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HomeMy WebLinkAboutFIN-19-065 - Long-Term Financial Plan Strategy Session ReportREPORT TO: Council Strategic Session DATE OF MEETING: August 26, 2019 SUBMITTED BY: Jonathan Lautenbach, Chief Financial Officer, 519-741-2200 x 7334 PREPARED BY: Jonathan Lautenbach, Chief Financial Officer, 519-741-2200 x 7334 WARD (S) INVOLVED: All DATE OF REPORT:August 22, 2019 REPORT NO.: FIN-19-065 SUBJECT: LTFP: Strategy Session #2 – Specific Issues& Financial Policies _________________________________________________________________________________________ RECOMMENDATION: FOR DISCUSSION BACKGROUND: A Long-Term Financial Planis a key strategic document which outlines a comprehensive financial framework for the municipality. It is aligned with the City’s Strategic Plan and includes guiding principles, financial priorities and strategies, as well as financial forecasting and modelling. Its purpose is to help Council and staff in the decision-making process by formalizing the financial policies and practices of the municipality and by highlighting areas of strategic focus aimed at strengthening the City’s overall financial position. In April, Council approved the project scope and timeline related to the development of a Long- Term Financial Plan (LTFP). The project plan identifiedmany elements and areas of focus that will beaddressed as part of the LTFP and also highlighted three specific issues:Infrastructure Funding, Operating Budget Room (Expiring Debt), and Investment Income, where additional engagement and discussion was planned due to the complexity and importance of the issues. The first Council strategic session was held in May and engaged Council on the first two rd specific issues. The August strategic session will focus on the 3issue, Investment Income, and also include some discussion on 3draft financial policies that have been developed as part of the work on LTFP. *** This information is available in accessible formats upon request. *** Please call 519-741-2345 or TTY 1-866-969-9994 for assistance. 1. a. - 1 REPORT: The purpose of theAuguststrategic session is to receive feedback related to the following specific issue: Specific IssueScope of Issue Investment IncomeDetermine an approach for budgeting investment incomethat balances potential returns with the need to mitigate variances due to market fluctuations Feedback is also being soughtrelated to the following draft financial policies: Specific PoliciesScope of Review Budget Control Policy (new)Review and document variance reporting process for operating, development of capital project reporting framework Capital Financing and Debt Policy (new)Include long-and short-term financing options for capital works, including debt and internal borrowing Investments Policy (existing)Review new prudent investor regulations, consider potential changes to overall investment strategy, review letter of credit requirements for development Information regarding the specific issue of Investment Incomeis included in background issue paperattached as an appendixto this report; Specific Issue 003 – Investment Income.For this specific issue, various options/strategies are provided for Council to consider. Staff are looking for Council to provide initial feedback related to these options. There are 3draft financial policies that are also included as appendices to this report: Financial Policy 001 – Budget Control Policy FinancialPolicy 002 – Capital Financing and Debt Policy Financial Policy 003 – Investment Policy The following summarizes the key considerations, additions, or changes related to each of these policies: 1. a. - 2 Financial Policy 001 –Budget Control Policy (New) PurposeSummary of Key Considerations, Additions, Changes The purpose of this policy is to Responsibilities and key accountabilities related to budgeting have been outlined in this policy establish guidelines and provide clarity regarding roles, Approval authority limits for Directors, GMs, andCFO are responsibilities, and key outlined in policy for both Operating and Capital accounts accountabilities, related to the financial management and Reportable operating account variances that require an budget control for operating and explanation increased from $50kto $100k capital accounts. This policy documents the process for the Operating Budget Variances to be reported based on June, September, and December results reporting of financial performance and results, including the New “Capital Status Report” will provide for regular variance reporting process for the reporting related to open capital projects and will replace annual operating budget, and the existingcapital balances process reporting of the status of capital projects. Financial Policy 002 –Capital Financing and Debt (New) PurposeSummary of Key Considerations, Additions, Changes The purpose of the policy is to Definitions are provided to provide clarity related to long- term debt, short-term financing, and internal borrowing establish guidelines and controls related to the issuance of long- Policy identifies when debt should be considered as a term debt, short-term financing, financing option, outlining possible uses of debt and internal reserve fund borrowing, to ensure the effective Debt limits have been set to support a responsible use of these financing options to approachto debt management taking into consideration support both the City’s current Provincial regulations, industry standards, and relevant benchmarks and future capital and infrastructure needs. A “pay-as-you-go” approach will be utilized where possible to support short-term capital financing needs Internal borrowing from reserves isoutlined as an option for short-term financing with criteria being outlined in the policy 1. a. - 3 Financial Policy 003 –Investment Policy (Existing) PurposeSummary of Key Considerations, Additions, Changes The purpose of the policy is to Eligible investments arethose permitted under section 418 of Ontario Regulation (O.reg) 438/97 unless establish guidelines and controls specifically excluded related to the investment and holding of public funds to ensure Additional language has been added to address Prudent funds are available when InvestmentStandards under Section 418.1 of O.reg needed, while maximizing 438/97 returns. The investment policy applies to all financial assets of Diversification percentages have been adjusted for the top 5 major chartered banks from 35% to 75% per issuer the City of Kitchener held within the general fund, capital fund, Schedules have been reduced/consolidated to simplify reserve funds, enterprise funds, the policy and provide more clarity to the reader and trust funds. Letter of Credit requirements have been revised to allow LCs from Schedule I, II, or III banks that have a “good” credit rating as outlined in Schedule A In order to receive meaningful feedback, staff have providedthe followingquestionsrelated to these items: Specific Issue 003 – Investment Income Do you support the establishment of an Investment Stabilization Reserve Fund to help mitigate fluctuations and variances in the Operating Budget? Does Council support moving to using a historical average for budgeting for investment income? Draft Financial Policies Do you have any questions or specific feedback regarding the policies prior to the final drafts coming forward to Council for approval? 