SECTION 1: LEGISLATIVE AND REGULATORY AUTHORITY INVESTMENTS

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2 SECTION 1: LEGISLATIVE AND REGULATORY AUTHORITY INVESTMENTS The Municipal Act as well as a number of Ontario regulations govern municipal investments. The following provides the specific references that municipal staff should consider in developing investment policies and procedures. The Municipal Act and associated regulations are amended from time to time and should be reviewed to ensure that any updates have been taken into consideration by the municipality with respect to their investment policies Municipal Act Sections (investments) Ontario Regulations Regulation Subject Amending O.Reg 399/02 Eligible Investments O. Reg 438/97 O.Reg. 655/05 Eligible Investments O. Reg. 438/97 Appendix B provides the regulations Section 418 Investment Section 419 Agents Section 420 Agreements Appendix A provides the relevant clauses Legislative & Regulatory Clauses 1

3 Regulation Highlights Ontario Regulation 399/02 and 655/05 Highlights Reporting Requirements Municipalities are required to prepare an annual report to Council The treasurer is required under the regulation to prepare an investment report which is to be delivered to Council annually or more often as directed by Council. The report shall contain: Statement of portfolio performance through the reporting period Estimated ratio of investments in the municipality s own securities compared to the municipality s total investment portfolio. A description of any changes to that ratio since the last report is also to be included. A treasurer s statement with respect to adherence to the municipality s investment policy A transaction listing of any changes to investment in its own securities, including purchase and or sale price The regulations further state that if an investment made by the municipality is, in the treasurer s opinion, not consistent with the investment policies and goals adopted by the municipality, the treasurer shall report the inconsistency to the council of the municipality within 30 days after becoming aware of it. Requirements for Establishing A Policy There are specific requirements that municipalities must adhere to in establishing an investment policy A Municipality is required to adopt a statement of the municipality s investment policies and goals. This policy must be developed and adopted prior to investment in the prescribed securities. The council of the municipality must consider a number of investment issues when developing their policy: Investment risk tolerance Preservation of municipal capital Risk aversion through portfolio diversification Seeking legal and/or financial advice with respect to the proposed investments Regulation Highlights 2

4 Investments Made under Section 142 of the Electricity Act: The municipality's investment policies and goals for investments made under section 142 of the Electricity Act, 1998 (bonds, debentures, promissory notes), must include the municipality s plans for the investment and how the proposed investment would affect the interest of municipal taxpayers. Clarification of provisions related to hydro debt under the Electricity Act were also included in O.Reg. 655/05. Sinking Fund Investments A municipality shall not invest more then 25 per cent of the total amount invested in all sinking and retirement funds in respect of debentures of the municipality, as estimated by its treasurer on the date of the investment, in short-term debt issued or guaranteed by the municipality. In this section, "short-term debt" means any debt, the terms of which provide that the principal and interest of the debt shall be fully repaid no later than 364 days after the debt is incurred. Exceptions to the Regulation The regulation provides exceptions for investments made before March 6, 1997 Despite this Regulation, an investment by a municipality in bonds, debentures or other indebtedness of a corporation made before March 6, 1997 may be continued if the bond, debenture or other indebtedness is rated, by Dominion Bond Rating Service Limited as "AA(low)" or higher; by Moody's Investors Services Inc. as "Aa3" or higher; or by Standard and Poor's as "AA-" or higher. If the rating of an investment falls below the standard required by that subsection, the municipality shall sell the investment within 90 days after the day the investment falls below the standard. Regulation Highlights 3

5 Currency Conditions Must be payable in Canadian $ According to the regulation, a municipality is not permitted to invest in a security that is expressed or payable in any currency other than Canadian dollars. This does not prevent a municipality from continuing an investment, made before this Regulation came into force, that is expressed and payable in the currency of the United States of America or the United Kingdom. New Powers for Municipalities to Control Costs by Entering into Forward Rate Agreements. Forward rate agreements allow municipalities to control for fluctuations in interest rates between the time that they decide to invest or borrow and the time the investment or debt instrument is executed. Eligible Instruments and Conditions The regulations identify the types of eligible investments as well as setting certain parameters and criteria There are seven general categories of investment instruments available for municipalities outlined in the Regulations. These include: 1. Bonds, Debentures, Promissory Notes 2. Deposit Receipts, Deposit Notes, Certificates of Deposit or Investment, Acceptances or Similar Instruments (Money Market) 3. Short Term Securities 4. Asset-Backed Securities 5. Negotiable Promissory Notes or Commercial Paper 6. Securities 7. Forward Rate Agreements Tables 1-7 provide a listing by category of investment of eligible investment instruments as well as the specific conditions for investing in each as identified in the Regulations. Regulation Highlights 4

6 Summary of Eligible Investments and Conditions Table 1a Bonds, Debentures, Promissory Notes or Other Evidence of Indebtedness Issued by or Guaranteed by: Section Issuer Canada or a province or territory of Canada An agency of Canada or a province or territory of Canada A Country other than Canada A Municipality in Canada including the municipality making the investment A school board or similar entity in Canada A local board as defined in the Municipal Affairs Act (not including a school board or a municipality) A conservation authority established under the Conservation Authorities Act The Municipal Finance Authority of British Columbia Conditions Rated by: Dominion Bond Rating Service Limited as "AA(low)" or higher; or Fitch: AA- or higher or Moody's Investors Services as "Aa3" or higher or Standards and Poor's as "AA-" or higher. If an investment at some point falls below this standard, the municipality shall sell the investment within 90 days after the day the investment falls below the standard. A municipality shall not invest in a security issued or guaranteed by a school board or similar entity unless, the money raised by issuing the security is to be used for school purposes. Tables Eligible Investments & Conditions 5

7 Summary of Eligible Investments and Conditions Table 1b Bonds, Debentures, Promissory Notes or Other Evidence of Indebtedness Issued by or Guaranteed by: Section Issuer Ontario Strategic Infrastructure Financing Authority (OFIFA) Post-secondary education institution as defined in s. 3 of the Post-Secondary Choice and Excellence Act, 2000 Board of Governors of college of applied arts and technology Board of a Public Hospital within the meaning of the Public Hospitals Act A non-profit housing corporation as defined in s. 13 of Housing Development Act Local housing corporation as defined in s. 2 of Social Housing Reform Act, 2000 Conditions Rated by: Dominion Bond Rating Service Limited as "AA (low)" or higher; or Fitch Rating as AA- or higher or Moody's Investors Services as "Aa3" or higher or Standards and Poor's as "AA-" or higher If an investment at some point falls below this standard, the municipality shall sell the investment within 90 days after the day the investment falls below the standard. Tables Eligible Investments & Conditions 6

8 Summary of Eligible Investments and Conditions Table 1c Bonds, Debentures, Promissory Notes or Other Evidence of Indebtedness Issued by or Guaranteed by: Section Issuer Conditions Bank Listed Schedule I, II or III of the Bank Act 2.4 Loan Corporation or Trust Company A Credit Union or League Rated by: Dominion Bond Rating Service Limited as "AA (low)" or higher; or Fitch Rating as AA or higher; or Moody's Investors Services as "Aa3" or higher or Standards and Poor's as "AA-" or higher Province of Ontario Savings office Tables Eligible Investments & Conditions 7

9 Summary of Eligible Investments and Conditions Table 1d Bonds, Debentures, Promissory Notes or Other Evidence of Indebtedness Issued by or Guaranteed by: Section Issuer Conditions 2.6 Issued or guaranteed by the International Bank for Reconstruction and Development Issued or guaranteed by a supranational financial institution or a supranational government organization other than the International Bank for Reconstruction and Development Rated by Dominion Bond Rating Service Limited as "AAA" or higher; or Fitch Rating as AAA or higher; or Moody's Investors Services as "Aaa" or higher or Standards and Poor's as "AAA" or higher If an investment at some point falls below this standard, the municipality shall sell the investment within 90 days after the day the investment falls below the standard. Tables Eligible Investments & Conditions 8

10 Table 1e Bonds, Debentures, Promissory Notes or Other Evidence of Indebtedness of a Corporation if: Section Issuer Conditions 2.2(i) and (ii) The Bond, debenture or other evidence of indebtedness is secured by the assignment, to a trustee, as defined in the Trustee Act, of payments that Canada or a province or territory of Canada has agreed to make or is required to make under a federal, provincial or territorial statute, and the payments are sufficient to meet the amounts payable under the bond, debenture or other evidence of indebtedness, including the amounts payable at maturity Incorporated under the laws of Canada or a province of Canada, the terms of which provide that the principal and interest shall be fully repaid more than five years after the date on which the municipality makes the investment Incorporated under the laws of Canada or a province of Canada, the terms of which provide that the principal and interest shall be fully repaid more than one year and no later than five years after the date on which the municipality makes the investment Rated by: Dominion Bond Rating Service Limited as "A" or higher; or Fitch Rating as A or higher; or Moody's Investors Services as "A2" or higher or Standards and Poor's as "A" or higher If an investment at some point falls below this standard, the municipality shall sell the investment within 90 days after the day the investment falls below the standard. A municipality shall not invest unless on the date the investment is made, the municipality has entered into an agreement with the Local Authority Services Limited and the CHUMS Financing Corporation to act together as the municipality s agent for the investment in the security. There is an exemption for the City of Ottawa in the regulation if certain conditions are met. Rated by: Dominion Bond Rating Service Limited as "AA (low)" or higher; or Fitch Rating as AA- or higher; or Moody's Investors Services as "Aa3" or higher or Standards and Poor's as "AA-" or higher If an investment at some point falls below this standard, the municipality shall sell the investment within 90 days after the day the investment falls below the standard. Tables Eligible Investments & Conditions 9

11 Table 1f Bonds, Debentures, Promissory Notes or Other Evidence of Indebtedness of a Corporation if: Section Issuer Conditions 2.10 If the municipality first acquires the bond, debenture, promissory note or other evidence of indebtedness as a gift in a will and the gift is not made for a charitable purpose. A municipality shall sell an investment within 90 days of the investment vests in the municipality. Tables Eligible Investments & Conditions 10

12 Table 1g Bonds, Debentures, Promissory Notes and Other Evidence of Indebtedness Section 2.9 Issuer Corporation incorporated under section 142 of the Electricity Act, 1998 Conditions Shall not invest in a security unless, at the time the investment is made and as long as it continues, the investment ranks, at a minimum, concurrently and equally in respect of payment of principal and interest with all unsecured debt of the corporation. A municipality shall not invest in a security unless, at the time the investment is made, the total amount of the municipality's investment in debt of any corporation incorporated under section 142 of the Electricity Act, 1998 that would result after the proposed investment is made does not exceed the total amount of investment in debt, including any interest accrued on such debt, of the municipality in such a corporation that existed on the day before the day the proposed investment is to be made. Any investment made, including any refinancing, renewal or replacement thereof, may not be held for longer than a total of 10 years from the date such investment is made. Must prepare a statement of the municipality's investment policies and goals for these types of investments considering its plans for the investment and how the proposed investment would affect the interest of municipal taxpayers. Upon disposition of any of these investments, the council of the municipality shall require the treasurer of the municipality to prepare and provide to the Council a report detailing the proposed use of funds realized in the disposition. Tables Eligible Investments & Conditions 11

