopted annual plans and strategic 10 year plan interest returns or cost projections. This may adversely impact cost control, capital investment decisions/returns/and feasibilities.

The primary objective of interest rate risk management is to reduce uncertainty to interest rate movements through fixing of wholesale market interest rates, thereby protecting investment returns and funding costs.

Credit risk

The Council may be exposed to credit risk in circumstances where a deterioration of the credit rating of an entity occurs with which the Council has placed investments or has concluded financial derivative contracts, or has concluded a major supply, construction or service contract.

In order to safeguard the Council against such risk the following guidelines have been adopted:

Investments are placed only with parties that meet certain minimum credit ratings and only up to certain limits.
Financial derivative contracts are to be concluded only with registered banks with certain minimum credit ratings.
All parties with whom the council intends to conclude major contracts will be subject to formal credit approval.

Funding risk

Funding risk management centres on the ability to re-finance or raise new debt at a future time at the same or more favourable pricing (fees and borrowing margins) and maturity terms of existing facilities/loans.

In order to safeguard the Council against this risk the following strategy has been adopted:

Obtaining Standard and Poor's credit rating to enable access to the capital markets as well as the traditional banking sector and retail market.
Cash advance facilities with at least two major banks.
Spreading maturity dates.

Foreign exchange risk

The Council may be exposed to this risk when purchasing offshore items that may be subject to currency fluctuations from the point a tender is accepted to the time payment is actually made.

The Council's objective is to ensure there are no material unhedged risks by purchasing forward exchange cover.

Operational risk

The Council manages the internal operational risks associated with this policy by:

Setting appropriate and clear cut levels of delegation and division of responsibility.
Timely, accurate and robust reporting procedures.
Regular review of the Treasury Management Policy, coupled with an annual internal audit of treasury operations.

Debt repayments

The Council will borrow for terms that best suit its current and desired debt maturity profile. In general terms borrowings will not be for greater terms than 25 years. However, given current financial market constraints, it would be unlikely that the council could secure borrowings for this length of time and would expect to refinance the loan a number of times during its life.

The Council makes systematic provision for the servicing and repayment of debt in its long-term financial planning. Generally the sources of funds for such costs will be rates and other revenue such as fees and charges and investment income and, if appropriate, the sale of assets.

Debt principal repayments are funded by a combination of the financing charge to each activity and, as a medium term rates smoothing measure, the use of funded depreciation not required for annual renewal (such funds being returned to the depreciation reserve over time).Return to top

Investment Policy

Mix of investments

The Council categorises its investments into four relatively distinct areas, the first three are long-term in nature and the fourth more short-term:

Perpetual Investment Fund. A long-term investment fund set up by the Council and containing the proceeds of sale of the Council's former shareholding in Powerco Limited. The Fund is managed on behalf of the Council by its 100 per cent owned investment management company - Taranaki Investment Management Limited (TIML).
Other pure commercial investments. Made and/or held in the context of the council's general strategic objectives purely for the commercial return received from them. The Council's investments in the four joint forestry ventures and some miscellaneous properties fall into this category. Other investments in this category could include convertible bonds, participating debentures and other quasi-equity instruments. Such investments are subjected to a broad range of active commercial reviews e.g. regular hold/sell reviews, portfolio analysis, comprehensive monitoring.
Semi-commercial investments. Where the pure commercial return rationale is modified by other strategic objectives or broader community outcomes. The Joint Venture Airport, the Council's forestry estates and miscellaneous properties fall into this category. Such investments are subjected to a narrower range of active commercial reviews given their infrastructural relationships, e.g. business monitoring and long-term planning appropriate to the scale and complexity of each business.
Treasury investments. Made from the surplus funds available to the council from time to time, and typically made in the form of financial instruments acquired from approved counter-parties.

It is noted that the dividend flow from pure investments are regarded as part of the long-term value creation objective. Any dividends over and above that amount incorporated in the budget for any year (or, in the case of the Perpetual Investment Fund - released by TIML from the Fund) are to be treated as an offset to borrowing requirements, and not utilised to support ongoing operating requirements of the Council. This same approach will apply to general surpluses arising from annual budgets (where not required for planned works/activities).

Perpetual Investment Fund - management of investment and risk

The Council created the Perpetual Investment Fund (the Fund) by resolution on 14 December 2004. The Fund represented the full proceeds of sale of the Council's shareholding in Powerco Limited ($259.43 million). The objectives outlined earlier in this policy were established as a basis for the contractual relationship with TIML in fulfilling its investment management role on behalf of the Council.