1. a. - 4 ALIGNMENT WITH CITY OF KITCHENER STRATEGIC PLAN: Strategic Priority:Effective and Efficient City Services Strategy:5.4 – Ensure the responsible stewardship of public funds within a supportive policy framework Strategic Action: #CS09 – Long Term Financial Plan FINANCIAL IMPLICATIONS: The LTFP will include a number of financial strategies aimed at strengthening the City’s overall financial position, ensuringthat the City can continue to deliver expected programsand services for the communityboth now and in the future. COMMUNITY ENGAGEMENT: INFORM – This report has been posted to the City’s website with the agenda in advance of the council / committee meeting. ACKNOWLEDGED BY: Dan Chapman, Chief Administrative Officer, Office of the CAO 1. a. - 5 Specific Issue 003 – Investment Income During the 2019 Budget deliberations, the amount of investment income that the City budgets for within the operating budget and the City’s overall investment strategy, was an area of interest raised by Council. The City has traditionally taken a conservative approach in terms of the amount of investment income that it has allocated annually in the operating budget. This has been done in part to try and mitigate risk and uncertainty related to potential market and interest rate fluctuations. Historically, the City’s actual investment returns have outperformed the amount that the City has budgeted for, with the exception of 2009 and 2010 as shown below: At the end of 2008, a recession caused interest rates to drop to unprecedented levels, resulting in shortfalls in subsequent years. This significant drop in interest rates required the City to reduce its budgeted investment income in 2010, putting a strain on other operational areasto make up the shortfall. This shortfall represented nearly a 1% tax rate increase in the operating budget. In years when investment income has outperformed budget, this surplus has been transferred at year end to the rate stabilization reserve and has been one of the contributing factors to surpluses that the City has seen in recent years. An investment income strategy that mitigates risks by reducing the potential for budget fluctuations is preferred and represents a responsible approach to budgeting that is aligned with best practices. LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 6 Specific Issue 003 – Investment Income The City invests “available funds” that are not immediately needed to fund day-to-day operations. These funds are made up of reserve funds, trust funds, capital, and operating funds. Information regarding the City’s investment portfolio for 2018 is shown below and is information that is provided to Council with regular operating budget variance reports: LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 7 Specific Issue 003 – Investment Income The City’s overall investment strategy is governed by the City’sexisting investment policy FIN- PLA-605. This policy was updated in 2017 buthas been reviewed and updated again as a result of changes that have taken place since that time related to municipal investment regulations. In March 2018, the provincial government released new Prudent Investor Standard under section 418.1 of the Municipal Act and updated Ontario Regulation 438/97. This change in legislation provides municipalities that meet certain eligibility criteria, the option to invest in a broader range of investments. Prior to this change, municipalities(other than the City of Toronto)were restricted to certain types of securities (e.g. government bonds, GICs, money market funds). Under the Prudent Investor Standard, eligible municipalities that “opt in”to the standard, cannow choose to investin more volatile products that could potentiallyprovide higher returns, but also have a greater degree of risk, such as investing in stocks traded on the openmarket. In order to be eligible to “opt-in” to Prudent Investment Standard, one of two eligible criteria must be met: Prudent Investor Standard -Eligibility Criteria CoK Eligibility $50M in Net Financial Assets $100M in Investments Although on paper, it appears that the City would meet the eligibility criteria, in reality, there are other elements of the standard to consider. In terms of having over a $100M in investments, Prudent Investor defines this as $100M in funds that are “not required immediately”. “Not required immediately” would suggestthat cash is not needed in the short- term and is available to be invested in long-term investments (greater than 18 months). The City’s long-term portfolio only totalled $33M in 2018 and annual cash flows needs would prevent the City from being able to shiftan additional$67Mtolong-term investments. Another consideration that makes “opting-in” potentially problematic, is that a municipality must pass a by-law to adopt the prudent investor standard. Once passed, an investment board is required to be set up that would have ultimate control over how the municipality’s funds are invested. The Treasurer of the municipality would have one seat on the board, but members of Council are not eligible to serve as board members. This would significantly limit the municipality’s control over the types of investments being entered into and would represent a risk to the municipality. Another issue is that once you “opt-in” you cannot “opt-out” of the standard. For these reasons, it is not recommended that the City adopt the new Prudent Investor Standard at this time, however, reviewing the standard has required the City to look at its LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 8 Specific Issue 003 – Investment Income current investment policy and consider changes that could potentially result in greater returns for the City. The City’s current investment policy attempts to manage risk related to overall investments by ensuring that the City’s investment portfolio is diversified. Diversification is a common practice in investing to mitigate potential losses, reducing overall investment risk. The current policy ensures the investment portfolio is diversified by restricting investments based on the portfolio mix by sector and also by the individual issuer. For short-term investments, a restriction of 35% per issuer is applied to the top 5 chartered banks in Canada. Major CanadianSchedule I banks are considered to be some of the most secure and stable financial institutions in the world. Limiting the amount that can be invested in any one particular bank in some cases has restricted the amount of returns that the City can achieve on an annual basis.The banking industry is a competitive marketplace, where some banks offer better product than others over the short-term. In order to ensure that the City’s policy isn’t a barrier to take advantage of these conditions, the revised investment policy (Financial Policy – 003) proposes changing this limit to 75% per issuer. Aside from reviewing the City’s overall investment policy, the performance of the City’s investments is ultimately reflected in the level of investment income that is included through the budget process and the actual returns that the City sees throughout the year. With this in mind, determining a consistent approach fortheamount of investment income to budget for annually is an important consideration. Any approach considered, shouldattempt to balance theamount of investment income to be included, with the ability to mitigate risk and uncertainty