THE REGIONAL MUNICIPALITY OF PEEL AUDIT AND RISK COMMITTEE

Transcription

1 THE REGIONAL MUNICIPALITY OF PEEL AUDIT AND RISK COMMITTEE AGENDA ARC - 3/2017 DATE: Thursday, May 25, 2017 TIME: LOCATION: 8:30 AM 9:30 AM Regional Council Chamber, 5th Floor Regional Administrative Headquarters 10 Peel Centre Drive, Suite A Brampton, Ontario MEMBERS: F. Dale; C. Fonseca; G. Miles; K. Ras; R. Starr; A. Thompson Chaired by Councillor Fonseca or Vice Chair Councillor Ras 1. DECLARATIONS OF CONFLICTS OF INTEREST 2. APPROVAL OF AGENDA 3. DELEGATIONS 3.1. Stephen VanOfwegen, Commissioner of Finance and Chief Financial Officer, Region of Peel, Presenting the 2015 Government Finance Officers Association Canadian Award for Financial Reporting to Corporate Finance Staff 3.2. Paul Lech, Partner, Risk Advisory, Deloitte, Regarding the Region of Peel Cash Management Strategy Plan 4. REPORTS 4.1. Region of Peel Cash Management Strategy 5. COMMUNICATIONS 6. IN CAMERA MATTERS 7. OTHER BUSINESS

2 ARC-3/ Thursday, May 25, NEXT MEETING October 5, 2017, 11:00 a.m. 12:30 p.m. Council Chamber, 5 th Floor Regional Administrative Headquarters 10 Peel Centre Drive, Suite A Brampton, Ontario 9. ADJOURNMENT

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5 3.2-2 Cash management strategy The Region of Peel s ability to realize long-term positive financial impact Audit and risk committee presentation Part of the Cash Management Strategy Project May 2017 Strictly confidential - For discussion purposes only

6 3.2-3 Cash management strategy project Project context and background The Region of Peel s Treasury function currently operates its investment portfolio within the confines of the Ontario Municipality Act ( OMA ), which defines the way it can invest (e.g. invest in high rated fixed income assets). In a historically low interest rate environment the Treasury function is continuously looking for opportunities to increase the positive financial impact of its cash management strategy. A new legislation has been recently proposed, the Prudent Investor Standard ( PIS ), that potentially broadens the range of investment options for the Region in order to generate additional return. To continuously improve the Treasury function s practices the Director of Corporate Finance & Treasurer and Executive Leadership Team ( ELT ) challenged whether the Treasury function can effectively capitalize on the new standards to generate additional return given its current practices and structure. Project mandate The project mandate to assess the Region of Peel s Treasury function revealed opportunities to improve and augment its current practices to potentially generate additional financial returns and reduce costs Project outcomes Increase the potential to generate greater financial returns Enhance Treasury function practices Redefine the Treasury function s mandate Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 2

7 3.2-4 Cash management strategy summary Three key observations Investment strategy and practice revision Utilize the breadth of investment options available to generate additional financial returns and consider additional investment strategy Borrowing strategy implementation Implement additional borrowing options to potentially reduce financing costs incurred by the Region of Peel Treasury function evolution Make required changes to the structure, governance model, technology platform, and processes to evolve the overall capabilities of the Treasury function Risk management implications The above key observations can be implemented and executed within the Region s current risk profile and risk tolerance levels Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 3

8 3.2-5 Investments 1. Opportunities exist to further expand current portfolio Prudent Investor Standards (Investments only) Immediate opportunities: Flexibility Ontario Municipality Act RoP policies Current portfolio Immediate potential opportunities Expand the current investment profile of the Region s current portfolio to cover the Region s internal policies Update Region s internal policies to allow for the full scope of investments permitted by OMA Operationalization efforts 2. Investment strategies Current investment strategy Buy and hold Region of Peel buys investments (e.g. highly rated fixed income assets) and holds them until maturity. Additional investment strategy Active investment Informed trading decisions by the Region of Peel to buy and sell its investments (e.g. highly rated fixed income assets) based on market events Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 4

