REVIEW AND UPDATE OF OECD LEADING PRACTICES FOR RAISING, MANAGING AND RETIRING PUBLIC DEBT, INCLUDING STATE GUARANTEES

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1 REVIEW AND UPDATE OF OECD LEADING PRACTICES FOR RAISING, MANAGING AND RETIRING PUBLIC DEBT, INCLUDING STATE GUARANTEES OECD Interim Report for G20 Finance Ministers and Central Bank Governors October 2013 This interim report was prepared for the Meeting of G20 Finance Ministers and Central Bank Governors in Washington DC in October This note has been prepared by OECD staff with feed-back or information provided by several members of the OECD Working Party on Public Debt Management. However, the findings, interpretations, and conclusions expressed in this interim report do not necessarily reflect the views of OECD member governments. For further information, please contact Mr. Hans Blommestein, Head of Bond Market and Public Debt Management Unit, OECD [Tel: ; hans.blommestein@oecd.org] or Mr. André Laboul, Head of the Financial Affairs Division, OECD [Tel: ; andre.laboul@oecd.org]. Organisation for Economic Co-operation and Development, 2 rue André-Pascal, Paris cedex 16, France

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4 TABLE OF CONTENTS MAIN POINTS AND SUGGESTED DELIVERABLES... 6 I. BACKGROUND... 7 I.1. The G20 request... 7 I.2. Introduction: why is there a need to review existing leading practices for public debt management?. 7 II. METHODOLOGY II.1. Nature of OECD leading practices II.2. Value-added of the OECD approach III. CURRENT STATUS III.1. Leading practices and the mandate of the OECD WPDM III.2. Dissemination of OECD leading practices for public debt management and borrowing operations over the past 30 years IV. SUMMARY OVERVIEW OF SUGGESTED UPDATES OF LEADING PRACTICES FROM KEY POLICY AREAS IV. 1. Is there a need to review the strategic objectives and basic micro portfolio approach of the public debt management strategy? A. Current Status B. Impact of the Crisis B.1 Rethinking public debt management? B.2 Possible conflicts between UMP and sovereign issuance and the proper functioning of government securities market C. Assessing Changes in Policy Mandates and/or Leading Practices D. Next Steps IV.2. Review of leading practices for primary market operations A. Current Status B. Impact of the Crisis B.1 The explosion in borrowing requirements worsened issuance conditions B.2 Primary dealer models under stress? C. Assessing Changes in Policy Mandates and/or Leading Practices C.1 Recent changes in issuing procedures and instruments C.2 The future of PD systems? C.3 Direct bidding C.4 Continued importance of transparency and predictability D. Next Steps Page 4

5 IV.3. Review of leading practices for enhancing secondary market efficiency and liquidity A. Current Status B. Impact of the Crisis C. Assessing Changes in Policy Mandates and/or Leading Practices D. Next Steps IV.3. Leading practices for investor relations A. Current Status B. Impact of the Crisis C. Assessing Changes in Policy Mandates and/or Leading Practices C.1 Stronger emphasis on direct investor relations since the crisis D. Next Steps IV.4. Transparency in debt management A. Current Status B. Impact of the Crisis C. Assessing Changes in Policy Mandates and/or Leading Practices D. Next Steps IV.5. Guarantees in public debt management A. Current Status B. Impact of the Crisis C. Assessing Changes in Policy Mandates and/or Leading Practices D. Next Steps V. EXPECTED RESULTS ANNEX A ANNEX B SELECTED REFERENCES NOTES... Ошибка! Закладка не определена.6 Page 5

6 MAIN POINTS AND SUGGESTED DELIVERABLES Recent reviews of possible shortcomings in existing OECD leading practices for raising, managing, and retiring public debt were in particular motivated by the (possible or potential) impact on leading practices of the huge borrowing challenges faced by debt managers, leading to very high government debt to GDP ratios. Additional reasons include (a) new and complex linkages between public debt management, government securities markets and monetary policy and (b) the large-scale issuance of government guarantees. This Interim Report to the G20 makes a start with (a) discussing recent reviews of possible shortcomings in existing leading practices and (b) identifying suggestions for up-dating or revising leading OECD practices associated with new or amended policies, procedures and techniques for public debt management, sovereign borrowing and government guarantees. It is envisaged that the Final Report will incorporate additional empirical material, including the practical and operational insights from recent discussions in the OECD Working Party on Debt Management. This will in particular cover the following areas: (1) an assessment of the basic micro portfolio approach of the public debt management strategy; (2) a review and suggested up-date of leading practices for primary markets and (3) secondary market operations; (4) suggested policy conclusions related to up-dated leading practices for investor relations and communications; (5) transparency recommendations in particular those based on a forthcoming report by an OECD task force on the Transparency of Debt Statistics Operations and Policies; (6) an evaluation of the need for an up-date and/or extension of the OECD (2005) report on leading practices for explicit contingent liabilities (state guarantees) in debt management. Page 6