related to potential changes to interest rates and market conditions. In 2019 the City budgeted investment income at $3.8 million. This was largelyinfluenced by higher investment income experienced in 2018 and a recent trend of outperforming budget targets in previous years. It raised budgeted investment income to its highest levels and highlighted the need todetermine a consistent and accepted approach moving forward. Five options are included below for Council to consider. Ahypothetical scenario is provided, indicating the amount that the City “would” have budgeted in 2019 if the particular approach was used and highlighting the budget variance that would occur if actual investment income results ended up being the same in 2019 as experienced in 2018. For each of these options, it is recommended that an Investment Stabilization Reserve Fund be set up to mitigate the impact of budget variances. LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 9 Specific Issue 003 – Investment Income Investment Income Options: Option A – Budget InvestmentIncome each year based on a 10-year historical average (excess funds over budget would be transferred to an investment stabilization reserve) The dotted red line in the graph above represents the proposed amount to be budgeted. Under this scenario the City would have budgeted $2.3 million in 2019 instead of $3.8 million. If 2018 results of $3.9 million in investment income was achieved again in 2019, the excess $1.6 million would be allocated to an investment stabilization reservefund. This optionwould represent an initial decrease to the amount that the City budgets for. A draw from the rate stabilization reserve fund would likelybe needed to smooth the impact of moving to this method.The City should also budget a draw from the investment stabilization reserve in years when the average decreases by more than $300,000 in any given year. This would be considered the most conservative option representing the least amount of risk. LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 10 Specific Issue 003 – Investment Income Option B – Budget Investment Income each year based on a 5-year historical average (excess funds over budget would be transferred to an investment stabilization reserve) The dotted red line in the graph above represents the proposed amount to be budgeted. Under this scenario the City would have budgeted $2.8 million in 2019 instead of $3.8 million. If 2018 results of $3.9 million in investment income was achieved again in 2019, the excess $1.1 million would be allocated to an investment stabilization reserve fund. This option would represent an initial decrease to the amount that the City budgets for. A draw from the rate stabilization reserve fund would likely be needed to smooth the impact of moving to this method.The City should also budget a draw from the investment stabilization reserve in years when the average decreases by more than $300,000 in any given year. This would be considered a more moderate option, balancing the risk of potential interest rate fluctuations with incremental increases to the operating budget when rates are increasing. A five-year historical timeframe is likely the longest period that Council would want to consider if there was support for moving to this type of method. LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 11 Specific Issue 003 – Investment Income Option C – Budget Investment Income each year based on a 3-year historical average (excess funds over budget would be transferred to an investment stabilization reserve) The dotted red line in the graph above represents the proposed amount to be budgeted. Under this scenario the City would have budgeted $3 million in 2019 instead of $3.8 million. If 2018 results of $3.9 million in investment income was achieved again in 2019, the excess $900K would be allocated to an investment stabilization reservefund. This option would represent an initial decrease to the amount that the City budgets for. A draw from the rate stabilization reserve fund would likely be needed to smooth the impact of moving to this method. The City should also budget a draw from the investment rate stabilization reserve in years when the average decreases by more than $300,000 in any given year. This would be considered a more moderate option, balancing the risk of potential interest rate fluctuations with incremental increases to the operating budget when rates are increasing. This would likely be considered the preferred option if there was support by Council to move to this type of method since it would balance some of the interest rate risk but still be responsive enough to current market trends. LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 12 Specific Issue 003 – Investment Income Option D – Budget Investment Income each year based on Bank of Canada rate projections (excess funds over budget would be transferred to an investment rate stabilization reserve) The dotted red line on the graph above represents the proposed amount to be budgeted. Under this scenario the City would have budgeted $4.2 million in 2019 instead of $3.8 million. If 2018 results of $3.9 million in investment was achieved again in 2019 the shortfall of $300K would need to be drawn from the tax rate stabilization reserve. This would be considered a most aggressive option with less consideration given for potential significant decreases in rates. LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 13 Specific Issue 003 – Investment Income Option E – Budget Investment Income annuallyat a fixed amount A fixed amount of $4 million has been used as an example to demonstrate the concept. The dotted red linein the graph represents the proposed amount to be budgeted.Under this scenario if the City would have budgeted $4 million in 2019 instead of $3.8 million. If 2018 results of $3.9 million in investment was achieved again in 2019 the shortfall of $100Kwould need to bedrawn from the investment stabilization reserve fund. If returns outperformed, the excess would go to the investment rate stabilization reserve. This option would add an element of predictability in terms of the amount to budget for each year but would not fully address the potential issue of both positive and negative fluctuations in rates. LONG-TERM FINANCIAL PLAN SPECIFIC ISSUE - 003 1. a. - 14 FINANCIAL POLICY –001 Budget Control Policy P OLICY S TATEMENT The City of Kitchener recognizesthe importance of having proper budget controls in place to support accountabilityand transparency, and toassurethe public that the financial affairs of the municipality are being managed diligently.Effective budget control of operating and capital accounts promotes fiscal responsibilityandis an essential aspect ofthe deliveryof programs, services,and projects for the community. Purpose The purpose of thispolicyis to establish guidelines and provideclarity regarding roles, responsibilities, and key accountabilities, related tothe financial management and budget control for operating and capital accounts. Thispolicy documents the process for the reporting of financial performance and results including the variance reporting process for the annual operating budget and the reporting of the status of capital projects. Definitions Account – an individual line item that has been provided with a budget allocation Capital Budget – means the annual Council approved plan for