13 Table 2 Deposit receipts, deposit notes, certificates of deposit or investment, acceptances or similar instruments Section Issuer Conditions Bank Loan Corporation or Trust Company Listed in Schedule I, II or III to the Bank Act (Canada) Registered under the Loan and Trust Corporation Act A Credit Union or League Applies under the Credit Unions and Caisses Populaires Act, 1994 Province of Ontario Savings office Table 3 Short-Term Securities Section Issuer A post secondary educational institution that is authorized to engage in an activity described in section 3 of the Post-secondary Education Choice and Excellence Act, The board of governors of a college of applied arts and technology of Ontario A board of a hospital within the meaning of the Public Hospitals Act. Conditions The terms of which provide that the principal and interest shall be fully repaid no later than 3 days after the day the investment was made The terms of which provide that the principal and interest shall be fully repaid no later than 3 days after the day the investment was made The terms of which provide that the principal and interest shall be fully repaid no later than 3 days after the day the investment was made Tables Eligible Investments & Conditions 12

14 Issuer Table 4 Asset Backed Securities (Section 2.7) Defined in subsection 50 (1) of Regulation 733 of the Revised Regulations of Ontario, 1990 made under the Loan and Trust Corporation Act Conditions A municipality shall not invest in an asset-backed security unless, on the date that the investment is made, The municipality itself is rated, or all of the municipality s long term debt obligations are rated, by Dominion Bond Rating Service Limited as "AA (low)" or higher, By Fitch Ratings as AA- by Moody's Investors Services Inc. as "Aa3" or higher, or by Standard and Poor's as "AA-" or higher; or the municipality has entered into an agreement with the Local Authority Services Limited and the CHUMS Financing Corporation to act together as the municipality's agent for the investment in that security, promissory note or commercial paper. The investment under the Local Authority Services Limited and the CHUMS Financing Corporation must be made in the public sector group of funds of the Local Authority Services Limited and the CHUMS Financing Corporation with, a. another municipality; b. a public hospital; c. a university in Ontario that is authorized to operate under section 3 of the Post-secondary Education Choice and Excellence Act, 2000; d. a college established under section 5 of the Ministry of Training, Colleges and Universities Act; e. a school board; or f. any agent of an institution listed in clauses (a) to (d). A municipality shall not invest in an asset-backed security that matures more than one year from the date of issue unless the security is rated, by Dominion Bond Rating Service Limited as "AAA"; or Fitch Ratings as AAA Moody's Investors Services Inc. as "Aaa"; or Standard and Poor's as "AAA". A municipality shall not invest in an asset-backed security that matures one year or less from the date of issue unless the security is rated, by Dominion Bond Rating Service Limited as "R-1(high)"; Fitch Rating as F1+, or Moody's Investors Services Inc. as "Prime-1"; or by Standard and Poor's as "A-1+". If an investment falls below the standard required, the municipality shall sell the investment within 30 days after the day the investment falls below the standard. Tables Eligible Investments & Conditions 13

15 Table 5 Negotiable Promissory Notes or Commercial Paper, other than asset-backed securities, maturing one year or less from the date of issue (Section 2.8) Issuer Conditions A municipality shall not invest unless the promissory note or commercial paper is rated, by Dominion Bond Rating Service Limited as "R-1(mid)" or higher; or Fitch Rating as F1 or Moody's Investors Services Inc. as "Prime-1"; or Standard and Poor's as "A-1+" If an investment falls below the standard required, the municipality shall sell the investment within 30 days after the day the investment falls below the standard. Note or commercial paper has been issued by a corporation that is incorporated under the laws of Canada or a province of Canada A municipality shall not invest in a security unless, on the date that the investment is made, all of the municipality's long-term debt obligations are rated, by Dominion Bond Rating Service Limited as "AA(low)" or higher, by Fitch Ratings AA- by Moody's Investors Services Inc. as "Aa3" or higher, or by Standard and Poor's as "AA-" or higher; or the municipality has entered into an agreement with the Local Authority Services Limited and the CHUMS Financing Corporation to act together as the municipality's agent for the investment in that security, promissory note or commercial paper. The investment under the Local Authority Services Limited and the CHUMS Financing Corporation must be made in the public sector group of funds of the Local Authority Services Limited and the CHUMS Financing Corporation with, a. another municipality; b. a public hospital; c. a university in Ontario that is authorized to operate under section 3 of the Post-secondary Education Choice and Excellence Act, 2000; d. a college established under section 5 of the Ministry of Training, Colleges and Universities Act; e. a school board; or f. any agent of an institution listed in clauses (a) (d) Tables Eligible Investments & Conditions 14

16 Table 6 Share of a Corporation Section Conditions Shares issued by a corporation that is incorporated under the laws of Canada or a province of Canada. Available only through the ONE Funds provided that the municipality has entered into an agreement with the Local Authority Services Limited and the CHUMS Financing Corporation to act together as the municipality s agent for the investment in the security 2.11 Securities of a corporation if the municipality first acquires the securities as a gift in a will and the gift is not made for a charitable purpose Shares of a corporation if: 2.12 i. the corporation has a debt payable to the municipality ii. iii. iv. under a court order, the corporation has received protection from its creditors the acquisition of the shares in lieu of the debt is authorized by the court order, and the treasurer of the municipality is of the opinion that the debt will be uncollectible by the municipality unless the debt is converted to shares under the court order Tables Eligible Investments & Conditions 15

17 Table 7 Forward Rate Agreements Section Conditions 10 A municipality that enters into an agreement to make an investment on a future date in a security prescribed by section 2 may enter one or more forward rate agreements with a bank listed in Schedule I, II or III to the Bank Act (Canada) in order to minimize the cost or risk associated with the investment because of fluctuations in interest rates. A forward rate agreement shall provide for the following matters: 1. Specifying a forward amount, which is the principal amount of the investment or that portion of the principal amount to which the agreement relates 2. Specifying a settlement day, which is a specified future date 3. Specifying a forward rate of interest, which is a notional rate of interest applicable on the settlement day 4. Specifying a reference rate of interest, which is the market rate of interest payable on a specified future date on an acceptance issued by a bank listed in Schedule I, II or III to the Bank Act (Canada) 5. Requiring a settlement payment to be payable on the settlement day if the forward rate and the reference rate of interest are different A municipality shall not enter a forward rate agreement if the forward amount described in paragraph 1 of subsection (2) for the investment whose cost or risk the agreement is intended to minimize, when added to all forward amounts under other forward rate agreements, if any, relating to the same investment, would exceed the total amount of the principal of the investment. A municipality shall not enter a forward rate agreement unless the settlement day under the agreement is within 12 months of the day on which the agreement is executed. In addition, a municipality shall not enter a forward rate agreement if the settlement exceeds the difference between the amount of interest that would be payable on the forward amount calculated at the forward rate of interest for the period for which the investment was made and the amount that would be payable calculated at the reference rate of interest. A municipality shall not enter a forward rate agreement except with a bank listed in Schedule I, II or III to the Bank Act (Canada) and only if the bank s long-term debt obligations on the day the agreement is entered are rated, (a) by Dominion Bond Rating Service as A(high) or higher; (b) by Fitch Ratings as A+ or higher; (c) by Moody s Investors Service Inc. as A1 or higher; or (d) by Standard and Poor s as A+ or higher Tables Eligible Investments & Conditions 16

18 Table 7 Forward Rate Agreements Section Conditions 11 Before a municipality passes a by-law authorizing a forward rate agreement, the Council of the municipality shall adopt a statement of policies and goals relating to the use of forward rate agreements. The Council of the municipality shall consider the following matters when preparing the statement of policies and goals: 1. The types of investments for which forward rate agreements are appropriate 2. The fixed costs and estimated costs to the municipality resulting from the use of such agreements 3. A detailed estimate of the expected results of using such agreements 4. The financial and other risks to the municipality that would exist with, and without, the use of such agreements. 5. Risk control measures relating to such agreements, such as: i. credit exposure limits based on credit ratings and on the degree of regulatory oversight and the regulatory capital of the other party to the agreement ii. standard agreements, and iii. ongoing monitoring with respect to the agreements 12 If a municipality has any subsisting forward rate agreements in a fiscal year, the treasurer of the municipality shall prepare and present to the Municipal Council once in that fiscal year, or more frequently if the Council so desires, a detailed report on all of those agreements. The report must contain the following information and documents: 1. A statement about the status of the forward rate agreements during the period of the report, including a comparison of the expected and actual results of using the agreements 2. A statement by the treasurer indicating whether, in his or her opinion, all of the forward rate agreements entered during the period of the report are consistent with the municipality s statement of policies and goals relating to the use of forward rate agreements 3. Such other information as the council may require 4. Such other information as the treasurer considers appropriate to include in the report The next section provides definitions for each type of instrument and some investment considerations. Tables Eligible Investments & Conditions 17

19 SECTION 2: DEFINITIONS OF ELIGIBLE INVESTMENT INSTRUMENTS 1. Bonds, Debentures, Promissory Notes (See Tables 1a-g for eligibility and conditions p. 5-11) Bonds are a core element of any municipal financial plan and are typically used for mid to long term investments There are several types of risk that should be evaluated prior to making a decision As stated earlier, the Ontario Regulation 399/02 sets out conditions that must be met for various types of Bonds, Debentures and Promissory Notes. Tables 1a-1g set out the types of instruments available within this category as well as the conditions. This should be used for quick reference in ensuring that a product of interest to the municipality is permitted under the regulation. Bonds and the money market are two of the most common types of investment instruments used by municipalities. Bonds Bonds are a debt security issued by such entities as corporations, governments, or their agencies, in return for cash from lenders and investors. It is a debt security, similar to an I.O.U. A bond holder is a creditor of the issuer and not a shareholder. As will be shown in table 1, the regulations clearly identify the type of bonds that municipalities may invest in and sets eligibility criteria associated with the various types of bonds which must be met. The issuer of a bond is effectively a borrower, and is required to pay interest to creditors (lenders) throughout the life of the bond. When a municipality purchases a bond, it is lending money to a government, municipality, corporation, agency or other entity known as the issuer. In return for the loan, the issuer promises to pay the municipality a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures, or comes due. Bonds are fixed-income securities because the interest payments and the face value are specified at the time the bond is issued and generally fixed for the life of the bond. If a municipality holds the bond until it matures, the future stream of payments received is known at the time of purchase. Description of Eligible Investments 18

