Navigating Liability Benchmarking for Local Authority Treasurers

Posted On: June 10 - 2024
Posted By: Jackie Shute

Navigating Liability Benchmarking: Insights for Local Authority Treasurers

Introduction

In today's rapidly evolving financial landscape, effective treasury management and capital allocation have become paramount for local authorities. This article offers a deep dive into the concept of liability benchmarking. This blog post aims to distill the key points, providing a comprehensive guide to understanding and implementing liability benchmarking.

Understanding the Liability Benchmark

The liability benchmark is a critical tool for local authorities to manage their debt portfolios effectively. At its core, it is not a single measure but a combination of several balances presented in a chart. These balances include:

Existing Loan Debt Outstanding: This represents the authority's existing loans that remain outstanding in future years. It's often useful to display this data in a stacked bar chart segregating fixed rate loans, variable rate loans, and Lender Option Borrower Option (LOBO) loans.
Loans CFR (Capital Financing Requirement): This is calculated according to the loans CFR definition in the Prudential Code and projected into the future, taking approved prudential borrowing and planned Minimum Revenue Provision (MRP) into account.
Net Loans Requirement: This is the authority's gross loan debt less treasury management investments at the last financial year-end, projected into the future based on approved prudential borrowing, planned MRP, and other major forecast cash flows.
Liability Benchmark (Gross Loans Requirement): This equals the net loans requirement plus a short-term liquidity allowance.

CIPFA strongly recommends that the liability benchmark should be produced for at least 10 years and ideally cover the full debt maturity profile of a local authority. This long-term view ensures a robust understanding of both existing debt and future debt requirements influenced by MRP and other cash flows.

Key Steps in Establishing a Liability Benchmark

Step 1: Establishing the Starting Position

The starting position involves pre-populated balance sheets and a detailed understanding of the treasury position. Local authorities must rearrange their balance sheets to reflect capital financing requirements and other identifiable components. This step also includes pooling approaches and setting a liquidity allowance.

Step 2: Projecting Net Loans Requirement/Surplus

Authorities must project their Capital Financing Requirements (CFRs), other balance sheet items, and the net loans requirement or surplus. This projection helps in determining future debt and investment needs.

Step 3: Determining the Benchmark

The benchmark is not based on treasury positions but reflects the consolidated or separate benchmarks, including a liquidity allowance margin over the net loans requirement. This step determines the liability benchmark and implies an investment benchmark.

Step 4: Overlaying the Treasury Portfolio

Authorities should compare their existing treasury portfolio with the required portfolio, considering if the Housing Revenue Account (HRA) can utilize surplus General Fund liquidity before external borrowing.

Step 5: Determining (Under) / Over Benchmark Positions

Identifying under-benchmark borrowing positions helps determine the required borrowing. Conversely, any borrowing beyond the stated need leads to an over-benchmark position which results in excess cash requiring investment.

Step 6: Portfolio Projections

Assuming borrowing up to the liability benchmark, authorities can project their portfolio balance and determine the operational boundary—the maximum of the benchmark or existing commitments. Investment portfolio projections drive the investment strategy.

Step 7: Revenue Expectations & Risk

Revenue implications must account for existing commitments and uncertainties in future requirements. Monte Carlo analysis can show the extent of uncertainty and expected positions. Authorities must consider the impact of over-benchmark positions on costs and the uncertainty of investment returns.

Ongoing Evaluation

Liability benchmarking is not a one-time event but an ongoing framework for decision-making. Authorities should continuously evaluate debt repayment, borrowing opportunities, HRA pooling approaches, and inter-fund loan positions, all calibrated to daily market rates.

The Importance of the Liability Benchmark

The liability benchmark offers several advantages:

Long-Term Financial Planning: It enables long-term cash projections which are essential for strategic financial planning.
Informed Borrowing Decisions: Borrowing decisions should be based on actual needs rather than solely on interest rates.
Risk Management: Identifying mismatches between actual loan debt and the liability benchmark helps manage treasury risks effectively.

Limitations of Not Using the Liability Benchmark

Failure to use the liability benchmark approach can result in several pitfalls:

Short-Term Focus: Using three-year data to make fifty-year decisions can lead to suboptimal long-term outcomes.
Misalignment with Asset Lives: Borrowing decisions based on asset lives and yield curve views may ignore current portfolio commitments, leading to overborrowing risks.
Inaccurate Borrowing Limits: Borrowing up to the authorized limit without considering the operational boundary and liability benchmark can result in affordability issues.
Misunderstood Internal Borrowing: The belief that internal borrowing will eventually need externalizing can maximize carry trade investment balances, increasing interest rate and credit risks.

Next Steps for Implementation

To implement the liability benchmark effectively, local authorities should:

Register for the Free Service: Authorities can register for the free liability benchmark implementation service at pslive.co.uk/liability-benchmark-registration.
Adjust Pre-Populated Data: Once registered, authorities should verify and adjust pre-populated data, ensuring HRA loans are correctly allocated, long-term treasury positions are accurate, and CFRs reflect policy.
Generate Reports and Evaluate Risks: Authorities can then generate their liability benchmark reports and evaluate revenue risks, considering ongoing services to professionalize treasury decision-making.

Conclusion

The article underscores the importance of liability benchmarking in local authority financial management. By following the outlined steps and utilizing the tools provided, authorities can ensure they are well-prepared to navigate the complexities of debt management and capital allocation. Adopting a long-term strategic approach to liability benchmarking not only enhances financial stability but also enables informed decision-making, ultimately benefiting the wider community.