7 I. BACKGROUND I.1. The G20 request G20 Finance Ministers and Central Bank Governors noted the ongoing work of the OECD to review leading practices for raising, managing and retiring public debt (Communiqué of G20 Finance Ministers and Central Bank Governors, Moscow, February 2013). This reference to the OECD was reiterated in the G20 Communiqué of April The G20 Communiqué of July 2013 called on the OECD for an interim report on its update of OECD leading practices for raising, managing, and retiring public debt, including on state guarantees, by our next meeting. (Communiqué of G20 Finance Ministers and Central Bank Governors, Moscow, July 2013.) This request was subsequently endorsed by the G20 Leaders Declaration stating: We ask our Finance Ministers, at their October meeting,... [to] review the OECD s interim report on updating its leading practices for raising, managing, and retiring public debt, including on state guarantees. (G20 Leaders Declaration, Saint Petersburg Summit, 5-6 September 2013.) I.2. Introduction: why is there a need to review existing leading practices for public debt management? Possible shortcomings in existing leading practices, and the resulting need to introduce new or revised policies, procedures and techniques for debt management operations, have been discussed and reviewed on a regular basis during meetings at the OECD, in particular in the OECD Working Party on Debt Management (OECD WPDM). (Members of this Forum include senior officials, mainly the heads, of Debt Management Offices or Agencies.) Recent reviews were in particular motivated by the (possible or potential) impact on leading practices of the huge borrowing challenges faced by debt managers, leading to very high government debt to GDP ratios (Charts 1 and 2). Page 7

8 Chart 1: Central government marketable gross borrowing in the OECD area Trillion USD Source: 2012 Survey on central government marketable debt and borrowing by OECD Working Party on Debt Management; OECD Sovereign Borrowing Outlook 2013, and OECD staff estimates. Chart 2: General and Central government debt in the OECD area Percentage of GDP Notes: * Central government marketable debt figures refer to government securities that can be sold and bought in the secondary market. ** General government gross debt figures are on a SNA basis. Source: 2012 Survey on central government marketable debt and borrowing by OECD Working Party on Debt Management; OECD Sovereign Borrowing Outlook 2013, OECD Economic Outlook 93 database (June 2013), and OECD staff estimates. Page 8

9 Additional reasons include (a) new and complex linkages between public debt management, government securities markets and monetary policy 1 and (b) the large-scale issuance of government guarantees. 2 An important part of the mandate of the OECD WPDM is to monitor recent developments and trends, to share experiences regarding policies, procedures and techniques, and to address possible policy implications. Especially since 2008 the WPDM has focused on the direct and indirect 3 impact of various stages and mutations of the unfolding global crisis on (i) policies, (ii) procedures and (iii) techniques for debt management operations. Accordingly, the OECD has responded to these policy challenges in a very practical fashion via focused discussions of the OECD WPDM. This timely, flexible and targeted response included the organisation of extra crisis sessions focused on the most acute challenges faced by sovereign issuers. On these occasions senior OECD debt managers discussed how best to respond to the huge increase in gross borrowing requirements, thereby also discussing in an in-depth fashion the adequacy of existing leading practices. From these very practical OECD discussions new or amended practices emerged such as those related to primary markets, including more frequent auctions; the greater use of syndications; the greater importance of investor relations and communication strategies; the future of primary dealer systems; the role of shorting in government debt markets 4 ; etc. This interim report will provide a tentative and preliminary overview of these up-dated, amended or extended OECD leading practices in public debt management, sovereign borrowing and government guarantees. Page 9

10 II. METHODOLOGY II.1. Nature of OECD leading practices It is important to have a proper understanding of what we mean by leading practices. The OECD Working Party on Public Debt Management represents a forum of peers. And it is within this forum that leading practices used by those OECD debt managers are regularly discussed. This peer dialogue forum of OECD debt managers has a very practical and operational focus. The OECD peers express views on which existing policies, procedures and techniques for debt management operations are considered effective for meeting today s challenges. A broad agreement on the adequacy of these procedures and techniques among the peers of debt management offices from a large group of major economies means that they can effectively be considered as leading practices. That said, this set of leading practices is not equivalent to a prescriptive set of practices, and also do not provide some sort of blueprint to be followed mechanically. Rather, this broad understanding about leading practices may change over time in response to new circumstances, including changing market and policy conditions and new procedures and techniques. A second distinctive feature of these leading practices is that they contain or reflect much more practical, detailed and operational policy information, as compared for example with the high-level synthesised international guidelines or policy principles used by other international organisations such as the high-level IMF-WB guidelines for public debt management. Ultimately, the OECD s leading practices are fairly detailed with an operational scope. They are largely the result of discussions by practitioners (i.e. the OECD debt managers). In fact, many of the discussions within the OECD WPDM are based on Survey results and policy documents prepared by the practitioners themselves (viz., the members of the WPDM). For these reasons the OECD leading practices and the IMF-WB guidelines complement each other. A third crucial feature is that these practices are not by definition best practices to be adopted and implemented directly, since the use of debt management practices in a specific country reflects often a response to specific policy challenges that in some respects (e.g. procedural or technical) may differ from the situation and practices in other jurisdictions (while the resulting different practices may be equally effective). These different practices may also mirror different circumstances due to institutional differences and other structural constraints [for example, the organisational differences of debt management offices (DMOs) 5 ]. Page 10

