The Domestic Market for Short-term Debt Securities

Transcription

1 The Domestic Market for Short-term Debt Securities Matthew Boge and Ian Wison* The Domestic Market for Short-term Debt Securities The market for short-term debt is dominated by the issuance of bank securities. Yieds on these securities act as an important reference rate within the financia system. The turmoi in goba markets during recent years has ed to significant changes in the short-term debt market as the funding profies of banks and other issuers of short-term securities has atered. Introduction Short-term debt securities are those issued with ess than 12 months to maturity. They pay an important roe within the domestic financia system, both as a source of iquidity for the banking sector and as a pricing benchmark for a wide range of contractua obigations. This artice considers how the composition of the short-term debt market has atered in recent years and how prospective reguatory initiatives may bring about further changes. The main deveopments that have occurred are a significant shift in the pattern of bank funding, a reduction in issuance by securitisation vehices and the reintroduction of Treasury notes by the Austraian Government. Banks Issuance Within the Austraian market, the banking sector is the predominant issuer of short-term debt securities, through the sae of certificates of deposit (CDs) and bank accepted bis (Tabe 1). Bi faciities are an important means by which banks extend credit to businesses. By accepting a bi of exchange drawn by one of its customers, the bank extends credit to the customer and guarantees repayment at maturity to the hoder of the bi. Bi acceptances account for around 2 per cent of bank ending to business and, as with overa business credit, acceptances have faen since eary 29 (Graph 1). Tabe 1: Short-term Debt Securities Outstanding Domesticay Issued As at 3 June 211 As at 3 June 27 $b % of tota $b % of tota Issued by: Banks as bank accepted bis as CDs AOFM (as Treasury notes) State and territory government authorities (semi-governments) Securitisers (as asset-backed commercia paper) Other corporations Tota Sources: ABS; AOFM; APRA; Austracear * The authors are from Domestic Markets Department. Buetin SEPTEMBER Quarter

2 $b $b Tota acceptances Source: APRA 26 Graph 1 Bank Accepted Bis Sod by acceptor To fund the extension of credit made to the drawer of a bi, the bank may se the acceptance into the market. However, in recent years, banks have increasingy preferred to retain most of their acceptances within their own portfoios, such that the outstanding stock of bis sod to investors is now ess than $25 biion, compared with $128 biion of tota acceptances. Whie bi faciities tend to function as revoving ines of credit, customers generay draw bis with quite short maturities, such as one month. In the expectation that further credit is ikey to be extended at the bi s maturity, banks prefer to fund themseves at onger maturities than the bis that they have accepted. Refecting this, most short-term debt securities issued by banks now tend to be certificates of deposit (Graph 2). 1 As at June 211, there was $181 biion in bank CDs outstanding. Since 24, bank bis and CDs issued by authorised deposit-taking institutions (ADIs) have been eigibe for sae under repurchase agreement (repo) to the Reserve Bank in its market operations, as a means of providing iquidity to the owner of the securities. The 1 Severa ADIs issue CDs with terms to maturity exceeding 12 months. These CDs are not incuded in the anaysis or data presented here. Long-term CDs (such as transferabe CDs) often pay reguar coupons, whereas a the securities discussed in this artice are zero-coupon (or discount) instruments. Unike deposits, CDs (of whatever maturity) are not protected accounts under the Banking Act 1959, and are therefore not covered by the Financia Caims Scheme $b Graph 2 Bis and Short-term CDs Issued by Banks Bis Sources: Austracear; RBA As at 3 June 211 CDs < Maturity (months) Reserve Bank does not purchase these securities on an outright basis and repos are ony contracted with counterparties that are not reated to the issuer of the security. 2 As securities that are eigibe for sae to the Reserve Bank count as iquid assets under APRA s prudentia iquidity requirements, ADIs have been abe to hod other entities bis and CDs in fufiment of these requirements. At present, around one-third of the bis and CDs sod into the market are hed by other ADIs (Graph 3). The importance of bi and CD hodings as a source of iquidity was highighted by the banks response to the emerging financia crisis in mid 27. Issuance of CDs rose sharpy, with most new securities issued to other ADIs. This gave ADIs greater scope to source iquidity from the Reserve Bank, were it to be needed. However, when the financia crisis reached its peak after the coapse of Lehman Brothers in ate 28, ADIs were permitted to securitise residentia mortgages they hed on their books and se these interna securitisations to the Bank under repo. These arrangements which remained in pace unti mid 29 essened the need for cross-hodings of CDs and issuance of those securities consequenty decined. 3 2 A repo is an agreement between two parties under which one party ses a security to the other, with a commitment to buy back the security at a ater date for a specified price. 3 Whie interna securitisations remain eigibe for the Reserve Bank s market operations, since mid 29, the Bank has ony been wiing to purchase these securities under repo in extraordinary circumstances. $b Reserve bank of Austraia

