2011-2012 Annual Report - Full Version - PDF - Palmerston North ...

Note 34Financial instrument risksFinancial Statements Note 34PNCC has adopted a Treasury Policy which prescribesthe framework within which the financial assetsand liabilities will be managed. The policy has aparticular focus on risks associated with financialinstruments. It does not allow any transactions whichare speculative in nature to be entered into.MCA NZ Limited is retained as investment advisorsfor the Long Term Investment Fund with Asia PacificRisk Management Limited engaged as advisors inrelation to PNCC’s term borrowings.PNCC has financial assets and liabilities as outlinedin note 10 (cash and cash equivalents), note 11 (tradeand other receivables), note 13 (other financialassets), note 14 (derivative financial instruments),note 20 (trade and other payables) and note 23(borrowings).The level of borrowing is determined by the Councilthrough the 10 Year Plan as modified each year bythe Annual Plan. All external debt must be authorisedby resolution of the Council. The Treasury Policycontains not only guidelines aimed at minimisingthe impact of various types of risk but also sets whatare assessed as being prudent maximum borrowinglimits.Investment policies and objectives for the Long TermInvestment Fund are included in the Treasury Policy.This incorporated PNCC’s risk and return objectives,the investment strategy (including acceptable classesof assets to be invested in), prudential guidelines, themanagement structure for the Fund and the processby which Fund performance will be measured. Riskmanagement policies aim to reduce the potentialnegative effects of the different investment riskson PNCC’s liabilities and distribution policies.Professional fund managers are mandated to managesignificant portions of the Fund within the frameworkdetermined by the Council.Market risksPrice riskPrice risk is the risk that the fair value of a financialinstrument will fluctuate as a result of changes inmarket prices. PNCC is exposed to equity securitiesprice risk on its equity investments, held as partof the Long Term Investment Fund, and in shareinvestments intended to be held long term. Thisprice risk arises due to market movements in listedsecurities or unlisted shares. This price risk ismanaged by diversification of PNCC’s investmentportfolio in accordance with the limits set out inPNCC’s investment policy.Currency riskCurrency risk is the risk that the fair value of afinancial instrument will fluctuate due to changesin foreign exchange rates. PNCC has exposure tocurrency risk through investment of a portion of itsLong Term Investment Fund in overseas shares.Fair value interest rate risksFair value interest rate risk is the risk that the valueof a financial instrument will fluctuate due tochanges in market interest rates. Borrowing issuedat fixed rates expose PNCC to fair value interest raterisk. PNCC’s Treasury Policy prescribes that no morethan 45% of the total borrowings will have a floatingrate profile. Fixed to floating interest rate swaps areentered into to hedge the fair value interest rate riskarising where PNCC has borrowed at fixed rates. Inaddition investments at fixed interest rates exposePNCC to fair value interest rate risk.Cash flow interest rate risksCash flow interest rate risk is the risk that cash flowsfrom a financial instrument will fluctuate becauseof changes in market interest rates. Borrowings andinvestments issued at variable interest rates exposePNCC to cash flow interest rate risk. PNCC managesits cash flow interest rate risk on borrowings by usinginterest rate swaps. Such interest rate swaps havethe economic effect of converting borrowings atfloating rates into fixed rates that are generally lowerthan those available if PNCC borrowed at fixed ratesdirectly. Under interest rate swaps, PNCC agrees withother parties to exchange, at specified intervals, thedifference between fixed contract rates and floatingrate interest amounts calculated by reference to theagreed notional principal amounts.Some financial instruments (in particular managedfunds and overseas shares forming part of the LongTerm Investment Fund) are not directly exposed tointerest rate risk.Credit riskCredit risk is the risk that a third party will default onits obligation to PNCC, causing PNCC to incur a loss.Financial instruments will potentially subject PNCC tocredit risk.Credit risk is minimised as a result of several keycontrols including maintaining maximum limits foreach broad class of counterparty and individualcounterparties, limiting investments to organisationswith a Standard and Poor’s investment grade ratingor equivalent, and controlling the level and spread oftrade and other receivables outstanding. As a resultthere are no significant concentrations of credit risk.The maximum exposure to credit risk is representedby the carrying amount of each financial asset in theStatement of Financial Position and the face value ofoff-balance sheet guarantees to community groups(refer Note 27).PNCC has no collateral or other credit enhancementsfor financial instruments that give rise to credit risk.182Palmerston North City Council Annual Report 2011/12