11 II.2. Value-added of the OECD approach The members of the OECD WPDM are for the larger part senior OECD officials responsible for, and directly in charge of, sovereign borrowing operations and debt management policies and operations. These WPDM members participated also in extra crisis sessions at OECD headquarters. Some of them also met on several occasions informally at both OECD headquarters and in member countries to discuss new and emerging public debt management issues, thereby underlining the practical and flexible nature of the WPDM in responding to new challenges. Since the members of this OECD policy forum are senior OECD officials that are deeply and practically involved in debt management, they are best placed to assess the merits of any decision to update or extend existing leading practices. For all these reasons, the OECD is an important contributor to the development and formulation of international leading practices in public debt management and associated government bond markets, including state guarantees. These features make the OECD WPDM the prime policy forum for discussing and reviewing possible shortcomings in leading practices and for assessing the effectiveness of new policies, procedures and techniques. It is therefore important that the extensive expertise and in-depth knowledge embodied in OECD s long-standing work in this policy area should be widely shared and used for the formulation of potential recommendations for an update of existing leading practices with a detailed and operational scope. These revised leading practices can then also be used as input for the debate on up-dating high-level policy guidelines or principles. III. CURRENT STATUS III.1. Leading practices and the mandate of the OECD WPDM An important part of the mandate of the OECD WPDM is to monitor recent developments and trends, to share experiences regarding policies, procedures and techniques, and to address possible policy implications. Especially since 2008 the WP has focused on the direct and indirect 6 impact of various stages and mutations of the unfolding global crisis on policies, procedures and techniques for debt management operations. On these occasions senior OECD debt managers discussed how best to respond to the huge increase in gross borrowing requirements, thereby also discussing in an in-depth fashion the adequacy of Page 11

12 existing leading practices. From these very practical OECD discussions new or amended practices emerged such as those related to primary and secondary markets, including more frequent but smaller auctions; the more important role of direct bidding; the greater use of syndications; the greater importance of investor relations and communication strategies; the future of primary dealer systems; the role of shorting activities in government debt markets; measures to enhance liquidity; etc. III.2. Dissemination of OECD leading practices for public debt management and borrowing operations over the past 30 years The dissemination of leading practices, country and market surveys and case studies is done by publishing on a regular basis policy reports. In addition, the OECD collects and distributes high quality data on government debt, bond markets and borrowing operations using a standard methodology. Thirty years ago, in 1983, the OECD published Government Debt Management, Volume 1: Objectives and Techniques and Volume 2: Debt Instruments and Selling Techniques, a study on objectives and techniques of government debt management. This publication, called the OECD Green Book because of the colour of its cover, provided detailed information about leading practices in OECD countries including the use of debt instruments, selling techniques, the organisation of primary and secondary markets in government securities as well as policy issues and techniques of government debt management. The second OECD Green Book, Government Securities and Debt Management in the 1990s, published in 1993, updated the 1983 study. The third OECD Green Book, Debt Management and Government Securities Markets in the 21st Century (Paris, 2002), provides an overview of leading practices, new developments and policy issues in debt management and government securities markets in the OECD area. A separate chapter is dedicated to practices and policy challenges in emerging debt markets. A related OECD publication, OECD Public Debt Markets: Trends and Recent Structural Changes (Paris, 2002), provides detailed structural country information on developments and leading practices in OECD bond markets. In 2005, the OECD published in 2005 a landmark study on leading risk management practices by OECD debt managers: Advances in Risk Management of Government Debt. The study discusses the use of leading practices by OECD debt management offices (DMOs) for addressing market risk and credit risk exposure. The study also identifies the (management of) risks associated with explicit contingent liabilities (i.e. guarantees) as an important policy challenge for OECD debt managers (see section IV.6. for details). Page 12

13 Since 2011, the OECD has published the OECD Sovereign Borrowing Outlook, based on an annual survey on the borrowing needs and funding policies of OECD countries. The responses are incorporated in the OECD Sovereign Borrowing Outlook to provide regular updates of trends and policy developments associated with sovereign borrowing requirements and debt levels from the perspective of public debt managers. To that end, the Outlook analyses (and reports on) structural changes in leading practices and policies in OECD primary and secondary markets (see sections IV.2 and IV.3 for details). The OECD also publishes key information on leading or best practices via the OECD Working Papers Series on Sovereign Borrowing and Public Debt Management 7 (available for free at the OECD website) and by using the OECD- Italian Treasury-World Bank Public Debt Management Network in Emerging Markets (the PDM Network for short) 8. IV. SUMMARY OVERVIEW OF SUGGESTED UPDATES OF LEADING PRACTICES FROM KEY POLICY AREAS IV. 1. Is there a need to review the strategic objectives and basic micro portfolio approach of the public debt management strategy? A. Current Status There is a consensus among OECD debt managers that the primary strategic objectives or functions of government debt management are 9 : (a) securing continuous (and non-interrupted) access to markets 10, while (b) minimising longer-term borrowing costs at an acceptable level of risk. These strategic objectives constitute the basis of the so-called standard micro portfolio approach to public debt management (PDM). The mandates of debt management offices (DMOs) normally have a microeconomic focus based on (a) and (b). Such mandates have usually eschewed any macroeconomic policy dimension 11. For these reasons, all clashes in policy mandate between central banks (CBs) and DMOs have been latent and not overt. Under normal (pre-crisis) circumstances, these distinct mandates have worked well. CBs and DMOs, as operationally independent institutions with different objectives, responsibilities and functions, have usually enjoyed clear working relationships that functioned (often in the same markets) without policy conflicts. Both CBs and DMOs could serve the general interest best by executing their separate, specific mandates. Page 13