The Council has contractually mandated TIML to manage the Fund on the following basis:

To establish and adhere to, investment policies, standards, and procedures for the Fund that are consistent with its duty to invest the Fund on a prudent, commercial basis. Such policy standards and procedures are to be consistent with the Council's policies and decisions. (TIML assesses the investment risks and manages them in terms of the founding principles through the statement in three below.)
To review those investment policies, standards, and procedures for the fund at least annually.
To cover in the statement of investment policies, standards, and procedures (but not limited to):
- The release rule[4] to apply to the fund in terms of a sustainable income flow to the Council.
- The classes of investments in which the fund is to be invested and the selection criteria for investments within those classes.
- The determination of benchmarks or standards against which the performance of the Fund as a whole, classes of investment, and individual investments will be assessed.
- Standards for reporting the investment performance of the fund.
- The balance between risk and return in the overall Fund portfolio.
- The Fund management structure.
- The management of credit, liquidity, operational, currency, market and other financial risks.
- The retention, exercise or delegation of voting rights acquired through investments.
- The method of, and basis for, valuation of investments including those not regularly traded at a public exchange. Return to top

[4] The release rule for the PIF is a formula that determines the annual release to be made from the PIF ahead of the year it will apply to. It has two components:

Eighty per cent of the previous year's release, inflation adjusted for the year prior to that to be budgeted for; plus
Twenty per cent of a 5.6 per cent portion of the year-end audited capital value of the PIF, inflation adjusted for the year prior to that to be budgeted for.

The 5.6 per cent is a long-term release target that strikes a balance between the sustainability of the annual release and the real capital value of the PIF.

The release rule smoothes the potential annual fluctuations that would otherwise occur if a straight percentage of annual value was used. As such it provides greater certainty for the council on annual release levels for budgeting purposes.

To manage the fund, meeting the Council's overall objectives and mandate to TIML, namely to manage the Fund through a clearly defined portfolio of financial investments managed by an independent body (TIML) with explicit commercial objectives and clear accountability in accordance with relevant legislation. TIML is to make investment decisions and determine investment policy in the best interests of the fund, including the exercise of all rights in respect of any voting securities that form part of the fund.

The investment model under this policy clearly determines TIML as the independent, commercial decision-making body in respect of the fund investment strategy, risk management and implementation. All authorities within current legal constraints and requirements for investment are to be exercised by TIML in meeting its mandate under the founding principles for the fund. Matters such as the asset allocations for different types of investments and their location, short-term and longer investment strategy and implementation, risk management and operations are clearly within TIML's decision-making mandate.

Should investment circumstances change to such a degree that the achievement of the objectives is unlikely, TIML also has an obligation to advise the council on its options at that time.

The only matters where the Council has an expectation of prior advice from TIML are over the following matters:

The use of derivatives/synthetics as a primary investment option.
Note: TIML has developed a policy on hedging (or other incidental arrangements) ancillary to normal commercial investments made, where such arrangements would be seen as commercial and prudent to mitigate overall investment risk. TIML will has informed the council of this policy and will continue to do so on an annual review basis.
Where TIML may wish to commit longer term borrowings for the purpose of leveraging the fund to better achieve its portfolio management objectives, Council approval will be firstly obtained. It is noted that any such borrowing would be made in terms of the Council's operative Long-Term Council Community Plan and related policies, be in accordance with the Act and must not adversely effect the council's current Standard and Poor's credit rating.

In giving effect to the management of the fund and subject always to the requirements of the Council's Liability Management Policy and the restrictions of the Local Government Act 2002, access may be required to the Council's short-term funding facilities to satisfy the short-term cash flow needs of the fund. The Council accepts this position provided that all costs associated with such access are charged to the fund.

Other pure commercial and semi-commercial investments

The Council's position on other pure investments is similar to that applying to the Perpetual Investment Fund except that TIML has a contracted advisory role rather than a decision-making role. Given these investments are already currently held by the Council, the issues revolve principally around active review of the hold/sell/buy decision and ensuring such investments deliver on expectation while held.

Treatment of surpluses from pure investments.
Any surplus operating funds over that budgeted to be received from pure investments are regarded as part of the long term vaklue creation objective, and any such surplus (or in the case of the PIF - additional funds released by TIML from the PIF cover and above the annual release and agreed costs), are to be applied to reducing debt, and not utilised to support ongoing operating requirements of the council. This same approach will apply to general operating surpluses arising from annual operating budgets (where not required for planned works/activities).
Arising from Asset Sales (excludes sales occuring within the PIF):
- Provided no existing restriction exists, any net sale proceeds are to be applied as an offset to borrowing requirements.

The Council's philosophy on semi-commercial investments broadly follows that for other pure investments but may be modified by broader community outcomes (if applicable) that could be contributed to by the investment in question.