expenditures and financing sources to complete Capital Projects or one-time expenditures Capital Budget Transfer – means the transfer of an unexpended budget amount from one Capital Project to another Capital Project – means an undertaking for which expenditures are incurred to acquire, improve, demolish or maintain land, buildings, structures, infrastructure, machinery and equipment, including installation of computer software, and any other project as defined from time to time to be capital and is the level at which Council approves funding in the capital budget 1. a. - 15 FINANCIAL POLICY –001 Budget Control Policy Department – Means any department of the Cityas reflected in the current organizational structure Operating Budget – means the annual Council approved plan for expenditures, revenues, staffing levels and service levels for operations of the City taking place from stst January 1to December 31in a given year Operating Budget Transfer – means the transfer of an unexpended budget amount from one current budget program to another Program – means an organizational unit as defined in the Operating Budget that may encompass one or more related municipal services, usually a division of a department thatis mandate driven and is the level at which Council approves funding in the operating budget Responsibilities Council Under section 224(d) and (d.1)of the Municipal Act 2001, Council is responsible for “ensuring that controllership policies, practices and procedures are in place to implement the decisions of Council” and “to ensurethe accountability and transparency of the operations of the municipality, including the activities of the senior managementof the municipality.” Council approves the spending plans as outlined in annual operating and capital budgetsand is responsible for monitoring the performance against those plans throughout the year. CAO Under section 229(a) of the Municipal Act 2001, the Chief Administrative Officer is responsiblefor “exercising general control and management of the affairs of the municipality for the purpose of ensuring the efficient and effective operation of the municipality.” This includes monitoring financial performance of the organization throughout the year, holding those that have been delegated financial responsibility accountable for the development, monitoring, and management of their budgets, and advising Councilat the appropriate timeof any significant financial matters arising. 1. a. - 16 FINANCIAL POLICY –001 Budget Control Policy CFO(Treasurer) Under section 286(1) of the Municipal Act 2001, the treasurer is responsible for “handling all of the financial affairs of the municipality on behalf of and in the manner directed by the council.” For the purpose of this policy this includes: -Directing the development, maintenance and communication of all financial policies, procedures, or practices to support fiscal responsibility -Ensuring departments have access to timely financial information to enable responsible decision making for the effective and efficient delivery of programs, services, and implementation of projects or initiatives -Monitoring financial performance of the organization throughout the year, ensuring compliance with the reporting requirements as outlined in this policy -Advising the CAO and Councilin a timely mannerof any significant financial mattersarising. General Managers General Managers(department heads)are responsible for the efficient and effective delivery of programs, services, projects, and initiatives within their respective portfolios and operationalareas of responsibility. For the purpose of this policythey are responsibleto: -Develop an annual operating and capital budgetfor their area of responsibility in accordance with budget guidelines -Ensure budgets established related to the delivery of service are accurate, realistic to be ableto meet service levels identifiedtoCouncil -Make decisions regarding how services are delivered within the limits of Council approved service levels and approved budgets -Where appropriate, delegate responsibility for the departmental budgets (e.g. Directors, Managers, Supervisors) -Hold those who have been delegated financial responsibility accountable for the development, monitoring and management of their budgets -Monitor financial performance of department throughout the year and take appropriate corrective action to ensure the department remains in a balanced budget position -Advise the CFO of any significant financial matters arising that may impact their ability to remain in a balanced budget position by fiscal year end 1. a. - 17 FINANCIAL POLICY –001 Budget Control Policy Directors Management staff within departments are responsible for the efficient and effective delivery of programs, services, projects, and initiatives within their respective portfolios and operational areas of responsibility. General Managers are ultimately responsible for the overall financial performance of their department, but Directors are responsible for the financial performance for their respective divisions and projects under their portfolio. Responsibilities related to this particular policy include: -Developing an annual operating or capital budget for their respective area of responsibility -Monitoring financial performance throughout the year -Advising the Department Headin atimely manner of any significant financial matters that will impact their ability to deliver an expected program, service, project, or initiative -Carry out all transactions in accordance with municipal policies and procedures (e.g. hiring, purchasing, contracts) Managers and Project Managers Management staff withindepartments are responsible for the efficient and effective delivery of programs, services, projects, and initiatives within their respective portfolios and operational areas of responsibility. Managers are responsible for the financial performance for their respective sections. This is also applicable to those staff that have been assigned, or as part of their role, or have responsibility for managing capital projects or initiatives. Responsibilities related to this particular policy include: -Developing an annual operating or capital budget for their respective area of responsibility -Monitoring financial performance throughout the year -Advising the Director in a timely manner of any significant financial matters that will impact their ability to deliver anexpected program, service, project, or initiative -Carry out all transactions in accordance with municipal policies and procedures (e.g. hiring, purchasing, contracts) 1. a. - 18 FINANCIAL POLICY –001 Budget Control Policy Policy/Guidelines Operating Budget Financial Controls The approved budget representsthe approved spending authorityfor a particular program or service and overall for the department. The following guidelinesare intended to provide departments with some flexibility to ensure the efficient and effective delivery of services while providing proper level financial controland oversight related to the operating budget accounts: 1.A General Manager, together with their staff, has the responsibility to deliver programs or services based on the budgeted level of service approved by Council as part of the annual budget process. This includes working within the net total budget allocation that has been provided for their respective departments. 