3 Graph 3 Graph 4 Bis and Short-term CDs Issued by Banks Bank Liabiities Hed by Corporations $b $b Tota 3 3 Short-term $b Non-financia Financia $b Excuding ADIs Hed by other banks Deposits Bis and CDs Source: APRA Sources: ABS; APRA Since that time, CD issuance has continued to fa. To some extent, this refects the efforts that ADIs have made toward extending the maturity of their iabiities by issuing more onger-term debt securities. However, the main adjustment in bank funding has been a switch from short-term securities to deposits of simiar maturity. Severa factors appear to have driven this change, on both the demand and suppy sides. Firsty, the roe of cash management trusts within the financia system has decined, particuary since the Austraian Government introduced a guarantee on deposits (of up to $1 miion) in ate 28. These trusts were significant investors in CDs. Secondy, the financia market turmoi of recent years has resuted in market participants viewing deposits as a more stabe source of funding than negotiabe instruments. To a certain extent, this is consistent with the proposed Base III iquidity reform measures. Under Base III, ADIs wi face more stringent iquidity reguations than at present, requiring them to hod iquid assets against their projected net cash outfows in a 3-day stress scenario. In that scenario, certain deposits (such as those paced by retai and non-financia corporate customers) are assumed to run-off at a sower rate than maturing securities. In response, to reorient their funding base aong these ines, ADIs have been prepared to pay a higher premium for deposit funding, increasing the rates they pay on deposits reative to those paid on bis and CDs. As a consequence, non-financia corporations have reduced their purchases of short-term securities and increased their pacements of deposits (Graph 4, eft-hand pane). Simiary, financia entities (such as pension funds) are now aso much more ikey to pace deposits with ADIs than purchase negotiabe instruments such as CDs. (Under Base III, however, deposits from those sources are assumed to run-off at the same rate as maturing securities.) Going forward, other aspects of the Base III measures may aso affect the market for bis and CDs. The requirement to hod iquid assets against a securities maturing within 3 days may remove the incentive for ADIs to issue any debt securities with ess than 31 days to maturity. Additionay, ony cash, baances hed at the Reserve Bank, Commonweath Government securities (CGS) and securities issued by the state and territory centra borrowing authorities wi quaify as iquid assets in the Austraian market. Hodings of certain private securities such as bis and CDs may sti count toward an ADI s iquidity requirement, but ony if the ADI has paid a fee to ensure access to the Reserve Bank s committed iquidity faciity. 4 4 The Reserve Bank s proposed committed iquidity faciity wi permit ADIs to se eigibe securities to the Bank under repurchase agreement. The eigibe securities wi correspond to those deemed eigibe for the Bank s market operations. Buetin SEPTEMBER Quarter