1. Acquisition/addition/disposal of other pure commercial investments and semi-commercial investments

All new investments of these types, additions to existing investments, and/or disposals of existing investments must be approved by the Council.Return to top

The Council will only make new investments, and/or retain existing investments if all the following criteria are met:

The investment has clear long-term benefits for the community of New Plymouth District.
The risks associated with the investment can be managed within acceptable levels.
Making or retaining the investment would not result in a breach of the borrowing limitations embodied in the Liability Management Policy of the Council. However, see below for instances where the Council acts with urgency and is satisfied any breach is either not material or is still within acceptable liability risk management parameters.
The overall value of any single investment does not exceed 30 per cent of the total consolidated assets of the Council at any time.
Total investments shall not exceed 35 per cent of the total consolidated assets of the Council.

If the Council/Investment Subcommittee receives a recommendation from TIML to dispose of all or part of its other pure commercial investment (as listed in the policy), the Council may act on that advice without further consultation with the public.

If the Council/Investment Subcommittee receives a recommendation from TIML to dispose of all or part of a semi-commercial investment (as listed in the policy), the Council may consult with the public on the disposal, depending on the significance of the disposal and the intended use of funds from that disposal.

The current policy positions of the council with respect to its other pure or semi-commercial investments are as follows:

Joint Venture forestry: Harvest at maturity and not renew any joint venture agreements, or sell its interest if the joint venture partner or other party wishes to purchase at a commercial price.

Council forestry: Retain the investment and continue to harvest on a rotational basis where commercially feasible (the land is generally retained for other council purposes unless it is classified as surplus to those purposes. It would then be classified as a pure investment for eventual disposal along with other surplus property).

New Plymouth Airport Joint Venture: Aim to achieve a break-even operating position without recourse to direct operational financial support from the joint venture partners and maximise any additional or ancillary opportunities as they arise to improve the financial sustainability of the overall operation. The joint venture is currently unable to make a return on capital given its limited revenue opportunities.

Surplus properties: The council has an exisiting process for declaring properties surplus to operational or future requirements and a review process for properties listed on the surplus list but not yet disposed of or able to be disposed of (due to other legal or process constraints).

These policy positions are reviewable by the council outside of this policy document (after considering any advice requested from TIML) - as such this document merely records those individual policy positions for information.

2. Management of other pure commercial investments and semi- commercial investments and risk

The Council will manage these investments in a manner which is dependent upon the size and nature of the investment.

The Council has delegated authority to the Investment Subcommittee to manage its other commercial investments where there is urgency required. The Investment Subcommittee monitors the performance of the investments and receives advice on its future position on such investments through TIML. On major decisions such as the holding or selling of such investments, the Investment Subcommittee would normally make recommendations to the Council.

The relationship between the Council and TIML is encompassed in a contract document approved by both parties. TIML also monitors the statements of intent of other pure commercial investments to enable an assessment of commercial risk and the management of that risk.

Under this management model the Council exercises decision-making power on the following types of investment issues:

Participating in the appointment of directors or other investor representatives as applicable.
Monitoring developments in the particular industry and the economy generally.
Monitoring the entity's performance and actively commenting on statements of intent where these are required.
Acting to protect and enhance the value of, and returns from, the Council's investments.

The Council's semi-commercial investments are managed more as a part of in-house operations so the risks inherent in them are addressed more at an internal level by the Council and its officers.

Subject always to the need to consider each opportunity on its own specific merits the council, in considering its option to further invest, may need to borrow funds to assist in funding its participation. To the extent that such borrowing would be outside the parameters and policies set out in this document, a submission will be made to the Council to approve the additional borrowing.

Treasury investments

Treasury investments comprise short-term surplus general funds that are held by the Council from time to time, and moneys held as restricted funds and bequests where the council has resolved to maintain a separate fund for the benefit of the specific parties or activity covered by the funds in question

Treasury investments shall only be made in NZD denominated instruments, and in accordance with the guidelines and parameters embodied in the "Treasury Investment Prudential Guidelines".

Reporting procedures

Reporting on all investments being managed or advised on by TIML will take place as per the contract document with TIML. The performance of the Perpetual Investment Fund and other pure and semi-commercial investments is principally measured through the following means:

Perpetual Investment Fund. TIML meeting the requirements of its contract with the Council, its statement of intent and appropriate benchmarks for fund performance.
Other investments. Statements of intent and appropriate benchmarks for investment performance.

Measuring the effectiveness of the Council's other treasury activities is achieved through a mixture of subjective and objective measures. The predominant subjective measures are as follows:

Adherence to Treasury Management Policy guidelines.
The overall quality of treasury management information.
The quality of relationships with the banking sector, and key participants in the capital market.

The General Manager Support Services has prime responsibility for determining performance in respect of these aspects.

Objective measures are as follows:

Specific exceptions to policies and guidelines which have not been authorised.
Compliance with policy control limits.
Average daily balance for liquidity management purposes to be less than $100,000.
Treasury investments invested in approved counterparties and maturity term.
Management of debt and interest rate risk.

These guidelines limit the maximum amount of investment in any one entity or sector, the maximum duration of such investments and the minimum credit quality of the investees.

Next review 2012 as part of LTP.

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