14 B. Impact of the Crisis The financial and economic crisis has led to some blurring of lines between public debt management (PDM) and monetary policy. DMOs have operated more extensively at the short end of the yield curve, and CBs have been increasingly active in the same long government bond markets as DMOs. Hence, although generally the formal mandates of CBs have not changed, balance sheet policies (unconventional monetary policy or UMP) during the past few years have tended to blur the separation of their operations from fiscal policy (FP). Serious fiscal vulnerabilities, perceptions of higher sovereign risk and considerable uncertainty about future interest rates have created new and complex interactions between PDM and monetary policy. As Blommestein and Turner (2012a,b) argued, this set of conditions created the threat of fiscal dominance 12. This has put public debt management and the functioning of sovereign debt markets in a macro spotlight. Of practical importance is that mandates became entangled to some degree during recent crisis episodes, in which the different mandates appeared sometimes to be in conflict 13. This raises therefore the fundamental issue as to whether there is a need to review the objectives and basic micro portfolio approach of the public debt management strategy and to suggest making possible changes in this conventional and widely accepted strategic mandate of PDM. B.1 Rethinking public debt management? The financial crisis has led to some rethinking about central banking strategies and operations. For debt managers it is of some consequence that actual central bank operations in segments of financial markets beyond short-term money markets have become more prominent. This new situation has prompted suggestions that a re-think of government debt management may be needed. In this context, an assessment of possible conflicts or strains between PDM and monetary policy is of importance. B.2 Possible conflicts between UMP and sovereign issuance and the proper functioning of government securities market Central banks and DMOs have different policy goals that sometimes may conflict. Recent studies have identified potential or actual conflicts of policy interest in implementing QE or MEP on the one hand, and the sovereign issuance strategy, on the other. For example, one paper found that the FED s asset purchase programme was countervailed by the US Treasury s public debt management strategy 14. Another study estimated that the US Treasury s extension of the average maturity of outstanding debt during the Large-Scale Asset Purchase (LSAP) programmes pushed the 10-year government bond yield up by 27 basis points during the first stage of the programme (LSAP1) and by 14 basis points during the Page 14

15 second stage (LSAP2) 15. In other words, the effectiveness of QE and Twist operations are constrained or limited by the public debt management strategy. More generally, Blommestein and Turner (2012) 16 show that in the past there has been quite a strong empirical link between actual debt management choices and two simple measures of both fiscal policy and monetary policy. They provide prima facie evidence for the U.S. that debt management choices have been (partly) endogenous with respect to macroeconomic policy. Moreover, Hoogduin et al (2010, 2011) found that, in the euro area, a steepening in the yield curve leads national debt managers to shorten the duration of their issuance 17. C. Assessing Changes in Policy Mandates and/or Leading Practices From this last finding we derive the key policy point that debt management choices seem not in practice to have been (fully) independent of monetary policy 18. This point may be particularly relevant for UMP such as QE, MEP and ECB s bond-buying programme Outright Monetary Transactions (OMTs). Indeed, non-standard monetary policy measures have undermined to some degree the separation between PDM and monetary policy. Before the 2008 crisis, policymakers in the OECD area (and in an increasing number of emerging public debt markets) had adopted the reasoning that potential policy conflicts between monetary policy and sovereign debt management could be (largely) avoided by following two separability principles : Central banks should not operate in the markets for long-dated government debt, but should limit their operations to the bills market. Government debt managers should be guided by a micro portfolio approach based on cost-minimisation mandates, while keeping the issuance of short-dated debt to a prudent level. But recent central bank activism in debt markets as a response to the crisis has inevitably to some degree gone against these two separability principles. A key problem is that QE operations decided by the central bank could easily be contradicted by Treasury financing decisions. Put differently, UMPs may induce the opposite reaction of the debt manager (the endogeneity point argued above) 19. Another key question is how to assess the (potential) impact of the exit of UMP (including tapering) on debt management and sovereign borrowing decisions. Also the use of new CB tools such as forward guidance may influence how PDM is conducted. Page 15

