WHAT DO YOU KNOW ABOUT TREASURY MANAGEMENT?

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Marshall Moore
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1 TREASURY MANAGEMENT

2 WHAT DO YOU KNOW ABOUT TREASURY MANAGEMENT?

3 TREASURY MANAGEMENT DEFINED The management of the organisation s: Investments Cash flows Banking Money market and capital market transactions Effective control of risks associated with those activities Pursuit of optimum performance consistent with those risk

4 TREASURY MANAGEMENT PRACTICES Treasury risk management Performance measurement Decision making and analysis Approved instruments, methods and techniques Organisation, clarity and segregation of responsibilities and dealing arrangements Reporting requirements and management information arrangements

5 STRATEGY AND GOVERNANCE

GOVERNANCE ISSUES Treasury management is often not well understood by senior management and politicians But is an extremely important area Often a need to take big decisions quickly

6 GOVERNANCE ISSUES Treasury management is often not well understood by senior management and politicians But is an extremely important area Often a need to take big decisions quickly Lack of time to seek specific approval Requires policies and strategies to be in place To provide a planned approach To provide legitimacy to treasury management actions Regular reporting

7 TREASURY MANAGEMENT POLICY STATEMENT Sets out the policies and objectives of Treasury management activities Defines Treasury management activities Outlines risk management approach Sets strategic context (alignment with strategic objectives)

8 TREASURY MANAGEMENT STRATEGY STATEMENT Links to the Medium Term Financial Plan Outlines legislative context Strategy for borrowing and investments Sets Treasury Limits View on Interest Rate Forecast Prudential Indicators Extraordinary Issues Establish Minimum Revenue Provision (MRP) Strategy for capital financing charges

9 THE FINANCIAL CONTROL ENVIRONMENT: ESTABLISHING AND MAINTAINING GOVERNANCE AND CONTROL Ethical framework model codes Sound decision making framework Sound systems and procedures Chief Finance Officer - ensuring adequate accounting records and expenditure is within affordable limits Financial regulations, financial plans and strategies Medium-Term Financial Plan (MTFP) and annual budgets Internal and external audit Audit Committee

10 Working Capital Collecting income effectively TM ISN T JUST ABOUT CASH Avoiding excessive stock holding Timing payments to creditors Avoiding excessive outflows of cash at certain times of the year (eg share dividends) Knowing what generated profit

11 TREASURY RISK MANAGEMENT

12 Liquidity risk Interest rate risk Exchange rate risk TREASURY MANAGEMENT RISKS Inflation risk Credit and counterparty risk Refinancing risk Legal and regulatory risk Fraud, error, corruption and contingency management Market value of investments

term borrowing from the markets to remedy any temporary shortfall which can t be met by maturing investments planning long term

13 LIQUIDITY RISK Cash is the life blood for ANY organisation Organisations can be solvent but illiquid Managing liquidity risk involves: accurate cash flow forecasting an overdraft facility in place for emergency use only contingency planning for short term borrowing from the markets to remedy any temporary shortfall which can t be met by maturing investments planning long term external borrowing around your investment rate strategy and interest rate expectations not around short term cash flow requirements

INTEREST RATE RISK An interest rate strategy is essential And a policy for borrowing and investing to support it Periodic review and monitoring of the strategy required

14 INTEREST RATE RISK An interest rate strategy is essential And a policy for borrowing and investing to support it Periodic review and monitoring of the strategy required Contingency plans in place for unexpected movements in interest rates Establish trigger points to take action Establish counterparty criteria Don t put all your eggs into one basket!