4 Trading in Bank Bis and CDs Within the market for bank bis and CDs, a distinction is drawn between prime and non-prime banks. The determination of prime banks is overseen by the Austraian Financia Markets Association (AFMA) through an annua seection process conducted amongst money-market participants. Prime banks need to be of a high credit quaity and with a sufficienty arge issuance program so as to promote iquidity. Currenty, there are six prime banks: ANZ, BNP Paribas, CBA, JPM Chase, NAB and WBC. These banks a have ong-term debt ratings of AA- or better and, at cose to $15 biion, their bi and CD issuance accounts for around 7 per cent of the market. 5 As much as one-third of prime bank issuance is ikey to be hed within the interbank market. The purpose of designating certain banks as prime is to create a homogenous group of iquid securities. Within the interbank market, most of the trading in prime bank bis and CDs is conducted via brokers. When posting bids and offers, buyers and seers do not specify a particuar bank; they are simpy deaing in prime bank debt. A buyer is presumed to be indifferent between receiving bis or CDs issued by any of the prime banks. 6 To promote iquidity in the market further, securities are grouped into maturity buckets corresponding to the first and second haf of each month ( eary and ate securities). Thus, an investor ooking to purchase three-month bis or CDs on the 1st of September woud be bidding for eary December paper and, if successfu, coud receive any bi or CD issued by a prime bank maturing between the 1st and the 15th of December. This feature naturay infuences the pricing of bank bis and CDs. When bidding, the buyer wi assume that the seer wi deiver the security that it is most in the seer s interest to 5 Excepting JPM Chase, bis and CDs issued by the prime banks are those abe to be deivered in settement of a position in the Sydney Futures Exchange s (SFE) 9-day bank bi futures contract. 6 Athough market convention permits a buyer to reject a trade within 1 minutes of execution if they ack sufficient credit imit for the name offered, it is extremey rare for buyers to exercise this option. deiver. For exampe, when the yied curve is upward soping, for a given rate the seer woud rather deiver a onger maturity security. In this environment, bis and CDs maturing in, say, the first haf of the month, wi be priced as though they mature on the 15th. Interest rates on prime bank bis and CDs act as key reference rates in the domestic market, not just as a pricing benchmark for other short-term debt securities, but aso for determining the payment obigations due on ong-term foating rate debt and on a range of derivatives, such as interest-rate swaps, cross-currency swaps and forward-rate agreements. The specific reference rates used are known as bank bi swap reference rates (BBSW) and their compiation is overseen by AFMA. Each trading day, AFMA surveys market participants for rates on prime bank bis and CDs for maturities ranging from one to six months. 7 Survey respondents report where these securities are trading in the market at 1 am. 8 This method is very different to that used by the British Bankers Association when deriving LIBOR (see Box A). As BBSW is set at 1 am, most of the trading activity in bis and CDs tends to occur at this time. Liquidity is generay greatest at the three-month maturity, with between $.5 biion and $1 biion in securities turning over most days in the interbank market. Trading tends to be particuary active towards the end of each haf-month period. As the iquidity of a three-month bi or CD decines noticeaby when its maturity effectivey drops to two-and-a-haf months, market participants may ook to cose out their trading positions ahead of that time. 7 Prior to 29, AFMA aso cacuated 9- and 12-month BBSW. However, the contraction of issuance at these maturities during the financia crisis prompted AFMA to discontinue their cacuations. 8 AMFA aso conducts an end-of-day rate set for prime bank bis and CDs. Whie the process is identica to that used for BBSW, these 4.3 pm rates are generay ony used for mark-to-market purposes and do not have the profie of the earier rate set. Refecting this, end-of-day trading is consideraby ess active than at 1 am. 42 Reserve bank of Austraia