2.A Director may approve overspendingof any particular account or budget line by making thenecessary balancing decisions within a program orbetween programswithintheir portfolio/or areaof responsibility,provided that: a.Total expenditures for the department do not exceed the net operating budget approved by Council b.Over-expenditures for a particular program do not exceed $100,000 c.Any transfers that are done to remain in a balanced budget position are not between tax supported, enterprise, or utility programs 3.A General Manager may approve overspending of any particular account or budget lineby making the necessary balancing decisions between programs within their department, provided that: a.Total expenditures for the department do not exceed the net operating budget approved by Council b.Over-expenditures for a particular program do not exceed $100,000 c.Any transfers that are done to remain in a balanced budget position are not between tax supported, enterprise, or utility programs 1. a. - 19 FINANCIAL POLICY –001 Budget Control Policy 4.A General Manager shall reportto the CFOany anticipated over-expenditurein a Program that will result in them exceeding their nettotal budgetfor their department as soon as such over-expenditure is reasonably known. The CFO is authorized to approvein-yeardepartment budget adjustments provided that: a.The amount of over-expenditure is less than $100,000 b.It’s been determined that funding from other programs are not available to offset the over-expenditure c.The over-expenditure is reported to Council as part of the next operating budget variancereport 5.Any expenditures that would result in total expenditures exceedingthe funding available in a Program by an amount greater than $100,000 requires Council approval.Council approval is deemed to have been provided for: a.Purchases that are made in accordance with the emergency provisions of the Purchasing By-law b.Costs to be incurred that in the opinion of the General Managerand CFO are unavoidable and required in order to ensure approved service levels are met (e.g. winter maintenance) Any costs incurred under the above provisions will be reported to Council as part of the next operating budget variance report. A separate report to Council is required for any other over-expenditures that fall outside of this process. 6.Operating Budget variancesof $100,000or greater will be identified and reported to Council threetimes a year based onJune, September, and December financial results 1. a. - 20 FINANCIAL POLICY –001 Budget Control Policy Capital Budget Financial Controls The approvedcapitalbudget represents the approved spending authorityfor a particular capital project or initiative. The following guidelines are intended to provide some flexibility for the execution of projects while at the same time establish an appropriateleveloffinancial controls for capitalbudget accounts: 1.A General Manager, together with their staff, has the responsibilityto effectively implement and manage projects based on the approved scope, timeline, and budget as approved by Council as part of the annual budget process. 2.General Managers may approve additional over-expenditures in a Capital Project that exceed the original project budgetwhere: a.The original scope of the project has not changed b.The amount of the over-expenditureis less than $200,000 c.Funding is available to fund the over-expenditure through the reallocation of funding from otherproject(s)withinthe same program area d.The over-expenditure is reported to Council as part of the next Capital Status Report 3.A General Manager shall notifythe CFO of any anticipated over-expenditure in a Capital Project where it is determined that funding is not available through the reallocation from other projects(s) within the same program area. The CFO will work with the General Managerto determine other potentialsources of funding. The CFO is authorized to approve additional funding for a Capital Project where: a.The original scope of the project has not changed b.The amount of the over-expenditure is less than $200,000 c.Funding is availableto be transferredfrom other department projects or thereissufficient funding available in anappropriate Capital Reserve Fundto fund the over-expenditure d.The over-expenditure is reported to Council as part of the next Capital Status Report 1. a. - 21 FINANCIAL POLICY –001 Budget Control Policy 4.Any Capital Project for which anticipated expenditures will exceed the funding availableby an amount greater than $200,000 requires Council approval. Council approval will be requested through: a.A separate report to Council outlining the amount and reason for the anticipated over-expenditureor; b.A tender report that identifies the over-expenditure, justification for proceedingwith the award, and identifies an appropriate source of funding to cover the anticipated budget shortfallor; c.The next regular Capital Status Report An exception to the above provisions is any purchase that is made in accordance with the emergency provisions of the purchasing by-law. 5.Project Closures a.A project is to be closed and any surplus funds returned to the original source of funding if any of the following criteria are met: Project completed at or under budget as determined by the General Manager Project completed over budget and recommendedfunding source for over-expenditure has been identified Project deleted or deferred in order to finance new project or to fund over expenditures in other projects The project has not commenced within two yearsafter budget approval and cannot be completed within a three year timeframe after commencement (no signed contractual agreement or POs issued) There has been no account activity on the project for the last 18 months b.Exceptions to the above conditions: There is a need for funding to be rolled to future years, to be utilized inprojects that have a similar scope and require additional funding (e.g. phase 1, phase 2) Project has not commenced within two years but an extension has been requested by the General Managerand approved by the CFO or theirdesignate 1. a. - 22 FINANCIAL POLICY –001 Budget Control Policy 6.Capital Status Updates to Council To accurately administer and report on the capital budget, Departments will be required to forward toFinancial Planning, twicea year, an accurate status of each projectowned or managed by their department. The status must include a description of the work in progress, the percentage of work complete, and a projected forecast for completion. A semi-annual CapitalStatus Report (based on June and December), will be prepared in each year to provide Council with an update on the status of Capital Projects. This report would: a.Provide the status of each Capital Project b.Report any anticipated over expenditures in accordance with the provisions of this policy and related financing adjustment recommendations c.Report any anticipated over expenditures for which there is insufficient funding in the appropriate project and related financing adjustment recommendations d.Report any additional expenditures incurred after the project has been closed and related financing recommendations e.Report any proposed deletion or deferral of projects to either finance new projects or to fund over-expenditures in other projects f.Address material changes in scope or nature of capital projects, material changes in timing with related financing adjustment