20 Municipalities must consider the various types of risk when investing in bonds and identify ways to mitigate the risks One risk that bondholders face is associated with changes in interest rates. If you buy a new bond and plan to keep it to maturity, changing prices, interest rates, and yields typically do not affect you, unless the bond is called. But when you buy or sell an existing bond, the price investors are actually willing to pay for the bond may fluctuate. And the bond's yield, or the expected return on the bond, may also change. When prevailing interest rates rise, newly issued bonds typically offer higher yields to keep pace. When that happens, existing bonds with lower coupon rates become less competitive. That's because investors are unlikely to buy an existing bond offering a lower coupon rate unless they can get it at a lower price. Thus higher interest rates mean lower prices for existing bonds. That is, they are sold at a discount. Conversely, when interest rates fall, an existing bond's coupon rate becomes more appealing to investors, driving the price up. Bonds are then said to be sold at a premium. Example: Price and interest rates A municipality owns a bond with a coupon rate of 5%. At three points in time, the prevailing interest rate is 5%, 7%, and 3%. Bond $20, year 5% 5% 7% 3% The prevailing interest rate is the same as the bond's coupon rate. The price of the bond is 100, meaning that buyers are willing to pay you the full $20,000 for your bond. 2. Prevailing interest rates rise to 7%. Buyers can get around 7% on new bonds, so they'll only be willing to buy your bond at a discount. In this example, the price drops to 94, meaning they are willing to pay you $18,800 ($20,000 x.94). 3. The prevailing interest rate drops to 3%. Buyers can only get 3% on new bonds, so they are willing to pay extra for your bond, because it pays higher interest. In this example, the price rises to 108, meaning they are willing to pay you $21,600 (20,000 x 1.08). Description of Eligible Investments 19

21 Inflation impacts the price of a bond Inflation has the same effect as interest rates. When the inflation rate rises, the price of a bond tends to drop, because the bond may not be paying enough interest to stay ahead of inflation. Remember that a bond's coupon rate is generally unchanged for the life of the bond. The longer a bond's maturity, the more chance that inflation will rise rapidly at some point and lower the bond's price. That's one reason bonds with a long maturity offer somewhat higher interest rates: they need to do so to attract buyers who otherwise would fear a rising inflation rate. (Another reason is that buyers want a higher interest rate if they are going to tie up their money longer.) The financial health of the company or government entity issuing a bond affects the price investors are willing to pay for the bond: If the issuer is financially strong, investors are confident that the issuer will be capable of paying the interest on the bond and pay off the bond at maturity. If the issuer encounters financial problems, or if investors think that it might, then investors may become less confident in the issuer. If so, the price they are willing to pay for the issuer's bonds may drop. All bonds operate on the same basic theory, but they are not all equal investments. Some are riskier than others and, therefore, offer higher interest. However, the Ontario regulations place significant restrictions on the quality of the instruments that a municipality can make investments which significantly mitigates default risk. To help investors assess the risk of default, bonds are evaluated by various rating systems (Moody s, DBRS and Standards and Poor). For example, the regulations allow only investment in bonds from another country that are rated as high quality investments (e.g. Moody s rating of Aa3 or higher). By investing in only high quality instruments, default risk is mitigated. Bondholders also face maturity risk. Generally, the longer the term to maturity, the more the risk and the higher the rate of return. Bondholders who sell their bonds in the secondary market (before maturity) face some risk as to the value of the bond at that time. Further information on the types of risks, considerations and how to mitigate risk has been included later in the manual. Description of Eligible Investments 20

22 Investment Bond Strategies Various strategies are available to investors to try to minimize risks, such as staggering the maturity dates of bonds and buying a diversified portfolio of bonds. Ladders, barbells, and bullets are strategies for timing bond investments, both when buying them and when they mature. These strategies can help cushion investments from interest rate fluctuations. The term for each strategy reflects its chief characteristic. Ladders With ladders, you typically reinvest in steps. Bonds mature at different times and the municipality continually reinvests them. Ladders are a popular strategy for staggering the maturity of bond investments and for setting up a schedule for reinvesting them as they mature. A ladder can help the investor reap the typically higher coupon rates of longer-term investments, while allowing the investor to reinvest a portion of the funds every few years. Example: Ladder strategy You buy three bonds with different maturity dates: two years, four years, and six years. As each bond matures, you have the option of buying another bond to keep the ladder going. In this example, you buy 10- year bonds. Longer-term bonds typically offer higher interest rates. Ladders are popular among investors who want bonds as part of a long-term investment objective. Ladders have several potential advantages: The periodic return of principal provides the investor with additional income beyond the set interest payments The income derived from principal and interest payments can either be directed back into the ladder if interest rates are relatively high or invested elsewhere if they are relatively low Interest rate volatility is reduced because the investor now determines the best investment option every few years, as each bond matures Investors should be aware that laddering can require commitment of assets over time, and return of principal at time of redemption is not guaranteed Description of Eligible Investments 21

23 Barbells Barbells are a strategy for buying short-term and long-term bonds, but not intermediate-term bonds. The long-term end of the barbell allows you to lock into attractive long-term interest rates, while the short-term end ensures that the investor will have the opportunity to invest elsewhere if the bond market takes a downturn. Example: Barbell Strategy You see appealing long-term interest rates, so you buy two long-term bonds. You also buy two short-term bonds. When the short-term bonds mature, you receive the principal and have the opportunity to reinvest it. Bullets Bullets are a strategy for having several bonds mature at the same time and minimizing the interest rate risk by staggering when you buy the bonds. This is useful when you know that you will need the proceeds from the bonds at a specific time such as a major capital project. Example: Bullet Strategy You want all bonds to mature in 10 years, but want to stagger the investment to reduce the interest rate risk. You buy a number of different bonds over a four year period. Another tool available to assist in diversifying not only the types of instruments held but also the maturity dates is the One Bond Fund, which is described on the next page. Description of Eligible Investments 22

24 Pooled Bond Funds (ONE Bond Fund) Municipalities are permitted to invest in bonds that are administered by LAS and CHUMS Financing Corporation (ONE Fund). ONE Funds are professionally managed, offering municipalities expertise held within two Ontario municipal organizations, LAS (a subsidiary of the Association of Municipalities of Ontario) and CHUMS Financing Corporation (a subsidiary of the Municipal Finance Officers' Association of Ontario) recognized in the Ontario Regulations. The One Bond Fund offers municipalities an opportunity for a diversified portfolio The ONE Funds program is overseen by CHUMS and LAS acting together as the agent. The agent is responsible for enrolling investors, paying and monitoring the performance of the service providers, and ensuring ongoing compliance with various legal agreements governing the operation of the program. The operation of the Funds is overseen by an Investment Advisory Committee comprised of municipal financial representatives. The Committee advises on service provider selection and policy changes, and is also responsible for fund performance monitoring, marketing and promotion, and recommending changes to the ONE Funds Investment Guidelines. The ONE Fund offers a Bond Fund (described below) or a Money Market Fund (described later in the report). The objective of the ONE Bond Fund is to provide higher than money market rates of return through a diversified portfolio of conservatively managed short term bonds while providing a reasonable degree of liquidity and safety of principal. The ONE Bond Fund may invest in government and government-backed securities, Schedule I and Schedule II banks, municipal debentures, asset-backed securities and commercial paper. The adjusted duration of the portfolio is constrained to between 70% and 130% of the Scotia Capital Short-Term All Government Bond Index and all securities must have a credit rating of A or better. Lower rated and unrated securities are not permitted. It is structured to serve the needs of municipal investors with a longer-term investment horizon and where immediate liquidity is of a lesser priority. This type of investment is best suited for longer term investments (i.e., over 12 months). The ONE Bond Fund offers next-day investment credit for new investments and withdrawals. Description of Eligible Investments 23

25 Over the past 5 years, the ONE Bond Fund has had an average holding of $130 million in the portfolio, with a total of 70 municipal participants. One funds offer small to mid sized Ontario municipalities access to a larger pool of diversified funds The key advantages to investing through a pooled bond fund as opposed to an individual bond fund are: Higher degree of diversification a pool of funds provides a high level of diversification. The ONE Fund is designed to offer lower default and liquidity risk because of the diversification and liquidity that pooling provides, while still providing the opportunity to earn a reasonable rate of return. Instead of being limited to only a single or a few types of bonds, the ONE Bond Fund purchases a wide range of bonds with diversified yields and maturities. A diversified investment portfolio like the ONE Bond Fund has a greater potential to maximize earnings over the long term. Access to larger pool of funds provides the ability to take advantage of the higher yields offered which most small to mid size municipalities, would not be able to access. Certain types of investments can only be economically accessed in large volumes and/or at high transaction costs. Local government investment pools like the ONE Funds allow municipalities to participate in these transactions at institutional market prices by combining their investment resources and minimizing costs for all pool participants. By pooling resources, every investment in ONE Funds, no matter how large or small, has the advantage of being part of the larger dollar value transactions where costs are lower and returns can be higher. In turn, each investor benefits by sharing in the larger return based on the amount invested. Access to expertise Many municipalities may not have the internal resources to be active portfolio managers or the resources to hire staff with the requisite expertise to oversee and administer an investment portfolio. Participation in a local government investment pool like the ONE Funds provides access to professional expertise with proven track records at an affordable cost. Flexible timing Investors can make investments or withdrawals from the ONE Funds at any time. There is no requirement to lock in investments for any specified period. By creating a portfolio of assets with varying terms of maturity, the ONE Fund provides the flexibility that municipalities need. Description of Eligible Investments 24

26 Debentures Debentures and promissory notes are also instruments available to municipalities under the provisions set out in the Ontario regulations Debentures are a form of bond certificate issued by a corporation, government or agency, repayment of which is guaranteed by the overall capital value of the company under certain specific terms. As such, it is more secure than shares of stock or general bonds. Debentures involve more risk than bonds supported by collateral. These unsecured promissory notes are backed by the general creditworthiness of the issuer. Promissory Notes A promissory note is an unconditional written promise to pay a certain sum of money at a definite time to the bearer or to a specified person on his order. Promissory notes are generally used as evidence of debt. These are documents signed by a borrower promising to repay a loan under agreed upon terms. It is an agreement to pay or repay a specified sum of money at a stated time or on demand. It is a written and enforceable promise of payment. The holder of a note made payable to the bearer may transfer his rights to another by delivery of the note. If the note is payable to order, it may be transferred by endorsement and delivery. Promissory Note Features: with or without interest on demand, fixed term, or fixed date terms weekly, monthly, yearly or balloon payments interest only or interest and principal payments secured or unsecured notes in connection with sale of the security or not It is a contract detailing the terms of a promise by one party (the maker) to pay a sum of money to the other (the payee). The terms of a note typically include the principal amount, the interest rate if any, and the maturity date. Sometimes there will be provisions concerning the payee's rights in the event of a default, which may include foreclosure of the maker's interest. A promissory note can be called at any time by the current owner of the note (debtor). The security of the note is as good as the creditworthiness of the issuer. Description of Eligible Investments 25