5 Box A LIBOR Each trading day, the British Bankers Association (BBA) pubishes interbank borrowing rates in the London market for 1 currencies, incuding the Austraian doar. These rates are known as London Interbank Offer Rates (LIBOR). Respondents to the BBA s survey report where their institution has borrowed, or potentiay coud borrow, in the unsecured interbank market for maturities ranging from overnight to 12 months. The BBA s cacuations are therefore reiant on the respondents reporting accurate data about their own (actua or potentia) borrowings. Party refecting the disparate credit standings of the respondents, there can be a reasonaby wide variation amongst the contributions. This contrasts with BBSW, where respondents report the current trading eves of other institutions debt, most of which is occurring transparenty over brokers screens. Consequenty, there is amost aways a high degree of correspondence between the individua contributions to the BBSW survey. In recent times, there have been concerns expressed about the reiabiity and integrity of the LIBOR fixings. 1 During the period of turmoi in goba markets in 28 and 29, unsecured interbank ending for a but the shortest maturities was significanty curtaied in many currencies. As a consequence, many respondents may have been reporting rates that did not correspond to any actua (or even potentia) borrowings. As to whether contributing banks coud have submitted rates purposefuy designed to infuence the LIBOR fixings in a manner beneficia to their firm (perhaps because they hed derivative or other positions whose payoffs were inked to the LIBOR fix), the BBA stress that for each rate, the ranked responses are trimmed of their top and bottom quarties and then averaged to produce the LIBOR fixing. In the Austraian context, to manipuate the BBSW rate set, an institution woud need to manipuate the traded market directy. Austraian doar rates are provided to the BBA by eight banks who operate in the London market for Austraian doars. Unsecured borrowings in this market are generay quite imited, however. Much of the offshore interbank borrowing and ending of Austraian doars takes pace via foreign exchange swaps, whereby funds are exchanged against another currency (usuay, US doars) with an agreement to unwind the exchange at a future date. In this way, Austraian entities that raise short-term funds offshore (such as ADIs and the states centra borrowing authorities) generay borrow in a foreign currency and swap the proceeds back into Austraian doars. Refecting this, whie LIBOR fixings are used as the principa reference rates in currencies such as the British pound, the Swiss franc and the US doar, Austraian doar LIBOR does not have a comparabe status. Rather, BBSW is used as the interbank reference rate for most Austraian doar derivatives and other financia instruments. 1 For a discussion, see Gynteberg and Woodridge (28). Buetin SEPTEMBER Quarter

6 Government Securities In March 29, the Austraian Office of Financia Management (AOFM) recommenced the issuance of Treasury notes on behaf of the Austraian Government, more than five years after a previousy issued notes had matured (Graph 5). Treasury notes are short-term CGS and are principay used to smooth the intra-year variation in the Government s financia position. Accordingy, the voume on issue can fuctuate appreciaby. In the 21/11 year, for exampe, Treasury notes outstanding ranged between $1 biion and $2 biion. Graph 5 CGS on Issue Face vaue; as at 3 June $b n Treasury bonds $b n Treasury indexed bonds* n Treasury notes * Adjusted for capita Indexation Bps Source: AOFM Graph 6 Spreads to 3-month OIS Rates BBSW Treasury notes M J S D M J S D M J S * Breaks due to no Treasury notes on issue with approximatey 3 months to maturity Sources: AFMA; RBA; Tuett Prebon (Austraia) Pty Ltd 5 Bps In the decade or so before 28/9, consistent budget surpuses meant that the Austraian Government accumuated significant financia assets (principay, deposits at the Reserve Bank). Instead of issuing Treasury notes, asset hodings were aowed to rise and fa so as to offset the short-term fuctuations in the Government s financia position arising from the intra-year cyces in receipts and payments. Unike the roe payed by Treasury bonds in the onger-term debt market, Treasury notes are not the principa reference rate within the money market. As noted above, that function is performed by interbank rates (namey, BBSW), as it is in most overseas markets. Hence, whie successive Governments have committed to maintaining a sufficient suppy of Treasury bonds in order to provide a risk-free curve for ong-term interest rates, the suppy of Treasury notes has been aowed to vary (and even cease) as the Government s financia position has varied. At present, Treasury notes are generay offered at tender once per week. Investor appetite was somewhat variabe when Treasury notes were initiay reintroduced, but, consistent with their risk-free status, yieds on these securities are now generay we beow other short-term interest rates (Graph 6), with strong demand from offshore investors such as foreign centra banks. To aid iquidity in these instruments, the AOFM now structures its issuance toward having arge individua notes, with no more than one note maturing in any haf-month period. The centra borrowing authorities of the states and territories aso issue short-term debt securities. 9 Most semi-government authorities appoint a pane of deaers through which they se their notes and/ or commercia paper. Whie some authorities tender set amounts, others se via reverse enquiry ; that is, they respond to indications of demand that the deaers have received from their investor cients. Refecting the benchmark status of prime bank bis and CDs, rates on semi-government short-term debt 9 For more detais on the debt programs of the centra borrowing authorities, see Lancaster and Dowing (211). 44 Reserve bank of Austraia