9 3.2-6 Borrowing program Available to the Region of Peel are additional options to manage its borrowing program. Bank debt warehousing Use a bank operating line of credit for temporary financing of capital projects before refinancing the bank line with a debt issuance Bank debt warehousing will allow the Region to match actual capital expenditures with debt issuance, thereby reducing its financing costs Bond forward agreement An effective tool to lock-in favorable rates in an environment of rising interest rates. If the Region of Peel anticipates an increase in interest rates, it can lock-in the rate today and potentially save on financing costs Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 5

10 3.2-7 Treasury function The Treasury function s operating model can be improved within critical elements of treasury PROCESS IMPROVEMENT GOVERNANCE RISK MANAGEMENT TREASURY STRUCTURE Treasury target state TREASURY DATA ROLE OF TREASURY FUNCTION STAKEHOLDER INTERACTION TREASURY TECHNOLOGY Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 6

11 3.2-8 Implementation roadmap A multi-stage roadmap has been developed to outline the necessary tactical steps to evolve the Region s Treasury function to its desired state Treasury Structure Region s optimal treasury function The purpose of the implementation plan is to guide the Treasury function to achieve its desired objectives Treasury Governance Risk Management Treasury Technology Current state Active Investment Benefits realized Borrowing Program The benefits will be realized throughout the evolution of the Treasury function Immediate Medium-term Long-term Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 7

12 3.2-9 Appendix Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 8

13 Investment strategies Active investment management provides the Region another investment strategy to generate additional return by capitalizing on market opportunities A mock scenario active investment vs. passive investment Financial instrument: Government of Canada Bond / Bond price: $100* / Bond maturity: 365 days* (repayment of original sum) / Coupon rate: 0.50%* (annual interest rate paid on the issuer s borrowed money) 1. Passive investment management ( Buy and hold ) Purchase price ~ $100 1 Regardless of value fluctuation hold onto the bond until maturity 365 days 1. Region purchases Government of Canada Bond Benefits Very conservative Not dependent on market Access to immediate liquidity Minimal cost Challenges Does not maximize potential returns + 2. Receive principal at maturity + interest earned while holding bond 2. Active investment management Purchase price ~ $ Region purchases Government of Canada Bond Macro-economic event such as BREXIT drives up Government of Canada bond prices above Region s purchase price 3. Region sells bond in the market to generate a profit = = Bank of Canada increases interest rates which decreases bond prices so the Region purchases bonds in the market at a perceived discount Benefits Additional returns to the Region Access to liquidity 365 days 5. The bond value increases above the price purchased and the Region sells the bond in the market at a profit Challenges Skilled portfolio manager required Active analysis of market conditions * Fictional values this is for illustrative purposes only and is a very simplified scenario Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 9

14 Borrowing Program Bank debt warehousing is an immediate and simple alternative debt borrowing strategy that can be utilized as it can provide greater matching of debt and expenditures Region s current borrowing program relies heavily on expenditure estimates provided by the project managers, which often times result in over-borrowing Project Manager Region Investors Region Investors Challenges Issuance of debt is based on estimated capital expenditures that have a tendency to be inaccurate 1 Project Manager estimates capital expenditures 2 Utilize estimates to issue long-term debt 3 Repay obligation + interest payments Alternative option - Bank debt warehousing will allow the Region to match actual capital expenditures with debt issuance, thereby reducing its financing costs 1 Bank line ($) 1 2 Time 2 Draw on bank line to pay actual capital expenditures Refinance with a debenture when threshold reached Max. limit Region Investors Region Investors Issue long-term debt based on actual expenditures incurred 4 Repay obligation + interest payments Benefits Greater matching of debt with expenditures Easy to manage No prepayment penalties for the bank debt Easier access to cash for immediate needs Potential savings Challenges Very minimal Debenture Bank line + debenture Cost of debt* 3.7% 3.6% * Approximate Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 10