27 2. Deposit Receipts, Deposit Notes, Certificates of Deposit or Investment, Acceptances or Similar Instruments (See Table 2 for eligibility and conditions p. 12) These instruments are also referred to as Money Market instruments. The Benefits of Money Market Funds Money market funds offer a number of potential advantages for investors: Money Market instruments are an important part of a municipality s investment portfolio Safety Money market funds invest exclusively in dollar denominated high-quality, short-term instruments issued by the federal government, corporations, municipalities, and banks Liquidity Money market funds are priced each day, shares can be purchased or sold at any time at the fund's current share price. Short-term holding Investors use money market funds to hold cash between investments. The yield on a money market fund is competitive with many savings accounts and is more liquid than bank CDs. Diversification Because money market investments are considered less volatile than bond funds, investors may want to invest in money market funds to help reduce volatility. Risks Involved in Money Markets Money market investors should be aware of two primary forms of risk: Income risk Money market yields can fall sharply in a relatively short period of time. Short-term yields have been much more volatile than long-term rates over time. Inflation risk Returns may not keep up with inflation, leading to purchasing power erosion for the investor. Description of Eligible Investments 26

28 Deposit Receipts These are used when accepting Earnest Money to bind an offer for property by a prospective purchase; also includes the terms of a contract. Deposit Notes This is a term deposit in a bank. Certificate of Deposit ONE Money Market offers diversification among a variety of financial instruments Also called a time deposit, this is a certificate issued by a bank that indicates a specified sum of money has been deposited. A CD bears a maturity date and a specified interest rate, and can be issued in any denomination. A certificate of deposit is an alternative to a regular savings account. Besides paying a higher interest, CDs differ from savings accounts in two basic ways. First the investor agrees to leave the money with the financial institution for a specified period of time (that is why it is called time deposits ). If the investor needs to withdraw the funds prior to that date, there is an interest penalty for early withdrawal. Second, the financial institution usually requires a minimum deposit. Generally, the larger the dollar value and the longer the term, the higher the rate of return. Considerations: What is the minimum deposit required? What is the length of maturity? What is the interest rate? Pooled Money Market Funds The ONE Money Market Fund is available for municipalities to participate. Consistent with the information identified in the bond section of the manual, participation in an investment pool like the ONE Funds offers diversification among a variety of financial instruments from different issuers, providers, and economic sectors. This helps protect municipalities of any size against the risk associated with adverse changes in credit and market conditions. Description of Eligible Investments 27

29 The ONE Money Market Fund may invest in government and government-backed securities, Schedule I and Schedule II banks, short-term municipal securities, asset-backed securities and commercial paper. The weighted average duration of the portfolio may not exceed 365 days and all securities must have a credit rating of R1 or better. Lower rated and unrated securities are not permitted. The objective of the ONE Money Market Fund is to provide competitive rates of return through a diversified portfolio of short to medium term money market securities while providing a high degree of liquidity and safety of principal. It is structured to serve the short term investment needs of municipal investors for funds that may be needed by participants on a day-to-day or near-term basis. Best suited for short-term investments (i.e., 0 12 months) of general operating funds and tax receipts, the ONE Money Market Fund offers next-day investment credit for new investments and withdrawals on the next banking day. This fund is appropriate for investors seeking stability of capital, liquidity and current interest income higher than savings account rates. It would be suitable for investors with very low tolerance for risk. Considerations: What is the minimum deposit required to earn the interest? What is the interest rate? Is it fixed or does it vary with market rates? Is the interest lower if you fail to maintain a specific minimum balance Is there a monthly service charge? What is it? Over the past 5 years, the ONE Money Market Fund has had an average holding of $250 million in the portfolio, with a total of 90 municipal participants. Description of Eligible Investments 28

30 3. Short-Term Securities (See Table 3 for eligibility and conditions p.12) When cash needs to be readily available, it should be invested in short-term, highly liquid assets. Historically, this meant bank demand deposits, such as chequing accounts, or time deposits, such as savings accounts. Today, investors have two other options for investing cash: money market vehicles (as described in the previous section) and enhanced cash strategies, such as short-term securities. While the money market and short-term securities attempt to preserve capital and provide liquidity, money markets aim to offer near-perfect liquidity whereas enhanced cash strategies attempt to offer higher yields than money market rates with slightly less liquidity. Under the Ontario Regulations there are only three issuers that a municipality can invest in short-term securities. These include: A post secondary educational institution that is authorized to engage in an activity described in section 3 of the Post-secondary Education Choice and Excellence Act, The board of governors of a college of applied arts and technology of Ontario A board of a hospital within the meaning of the Public Hospitals Act. Description of Eligible Investments 29

31 4. Asset Backed Securities (See Table 4 for eligibility and conditions p.13) Asset-backed securities (ABS), are bonds or notes backed by financial assets. Typically these assets consist of receivables other than mortgage loans such as credit card receivables, auto loans, manufacturedhousing contracts and home-equity loans. ABS differ from most other kinds of bonds in that their creditworthiness is derived from sources other than the paying ability of the originator of the underlying assets. Restricted to those made defined in subsection 50(1) of Regulation 733 of the Revised Regulations of Ontario, 1990 made under the Loan and Trust Corporation Act Financial institutions that originate loans including banks, credit card providers, auto finance companies and consumer finance companies turn their loans into marketable securities through a process known as securitization. The loan originators are commonly referred to as the issuers of ABS, but in fact they are the sponsors, not the direct issuers, of these securities. Asset-backed securities enable depository institutions, finance companies, and other corporations to "liquefy" their balance sheets (i.e., raise cash by borrowing against assets) and develop new sources of capital. Assets such as credit card balances, outstanding automobile and home equity loans are packaged as the collateral for intermediate-term (i.e., maturity of one to five years) securities and sold in the public markets or as private placements. Issuers reap advantages by securitizing assets rather than keeping them on their books. By packaging their portfolios of credit card receivables as securities, major commercial banks, for example, have been able to reduce the amount of capital they would otherwise have to maintain under new, stringent capital guidelines mandated by bank regulators. The "pooling" of assets occurs to make the securitization large enough to be economical and to diversify the qualities of the underlying assets. These financial institutions sell pools of loans, whose sole function is to buy such assets in order to securitize them. Ontario Regulations restricts investments in asset-backed securities to those made defined in subsection 50(1) of Regulation 733 of the Revised Regulations of Ontario, 1990 made under the Loan and Trust Corporation Act. There are specific minimum credit standards that also must be met (see table 4). As shown in table 4 of the manual, there are a number of conditions set out in the regulations such as minimum rating requirements of the ABS and a requirement that it must be done through the ONE Fund. Description of Eligible Investments 30

32 5. Negotiable Promissory Notes or Commercial Paper (other than asset-backed securities) (See Table 5 for eligibility and conditions p.14) Negotiable Promissory Notes An instrument is negotiable when the rules of law allow it to be traded between parties. A promissory note can be negotiable and transferred to a third party. At this point the issuer owes the third party instead of the original debtor. Commercial Paper Commercial Paper is a short-term, unsecured, discounted, and negotiable note sold by one company to another in order to satisfy immediate cash needs. It is a type of short-term negotiable instrument, usually an unsecured promissory note, that calls for the payment of money at a specified date. Because it is not backed by collateral, commercial paper is usually issued by major firms whose credit-rating is so good that their notes are immediately accepted for trading. Commercial paper is an important source of cash for the issuing firm; it supplements bank loans and is usually payable at a lower rate of interest than the prime discount rate. The Ontario Regulations sets strict minimum credit rating criteria that must be met in order for a municipality to invest in these types of instruments (see table 5). Investments under LAS and the CHUMS Financing Corporation are permitted, under specific conditions. Description of Eligible Investments 31

33 6. Shares in a Corporation (See Table 6 for eligibility and conditions p.15) This is a new investment opportunity available to municipalities Equities are stocks or shares of a corporation. When you buy common stocks, you are in effect becoming a part owner of the corporation. Along with ownership you usually get voting rights. The terms shares and stocks mean the same thing. There are two ways an investor can earn money on shares: The shares pay a dividend (dividend income) or The value of the shares increases (capital gains) Companies can pay dividends on their shares. The amount of the dividend is set by the company s board of directors based on the company s profit. Dividends are usually paid every three months. The value of the shares rises and falls based on what investors in the capital market perceive the company s prospects to be. An equity is a medium to high risk investment. The rate of return will depend on what the equity was purchased for and changes in the market. The potential of a higher return on equities compared to bonds is available, however, there is greater risk. The regulation states that a municipality can invest in shares issued by a corporation that is incorporated under the laws of Canada or a province of Canada. However, this is available only through the ONE Funds. In addition to equity investments through the ONE Funds, the municipality can hold equity shares of corporations if: i. the corporation has a debt payable to the municipality ii. under a court order, the corporation has received protection from its creditors iii. the acquisition of the shares in lieu of the debt is authorized by the court order, and iv. the treasurer of the municipality is of the opinion that the debt will be uncollectible by the municipality unless the debt is converted to shares under the court order.. A municipality can invest in securities of a corporation if the municipality first acquires the securities as a gift in a will and the gift is not made for a charitable purpose. Description of Eligible Investments 32

34 7. Forward Rate Agreements (See Table 6 for eligibility and conditions p.16) This is a new investment opportunity available to municipalities Borrowers lengthen maturities when rates are expected to rise, shorten when they expect rates to drop. Sometimes however market movements can outstrip the Treasurer s abilities to manage rate exposure using cash market alternatives alone. Forward Rate Agreements (FRA) were invented to fill this gap. FRAs offer a way to manage short term rate exposures without encumbering the balance sheet. A Forward Rate Agreement (FRA) is a tailor-made contract. As the name implies, it is an agreement to fix a future interest rate today. A forward contract specifies an interest rate to be paid on an obligation beginning on some future date. Companies use FRAs to protect short term borrowing or investment programs from market surprises. FRAs provide the chance to protect against falling interest rates and allow a municipality to plan cash flows. The price of the FRA will depend on how interest rates are expected to do in the future. FRA can be sold back at any time at the market price. The regulations provide certain conditions that must be met as outlined in table 7. These include identifying specific instruments available to municipalities as well as identifying the creditworthiness of the asset and setting out what must be included in the terms of the agreement. This includes a requirement that the agreement cannot extend beyond 12 months. Description of Eligible Investments 33