7 securities tend to be set at a margin to BBSW, with the spreads beow BBSW tending to be somewhat ess than those impied by Treasury note yieds. As at 3 June, there was $12 biion in semigovernment short-term debt on issue in the domestic market (athough, as with Treasury notes, the outstanding voume can vary substantiay through the year). In addition to their domestic issuance, the semi-government authorities aso maintain offshore commercia paper (CP) programs. This CP is aso issued through deaer panes, but is generay denominated in foreign currencies with the proceeds swapped back to Austraian doars. Other Short-term Debt Securities The domestic market for asset-backed commercia paper (ABCP) had grown steadiy throughout much of the past decade, with most issuing entities (often known as conduits) acting as warehouses for residentia mortgages purchased from a range of originators. However, as with securitised asset markets in genera, the market for ABCP was adversey affected by the dramatic reassessment of risk that, from mid 27, brought about a proonged period of turmoi in goba markets. Initiay, domestic issuance rose sharpy as the conduits, facing increasingy difficut conditions in Europe and the United States, reoriented their funding onshore (Graph 7). Subsequenty, as the domestic market for ABCP aso deteriorated, conduits were forced to draw on their back-up iquidity faciities with sponsoring banks. 1 Athough a number of programs remain in operation, issuance of ABCP has continued to decine. In part, this refects a reduction in the suppy of assets typicay purchased by the conduits (such as mortgage originator oans). Additionay, with investor demand for ABCP sow to recover, the issuance of many conduits has faen in ine with the ongoing amortisation of the oans hed by them. The credit ratings for many of the domestic ABCP programs have aso been owered since the period of market turmoi. $b Graph 7 Short-term Debt Securities Issued by Private Non-banks Other 1999 Source: ABS ABCP The financia crisis aso brought asting structura change to the issuance of commercia paper by other non-bank entities. The funding difficuties encountered during 28 and 29 prompted severa major issuers to permanenty cease their ending activity in particuar markets (such as car deaer finance), with their CP programs scaed back accordingy. Simiary, severa of the financing companies affiiated with banks ceased issuing debt into the market in their own name and now either obtain funding directy from their parent bank or have had their financing activity brought onto the parent bank s baance sheet. $b For an overview of the Austraian ABCP market, see Back and Fisher. Buetin SEPTEMBER Quarter