16 Other policy considerations are associated with worries that UMP may affect the efficient functioning of markets. More specifically, at some (unknown) threshold additional CB purchases of Treasuries may affect market functioning by reducing liquidity 20. In other words, OECD policymakers are required to come to grips with a wide range of major new complexities and challenges, prompting important questions such as: Are fundamental changes necessary? For example, do we need a new policy framework for all official actions that affect the maturity structure of government debt for macroeconomic objectives (including QE, tapering and exiting)? Should debt management be integrated into a high-level, broader macroeconomic framework of analysis that ensures or facilitates a consistent policy mix, while respecting the operational independence of DMOs and CBs? Will this require a re-think of the monetary policy dimension of the policy mandates for debt managers? D. Next Steps It is envisaged to consult the OECD Working Party on Public Debt Management about (1) the above fundamental questions and (2) a set of suggested policy conclusions related to the objectives and basic approach of the public debt management strategy. Results will be incorporated in the final report on leading OECD practices to the G20 Finance Ministers and Governors. IV.2. Review of leading practices for primary market operations A. Current Status Tougher issuance conditions related to the crisis-related surge in government borrowing needs are important reasons why issuance arrangements have not always been working as efficiently as before the crisis. This prompted debt management offices (DMOs) in the OECD area to review existing issuance policies and procedures. In fact, various DMOs implemented changes in existing issuance procedures and policies that may have led to a somewhat greater diversity of primary market arrangements and procedures 21. The crisis also had an impact on the use of indicators or guidelines relating to the key risks of the maturity structure of issuance or of outstanding debt. In response, the WPDM also reviewed strategies and indicators for the management of the debt portfolio. In this report, we are making a distinction between the funding strategy versus borrowing needs or requirements. The funding strategy entails decisions on how (gross) borrowing needs are going to be financed using different instruments (such as long-term, short-term, nominal, price-indexed, etc.) and Page 16

17 distribution channels. Gross borrowing needs are calculated on the basis of budget deficits and redemptions. B. Impact of the Crisis B.1 The explosion in borrowing requirements worsened issuance conditions Borrowing needs increased significantly in response to the soaring costs of financial support schemes and other crisis-related expenditures as well as recession-induced falls in tax income and an increase in recession-related expenditures. Later on, increased sovereign debt ratios, perceptions that sovereign risk has increased and related concerns about of the loss of the risk free status of sovereign debt in some jurisdictions, financial sector adjustments to a new regulatory environment, and the refinancing needs of the financial sector (notably banks), led to greater complexities in raising funds. Some OECD debt managers reported episodes with weak demand and distortions in primary markets. Others also reported lower liquidity in secondary markets, in part due to sell-offs by foreign investors of sovereign bonds previously considered safe 22. Delegates from the OECD Working Party on Public Debt Management (WPDM) confirmed the following trends and developments around the peak of the crisis: (a) dramatically increased borrowing requirements and concerns about possible market absorption problems; (b) changes in issuance methods, including more flexible auctions, introduction of auction fees, and the use of distribution methods other than auctions such as syndication, Dutch Direct Auction procedures and private placement (see section Recent changes in issuing procedures and instruments); (c) changes in optimal sovereign portfolios. B.2 Primary dealer models under stress? In the wake of the global financial crisis and, later, in response to extreme pressures in several euro area sovereign debt markets, questions have been raised about the functioning and future of primary dealer systems (PDs). Tough issuance conditions are the reasons why existing PD arrangements have not always been working as efficiently as before the crisis. This raises the question of whether PD requirements need to be revised, temporarily or on a more permanent basis. Part of this discussion also focused on the impact of regulatory changes on PDs ability/willingness to provide liquidity in sovereign bond markets, reduced capital allocations and risk budgets for PD activities, increased general risk aversion and reduced profitability from government bond market-making. Reports about balance sheet weaknesses of primary dealer banks are of great concern for Page 17

18 DMOs, as they may be linked to a lesser ability or willingness of PDs to be active in funding ongoing huge borrowing programmes. Perceptions of higher sovereign risk may further aggravate this situation. Sovereigns are faced with new challenges to ensure that appropriate incentives are in place for PDs to continue to participate actively in both primary and secondary markets and to make sure that they can access successfully a wide range of markets. Also effective issuance techniques (as discussed above) are in this context of great importance. C. Assessing Changes in Policy Mandates and/or Leading Practices C.1 Recent changes in issuing procedures and instruments Issuance conditions have therefore become tougher with sometimes weak demand at auctions (lower cover ratios) and greater auction tails reflecting relatively unsuccessful auction results. Several OECD countries experienced difficulties in their auctions due to relatively low demand which on occasion triggered sell-offs and a strong increase in yields. However, issuance conditions in euro zone government securities markets have improved since September 2012, with several sovereigns benefitting from the announcement by the ECB of the new Outright Monetary Transactions (OMT) back-stop facility on 6 September 2012 (see for details OECD Sovereign Borrowing Outlook 2013). Since 2008, OECD debt managers have been facing huge funding challenges and changing trends in the composition of the investor base (see section IV.4). In response, many DMOs reported changes in issuance procedures in order to address potential market absorption problems. Considerable funding needs together with at times unfavourable and more complex market conditions raise important policy issues and challenges such as: Dealing with lower cover ratios and greater auction tails. Decreasing liquidity in secondary markets (with sometimes decoupling of secondary market prices from sovereign funding costs) (see section IV.3). Ultra-high funding costs in some countries. Episodes with extreme volatility in sovereign debt markets. Concerns about the (alleged) loss of risk free status of some sovereigns (while the demand for AAA sovereign assets is rising 23 ). Against this backdrop, many DMOs have adopted changes in issuance procedures so as to address the consequences of increased competition in raising funds and potential market absorption Page 18