15 Adverse movements in currency exchange rates can dramatically affect the profitability of business transacted with organisations in other countries Not to hedge would be imprudent EXCHANGE RATE RISK Policy for public service organisations is that when income is received in foreign currency, it is converted to domestic as soon as possible Most countries require State and Local Authority borrowing to be in the local currency. Federal borrowing is usually in a range of currencies

16 The UK has enjoyed nearly two decades of consistently low inflation Boom and bust cycles have been eliminated from the UK economy Inflation back as a very real potential issue resulting from Brexit Can wipe out profitability and undermine financial planning and resource allocation INFLATION RISK

17 COUNTERPARTY RISK Credit and counterparty risk Establish criteria for assessing and monitoring the credit worthiness of investment counterparties Construct a list of approved counterparties Use rating agencies Check with Reserve Bank Accountancy bodies can help Financial services regulator will publish guidance

1 2 3 4 5 6 Proactive debt management is essential Opportunities for revenue savings and managing interest rate exposure keep reliable records of borrowing, leasing and other

18 Proactive debt management is essential Opportunities for revenue savings and managing interest rate exposure keep reliable records of borrowing, leasing and other financing deals Must plan well ahead for refinancing when deals expire Avoid bunching of expiry dates spread risk Avoid mortgaging the future for current revenue savings REFINANCING RISK

LEGAL AND REGULATORY RISK Legal & regulatory risk identify legal powers If in doubt, check carefully Check conformity with all relevant regulations, codes, standards, best practice Need to remain

19 LEGAL AND REGULATORY RISK Legal & regulatory risk identify legal powers If in doubt, check carefully Check conformity with all relevant regulations, codes, standards, best practice Need to remain within powers (vires) Need systems and processes to remain within the regulatory regime Light touch regulation unlikely in future! Risk to professional advisory staff in the event of investment losses (e.g. Icelandic Banks)

RISK OF FRAUD, CORRUPTION AND ERROR Ensure adequate levels of internal check are in operation and ensure proper division of duties Establish good record keeping Ensure regular change of passwords and

20 RISK OF FRAUD, CORRUPTION AND ERROR Ensure adequate levels of internal check are in operation and ensure proper division of duties Establish good record keeping Ensure regular change of passwords and tight security What if a key member of the TM staff is suddenly absent will division of duties break down? Treasury management is a potentially high risk area for fraud Ensure all TM staff are fully aware of all anti money laundering regulations

International accounting standards give an obligation to value investments at market value REPORTING RISKS: MARKET VALUE Losses (or contingencies) need to be shown at the

21 International accounting standards give an obligation to value investments at market value REPORTING RISKS: MARKET VALUE Losses (or contingencies) need to be shown at the earliest opportunity Market value can be difficult to ascertain Valuation fees are significant Can apply to long term investments, affected by short term fluctuations in markets

22 MANAGING BORROWING

23 SOVEREIGN DEBT AS A PERCENTAGE OF GDP BY CIA FACTBOOK, CC BY-SA 3.0,

24 EU COUNTRIES: DEBT AS A PERCENTAGE OF GDP (2011)

25 UK GOVERNMENT SPENDING 1974 TO DATE ( BN) ADJUSTED FOR INFLATION

26 UK DEBT AS A PERCENTAGE OF GDP 1974 TO DATE

27 BOND YIELDS AS AT 3 OCTOBER Year Government Bond Yields COUNT RY YIELD United States» 1.61% Canada 0.98% Brazil 11.45% Mexico 6.04% Germany» -0.10% United Kingdom» 0.73% France 0.22% Italy 1.26% Spain 0.93% Netherlands 0.03% Portugal 3.37% Greece 8.10% Switzerland -0.60% Japan» -0.08% Australia» 1.90% New Zealand 2.28% Hong Kong 0.86% Singapore 1.78% South Korea 1.41% India 6.77%

28 US DEBT AND PROJECTED TO 2050

29 WHO OWNS US DEBT?

30 AFRICAN SOVEREIGN DEBT

31 THE SCALE OF AFRICA

32 AFRICAN GOVERNMENT BOND ISSUES In 2014 Senegal, Côte d Ivoire (less than five years after a government-debt default) and Zambia each placed bonds worth $1 billion The total new bond issues in 2014 included bonds from Kenya, South Africa, Ethiopia and Ghana raised almost US$7bn by the end of the third quarter, bringing the cumulative total since 2006 to US$25.8bn All the issues were oversubscribed Kenya issued a record-breaking level of $2 billion in debt This was oversubscribed four times over