recommendations g.Report on any closures of capital projects 1. a. - 23 FINANCIAL POLICY –002 Capital Financing and Debt Policy P OLICY S TATEMENT The City of Kitchener recognizes that if properlymanaged,debt can be an effective toolto address part of the City’s long-term capital financing needs. Debt should be carefully consideredbefore entering into to ensure that its use adhereswith the City’s policy and is the appropriate funding source for theparticular project or initiativebeing considered. In addition to long-term debt, short-term financing, and internal reserve fund borrowing are also governed by this policy. Purpose The purpose of the policy is to establish guidelines and controls related to the issuance of long-term debt, short-term financing, and internal reserve fund borrowing, to ensure the effective use of these financing optionsto support both the City’s current and future capital andinfrastructure needs. Definitions Capital Expenditure –any expenditure incurred related to the acquisition, rehabilitation, or replacement ofa tangible capital asset orrelated infrastructure Capital Pool–tax supported capital requirements that are funded from property taxes, dividends (hydro and gas utility), and debt Debt – means borrowing of funds as defined under part XIII section 401(1) of the Municipal Act 2001 Debt Charges – the amount needed to coverannual principaland interest payments Debt Limit – the maximum level of debt that is deemed acceptable for the City Debt Term – the period over which debt repayments will be made Enterprises – business units that are self-sustaining and funded by user fees 1. a. - 24 FINANCIAL POLICY –002 Capital Financing and Debt Policy Internal borrowing – borrowing from reserve funds for the purpose of funding a capital expenditure to avoid/minimize the need for long-term debt Long-Term Debt – debt with a term of greater than five years, and debenturedebt as defined under section 408(1) of the Municipal Act Operating Expenses – expenses related toannual operations of the municipality/enterprisesthat aregenerally reflected as costs included in the City annual operating budget Reserve Funds – fundsthat has been set aside by Council for a specific purposeor as required by legislation Short-Term Financing – debt with a term of five yearsor less Temporary Borrowing– borrowing not exceeding one year that may be required for the City to meet annual obligations and cash flow needs Tax Supported – any expenditure that would typically be funded through property taxes Responsibilities Council Under section 224(e) of the Municipal Act 2001, Council is responsible for “maintaining the financial integrity of the municipality.”Capital financing and the level of debt that the municipality takes on can have significantfinancial implications if not managed properly. Council is required to make good decisions that adhere to the financial policies in procedures that have been put in place to provide financial governance for the municipality. CAO Under section 229(a) of the Municipal Act 2001, the Chief Administrative Officer is responsiblefor “exercising general control and management of the affairs of the municipality for the purpose of ensuring the efficient and effective operation of the municipality.” This includes ensuring that processes are in place that support the effective administration related to capital financing anddebt management. 1. a. - 25 FINANCIAL POLICY –002 Capital Financing and Debt Policy CFO(Treasurer) Under section 286(1) of the Municipal Act 2001, the treasurer is responsible for “handling all of the financial affairs of the municipality on behalf of and in the manner directed by the council.” For the purpose of this policy this includes: -monitoring existing debt levels and the impacts ofdebt charges within the annualoperating budget -advising Councilaccordingly ofany concerns related to overall debt levels -promote the appropriate use ofdebt asa potentialfundingoptionas needs related to capital expenditures are identified through the budget process and as applicable throughout the year Policy/Guidelines 1.Use of Debt Debt will be consideredas a means to finance: New, non-recurring infrastructure requirements(acquisition, design, construction) Portion of growth related project costs not covered from Development Charges Capital Projects that will result in additional or new services forresidents Replacement of infrastructure, where the cost of deferring replacement exceeds the debt servicing costs and where other sources of financing are not readilyavailable Projects that are partly grant fundedand require matching funds to proceed Debt is not permitted to be incurred to: Fund operatingexpenses of the municipality or enterprises 2.Debt Approval New debt to be issued will typically be identified through the annual budget process Council approves the use of debt through the approval of the budget resolution which is consolidated in the City’sdebt borrowing by-law 1. a. - 26 FINANCIAL POLICY –002 Capital Financing and Debt Policy Once debt is approved, debt requirements will be provided to the upper-tier municipality for debt issuance 3.Debt Planning and Monitoring Before issuing new debt consideration should be given to: The City’s overall capacity to take on more debt(debt levels versuslimits) Understanding the impacts of new debtcharges within the annual operating budget and how they may impact the City’s ability to deliver programs and services within an expected/reasonable rate increase Ensuring that any increase in utility or enterprise related debt is reflected in user rate models that have been developed as part of long-term planning requirements The City’s current debt to reserve ratio, with a ratio of 1:1being used as a benchmark to guide decisions related to the City overall debt strategy (additional debt versus debt reduction) 4.Debt Limits The City must comply with annual debt and financial obligations limits as outlined in Ontario Regulation 403/02. The Province provides the City with and Annual Repayment Limit that caps overall debt charges to 25% of the City’s ownsource revenues Debt servicing costs as a % of total revenues is used as an indicator by the Province to assess a municipality’sfinancial risk related to overall debt levels, assigning a rating based on the following thresholds: Low: <5% Mod: 5% to 10% High: >10% To demonstrate a responsibleapproach todebt management, the City has established its own debt limits as follows: Tax supported debt charges will be limited to 10% of the City’s own source revenues 1. a. - 27 FINANCIAL POLICY –002 Capital Financing and Debt Policy Rate supported debt charges will be limited to 10% of the City’s rate supported revenues Capital Pool debt charges will not increase by more than 5% annually 5.Term of Debt Debt will only be issued for a term greater than 5 years The term of the debt should not exceed the useful life of the underlying capital asset that it is financing The preferred term for long-term debt is 10 years to align with the City’s capital forecast 6.Short-Term Capital Financing The City will utilize a “pay-as-you-go” approach where possible for advancing capital work Capital reserves funds will be reviewed as part of the annualbudget processwith available funding being allocated to address immediate capital needs 7.Internal Borrowing From Reserves Borrowing from reservesfor the purpose of addressing capital