19 problems. Delegates from the OECD Working Party on Public Debt Management confirmed the following trends and developments since : (a) Changes in issuance methods and procedures, including more flexible auction calendars (weekly or monthly instead of quarterly/annual) and/or more flexibility in the amounts offered, an increase in the number of instruments issued at each auction date, an increase in the size of existing non-competitive subscriptions, and using other distribution methods than regular auctions including mini-tenders, Dutch Direct Auction (DDA) procedures, private placement and syndications. (b) Changes in optimal sovereign portfolios (driven by new benchmarks with greater emphasis on shorter-term paper and a reformulated cost-risk trade-off). (c) Using buyback and exchange auctions in order to mitigate rollover risk and to enhance liquidity (see section IV.3 for details). (d) Introduction/re-introduction of new maturities. (e) Introduction of new funding instruments such as (higher) linker issuance, variable or floating rate notes, and ultra-long instruments. (f) Introduction of new distribution facilities 25. The final report to G20 Finance Ministers and Central Bank Governors will provide a country-bycountry overview within the OECD area. In addition, a new Survey by the OECD Working Party on Debt Management seeks deeper insights on syndication design and implementation. To that end the final report will examine and compare different approaches and leading practices concerning syndication operations by focusing on objectives, operational aspects and market outcomes. C.2 The future of PD systems? In response to these challenges, several debt managers have made changes to the balance of PD obligations and privileges (as reported in the 2012 OECD survey on the Functioning and future of primary dealer systems), often in combination with the overall issuance architecture. Additional details, including survey results, will be discussed in the final report. Page 19

20 C.3 Direct bidding Direct bidding has been a widely discussed topic amongst sovereign issuers in recent years. Observers note that direct bidders generally do not have to abide by the same bidding requirements as primary dealers, and hence may face less risk in auctions. Others have suggested that a large direct bidding presence in sovereign debt auctions may result in primary dealers modifying bidding behaviour in efforts to minimize risk. Critics of direct bidding often point out that the practice disintermediates primary dealers, adversely impacting the attractiveness of being a primary dealer. The final report will discuss responses to a recent Survey among members of the OECD WPDM 26. The responses will be used to focus discussion and facilitate a meaningful exchange of views on the topic of direct bidding. The Survey is designed to understand the extent to which sovereigns allow participation by direct bidders in their sovereign debt auctions, the reasons why sovereigns do or do not allow direct bidding, how sovereigns manage direct participation, and the potential impact of direct bidding on bidding behaviour of other bidders and debt issuance costs. C.4 Continued importance of transparency and predictability Although issuance procedures and targets for portfolio management became somewhat more opportunistic in some jurisdictions, debt managers generally agreed that the importance of transparency and predictability has not diminished (see also section IV.5). D. Next Steps All in all, most OECD sovereign issuers were fairly successful in raising huge amounts of funds, even during highly stressed market conditions. Hence, in most cases, difficulties surrounding auctions can therefore be best interpreted as single market events and not as unambiguous evidence of systemic market absorption problems. As noted, the final report will benefit from responses to a number of Surveys among OECD debt managers covering primary market operations and policies. This will include the state-of play in different primary markets, responses by DMOs to tougher issuance conditions, a detailed overview of changes in issuing procedures and techniques and the introduction of new instruments. All this information and associated policy analyses will be used to suggest and frame a set of suggested policy conclusions related to updated leading practices for primary market operations. Page 20

21 IV.3. Review of leading practices for enhancing secondary market efficiency and liquidity A. Current Status Secondary market liquidity is an essential feature of a well-functioning and resilient government bond market. Efficient secondary market operations and liquidity are therefore of great importance for issuers, dealers and investors. Liquid markets are also of great importance for other policymakers such as central banks because of the relevance of these markets to monetary policy and to financial stability. Investors place a high value on being able to trade sizeable volumes of bonds without the risk that these trades will impact on bond prices. High liquidity facilitates entry to and exit from a market, as well as enabling investors to easily adjust portfolio positions. Liquidity in government bond markets also has a direct impact on funding possibilities and financing costs, and may assist in the development of financial markets more generally. This is because of the important benchmark or reference role played by government bonds. Liquidity in secondary markets government bond markets is therefore of particular interest to debt management offices and finance ministries as it has a direct impact on funding possibilities and costs. For a government bond market to provide efficient price signals for other sectors of financial markets, it requires a strong level of liquidity, even in times of market dislocation or stress. Liquidity is therefore also a key issue in the development of financial markets 27 as it affects the risk-return terms for issuers and, conversely, the attractiveness of government paper for domestic and foreign investors. Active secondary market trading improves liquidity and improves the price discovery process. Secondary market liquidity and active trading relies on several microstructure aspects that should be considered: i) concentrated issuance of key benchmark tenors, ii) well-functioning spot and repo markets; iii) ability to short sell bonds, iv) derivatives markets; and v) automation and electronic market structures. Several meetings and publications 28 by the OECD WPDM have focused on the policies and operational details related to these leading practices that enhance market efficiency and secondary market liquidity. At times, other proceedings under the aegis of the WPDM also discussed these issues. For example, the Tenth Annual OECD-World Bank-IMF Global Bond Market Forum in 2008 focused on secondary market liquidity in domestic public debt markets. Among the key policy conclusions of that Page 21