33 THE POPULARITY OF GOVERNMENT BOND ISSUES Even Ghana, already deep in debt and with the continent s worst-performing currency was able to raise another $1 billion in euro-denominated debt in late 2014 The coupon rate on Ethiopia s US$1bn issue in December 2014 was 6.625% reflecting a rapid increase in debt, a weak currency and limited foreign exchange reserves The Democratic Republic of the Congo, Gabon, Namibia, Nigeria, Rwanda and Senegal have also issued similar bonds Ghana was one of the first beneficiaries of the HIPC initiative All these countries were beneficiaries of the debt cancellation programme

34 THE NEW GROWTH IN BONDS AND INDEBTEDNESS In 2009 the whole of sub-saharan Africa raised less than $5 billion through bond issues, including both private and sovereign bonds (IMF figures) By 2013 that had grown to $14 billion, and the 2014 total was around $20 billion Africa s total debt-to-gdp ratio, which had fallen to less than 30% by 2008 (thanks to debt forgiveness as well as booming commodity prices), remains low, because GDP has been growing fast But in some countries debt is now heading back up towards 70% of GDP

35 AFRICAN DEBT

36 CHANGES IN BORROWING PATTERNS Africa used to borrow from official lenders: foreign governments, the World Bank, the African Development Bank and the IMF Today more than half of its new borrowing is from private sources Government loans and assistance are out of fashion There have been large corporate-bond issues from Ethiopia, Mozambique and Nigeria Corporate debt is usually dollar-denominated, making it liable to currency fluctuations and this restricts the number of corporate African companies issuing bonds Several governments, including those of Mozambique and Ghana, have recently had to issue bonds denominated in dollars instead of in local currencies The potentially bigger worry for Africa is the nature of private lending because private lenders are less forgiving

37 WHY INVESTORS ARE WILLING TO INVEST IN AFRICA The world s debt investors are willing to tolerate higher levels of risk as long as investment opportunities elsewhere pay next to nothing or even negative interest rates The demand for Government bonds continues to rise African governments continue to borrow to sustain government spending levels and to make up for falling commodity prices Over 60 percent of Africa s debt is owed to official creditors such as the World Bank, The IMF and world leaders Only ten or twelve countries account for seventy five percent of Africa s total debt Do you know which they are?

38 EUROBOND ISSUES IN AFRICAN NATIONS

39 HIPC COUNTRIES

40 EU COUNTRIES INTEREST RATES ON GOVERNMENT BONDS

41 WHAT IS A YIELD CURVE?

42 YIELD CURVE Reflects interest rates against maturity (in years) It is a snapshot in time Must be expressed in terms of constant credit risk The price and yield for Government Bonds are in inverse relationship If the majority of investors sell Gilts: Gilt price falls, gilt yields increase If the majority of investors buy Gilts: Gilt price rises, gilt yields fall Investors look at likely future inflation in terms of the implied interest rate (Lower=buy, Higher=sell)

43 01/09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/2011 Price Yield BOND YIELD/PRICE RELATIONSHIP 120 Bond Yield / Price Relationship Price (LHS) Yield (RHS) Date

44 Interest Rate (%) CURRENT UK MONEY MARKET YIELD CURVE (2013) 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% O/N 7 Day 1 Month 3 Month 6 Month 1 Year 2 Year Money Market Yields

45 Interest Rate UK GILT YIELD CURVE (2013) 3.50% Gilt Yield Curve 3.00% 2.50% 2.00% 1.50% Gilt Yield Curve 1.00% 0.50% 0.00% Maturities

46 TYPE OF BORROWING

47 EXTERNAL BORROWING VOLATILITY Volatility is the exposure of the debt (net of investments) portfolio to changes in short term interest rates The key concept of volatility is that, as interest rates fall, the propensity is to borrow at fixed interest rates increases. This is in order to lock in these cheap rates in case rates start to rise Conversely, as interest rates rise, the propensity to avoid fixed rate borrowing and to borrow variable rate debt reduces. This is because the main expectation is that lower rates are likely to be available at a later time