financing needsis permitted under the following conditions: A reservefund providing fundingwill not be adversely affected as aresult of providing funding for a purpose other than what it was originally intended The reserve should have a balance that is above its mid-level target The amount borrowed will be repaid with interest over a term not to exceed 5 years Interest to be repaid will reflect annual interest that the reserve would have earned if the funding hadn’t been provided Funding provided underthis scenario will be transferred to the Internal Borrowing Reserve Fundto support better tracking and transparency 1. a. - 28 FINANCIAL POLICY –003 Investment Policy P OLICY S TATEMENT It is the policy of the City of Kitchener to invest public funds in a manner that will provide thehighestinvestmentreturnwhileprotectingandpreservingcapital,maintaining liquidity, meetingthedailycashflowdemandsoftheCityandconformingtoall legislationgoverningtheinvestmentofpublicfunds. P URPOSE The purpose of the policy is to establish guidelines and controls related to the investment and holding of public funds to ensure funds are available when needed, while maximizing return.The investment policy applies to all financial assets of the City of Kitchener held within the general fund, capital fund, reserve funds, enterprise funds, and trust funds. D EFINITIONS Asset-backed Securities – short- or long-term debt instruments, which are backed by high quality assets (such as loans or mortgages) of the issuer, issued under Reg. 733(50)(1) of the Loans and Trust Corporations Act Commercial Paper – short-termnotesordraftsissuedby a corporation,incorporated underthelawsofCanadaor a provinceofCanada Credit Risk – risktoaninvestorthattheissuerofaninvestmentwilldefaultinterestor principalpayments CreditUnion - communitybasedfinancialco-operativesownedand controlledby members Diversification – processofinvestingin a rangeofsecuritytypesbyclass,sector, maturity, andqualityrating DominionBondRatingService(DBRS) – a servicethatassessesthecreditratingof institutions Forward Rate Agreement (FRA) – contract with a qualified financial institution allowing an investor to fix the interest rate to be received on an investment for a specified term beginning at an agreed to future date Interest rate risk – risk of an increase or decrease in the value of a fixed income security caused by declining or rising interest rates 1.a. - 29 FINANCIAL POLICY –003 Investment Policy Long-terminvestment – investmentwhosetermtomaturityisgreaterthanoneyear Liquidity – measureofasset’sconvertibilityinto cash ONEFundPublic Sector Group of Funds – pooledinvestmentfundmeetingtheeligibility criteriadefinedbytheregulationsundertheMunicipalAct.ItisoperatedbytheLocal AuthoritiesServiceLimitedandCHUMSFinancingCorporation Regulation – Ontario Regulation 438/97 related to section 418 and 418.1 of the Municipal Act, 2001 “Eligible Investments, Related Financial Agreements and Prudent Investment” Schedule I Bank – a charteredbankoperatingundertheBankAct. Thevotingshares mustbewidelyheldwithnoinvestorholdingmorethan10% andforeignownership limitedto 25% ScheduleII Bank – a charteredbankoperatingundertheBankAct. It maybewholly ownedbynon-residents ScheduleIIIBank – aforeignbankbranchofforeigninstitutionsoperatingunder the BankActundercertainrestrictions Short-term Investment – investmentwhosetermtomaturityisoneyearorless Supranational Institutions – an agency sponsored by highly rated foreign bank(s) or Governments issuing debt to fund loans in developing countries for large infrastructure projects. They may be owned or guaranteed by a consortium of national governments Trust Company – financialinstitutionwhichactsas a fiduciary, trusteeoragentinthe administrationoftrustfunds, estatesand custodialarrangements R ESPONSIBILITIES Council Under section 224(e) of the Municipal Act 2001, Council is responsible for “maintaining the financialintegrity of the municipality.” Council is required to make decisions that adhere to the financial policies and procedures that have been put in place to provide investment income for the municipality. 1. a. - 30 FINANCIAL POLICY –003 Investment Policy CAO Under section 229(a) of the Municipal Act 2001, the Chief Administrative Officer is responsiblefor “exercising general control and management of the affairs of the municipality for the purpose of ensuring the efficient and effective operation of the municipality.” This includes ensuring that processes are in place that support the effective administration related to investment of City funds. CFO (Treasurer) Under section 286(1) of the Municipal Act 2001, the treasurer is responsible for “handling all of the financial affairs of the municipality onbehalf of and in the manner directed by the council.” For the purpose of this policy this includes: -Monitoring adherence to statutory requirements -Ensuring preservation of capital -Monitoring interest rate risk -Ensuring liquidity of investments -Maximizingreturn on investments DIRECTOROFFINANCIALPLANNING As part oftheir rolethe Director of Financial Planning has been delegated authority and is responsible for: -Managing the City’s overall investment portfolio -Establishing investment procedures aligned with this policy -Monitoring cash flow to make effective investment decisions -Ensuring proper controls are in place related to investments -Delegating specific investment related tasks to staff where appropriate 1. a. - 31 FINANCIAL POLICY –003 Investment Policy P OLICY/G UIDELINES 1.Objectives The primary objectives, in order of priority, of the City’s investment activities shall be: a.Adherence to statutory requirements Investment activity will be governed by the Municipal Act as amended and limited to eligible investments under the Act and associated provincial regulations b.Preservation of capital Safety of principal is a key objective of the investment program. Investments of the City shall be undertaken in a manner that seeks to ensure the preservation of capital including: Utilizing credit ratings to assess the overall credit risk related to a particular investment Diversifying the overall investment portfolioin accordance with this policy Properly assessingand mitigating risk associated with fluctuating interest rates for short- and long-term investments c.Liquidity The City’s investment portfolio will remain sufficiently liquid to enable the City to meet all operating and capital requirements that might be reasonably anticipated and to limit temporary borrowing requirements. d.Return on Investments The investment portfolio shall be designed to attain the maximum rate of return while meeting the above three objectives 2.Eligible investments a.Section 418 ofOntario Regulation 438/97 provides a list of eligible securities that the municipality may investin. The regulationincludes 1. a. - 32 FINANCIAL POLICY –003 Investment Policy securities such as bonds, debentures, promissory notes, and other evidence of indebtedness. The City of Kitchener will consider potential investment opportunities related to all eligible securities types included in the regulation provided that: They align with the City’s overall investment policy objectives and comply with all other aspects of this policy They have a credit rating of “Superior” or “Good” as defined in Schedule A and meet the minimum credit rating requirements and conditions as outlined in the regulation They have