35 SECTION 3 INVESTMENT CONSIDERATIONS There are a number of considerations that municipalities should make prior to investing in various instruments. There are a number of investment considerations that a municipality must make prior to investing 1. Type of Instrument The regulations identify a broad range of high quality investment options. Some municipalities also place additional restrictions on the type of bond, promissory note or debenture which a municipality may invest as part of the overall investment portfolio. 2. Proportion of Funds To Invest Consideration may also be given to the proportion of the portfolio that will be invested in a particular type of investment. For example, municipalities, as part of their investment policy may set limits on the percentage of the total portfolio that can be invested in a sector of funds. Examples include (for illustrative purposes only): investments in pooled funds shall not be less than 30% of total investment portfolio securities offered by the Government of Canada or an eligible Province of Canada shall comprise not less than 30% of the total investment portfolio investments in eligible financial institutions shall not exceed 60%of the total portfolio maximum portfolio limit for municipal instruments shall not exceed 25% and no individual investment in a municipal instrument shall exceed 5% of the total investment portfolio 3. Price The price paid for a bond is based on a whole host of variables, including interest rates, supply and demand, credit quality, maturity and tax status. Newly issued bonds normally sell at or close to their face value. Bonds traded in the secondary market, however, fluctuate in price in response to changing interest rates. When the price of a bond increases above its face value, it is said to be selling at a premium. When a bond sells below face value, it is said to be selling at a discount. Investment Considerations 34

36 4. Credit Rating The regulations set out minimum criteria which restricts investment to high quality instruments. Some municipalities also place additional restrictions on investments associated with minimum credit ratings beyond those set out in the regulations. The following table sets out the credit rating scales used by Moody s, DBRS, Fitch s and Standard and Poor s agencies. Investment Grade Moody's Standard & Poors DBRS Short Term and Commercial Paper DBRS Long Term Fitch Short Term and Commercial Paper Fitch Long Term Highest Quality (extremely strong) Aaa AAA R-1 (high) AAA R-1 (high) AAA High Quality (very strong) Aa1 to Aa3 AA+ to AA- R-1 (middle) AA R-1 (middle) AA+ to AA- Upper Medium Grade (strong) A-1, A A+ to A- R-1 (low) A R-1 (low) A+ to A- Medium Grade (good) Baa-1, Baa BBB+ to BBB- R-2 (high) BBB R-2 (high) BBB Lower Medium Grade (somewhat speculative) Ba BB+ to BB- R-2 (middle) BB R-2 (middle) BB Low Grade (speculative/weak) B B+ to B- R-2 (low) B R-2 (low) B Poor Quality (may default/very weak) Caa CCC to CCC- R-3 (high) CCC R-3 (high) CCC Most Speculative Ca CC R-3 (middle) CC R-3 (middle) DDD No interest Being Paid or Bankruptcy Petition Filed C R R-3 (low) C R-3 (low) DD In Default C D D D D D Investment Considerations 35

37 5. Assessing Risks and Returns An assessment of the interest rate, maturity, liquidity and credit risk is required for each investment. There is a need to: identify risks limit those risks utilize manageable risk to provide a reasonable market yield on the portfolio through diversification and investment strategy, including participation in local government investment pools. It is necessary to identify the types of risks and determine what level of risk the municipality is willing to take There is clearly a balance between the level of risk that the municipality is willing to assume to gain additional return. As such, it is necessary to identify the types of risks and determine what level of risk the municipality is willing to take in order to identify what the resulting reasonable level of return will be. Investment policies should be established to address and set parameters for risk and establish realistic benchmark measurements. Investments that offer potentially high returns are accompanied by higher risk factors. It is up to the municipality to decide how much risk they are willing to assume (within the parameters set out by the regulations and legislation). Virtually all investments have some degree of risk. When investing in bonds, it s important to remember that an investment s return is linked to its risk. The higher the return, the higher the risk. Conversely, relatively safe investments offer relatively lower returns. This relationship may not hold exactly true over short periods of time, but over a long investment period, increased return typically means increased risk. Types of Risk Credit Risk this involves the credit of counterparties or the credit risk of the individual securities. Since the majority of public funds are invested in the most secure government issued securities, the credit risk is minimized. Liquidity Risk the risk that funds will not be available when needed. To avoid such risks, a sufficient amount of investments must be kept short term to meet cash flow demands. Cash flow forecasting, as has been discussed earlier in the manual is needed to reduce liquidity risk by providing opportunities for municipalities to maximize returns through a balanced portfolio approach (including investments in instruments with short, medium and long term maturities). The most liquid investment options are savings accounts and money market accounts. Investment Considerations 36

38 Market or Interest Rate Risk this involves the risk to capital and/or return as market interest rates fluctuate. It is possible that an asset will have to be sold at a price that is lower than the purchase, or book, price. For public funds, most market fluctuation risk can be reduced by matching securities to liabilities and buying only very short-term securities where volatility is minimal. Accurate reporting is also critical so that the investment officer knows the actual book value of a security (including accrued interest, amortization and accretion). Credit, liquidity and market risks can be mitigated to various degrees by limiting investments to high-quality credits, insisting on collateralization for certain investments, ensuring that there is an active secondary market for investments, and shortening maturities when interest rates are expected to rise. 6. Understanding Yield Curves Changes in interest rates don t affect all bonds equally. The longer it takes for a bond to mature, the greater the risk that prices will fluctuate along the way and that the fluctuations will be greater and the more the investors expect to be compensated for taking the extra risk. There is a direct link between maturity and yield. It can best be seen by drawing a line between the yields available on like securities of different maturities, from shortest to longest. The yield curve is what economists use to capture the overall movement of interest rates (which are known as "yields.") A yield curve is the graphic or numeric presentation of bond equivalent yields to maturity on debt that is identical in every aspect except time to maturity. By watching the yield curve, a municipality can gain a sense of where the market perceives interest rates to be headed one of the important factors that affects bond prices. Having said this however, the rates on bonds of different maturities behave quite independently of each other, with short-term rates and long-term rates often moving in opposite directions simultaneously. What's important is the overall pattern of interestrate movement and what it says about the future of the economy. Investment Considerations 37

39 Yield Yield Yield Yield Normal Yield Time Steep Yield Time Inverted Yield Time Flat Yield Normal Yield A normal yield curve would show a fairly steady rise in yields between short and intermediate term issues and a less pronounced rise between intermediate and long term issues. That is as it should be, since the longer the investor s money is at risk, the more the investor should expect to earn. Steep Yield Curve If the yield curve is said to be steep, it means the yields on short term securities are relatively low when compared to long term issues. This means there is an opportunity to obtain significantly increased bond income (yield) by buying a longer maturity than a short one. This shape is typical at the beginning of an economic expansion, just after the end of a recession. At that point, economic stagnation will have depressed short term interest rates, but once the demand for capital (and the fear of inflation) is reestablished by growing economic activity, rates begin to rise. In these circumstances, long-term investors fear being locked into low rates, so they demand greater compensation much more quickly than short term lenders who face less risk. Short term investors can trade out of their T-bills in a matter of months, giving them the flexibility to buy higher-yielding securities should the opportunity arise. Inverted Yield Curve When yields on short term issues are higher than those on longer term issues, the yield curve is said to be inverted. This suggests that investors expect interest rates to decline. An inverted yield curve is sometimes considered to be an indication of a pending recession. At first glance an inverted yield curve seems like a paradox. Why would long term investors settle for lower yields while short term investors take so much less risk? The answer is that long term investors will settle for lower yields now if they think rates and the economy are going even lower in the future. They're betting that this is their last chance to lock in rates before the bottom falls out. Inverted yield curves are rare. Never ignore them. They are always followed by economic slowdown or outright recession as well as lower interest rates across the board. Flat Yield If the yield curve is flat, it means the difference between short and long term rates is relatively small. This means that the reward for extending maturities is relatively small, and many investors will choose to stay in the short end of the maturity range. Time Investment Considerations 38

40 Yield or Return Yield or return is an important consideration when looking at investment strategies. Investors use several measures to determine yield. Together, these factors help determine the value of the bond investment and the degree to which it matches financial objectives Current Yield (Current Return) - A yield calculation determined by dividing the annual interest received on a security by the current market price of that security. Current yield is a more accurate measure of the return on a bond than the coupon rate because it takes into account the market price. However, it does not consider the difference between the bond s purchase price and the amount the bond can be redeemed for at maturity. Yield-to-Maturity - Yield to maturity and yield to call, which are considered more meaningful, provide the total return received by holding the bond until it matures or is called. It also enables comparison of bonds with different maturities and coupons. The rate of return yielded by a debt security held to maturity when both interest payments and the investor's potential capital gain or loss are included in the calculation of return. Another way to describe yield to maturity includes not just the interest payments you will receive, but also the net rise or fall in the price of the bond as it moves toward its maturity date. Amount of Surplus Funds and Timing The Availability of Funds A bond s maturity refers to the specific future date on which the investor s principal will be repaid. Bond maturities generally range from one day up to 30 years. Maturity ranges are often categorized as follows: Short term notes: maturities of up to five years; Intermediate notes/bonds: maturities of five to 12 years; Long term bonds: maturities of 12 or more years. The ONE Fund, being a pool of funds does not have one set date for maturity but includes a broad range of instruments with different maturity dates. Generally, the average maturity of the ONE Bond portfolio is less than 4 years. Some municipalities choose to limit the proportionate amount of the portfolio that can be invested in long term instruments. Examples include: the term of approved investments for Schedule B banks shall not exceed 12 months the term of approved investments for six major Charter banks shall not exceed 5 years Government of Canada instruments shall not exceed 20 years in term Investment Considerations 39

41 SECTION 4 DEVELOPING A COMPREHENSIVE INVESTMENT POLICY Investment policies are required under the Municipal Act and are considered to be the most important cash management policy All municipalities have cash flow needs that must be carefully managed to ensure that there is sufficient cash to meet obligations and that idle cash is efficiently invested. Written investment policies should be available to guide cash managers as they make daily decisions about the allocation of public funds among allowable investment instruments. In the absence of such policies, investment officers expose themselves to the second guessing of both management and elected officials. The foundation of any successful investment program is a comprehensive policy that reflects the municipality s investment philosophy and tolerance for risk. For many municipalities, developing policies and procedures is a time-consuming process that may be low on the list of priorities due to other commitments. However, the Municipal Act requires every municipality to adopt a statement of the municipality s investment policies and goals which must be developed and adopted prior to investment in the prescribed securities. The investment policy should set the standard for and control all the functions of investing by the municipality. It is considered by many to be the most important policy in the cash management area. An investment policy is much more than a simple list of authorized investment instruments. A welldeveloped investment policy can and should be a valuable tool for managing a municipal investment program. Such a policy defines the parameters of the investment program and indemnifies investment officers from personal liability so long as they adhere to the tenets of their respective policies. As identified in the Ontario Regulation 399/02, a Municipality is required to adopt a statement of the municipality s investment policies and goals. This policy must be developed and adopted prior to investment in the prescribed securities. The Council of the municipality must consider a number of investment issues when developing their policy including: Investment risk tolerance Preservation of municipal capital Risk aversion through portfolio diversification Seeking legal and/or financial advice with respect to the proposed investments Developing a Comprehensive Investment Policy 40