15 Borrowing Program Available to the Region are options to manage its debt in a more cost effective manner Bond Forward Agreement is an effective tool to lock-in favorable rates in an environment of rising interest rates. If the Region anticipates an increase in interest rates, it can lock-in the rate today Region Region Region Bank Bond forward agreement vs. 1 Region will issue debt within the next 6 months a Region assesses likely interest rate increase over the next 6 months b Region decides to lock the rate at current interest rate 3 Region enters into agreement with Bank to guarantee interest rate 4 At the agreement date the difference between contract interest rate and market interest rate will determine the profit or loss incurred by the Region Benefits Mitigate interest rate exposure - locking in rate could potentially save on financing costs Enables the Region to better forecast costs Challenges May result in securing an unfavourable rate relative to the current market interest rates Additional options available to Region are presented below: Commercial Paper Program An unsecured, short-term debt instrument to meet immediate cash flow requirements; however, susceptible to market volatility. Public-private partnership (3P) A long-term performance based approach to procuring public infrastructure. The private partner assumes responsibility for development of capital project but this option can be time consuming to find appropriate partner and expensive to break contract. Deloitte LLP and affiliated entities. Strictly Confidential For discussion purposes only 11

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17 4.1-1 REPORT Meeting Date: Audit & Risk Committee DATE: May 25, 2017 REPORT TITLE: FROM: REGION OF PEEL CASH MANAGEMENT STRATEGY Stephen VanOfwegen, Commissioner of Finance & Chief Financial Officer RECOMMENDATIONS That the Region of Peel s Cash Management Strategy, be approved; And further, that four Full Time Equivalents required to enable the Region of Peel s Cash Management Strategy, be approved; And further, that the annual costs to enable the Region of Peel s Cash Management Strategy, estimated to be $800,000 including staffing, funded from within the existing 2017 Budget or from a working fund reserve draw if required, be approved; And further, that a capital project in the amount of $985,000 and funded from the Financial Management Information Systems reserve R2313, to support the month Cash Management Strategy implementation project, be approved. REPORT HIGHLIGHTS Deloitte s assessment of the Region of Peel s (Region) current Treasury capabilities revealed sound practices relative to peer municipalities. The Cash Management Strategy (CMS) proposed is aligned to the Region s risk tolerance and appetite and identifies opportunities to improve and augment current practices with an expectation to generate additional investment returns and reduce borrowing costs while remaining within the Region s moderate risk appetite. It is anticipated that total annual returns on the investment of the Region s $2.3 billion General Fund will increase by at least 0.10 per cent resulting in additional investment income of $2.3M after the new delivery approach, moving from the current passive investing strategy to an active investment strategy, is implemented. DISCUSSION 1. Background In March 2017, Deloitte completed a review of the Region s current Treasury services, developed a CMS (available for viewing at the Office of the Regional Clerk), and defined a Treasury target state with an organizational structure and delivery approach to support the implementation and execution of the CMS.