22 Forum meeting is that liquidity is not very well understood and that a key challenge for strengthening liquidity is a better understanding of liquidity as a concept. 29 The complexities and elusiveness of liquidity is also supported by several recent in-depth studies that suggest the need for further research. In particular practical and reliable measures that would systematically and accurately measure liquidity in secondary government bond markets would benefit DMOs. B. Impact of the Crisis There have been many new factors impinging on liquidity in government bond markets since the onset of the global financial crisis. Some of these relate to investor sentiment, while others arise from regulatory changes. The ongoing process of regulatory changes (i.e. Basel II and III, Solvency II, CACs, MiFID, Dodd Frank Act, etc.) in the financial system, which started anew a few years ago, is likely to have an impact on secondary market liquidity of government bonds. A new Survey by the OECD WPDM is designed to gauge the experience of working party members in regard to issues they face around observing, influencing and anticipating changes to liquidity in their secondary government bond markets. The results of this survey will be included in the final version of the G20 Report. C. Assessing Changes in Policy Mandates and/or Leading Practices Primary dealers (PDs) execute their obligations in secondary markets by standing ready to give two way quotations (prices) in certain (designated) government securities, thereby contributing to liquid markets. However, in times of high volatility and uncertainty, together with rapidly widening bid-ask spreads and increasing yields, market making may at times become very challenging. In response, countries introduced measures to improve the deteriorated balance between obligations and privileges. A previous survey by the WPDM indicated that more than half of the responding DMOs eased PDs market quoting obligations. Several sovereign issuers recently modified their quoting obligation systems with the dual objectives of easing quoting obligations but also to increase flexibility (so as to better adapt to changing market conditions). According to the survey results, governments may (temporarily) opt to drastically decrease (or even completely suspend) quoting obligations during extreme crisis episodes. A recent OECD study (based on a Survey by the OECD WPDM) discussed the use of bond buybacks and exchanges. The report showed that exchanges and buybacks allow debt managers to increase the issuance of on-the-run securities above and beyond what would otherwise have been possible. The Page 22

23 resulting more rapid build-up of new bonds enhances market liquidity of these securities. This in turn should eventually be reflected in higher bond prices. Hence, bond exchanges and buybacks may also contribute to lower funding costs for governments 30. D. Next Steps The final report will incorporate the responses to two recent Surveys by the OECD WPDM. One Survey deals with the (potential) impact of new regulations on the liquidity of secondary markets. The second Survey gauges the experience of working party members in regard to issues they face around observing, influencing and anticipating changes to liquidity in their secondary government bond markets. Suggested policy conclusions related to (up-dated or revised) leading practices for secondary markets will be added as well to the final report. These conclusions will also benefit from insights and findings from two recent OECD studies. The first study provides a debt management assessment of recently proposed restrictions on shorting operations 31. OECD debt managers concluded that there is plenty of empirical evidence on the benefits of short selling, including more liquidity and better pricing efficiency. The OTC study 32 reviews Debt Management Office (DMO) collateralisation policies and practices in light of the higher capital costs and funding requirements faced by financial institutions and other dealers who transact in the over-the-counter derivatives (OTCD) market. The final report will assess whether key recommendations from the study need to be updated in light of the (potential) implications of the latest regulatory developments for debt management policies and practices. All this information and associated policy analyses will be used to suggest and frame a set of suggested policy conclusions related to updated leading practices for secondary market operations. IV.3. Leading practices for investor relations 33 A. Current Status All respondents to a recent OECD Survey 34 indicated that they have some type of investor relation (IR) function, ranging from a dedicated group to a general communications function under which IR is considered a component. In fact, the majority of OECD debt managers do not have a special group dedicated to IR. Instead, they integrate IR functions with other areas of the business or consider broader communications as serving an adequate and relevant IR role (for example, a funding and debt management strategy, planning materials and discussions with primary dealers). Page 23