42 An investment policy has a number of key elements There are a number of key elements that are recommended to be included in an investment policy. These include: Policy Statement Scope Objectives Authority Standard of Care Safekeeping and Custody Internal Controls Suitable and Authorized Investments Investment Parameters Reporting Performance Standards Definitions/Glossary Table 8 - The next section of the manual provides a brief description of each as well as some helpful hints on what should be included in the development of an investment policy. Developing a Comprehensive Investment Policy 41

43 Element Policy Statement Scope Objectives Authority Table 8 Comments This identifies the key purpose(s) of the policy. Keep in mind the difference between a policy and a procedure. A policy sets out what you can do. A procedure spells out how you are going to do it. Some policies get bogged down in too much detail and become quickly outdated. Adopt investment policy as a resolution of Council. By adopting the policy through ordinance or a resolution, the policy becomes an official document. Clearly describe which funds are covered by the policy and which funds are covered by a separate policy. The policy should be clear on which funds are covered by the policy since some funds, such as bond proceeds or pension funds, may have different investment objectives or different investment horizons and would be better managed under a separate policy. This identifies and defines the financial assets that are included in the investment policy: General funds Operating funds Special revenue funds Reserve funds Sinking funds Capital project funds Trust and agency funds Retirement and pension funds Include a clear and concise statement of objectives. Simply stating investment objectives as safety, liquidity, and yield will not help governments protect their funds. Statements describing how these objectives will be achieved offer better guidance. The objective should include explicit statements of objectives. This provides a prioritized list of objectives and a description including but not limited to the following: Legality Safety/preservation of capital Maintenance of liquidity Competitive Rate of Return (Yield) This includes identification of the sections of the Municipal Act, as well as the Ontario Regulations. In addition, this may include the internal municipal signing authorities. Developing a Comprehensive Investment Policy 42

44 Element Standards of Care Safekeeping and Custody Internal Controls Suitable and Authorized Investments Comments This may include such items: Prudence Ethics and Conflict of Interest Delegation of Authority Competitive Selection - Require a formal process for selecting financial institutions and broker/dealers and describe this process in the policy. The point of this section is to specify what process governments will use to screen firms selling securities. This section should require a due diligence review of prospective firms, specify minimum credit criteria for financial institutions, and limit transactions to only those firms on the approved list. The list should be included as an appendix item. Require competitive quotes from at least three financial institutions and/or broker/dealers. Many municipalities obtain competitive quotes for their investment transactions but do not specifically require them in the investment policy. By not requiring competitive quotes, this practice could be lost over time. Adding this requirement to the investment policy ensures that the competitive quotation process is always used and the most efficient trade execution for investment transactions. This may include policy statements pertaining to how securities will be held. This may include statements pertaining to the frequency of independent review and maintenance of operating procedures for effective control and management of investment activities. Examples include formal signing officers to approve transactions and should address separation of duties such that no one person can independently execute an agreement for purchase/sale and cause it to be settled for the exchange of cash or securities. This typically includes statements as to which investment types the municipality will consider investing. While the Municipal Act and respective regulations places restrictions on the type and quality of the instruments, municipalities may place additional restrictions on the type of investment permitted. This requires knowledge of investment legislation and regulations and a determination if all of the allowable investment instruments are appropriate for your investment program. Caution should be exercised in copying other municipal investment policies, without fully understanding whether the instruments included in the policy are appropriate. To reduce risk some municipalities may prefer an investment program that is more restrictive than that allowed in the Municipal Act and supporting regulations. Developing a Comprehensive Investment Policy 43

45 Element Investment Parameters Reporting Performance Standards Definitions Comments It is recommended that the policy include clear, explicit language describing allowable investment instruments and the respective parameters. This leaves little room for interpretation and helps protect municipalities from imprudent investment decisions. This typically specifies the quality of investments, the quantity or range in percentage terms for various portfolio holdings by type of investment instrument and the maximum term of investments. There may be specific policy statements addressing such issues as: Diversification/Portfolio Share - Avoid arbitrary percentages when discussing diversification requirements; instead, use guidelines such as no more than 5 percent of the portfolio can be invested in the securities of a single issuer or no more than 20 percent of the portfolio may be invested beyond one year. Many investment policies include specific diversification guidelines such as, The portfolio must be invested in 50 percent Treasuries, 30 percent certificates of deposit, 10 percent commercial paper, and 10 percent local government investment pool. Arbitrary percentages can restrict the ability of governments to implement effective investment strategies. The purpose of diversification is to reduce risk in the portfolio. This can be accomplished by investing in a variety of maturities and avoiding over-concentration in specific sectors Maximum Maturity Percentage weightings for class and type of investments Minimum credit rating standards different from those in the regulations In addition to the minimum reporting requirements set out in the regulations, the policy should identify the frequency and type of reporting that will be provided. This establishes benchmarks upon which performance will be measured and may identify the frequency upon which performance will be evaluated and reported. Pick relevant benchmarks to gauge investment performance. Many investment policies specify the 90-day Treasury bill as the benchmark in one section and then state that the portfolio must maintain a one-year weighted average maturity in another section. The benchmark should mirror the weighted average maturity of the portfolio in order to provide a meaningful performance comparison. A list of benchmarks with varying weighted average maturities can be included in the policy to cover times when the portfolio's weighted average maturity changes. An investment policy may need to have a supporting glossary of key terms. Developing a Comprehensive Investment Policy 44

46 SECTION 5 SAMPLE CLAUSES ON DEVELOPING AN INVESTMENT POLICY While there are standard areas that should be addressed in an investment policy, customization of a policy is needed to fit the municipality s specific needs and environment The next section of the manual provides sample clauses that can be used by a municipality to develop an appropriate investment policy. These sample clauses are not intended to supplant an existing policy but have been provided to give treasurers and those responsible for a municipality s investments an array of possible approaches. Although sample policies provide useful guidance for the development of an investment policy, municipalities need to customize their policy to ensure that careful consideration has been given to those factors that make each municipality unique: including the timing of revenues and expenditures liquidity constraints the in-house expertise of the investment staff Post Investment Development Once an investment policy for the municipality has been developed, the policy should be approved by Council. Upon approval, the investment officer should evaluate the municipality s current investment program to ensure that all activities comply with the new policy. Any discrepancies should be corrected. This is also an ideal time to formalize procedures for implementing the investment policy. Written procedures outline the process for making investment decisions, detail the activities of the investment staff, and specify how investment decisions are to be carried out. Sample Investment Policy Clauses 45

47 Policy or Policy Statement (examples) Example 1 A policy to govern the management of the Corporation s surplus funds and investment portfolio. A policy statement sets out what you can do Example 2 The Municipality strives for the optimum utilization of its cash resources within statutory limitations and the basic need to protect and preserve capital, while maintaining solvency and liquidity to meet on-going financial requirements. Example 3 It is the policy of the Municipality to invest municipal funds in a manner which will provide the highest return with the maximum security while meeting the daily cash flow demands of the municipality and conforming to all applicable law. Example 4 The purpose of this investment policy is to establish and maintain practices and procedures to invest public funds with the highest return on investment with the maximum security and appropriate liquidity while meeting daily cash flow demands and conforming to all legislation governing the investment of public funds. The policy has been prepared in consultation with the Treasurer and Legal Services. Example 5 The purpose of this policy is to establish procedures and practices for a program designed to maximize the use of idle funds held in accounts through a program of term investments. The goals of the investment policy, within the authority granted to the Municipality under the Municipal or other Acts of Ontario as revised from time to time, are as follows: the preservation of capital (safety) is paramount, and additional, but subservient goals, are to provide cash availability (liquidity) and maximum yield on term investments of idle cash This policy will be implemented with the aid of the accompanying guidelines through the authority of the Treasurer or designate in the Finance Department. Sample Investment Policy Clauses 46

48 Scope (examples) Example 1 The policy, as outlined, applies to all future investment of Revenue, Reserve, Trust and Sinking Funds of the Municipality. The scope clearly describes which funds are covered by the policy Example 2 This investment policy applies to all investments made on behalf of the Municipality and its agencies, boards and commissions including, but not limited to, operating funds, reserves, reserve funds, sinking funds, pension funds, trust funds and any new fund created by the Municipality unless specifically exempted. Example 3 This policy applies to the investment activities of the Operating, Capital, Trust, Reserves and Reserve Funds. Example 4 This policy applies to the investment of short-term operating funds. Longer-term funds, including investments of employees' investment retirement funds and proceeds from certain bond issues, are covered by a separate policy. Example 5 Except for cash in certain restricted and special funds, the Municipality will consolidate cash balances from all funds to maximize investment earnings. Investment income will be allocated to the various funds based on their respective participation and in accordance with generally accepted accounting principles. Sample Investment Policy Clauses 47

49 Objectives (examples) Example 1 Include clear and concise statements of objectives Safety Safety of principal is the foremost objective of the investment program. Investments shall be undertaken in a manner that seeks to ensure the preservation of capital in the overall portfolio. The objective will be to mitigate credit risk and interest rate risk. Credit Risk The municipality will minimize credit risk, the risk of loss due to the failure of the security issuer or backer, by: Limiting investments to the safest types of securities Pre-qualifying the financial institutions, broker/dealers, intermediaries, and advisers with which the Municipality will do business Diversifying the investment portfolio so that potential losses on individual securities will be minimized. Interest Rate Risk The Municipality will minimize the risk that the market value of securities in the portfolio will fall due to changes in general interest rates, by: Structuring the investment portfolio so that securities mature to meet cash requirements for ongoing operations, thereby avoiding the need to sell securities on the open market prior to maturity Investing operating funds primarily in shorter-term securities, money market mutual funds, or similar investment pools. Liquidity The investment portfolio shall remain sufficiently liquid to meet all operating requirements that may be reasonably anticipated. This is accomplished by structuring the portfolio so that securities mature concurrent with cash needs to meet anticipated demands (static liquidity). Furthermore, since all possible cash demands cannot be anticipated, the portfolio should consist largely of securities with active secondary or resale markets (dynamic liquidity). A portion of the portfolio also may be placed in money market mutual funds or local government investment pools which offer same-day liquidity for short-term funds. Sample Investment Policy Clauses 48

50 Yield The investment portfolio shall be designed with the objective of attaining a market rate of return throughout budgetary and economic cycles, taking into account the investment risk constraints and liquidity needs. Return on investment is of secondary importance compared to the safety and liquidity objectives described above. The core of investments is limited to relatively low risk securities in anticipation of earning a fair return relative to the risk being assumed. Securities shall not be sold prior to maturity with the following exceptions: A security with declining credit may be sold early to minimize loss of principal A security swap would improve the quality, yield, or target duration in the portfolio Liquidity needs of the portfolio require that the security be sold. Example 2 The primary objectives of the Investment Program, in priority order, shall be: Adherence to Statutory Requirements All investment activities shall be governed by the Municipal Act as amended. Investments, unless limited further by Council, will be those deemed eligible under Ontario Regulation 438/97 or as authorized by subsequent provincial regulations. Preservation of Capital Safety of principal is an important objective of the investment program. Investments shall be undertaken in a manner that seeks to ensure the preservation of capital in the overall portfolio. Staff shall endeavor to mitigate credit and interest rate risk. Credit Risk Limiting investments to safer types of securities Pre-qualifying the financial institutions, broker/dealers, intermediaries, and advisers with which the Municipality does business subject to the Treasurer s approval; and Diversifying the investment portfolio so that potential losses on individual securities will be minimized. Sample Investment Policy Clauses 49

