In praise of the Liability Benchmark
0Jackie Shute responds to recent criticisms of the framework used to plan the future borrowing requirements of a local authority.
I’m not suggesting that this debate will have the same furore as leave/remain or vaccine/no vaccine, but I listened with interest to the Liability Benchmark panel session at the Room151 Monthly Online Treasury Briefing and couldn’t help but notice the strength of arguments against the framework.
As an unashamed proponent of the Liability Benchmark, in addition to the supportive arguments made at the session, I wanted to bust some of the myths and concerns around the concept.
It’s not hard, it is just new and different but, once you get your head round it, you’ll appreciate there is no better tool for treasury portfolio management.
Is it too technical to implement?
For those of us who’ve been around in local authority treasury a while, there have been many difficult changes that have to be accommodated to operate a new and improved framework (for example, the Prudential Code 2003, HRA Self-financing 2012 and IFRS implementation). As professionals, it is necessary to understand and operate within new requirements.
There is no doubt that this framework presents a very new way of looking at the treasury operations compared to traditional approaches. CIPFA has provided workshop and conference sessions on Liability Benchmarking for years, ever since the Treasury Risk Management Toolkit was produced in 2012. And ahead of the publication of the final revised codes, CIPFA launched a Liability Benchmark Implementation Service free to all local authorities (and still available).
So yes, it’s quite new to many who may have missed the clues about the direction of travel in the toolkit, but help and support is available to those who are in the 60% of respondents that do not feel prepared. It’s not hard, it is just new and different but, once you get your head round it, you’ll appreciate there is no better tool for treasury portfolio management.
Why not just project the balance sheet instead?
Projecting the balance sheet is exactly what this framework does – it’s just articulating this in a meaningful way to the treasury team. The Net Loans Requirement (or Net Surplus) is a reflection of all the non-treasury activities of the organisation and moves when capital or revenue cashflows occur.
The whole framework is based around projecting the balance sheet over the long term, reflecting the corporate plans and consequently determining the impact on the Net Loans Requirement. This NLR represents the net position that the treasury team is responsible for managing, and the starting point for the construction of the Liability Benchmark.
Isn’t it unrealistic to assume a capital programme won’t have additions?
One of the interesting amendments to the codes was the requirement for the prudential indicators to be reported quarterly and integrated with the revenue, capital and balance sheet monitoring processes. As established above, the starting point for the Liability Benchmark is from the corporate plans, it is just articulated in a different way.
It should therefore reflect everything that is contained within the revenue, capital and balance sheet monitoring expectations, however long those projections exist for. For housing authorities, you have the gift of the HRA business plan, which is central to the starting point of the housing element of the total net cashflows.
Operationally, it is more likely that a working version of the balance sheet projections is maintained, perhaps allowing for slippage or for different expectations on future balance sheet movements that have not arisen from corporate plans. The tools allow for this. However, when reporting this information alongside the corporate plans, it may be useful to highlight any assumptions that sit behind the LB chart where they differ from the figures articulated in the monitoring.
Does it ignore interest rate risk and market risk?
Absolutely not. The natural extension of determining the balance sheet projections and consequential LB and treasury portfolio positions is to ascertain the impact that has on the revenue account, namely the extent of interest rate risk.
Admittedly, the LB chart on its own is the balance sheet projections and, on its own, it does not provide any insights into the revenue risk profile, which is obviously key in analysing strategic options. These loan and treasury investment portfolio balance projections, coupled with existing portfolio commitments, provide the insightful fan charts that articulate the interest rate risk exposures that the revenue account faces.
I stick my neck out here and say there is literally no better way of determining your interest rate risk unless you start with the balance sheet projections of your treasury portfolios. For local authorities exposed to market risk through investments in pooled funds, the potential volatility of these instruments is also reflected in the risk exposures; a particularly relevant factor for the impending end of the statutory override.
How can the framework provide governance if members don’t understand it?
This is a valid concern. Without adequate training and information, and well-drafted strategies, it is likely to cause some confusion. In my experience, the Capital Financing Requirement (CFR) is something that very few elected members really understand. Perhaps they have always considered that to be the benchmark for the level of external borrowing; indeed many strategies still include “under-/over-borrowed relative to CFR”.
It is likely to be harder for those local authorities to explain how last year’s “under” has gone to an “over” this year, and perhaps less of an issue for those who embraced the toolkit’s recommendations. It all comes down to training and education and giving due consideration to ensuring the strategies are well presented.
Why is it focusing on liabilities?
Ok, so this wasn’t a point raised, but I did want to make clear that while it is referred to as the Liability Benchmark, the framework also provides the investment benchmark (for treasury purposes). The framework that projects your Net Loans Requirement/Surplus derives your LB and implies your Investment benchmark.
This not only shows the impact on investment balances for any existing over-benchmark positions, but, more importantly, identifies the longevity of investment balances. It easily demonstrates whether investments held are just those required for liquidity, or whether there is a balance in excess of that, which could be available for debt repayment and, if not, investment in more strategic instruments.
While there may be some time until the Liability Benchmark is required to make an appearance in your formal strategies, entering into any borrowing commitments now that contradicts the spirit of the codes may be challenging to justify.
To conclude, while there may be some time until the Liability Benchmark is required to make an appearance in your formal strategies, entering into any borrowing commitments now that contradicts the spirit of the codes may be challenging to justify. The CIPFA LB Implementation Service is ongoing and designed to support you through tools and training sessions. CIPFA is committed to ensuring you have all the help you need to integrate this framework into your decisions and reporting.
Every local authority should have access to these tools, so let’s hope if the poll is repeated in a few months’ time, 100% feel adequately prepared.
Jackie Shute is co-founder and director of Public Sector Live.
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