24 IR mission statements provide sovereigns with an opportunity to demonstrate or frame their commitment to debt management objectives such as sharing adequate information and maintaining relationships with stakeholders. B. Impact of the Crisis The global financial and economic crises triggered a strong surge in government borrowing needs in most OECD countries thereby putting the spotlight not only on challenges regarding issuance methods but also on changes in the composition and preferences of the investor base. This put the focus on (changing) priorities for DMOs (and primary dealers) in how best to deal with investors. For example, a recent OECD Survey on Investor Relations and Communications among DMOs observed a greater emphasis on the importance of the Investor Relations and the Communication Strategy during the last couple of years, citing a variety of reasons, ranging from the need to ensure demand as funding requirements increased and/or circumstances changed, to the need for diversification of the investor base. The investor base for government securities has been undergoing important changes. For example, as noted, UMP such as QE has led to a rapid and massive expansion of central banks balance sheets. The main component of this balance sheet expansion is purchases of government securities. As a result, domestic central banks play a much more prominent role as investors in government securities markets. Investment strategies and environments have been changing over the past several years, as global investors have adjusted to crisis related challenges and policies such as quantitative easing, changes in the relative attractiveness or riskiness of developed and emerging market assets, and greater emphasis on individual country risk instead of asset classes. New and demanding challenges were added since 2010 by the unfolding crisis in the Euro area. Moreover, regulatory changes, new or anticipated, with direct and indirect impacts on investment strategies are also having an influence on the investor base for government securities. C. Assessing Changes in Policy Mandates and/or Leading Practices Over the past decade, investor relations (IR) have evolved for most OECD debt managers. A recent OECD Survey 35 among OECD DMOs suggests a general expansion of IR activities as the IR function has evolved, which may be a result of circumstances in financial markets, more globalised financial markets, and the increasing acknowledgement of the important role of transparency and communication for a country s debt programme. Page 24

25 This evolution of the IR function involves incremental improvements (improving upon existing IR activities and practices) and strategic improvements (creating new activities and practices based on feedback and/or specific changes in circumstances). The first type of improvements includes more information/details ( extended scale and scope ), broadening of communication channels, more advertising activities, etc. The latter type includes moving from a focus on increasing demand to a focus on diversifying investor base, move from deal-related road shows to non-deal- related road shows, greater adaptation to actual market needs ( geared toward a global investor base ), etc. C.1 Stronger emphasis on direct investor relations since the crisis Since the crisis, direct contacts with large (foreign) investors (including via road shows) have become more important than before, in particular to explain changes in the overall situation and policy-framework. All forms of communication are of importance, including high-quality websites. In this context, primary dealers principal job is to sell debt, while the principal task of DMOs is to explain how they (and the government more generally) operate. D. Next Steps The final report will include the latest findings from a Survey on structural changes in the investor base, investor relations and communications. This updated information and associated policy analyses will be used to suggest and frame a set of suggested policy conclusions related to up-dated leading practices for investor relations and communications. IV.4. Transparency in debt management A. Current Status The growing importance of, and attention for, transparency is a worldwide trend. Transparency is linked to accountability, disclosure policies and accounting standards. Increased transparency in sovereign debt management refers in particular to (a) the institutional set-up and formulation of the public debt management strategy (including for borrowing, funding and risk profile) and associated policies; (b) primary public debt markets and (c) secondary public debt markets. Transparency is an issue that touches all layers and institutions involved in the management, issuance and administration of public debt: Debt Management Office (DMO), Minister of Finance, Central Bank, Parliament, markets, the media and the general public. This means that the allocation of responsibilities and objectives for public debt management should be publicly disclosed and explained. Moreover, Page 25

26 accountability needs to be supported by an adequate legal framework (including financial legislation) and clearly defined budget procedures. Greater accountability is a reflection of a greater demand for openness and a more critical attitude by markets and the general public. Greater accountability and transparency may contribute to (de facto or de jure) more operational autonomy for debt management operations. In addition, more transparency about risk guidelines allows a greater emphasis on sophisticated riskadjusted performance systems, thereby contributing to a better assessment of the performance of DMOs. Disclosure of risk-adjusted performance indicators, in turn, has enhanced the credibility of debt managers. B. Impact of the Crisis Since the onset of the crisis and the associated huge increase in sovereign borrowing operations, governments are facing additional pressures from investors and others to increase the transparency of borrowing operations, methods for the calculation of central government debt figures, measures for rollover risk, maturity structure, derivatives and contingent liabilities. Recent areas of discussion include making the (risk characteristics of the) government balance sheet (central bank + central government) more transparent while also addressing the questions as to which items should be part of the mandate of debt managers (steps towards integrated risk management by implementation of the logic of sovereign asset and liability management, SALM 36 ). But the debate also involves moving towards greater transparency of off-balance sheet items such as contingent liabilities and derivatives. C. Assessing Changes in Policy Mandates and/or Leading Practices Transparency in primary market procedures and techniques and fairness in treating dealers and investors are essential for low borrowing costs. It is also important that all potential buyers of government securities are provided simultaneously with the same information. Auctions are the most commonly used tool by sovereign issuers in the OECD area. They allow for a high level of transparency together with the timely and frequent publication of auction calendars and prompt dissemination of auction results. DMOs with a high degree of operational autonomy are in a better position to act as professional market players with highly transparent and predictable policies. Page 26