8 Box B Overnight Indexed Swaps Interest rate swaps are derivatives in which one party agrees to exchange fixed ( swap ) rate payments on a notiona amount against receipts determined by a foating (reference) rate appied to the same amount. In the Austraian market, overnight indexed swaps (OIS) are swaps referenced to the cash rate the rate on unsecured oans in the overnight interbank market. In contrast to yieds on debt securities, swap rates cannot stricty be thought of as rates of return, as a swap invoves no upfront investment of funds. To earn the OIS rate, an investor woud need to receive the fixed rate in the swap and separatey pace funds equa to the notiona amount of the swap in the overnight cash market each day for the duration of the swap. The interest receipts from these overnight oans woud offset the foating rate payments that are made in the swap. As such investments in the interbank market incur credit risk, OIS rates are therefore not risk-free rates. However, each day, the investor can decide anew which bank to pace funds with. In this regard, overnight bank ending through the ife of the swap is ess risky than ending to the one bank for the fu term. For this reason, OIS rates are usuay beow the rates on unsecured bank debt (such as bis and CDs) of equivaent maturity (Graph 6). From the borrowing bank s point of view, the spread represents the cost of converting their funding from overnight to term maturity. During the financia turmoi of 28 and 29, these spreads became eevated as investors demanded considerabe premiums for term ending. As the cash rate is the operationa target for the Reserve Bank s monetary poicy, banks use trades in OIS to hedge their interest rate exposure. Others may use OIS to specuate on the near-term direction of the cash rate. For these reasons, OIS rates generay provide the most direct means of gauging market expectations for the future course of monetary poicy. 1 For exampe, just prior to the Reserve Bank Board meeting in June 211, one-month OIS was quoted at 4.8 per cent (Graph B1). As the existing cash rate target was 4.75 per cent, this impied that market participants saw some chance of an increase in the cash rate during the coming month. 2 % Graph B1 Forward Cash Rates Impied forward cash rates As at 6 June 211 OIS rates Months Sources: RBA; Tuett Prebon (Austraia) Pty Ltd 1 Simiar information can be geaned from the SFE s 3 day interbank cash rate futures, which are aso indexed to the cash rate. 2 At the termination of an OIS, the foating rate payment due wi be equa to the compounded cash rate over the term of the swap. Because of this compounding, OIS rates wi exceed the arithmetic average of the forward cash rates (as in Graph B1). % Reserve bank of Austraia

9 Subsequenty, OIS rates have decined, suggesting that market participants expect a near-term easing in monetary poicy. Inferring expectations about the future cash rate from the OIS curve can be probematic, however. Investors who ock in an interest rate for onger maturities may demand compensation in the form of higher rates. In this sense, forward cash rates may exceed cash rate expectations by a term premium. 3 Various statistica techniques can be used to try to extract such a premium, athough it is difficut to gain reiabe estimates. 4 Furthermore, movements in OIS rates (and, indeed, in many interest rates) can at times be exaggerated when arge shifts in the positions of market participants overwhem the avaiabe iquidity in the market. The dramatic fa in OIS rates during August 211 may be one instance of such an occurrence. 3 Note that this term premium (which refects compensation for interest rate risk) is conceptuay distinct from that auded to above when discussing spreads between bank bi and OIS rates. That premium refects compensation for the additiona credit and/or iquidity risk invoved in purchasing term funding instruments such as bis. The term risk embedded in OIS (which is a derivative, not a funding instrument) ony reates to interest rate risk. 4 Theoreticay, there is no reason why this premium may not be negative. However, empirica studies, both on Austraian doar and foreign currency interest rates, generay find that the term premium is positive. Buetin SEPTEMBER Quarter

10 Concusion The domestic money market is dominated by bank bis and CDs, principay those issued by the prime banks. The importance of prime bank securities is further enhanced by the reference roe that BBSW pays in determining settement amounts on derivatives and other contractua payments. Recent structura changes have diminished the reative suppy of bank bis and CDs and forthcoming changes to the iquidity reguations imposed on ADIs may further ater the market. Since the financia crisis, there has aso been a reduction in issuance by securitisers and other private non-bank entities, whie changes in the Austraian Government s financia position have seen Treasury notes reintroduced into the market. R References Back S and C Fisher (28), The Asset-backed Commercia Paper Market, RBA Buetin, January, pp 1 1. Lancaster D and S Dowing (211), The Austraian Semi-government Bond Market, RBA Buetin, September, pp Gynteberg J and P Woodridge (28), Interbank Rate Fixings During the Recent Turmoi, BIS Quartery Review, March, pp Reserve bank of Austraia