not been specifically restricted or excluded in this policy b.Exclusions – Prudent Investor Standard (Section 418.1) Part of Ontario Regulation 438/97 includes new prudent investor standards that allow municipalities that meet certain eligibility criteriathe optionto invest in a broader range of securities. The City of Kitchener has not opted-in to this new standard and as such, is only authorized to invest in securities described under section 418 and not section 418.1 of the regulation. c.The City may enter Forward Rate Agreements (FRA) to reduce the risk of future interest rate changes associated with known cash inflows provided that: The FRA is only executed with Schedule I, II, or III Banks whose minimum DBRS rating is “A(high)” or equivalent as prescribed in the regulation The term of any FRA must be less than 12 months An agreement must specify the forward amount, settlement date, forward interest rate, reference interest rate, as well as other pertinent details as prescribed in the regulation The agreement must be reviewed and approved by the Treasurer and comply with all other requirements of the regulation d.The City of Kitchener may enter into an Agency Agreement with the “ONE Fund Program”for the purpose of participating in joint municipal investment funds. Unrated municipalities are only permitted to invest in the following securities if made through the ONE FundProgram: 1. a. - 33 FINANCIAL POLICY –003 Investment Policy Commercial paper Corporate debt and shares Asset-backed securities A Council approved bylaw is required prior to entering into any such agreement. 3.Diversification The City of Kitchener will diversify its investments by security type and institution according to Schedule B. These restrictions apply at the time an investment is made. At specific times, portfolio limitations may be exceeded as a result of timing of individual instrument maturities. 4.Safekeeping and custody Investments are held in safekeeping either in the City's safety deposit box or by the vendor financial institution. 5.Term of investments To the extent possible, the City will attempt to match its investments with anticipated cash flow requirements. Unless matched to a specific cash flow, the City will not directly invest in securities maturing more than 365 days from the date of purchase. Reserve and Trust Funds may be invested in securities exceeding 365 days if the maturity of such investments is made to coincide as nearly as possible with the expected use of the funds. 6.Performance standards The investment portfolio shall be designed with the objective of obtaining a rate of return throughout budgetary and economic cycles commensurate with the investment risk constraints and the cash flow needs.Yields on the short-term portfolio should be higher than the rate given by the City’s bank for the City’s general bank account. 1. a. - 34 FINANCIAL POLICY –003 Investment Policy 7.Standard of care a.Prudence 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 and employees exercising due diligence and acting in accordance with written procedures and this Policy 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 the Policy. b.Ethics and Conflicts of Interest Officersandemployeesinvolvedintheinvestmentprocessshallrefrain frompersonalbusinessactivitythatcouldconflictwiththeproper executionandmanagementoftheinvestmentprogram, orthatcould impairtheirabilitytomakeimpartialdecisions. Employeesandinvestment officialsshall discloseanymaterialinterestsinfinancialinstitutionswith whichtheyconductbusiness. Theyshallfurtherdiscloseanypersonal financial/investmentpositionsthatcouldberelatedtotheperformance oftheinvestmentportfolio. Officersandemployeesshallnotundertake personaltransactionswiththesameindividualswithwhombusinessis conducted on behalfoftheCorporation. c.Internal Control The Treasurer shall ensure adequate internal controls over investment policies and procedures. The Treasurer shall establish a process of independent review by an internal or external auditor. d.Reporting The Treasurer shall provide an investment report to Council at least twice per year. 1. a. - 35 FINANCIAL POLICY –003 Investment Policy 8.Authorized investment dealers Authorized investment dealers must be registered as Investment Dealers with the Ontario Securities Commission and be members of the Investment Dealers Association of Canada, and be approved by the Treasurer. 9.Securities for subdivision and Development Servicing The objective of the securities policy is to ensure that monies to guarantee the installation of services will be available to the City when required. The City of Kitchener shall accept only the following approved securities: a.Letter of Credit (in prescribed form acceptable to the City Solicitor) issued by a Schedule I bank, Schedule II bank, Schedule III bank or Trust Company with aminimum DBRS rating of R-1 (low) or A(low) (orequivalent). b.Letter of Credit (in prescribed form acceptable to the City Solicitor) issued by a Credit Union provided that: The Credit Union is verified as a member of the Central 1 Credit Union The Central 1Credit Union is rated R-1 (middle) or higher The Credit Union has its Head Office in Ontario The cumulative Letters of Credit do not exceed 1% of the Credit Union’s Tier 1 Capital as per the Credit Union’s most recent audited financial statements. 1. a. - 36 FINANCIAL POLICY –003 Investment Policy SCHEDULE A: LONG-TERM CREDIT RATINGS The following chart compares the different scales for long-term securities used by four rating agencies recognized in Ontario Regulation 438/97. Credit QualityDBRSS&PMoody’sFitch Superior: extremely strong capacity AAAAAA AaaAAA to repay principal and interestAA (high)AA+Aa1AA+ AAAAAa2AA AA (low)AA-Aa3AA- Good: strong capacity to repay A (high)A+A1A+ principal and interestA A A2A A (low)A-A3A- SHORT-TERMCREDITRATINGS The following chart compares the different scales for short-term securities used by three rating agencies recognized in Ontario Regulation 438/97. Credit QualityDBRSS&PFitch Superior: extremely strong capacity to repay R-1 (high)A-1+F-1+ principal and interestR-1 (middle) Good: strong capacity to repay principal and R-1 (low)A-1F-1 interest 1. a. - 37 FINANCIAL POLICY –003 Investment Policy Schedule B: INVESTMENT POLICY DIVERSIFICATION SUMMARY – SHORT-TERM PORTFOLIO SectorMaximum Limits Portfolio Share Government of Canada100%None Provinces100%25%/issuer Municipalities20%10%/issuer Schedule I Banks100%Top 5 major chartered banks: 75%/issuer; Other Schedule I banks: 25%/issuer Schedule II Banks and 30%HSBC Canada: 25%; Schedule III BanksOther Schedule II and III banks: 10%/issuer Credit Unions and Trust 20%10%/issuer Companies Pooled Investment Funds100%None INVESTMENT POLICY DIVERSIFICATION SUMMARY – LONG-TERM PORTFOLIO SectorMaximum Limits Portfolio Share Government of Canada100%None Governments of other 10%5%/issuer countries and supranationals Provinces50%25%/issuer Municipalities35% total10%/issuer Region of Waterloo35% Other municipalities 25% College, University, Housing 10% Corp., Hospital Incorporated Municipal 100%Common Shares –Total issued to City at Electrical Utilitiesincorporation; Preferred Shares –None Financial75% totalTop 5 -25%/issuer Schedule I banks – top 5 75% major chartered banksOther – 10%/issuer Other Schedule I, II, III 20% banks, Trust Companies, Credit Unions Pooled Investment Funds75%10% limit on equity portfolio 1. a. - 38