18 4.1-2 REGION OF PEEL CASH MANAGEMENT STRATEGY In Deloitte s scope of work, four reports were completed: 1. Treasury Diagnostic - A review of the Region s current Treasury services, including processes, technologies, resources and policies; 2. Debt & Investment Tools Evaluation of permissible debt and investment tools; 3. Region of Peel s CMS - A CMS identifying an investment management strategy; a borrowing program strategy; and a Treasury target state with proposed organizational structure, governance, process improvement opportunities, risk management considerations, and treasury technology and data recommendations; and, 4. Implementation Plan - An Implementation Plan to ensure the successful realization of the CMS, including eight specific and prioritized plans. 2. Treasury Diagnostic Deloitte s assessment of the Region s current Treasury capabilities revealed sound practices relative to peer municipalities; and identified opportunities to enhance the overall effectiveness of the Treasury function in line with leading corporate practices. Key opportunities identified include: 1. Develop a CMS to clearly define the Treasury function s mandate and its roles and responsibilities; 2. Address key person risk and succession planning of the four-person Treasury team through an updated organizational structure and procedural documentation; 3. Improve cash forecasting and monitoring processes through process improvements and technology support; and 4. Segregation of duties for active investment, in Treasury s future target state, will be required and can be achieved by structuring the team with a properly segregated and defined front office, middle office and back office (further information provided in Delivery Approach section of this report). The Treasury Diagnostic provided a firm understanding of the current state of the Region s Treasury function and the necessary background to holistically review and advise on the CMS, develop implementation strategies that remediate the identified risks and opportunities, and facilitate the evolution of the Treasury function. 3. Cash Management Strategy The CMS reviews investment management strategy options (passive and active management); a borrowing program strategy, including simulation of associated costs, and the development of Treasury s target state. The CMS proposed is aligned to the Region s risk tolerance and appetite and identifies opportunities to improve and augment current practices with an expectation to generate additional investment returns and reduce borrowing costs while remaining within the Region s moderate risk appetite. Investment Management Strategy In reviewing an investment management approach, Deloitte took into account the mandate of the unique characteristics of the General Fund and Sinking Fund, to provide additional

19 4.1-3 REGION OF PEEL CASH MANAGEMENT STRATEGY options to consider. Opportunities for the Region to expand its current investment options exist within the parameters of the Region s own policies and the Municipal Act, Deloitte has identified options to best manage the funds in consideration of their short, medium and long term objectives along with risk management techniques. Where applicable, perspective on the potential implications/provisions of Prudent Investor Status was also included. The CMS moves the Region from a passive investment management strategy to an active investment management approach that aligns to the Region s current moderate risk appetite. Borrowing Program Strategy The analysis of three debt strategies identified the option of using bank debt warehousing, similar to a Line of Credit product for personal use, as one of the options with the greatest potential benefit to the Region with minimal administrative burden. The approach of using bank debt warehousing is an agile strategy that allows the Region to use just-in-time financing to build up to a benchmark size debt issuance (typically $150M). Bank debt warehousing can also allow for borrowing only based on actual spend and a reduced reliance on forecasted expenditures. The use of Bond Forward Agreements to mitigate risk was suggested. When using bank debt warehousing, using a Bond Forward Agreement allows the Region to lock in at an interest rate when it is perceived that rates will be increasing in the near future. Bond Forward Agreements permit timing flexibility as to when debt is issued, while locking in interest rates at a period where it is perceived that rates are at a low point and takes advantage of interest rates today. Treasury Target State A proposed Treasury target state identified the improvements required to effectively support and sustain the active investment management strategy and the agile borrowing program. The target state includes an organizational structure that formally segregates duties within the Treasury team in a front, middle and back office structure found in industry leading practices as outlined in the following section Delivery Approach. A Treasury Oversight Committee is proposed to enable the appropriate oversight and compliance of Treasury s activities and policies with the Region s risk appetite, and as a measure that could be leveraged when Prudent Investor Status is granted in the future. The evolution of Treasury s role within the Region as a catalyst to improve cash forecasting and a strategist that can contribute to setting the overall strategic direction of the Region can positively impact broader decisions, reduce debt financing costs, and has the opportunity to generate extra return on its investment portfolio. 4. Delivery Approach A critical element to ensuring the success and compliance of implementing the CMS with an active investment management portfolio and agile borrowing program is the segregation of duties in the delivery of Treasury services. To achieve a segregation of duties, an industry best-practice is to have a front office, middle office and back office function. The broader roles and responsibilities of each of these three functions are as follows: Front Office: Directly generates revenue through management of an active investment portfolio, is client/market facing with access to the financial markets, and typically manages the sales and trading.