51 Interest Rate Risk Structuring the investment portfolio so that securities mature to meet ongoing cash flow requirements, thereby reducing the need to sell securities on the open market prior to maturity; Investing operating funds primarily in shorter-term securities or approved investment pools; and Diversifying longer-term holdings to match term exposures to requirements of underlying reserve funds and to mitigate effects of interest rate volatility. Maintaining Liquidity The investment portfolio shall remain sufficiently liquid to meet all operating or cash flow requirements and limit temporary borrowing requirements. This shall be done where possible by structuring the portfolio such that securities mature concurrent with anticipated cash demands. Furthermore, since all possible cash demands cannot be anticipated, the portfolio shall consist largely of securities with active secondary or resale markets. A portion of the portfolio may be placed in local government investment pools which offer liquidity for short-term funds. Earning a Competitive Rate of Return Without compromising other objectives, the Municipality shall maximize the rate of return earned on its portfolio by implementing a dynamic investment strategy as part of its investment program. Trends in macro-economic variables will be monitored including interest rates, inflation, and foreign exchange rates, as affected through the political arena and international developments and perceptions. Diversification, as well as ensuring safety of principal by limiting exposure to credit, sector or term risks, also provides opportunities to enhance the investment returns of the municipality s portfolio by means of prudent and timely adjustments to asset mix. Sample Investment Policy Clauses 50

52 Example 3 Conformity to Statutory Requirements As specified in Sections of the Municipal Act and Regulation 438/97. Eligible investments may be summarized as securities of Federal, Provincial, or Municipal Governments or of banks or trust companies. Preservation of Capital Since public funds are at stake, the Municipality should adopt a conservative risk policy using the accepted measure of risk, bond ratings. Portfolio diversification will also be used to minimize risk. A limit should be set for amounts that may be invested in higher risk instruments. Maintenance of Liquidity If cash flows are unpredictable, liquidity should be kept high in order to cope with unplanned events. Rate of Return Maximization The challenge is to obtain the best ongoing return possible subject to the self-imposed constraints of other parts of the investment policy, not by compromising them. Example 4 Investment Guidelines are provided in this policy in order to ensure compliance with provisions of the Municipal Act, 2001 as such may be amended from time to time and any prescribed regulations there under and the significant goals of the investment policy are as follows in order of importance: Security of deposit is the prime consideration when investing any funds under the care, custody and control of the Municipality; The obtaining of a diversified portfolio of investments is required to ensure cash availability to meet daily cash needs, and The maximization of returns from term investments must be in accordance with guidelines on safety, liquidity, risk and authority, in order to provide general revenues to the Municipality and reduce amounts otherwise required from taxation by the Municipality. Sample Investment Policy Clauses 51

53 Authority (examples) This includes identification of the sections of the Municipal Act, as well as the Ontario Regulations. In addition, this may include the internal municipal signing authorities. Example 1 The Municipal Act, 2001 (S.O. 2001, c. 25) provides in Section 418, the legislative authority for the Municipality to invest surplus funds in accordance with certain prescribed rules. Section 419 permits the municipality to invest money through an agent and Section 420 permits the Municipality to enter into agreements to invest money jointly with other municipalities and prescribed bodies. The prescribed rules governing investment are contained in Ontario Regulations 77/97 and 399/02. When investing is feasible, it shall be done only with the prior approval of the Treasurer or Treasurer s designate. A signed copy of the Investment Purchase Authorization form, attached as Schedule I to this Policy, is required to be completed, prior to placing an investment, and the form is to be signed by the authorized signing authorities for the Municipality. Example 2 Investments made by the Municipality are settled by cheque requisition or electronically by wire. A Voucher Payable Request initiates a cheque requisition and is authorized by the Manager of Accounting and Payroll and verified by the Director or Assistant Director of Financial Management Services. Investments settled by wire require staff approvals by any three of the following approved staff; Director of Financial Management Services, Assistant Director of Financial Management Services, Manager of Accounting and Payroll, and Intermediate Bookkeeper. Sample Investment Policy Clauses 52

54 Standards of Care (examples) Prudence This may include such items as Prudence, Ethics and Conflict of Interest, Delegation of Authority, Competitive Selection Example 1 Investments shall be made with judgment and care, under circumstances then prevailing, which persons of prudence, discretion and intelligence exercise in the management of their own affairs, not for speculation, but for investment, considering the probable safety of their capital as well as the probable income to be derived. Investment officers acting in accordance with written procedure and this investment policy and exercising due diligence, shall be relieved of personal responsibility for an individual security s credit risks or market price changes, provided deviations from expectations are reported in a timely fashion and the liquidation or the sale of securities are carried out in accordance with the terms of this Policy. Example 2 The standard of prudence to be used by investment officials shall be the prudent person standard and shall be applied in the context of managing an overall portfolio. Investment officers acting in accordance with written procedures and the investment policy and exercising due diligence shall take all necessary actions to ensure the maximum performance of investments on a portfolio basis, subject to the prescribed risk parameters dictated by the investment policy. Ethics and Conflict of Interest Example 1 Officers and employees involved in the investment process shall refrain from personal business activity that could conflict with the proper execution and management of the investment program, or that could impair their ability to make impartial decisions. Employees and investment officials shall disclose any material interests in financial institutions with which they conduct business. They shall further disclose any personal financial/investment positions that could be related to the performance of the investment portfolio. Employees and officers shall not undertake personal investment transactions with the same individual with whom business is conducted on behalf of the Municipality. Sample Investment Policy Clauses 53

55 Example 2 Investment officers shall refrain from personal business activity that could conflict with proper execution of the investment program or which could impair their ability to make important investment decisions. Investment officers shall disclose to the Treasurer of the Municipality any material financial interests in financial institutions that conduct business within Canada, and they shall further disclose any significant personal financial or investment positions that could be related to the performance of the portfolios. Delegation of Authority Example 1 The Treasurer has overall responsibility for the prudent investment of the Municipality s portfolio. However, the Director of Policy, Risk and Treasury is responsible for the implementation of the investment program and the establishment of investment procedures consistent with this policy. Such procedures shall include explicit delegation of authority to persons responsible for investment transactions. No person may engage in an investment transaction except as provided under the terms of this Policy. The Director shall be responsible for all transactions undertaken, and shall establish a system of controls to regulate the activities of subordinate officials and shall exercise control over that staff. Example 2 The Director of Financial Management Services is responsible for the prudent investment of the Municipality s portfolio. Authority to manage and implement the investment program is granted to the Assistant Director, or in the Assistant Director s absence, the Manager of Accounting and Payroll, hereinafter referred to as investment officer, who shall act in accordance with established procedures and internal controls consistent with this investment policy. No person may engage in an investment transaction except as provided under the terms of this policy. The Director shall be responsible for all transactions undertaken and shall establish a system of controls to regulate the activities of subordinate officials. Those investments governed by the provisions of the ONE The Public Sector Group of Funds agreement shall be deemed delegated to that Agent. Example 3 The Treasurer shall establish written procedures and policies for the operation of the investment program consistent with this investment policy. Such procedures shall include explicit delegation of authority to persons responsible for investment transactions. No person may engage in an investment transaction except as provided under the terms of this policy and the procedures and policies established by the Municipal Treasurer. Sample Investment Policy Clauses 54

56 Competitive Selection Example 1 The purchase and sale of securities shall be transacted through a competitive process with financial institutions approved by the Director. The Municipality will accept the offer that optimizes the investment objectives of the portfolio. A minimum of three quotations shall be obtained for each short-term transaction prior to placement and a reasonable number of quotations for each long-term transaction, considering the existing market conditions at the time of placement. Written records shall be retained of each transaction including the name of the institution solicited, rate quoted, description of the security, investment selected, as well as any other considerations that impacted the decision. If the highest yield security was not selected, an explanation describing the rationale shall be included in this record. Example 2 All securities purchase/sales will be transacted through a competitive process only with financial institutions approved by the Treasurer. The Municipality will accept the offer which: (a) has the highest rate of return within the maturity required; and (b) optimizes the investment objectives of the overall portfolio. When selling a security, the Municipality will select the bid that generates the highest sale price. If there is a tie bid between one or more brokers, the Municipality will award the winning bid to the brokers on a rotating basis. It will be the responsibility of the personnel involved with each purchase/sale to produce and retain written records of each transaction including the name of the financial institutions solicited, rate quoted, description of the security, investment selected, and any special considerations that had an impact on the decision. If the lowest priced security (highest yield) was not selected for purchase, an explanation describing the rationale shall be included in this record. Sample Investment Policy Clauses 55

57 Safekeeping and Custody (examples) This may include policy statements pertaining to how securities will be held Example 1 All securities shall be held for safekeeping by a financial institution approved by the Municipality. Individual accounts shall be maintained for each portfolio. All securities shall be held in the name of the municipality. The depository shall issue a safekeeping receipt to the municipality listing the specific instrument, rate, maturity and other pertinent information. On a monthly basis, the depository will also provide reports which list all securities held by the municipality, the book value of holdings and the market value as of month-end. Example 2 All security transactions entered into shall be conducted on a delivery against payment basis. Securities may be held by a third party custodian, designated by the Treasurer of the Municipality and evidenced by safekeeping receipts. The Treasurer of the Municipality may enter into a securities lending arrangement with the custodian. Statements pertaining to the frequency of independent review and maintenance of operating procedures for effective control and management of investment activities. Internal Controls (examples) Example 1 The Treasurer shall establish an annual process of independent review by an external auditor. This review will provide internal control by assuring compliance with policies and procedures. Example 2 The Treasurer of the municipality shall establish an annual process of independent review by the municipality s auditor. This review will provide assurance of compliance with governing legislation, this investment policy and procedures established by the Treasurer. Example 3 The Treasurer or delegate shall develop and maintain all necessary operating procedures for effective control and management of the investment function and reasonable assurance that he Corporation s investments are properly managed and adequately protected. Sample Investment Policy Clauses 56