48 DEBT MATURITY PROFILES Over many years, a Government will enter into a large number of financial instruments (especially loans) These will be at a range of interest rates, for differing periods and with different terms and conditions Large financial investments in infrastructure will normally lead to an increased need to borrow and growth in the overall debt portfolio This mixed portfolio of loans needs to be managed proactively to avoid unnecessarily high exposure to the market when loans mature and need to be refinanced Part of the Treasury Manager s role is to adjust the debt portfolio to avoid unplanned peaks and troughs in the maturity profile If interest rates are low, the opportunity can be taken to refinance some loans in advance to reduce the impact of a spike in the maturity profile at some future date

49 PWLB Maturity PWLB Annuities PWLB EIP PWLB Variable Market END LOADED MATURITY PROFILE 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 0

50 FRONT LOADED MATURITY PROFILE 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 0 PWLB Maturity PWLB Annuities PWLB EIP PWLB Variable Market

51 12,000,000 FLAT MATURITY PROFILE 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 0 PWLB Maturity PWLB Annuities PWLB EIP PWLB Variable Market

52 DEBT MATURITY PROFILES Class Discussion: Compare these three debt maturity profiles. Which do you think demonstrates evidence of proactive management? Would you be concerned if the Government was about to enter a phase of heavy capital investment funded by borrowing? Do you have a view on which profile is the best if: The interest rate is currently 1.5% The interest rate is currently 12%

53 DEBT RESTRUCTURING WHAT IS IT? An essential tool in minimising interest costs Restructure existing loans portfolio by moving between:- short and long term debt fixed and variable rate debt Government based (PWLB) debt and market debt

54 WHY RESTRUCTURE DEBT? What budgetary pressures are there to find savings? How much and when? Seek to take advantage of perceived value in the interest rate yield curve (e.g. cheaper rates in short term debt than long term debt) Need to ensure a balanced debt maturity profile (for example avoiding more than 10% of debt maturing in any one financial year) Accounting Codes of Practice on T.M. objective:- pursuit of optimum performance consistent with those risks Accounting considerations (IPSAS/IFRS and disclosure requirements)

55 CASH FLOW MANAGEMENT

56 Cash flow and cash flow forecasting CASH FLOW MANAGEMENT Investments and borrowings - particularly up to 1 year Availability of borrowing facilities Interest rate movement

57 The amount of cash surplus or requirement CASH FORECAST WILL SHOW When the cash surplus or requirement will arrive How long the cash surplus or requirement will last How the cash will eventually be used or generated

58 PROCESS OF LIQUIDITY MANAGEMENT

59 The importance of the Cash Forecast FORECASTING LIQUIDITY Cash Forecasts normally prepared on three time scales: 1. Very short term - up to 1 week 2. Short to medium term - 1 week to 6 months 3. Long term - 6 months to 3 years

60 CASH FLOW FORECASTING: CORE CASH ANALYSIS

61 TREASURY STRATEGY: THE FUTURE Redemption of debt: new opportunities Refinancing risks higher Reducing capital investment opportunities Need clearer links to corporate strategic objectives Credit risks increasing Financial markets changing Regulatory framework tougher Government controls and central bank controls Sovereign debt risk a new hazard

62 FINAL THOUGHTS Treasury Management issues are likely to put a Government or other public sector organisation into financial crisis Many senior managers including senior financial managers do not have a strong grasp of treasury management issues Debt and cash needs to be managed proactively to understand the longer term consequences If austerity is plan A, what is plan B? Upping the dosage? A crisis in cash can undermine a country s economy. Solving the crisis can put our children in crisis Most organisations, including Governments, need to think more about fiscal responsibility and financial stability

Fiscal Policy and the Global Crisis

Fiscal Policy and the Global Crisis Presentation at Koҫ University, Istanbul Carlo Cottarelli Director IMF Fiscal Affairs Department June 9, 2009 1 Two fiscal questions What is the appropriate fiscal policy