20 4.1-4 REGION OF PEEL CASH MANAGEMENT STRATEGY Middle Office: Ensures the front office activities comply with the organizational objectives, policies and risk appetite, is responsible for the management of the borrowing program and typically monitors risks, completes risk reporting, manages internal controls and conducts cash-flow analysis. Back Office: Provides vital operational support and administration, typically conducts settlements, reporting, reconciliation, regulatory compliance and position clearing. 5. Implementation Timelines The implementation of the CMS will require months to execute all of the required projects within Deloitte s recommended Implementation Plan, including the change in approach for Treasury services, the resourcing required and the technology requirements, both hardware and software, to support the CMS. A project to implement technology changes will be included in the 2018 capital budget. RISK ASSESSMENT In order to effectively identify, monitor, and manage the risks associated with more active investment management, there is a need to clearly define the risk management structure. Within the CMS, a three lines of defense model that is industry standard, has been identified. The three lines of defense model is: Source: Region of Peel Cash Management Strategy As part of the development of the CMS the risk management policies were reviewed and assessed to ensure the CMS falls within the Region s current risk appetite. The CMS identified aligns to the Region s moderate risk appetite where risks are managed and maintained.

21 4.1-5 REGION OF PEEL CASH MANAGEMENT STRATEGY FINANCIAL IMPLICATIONS In 2015, the Region s total internally managed investment portfolio had a gross per cent realized return of 3.1 per cent. By comparison, two municipalities that have implemented active investment management had returns in 2015 between 3.95 per cent and 4.48 per cent. After implementing the active investment strategy, staff have conservatively estimated that total annual returns on the Region s current $2.3 billion General Fund will increase by at least 0.10 per cent resulting in additional investment income of $2.3M. The operationalization of the Region s CMS will require annual costs of $800,000. It is estimated that the full annual amount will not be required in 2017 and will be funded from within the existing 2017 Budget or from a one-time Working Fund reserve draw if required. Operating costs for the 2018 Budget will be fully funded by an increase in investment income of $2.3 million. Higher returns will partially offset the need for raising future tax levies and water rates or provide flexibility to address unmet needs e.g. state of good repair. There are sufficient uncommitted funds in the Financial Management Information Systems Reserve fund R-2313 to fund the estimated $985,000 in capital expenditures required to facilitate the CMS implementation. Reporting on the Region s Treasury activities and portfolio performance is provided on an annual basis through the annual Treasury Report. CONCLUSION The Treasury review and development of a CMS is a measure the Region has taken to ensure its current structure is well positioned and the portfolio is maximizing the opportunities within the Region s own policies and the Ontario Municipal Act. The CMS and Treasury delivery approach increases the Region s potential to generate greater financial returns by moving from a passive investment management strategy to an active investment management strategy and reduced debt financing costs with an agile borrowing program that leverages bank debt warehousing. Throughout the review, the lens of Prudent Investor Standard (PIS), a non-prescriptive broad authority to invest as a prudent person would, was applied and the Treasury target state is designed to move the Region in the same intended direction of PIS. The Treasury target state will position the Region to implement the extension of the Prudent Investor Standard if granted through Bill 68, Modernizing Ontario s Municipal Legislation in active investment. The Region s CMS supports the Region s three pillars of the Long Term Financial Planning Strategy (LTFPS), supporting the Region s financial sustainability, vulnerability and flexibility through increased revenues and decreased borrowing costs; and six of the nine financial principles in the LTFPS: Respect the tax and utility rate payer, ensure the Capital Plan is sustainable, deliver value for money, make prudent investments, mitigate significant

22 4.1-6 REGION OF PEEL CASH MANAGEMENT STRATEGY fluctuations in the tax and utility rates, borrow only for substantial long-term assets at affordable levels. Stephen VanOfwegen, Commissioner of Finance & Chief Financial Officer Approved for Submission: D. Szwarc, Chief Administrative Officer For further information regarding this report, please contact Dave Bingham, ext Authored by: Angela McLean Reviewed in workflow by: Finance Support Unit