58 Example 4 The Treasurer is responsible for the development and maintenance of suitable procedures to provide for effective control and management of investments. The procedures include the following requirements: The Treasurer designates, in writing, all persons authorized to enter into investment transactions on behalf of the Municipality All investments are confirmed by signature by the individual making the investment and ratified by signature by the Treasurer, or designate. Either the Director, Finance or the Controller may be designated to ratify investments. All cash management transactions are recorded and interest earnings distributed to the various funds, as the case may be, in accordance with Municipality policies and generally accepted accounting principles for Ontario municipalities. Periodic audits are carried out to determine whether or not the investment guidelines provided by this policy are being followed and to evaluate the adequacy of internal controls. Provision is made to obtain insurance coverage at all times to guard against any losses that may occur due to misappropriation, theft, or other acts of fraud by employees. The Treasurer shall submit to Council, at least once per year, a report on the performance of the Municipality portfolio of investments during the period covered by the report. Example 5 The investment officer is responsible for establishing and maintaining an internal control structure designed to ensure that the assets of the [entity] are protected from loss, theft or misuse. The internal control structure shall be designed to provide reasonable assurance that these objectives are met. The concept of reasonable assurance recognizes that (1) the cost of a control should not exceed the benefits likely to be derived and (2) the valuation of costs and benefits requires estimates and judgments by management. Accordingly, the investment officer shall establish a process for an annual independent review by an external auditor to assure compliance with policies and procedures. The internal controls shall address the following points: Control of collusion Separation of transaction authority from accounting and recordkeeping Custodial safekeeping Avoidance of physical delivery securities Clear delegation of authority to subordinate staff members Written confirmation of transactions for investments and wire transfers Development of a wire transfer agreement with the lead bank and third-party custodian. Sample Investment Policy Clauses 57

59 Suitable and Authorized Investments (examples) Municipalities may place additional restrictions on the type of investment permitted, beyond that identified by the Municipal Act and Ontario Regulations Example 1 Investments issued or guaranteed by the following institutions will be permitted by this policy, as deemed eligible by Ontario Regulation 438/97 or as authorized by subsequent provincial regulations: 1. The Government of Canada. 2. Provincial governments of Canada. 3. A municipality, school board or local board as defined in the Municipal Affairs Act or a conservation authority established under the Conservation Authorities Act. 4. Schedule I banks subject to a minimum DBRS rating of R-1 middle or AA. Schedule I banks are set out by Section 14 of the Bank Act. 5. Schedule II banks subject to a minimum DBRS rating of R-1 high or AAA. Schedule II banks are set out by Section 14 of the Bank Act. 6. Loan or trust corporations, registered under the Loan and Trust Corporation Act and subject to a minimum DBRS rating of R-1 middle or AA. 7. Credit unions or leagues to which the Credit Unions and Caisses Populaires Act applies, subject to a minimum DBRS rating of R-1 middle or AA. 8. Bonds, debentures, promissory notes and other evidences of indebtedness of a corporation incorporated under section 142 of the Electricity Act, Joint Municipal Investment pools permitted under the Municipal Act. Example 2 The portfolio aims for both diversification and near risk-free investments to ensure security of the capital. Emphasis is placed on securities offered by or unconditionally guaranteed by the Government of Canada, a Province of Canada or the six major chartered banks (Royal Bank of Canada, Canadian Imperial Bank of Commerce, Bank of Montreal, Bank of Nova Scotia, Toronto Dominion Bank, and National Bank of Canada). Sample Investment Policy Clauses 58

60 Example 3 The following are authorized investments: Bonds, debentures, or other evidences of indebtedness of or guaranteed by the Government of Canada, the Province of Ontario, or another province of Canada; Bonds, debentures, term deposits, deposit receipts, deposit notes, certificates of instruments issued, accepted, guaranteed or endorsed by any bank in Schedule I or II to the Bank Act (Canada); Bonds, debentures or promissory notes of a metropolitan, regional or district municipality, a school board, or a local board as defined in the Municipal Affairs Act or a conservation authority established under the Conservation Authorities Act; Bonds, debentures or other securities issued or guaranteed by the International Bank for Reconstruction and Development; Asset-backed securities; and Negotiable promissory notes or commercial paper maturing not more than one year from date of issue issued by a Canadian corporation. All authorized investments must meet or exceed the minimum credit ratings as detailed in Appendix 1 paper and are to be used in conjunction with the sector limitations noted in the Investment Parameters section of this Policy. The investments shall be diversified by: Limiting investments to avoid over-concentration in securities from a specific issuer or sector (excluding Government of Canada securities); Limiting investment in securities to those that have higher credit ratings; Investing in securities with varying maturities; and Investing in mainly liquid, marketable securities which have an active secondary market, to ensure that appropriate liquidity is maintained in order to meet ongoing obligations. In order to promote diversification in the Municipality s portfolio holdings, percentage weightings for class and type of securities shall be established and maintained. The Appendix sets out the: maximum allowable exposure for each classification of security as a percentage of the total portfolio maximum allowable exposure for each specific issuer in a security class as a percentage of the total portfolio maximum term limit for each investment class and issuer minimum and maximum term exposures in order to ensure liquidity requirements are maintained Sample Investment Policy Clauses 59

61 Furthermore, to the extent possible, the Municipality shall match its investments with anticipated cash flow requirements. Unless matched to a specific cash flow, the Municipality will not directly invest in securities maturing more than ten (10) years from the date of purchase. Reserve funds and other funds with longerterm investment horizons may be invested in securities exceeding ten (10) years if the maturity of such investments are made to coincide as nearly as practicable with the expected use of funds. The Municipality shall adopt weighted average maturity limitations consistent with investment objectives. The Municipality shall also hold sufficient funds in short term investment instruments in order to maintain adequate liquidity. See next page for examples of both suitable and authorized investments and investment parameters. Sample Investment Policy Clauses 60

62 Minimum Credit Rating Money Market Rating Sector/Credit Exposure Limitation 1 (maximum) Individual Limit Sector Term Limitation (Maximum) Portfolio Limit ( a ) ( b ) ( c ) ( d ) ( e ) ( f ) Federal Canada N/A R1 high 100% 100% 20 years Federal Guarantees N/A R1 high 50% 25% 20 years Federal Total 100% Provincial 2 AA R1 mid 50% 25% 20 years A R1 mid 20% 10% 10 years BBB R1 mid 10% 5% 5 years Provincial Total 80% Municipal Region of York N/A 25% 25% None Other Municipalities AAA 25% 5% 10 years and School Boards AA 15% 5% 10 years A 10% 2% 5 years Municipal Total 35% Asset Backed 3 AAA 20% 5% 5 years Banks Schedule I Banks AA(L) R1 mid 75% 25% 1 year AA(L) R1 mid 10% 5% 5 years A R1 low 20% 6 months Schedule II Banks R1 high 15% 5% 6 months R1 mid 10% 3% 6 months Bank Total 80% Commercial Paper R1 high 15% 5% 1 year R1 mid 10% 2% 6 months Commercial 3 Total 20% 1 exposure % limitations to be applied to the par value of the total portfolio 2 includes Provincial Guarantees 3 subject to Provincial regulatory approval PORTFOLIO TERM LIMITATIONS 1 Percentage Term Limitation Minimum Maximum Less than 90 days 20% 100% Less than 1 year 30% 100% From 1 year up to, but not including 5 years 0% 60% From 5 years up to, but not including 10 years 2 0% 40% From 10 years up to 20 years 0% 20% Other Restrictions: 1) Term is limited to an individual maximum term of 20 years and a weighted average term of 4 years for the whole portfolio 2) Investments for terms in excess of 1 year are restricted to any of the Canadian Federal, Provincial and Municipal governments, the top 5 Canadian Schedule 1 banks, asset backed securities; and institutions guaranteed by the aforementioned, subject to the credit rating limitation set out on Appendix 1. Sample Investment Policy Clauses 61

63 Example 4 Term investments will be made only in those instruments specified by prescribed regulations ordered under The Municipal Act of Ontario as revised and then for reasons of security and liquidity, only with those issued or guaranteed by the following institutions: The Government of Canada, including its agencies The Provincial Governments of Canada, including their agencies A Canadian metropolitan, regional, district municipality, a municipality and school boards as defined in the Municipal Affairs Act or of a conservation authority established under the Conservation Authorities Act. The Municipal Finance Authority of British Columbia Schedule I banks. Minimum Short Term Rating R1(low), Minimum Rating on Long Term Investments AA (low). Schedule II banks. Minimum Short Term Rating R1(low), Minimum Rating on Long Term Investments AA (low). Schedule II banks are limited to those whose foreign parent companies unconditionally guarantee the instruments offered. Trust companies, Provincially or Federally incorporated, which are rated prime quality by any of the recognized rating houses. Joint Municipal Investment pools permitted under the Municipal Act, provided the investment guidelines of the pool comply with the Municipality s statement of policies and goals contained in this policy. An agreement between the Municipality and the Investment pool is required, and the Treasurer shall provide a statement to the Municipal Council that there is compliance in the by-law. Investment in asset backed securities and negotiable promissory notes/commercial paper is restricted to joint investment through agreement with the Local Authority Services Limited or CHUMS Financing Corporation, as the Municipality s debt is not separately rated as defined in O. Reg. 399/02. Recognized rating houses are meant to be Dominion Bond Rating Service, Moody's Investor Services, Fitch Rating Services or Standard and Poor's Corporation. Periodic reviews of the credit ratings on an annual basis must be carried out to determine the status of each of the above institutions as proposed in these guidelines and the Treasurer or designate shall take whatever steps are necessary to ensure investments remain with prime quality institutions. The Municipality shall not invest in a security that is expressed or payable in any currency other than Canadian dollars. Sample Investment Policy Clauses 62

64 Investment Parameters (examples) Clear, explicit language describing allowable investment instruments and the respective parameters leaves little room for interpretation and helps protect municipalities from imprudent investment decisions Example 1 Diversification The investments shall be diversified by: Limiting investments to avoid over-concentration in securities from a specific issuer or business sector (excluding Government of Canada securities); Limiting investment in securities that have higher credit risks; Investing in securities with varying maturities, and; Investing in mainly liquid, marketable securities that have an active secondary market to ensure that appropriate liquidity is maintained in order to meet ongoing obligations. In order to ensure maximum security and proper diversification of the portfolio, additional limitations apply as set out in the Appendix (next page) for the maximum allowable exposure for each classification of security as a percentage of the total portfolio. The schedule also sets out the maximum allowable exposure for each specific issuer in a security class as a percentage of the total portfolio. Note that portfolio percentage restrictions apply at the time an investment is made. At specific times, the portfolio limitations may be exceeded as a result of the timing of maturities. Maximum Maturities To the extent possible, the Municipality shall attempt to match investments with anticipated cash flow requirements. Unless matched to a specific cash flow, the Municipality will not directly invest in securities maturing more than ten (10) years from the date of purchase. Reserve and Trust funds with longer-term horizons may be invested in securities exceeding ten (10) years if the maturities of such investments are made to coincide as nearly as practicable with the expected use of the funds. Sample Investment Policy Clauses 63

65 For example, this policy includes parameters that allow a maximum of 50% of the total portfolio to be invested in Schedule II banks, with a maximum of 15% in any one bank. Sample Investment Policy Clauses 64

66 Sample Investment Policy Clauses 65