The IRS market. the debt management view Richárd Farkas Judit Páles GDMA - Hungary

Transcription

1 The IRS market the debt management view Richárd Farkas Judit Páles GDMA - Hungary

2 IRS in the practice of debt management agencies The main task of the debt management agencies is threefold: to secure the financing needs of the government at the lowest level of cost with an acceptable level of risk

3 IRS in the 80es The debt management was a huge player on the domestic market The debt management function was not isolated from the other tasks of the state (e. g. interest rate policy) Debt management agencies entered the IRS market occasionally Most of the debt management agencies acted opportunistically The main reason for IRS was cost reduction Debt managers took risks without correct measurement of the risks taken

4 IRS in the 80es Debt managers take risks in the form of betting against the market They took part in the convergence game; betting on the ongoing European monetary union, exchange rate movements and convergence of interest rates Time revealed, in many cases the the debt managers were right, and costs decreased Sometimes they were false and costs increased

5 IRS in the 80es Debt managers had access to information not available to the other actors on the market Private information included the interest rate policy (if the central bank accomplished debt management tasks), and the debt managers own financing strategy If one of the actors has private information, rational actors either leave this market or require higher gains as a compensation This situation ends in a loose-loose situation in the view of debt manager

6 IRS in the 80es The IRS activities had a signalling side-effect Reason: private information of debt management Result: interference with the interest rate policy Remedy: transparency

7 Canada the exception that proves the rule In the 80es Canada was an exception Launched the IRS programme in Used IRS systematically In order to reduce costs the debt manager decided to transform part of the fixed rate debt into floating rate debt In the first years the programme turned out to be cost effective Later the cost benefits diminished In 1995 the duration of the total debt decreased, so the debt manager had to either stop issuing short-term bills or terminate the IRS programme; the decision was the latter

8 Cost reduction via IRS For the debt management agency there are two ways to build a variable interest rate bearing debt: 1) Issuing short term bills 2) Issuing fixed rate bonds and entering an IRS agreement 3) Issuing floater bonds As the market of floating rate bonds lacks investor demand, we concentrate on the 1 st and 2 nd options

9 Cost reduction via IRS The cost of financing with T-bills (issuing bills) is the short term treasury yield The cost of financing with issuing bonds & entering IRS (issuing synthetic bills) is the long term treasury yield plus the interbank rate minus the swap rate The synthetic issuance is cost effective if the short term yield is higher than the long term yield plus the interbank rate minus the swap rate I.E. IRS is cost effective if short yield interbank rate > long yield swap rate interbank rate short yield < swap rate long yield short spread < swap spread

10 Theory suggests: The state is the best debtor The state has absolute advantage compared to the banking sector: Both short spread and swap spread are positive The state has comparative advantage on the longer term: Swap spread is higher than short spread Cost reduction via IRS The effect of IRS programme in France short spread swap spread difference

11 Cost reduction via IRS On the market prices are driven by demand and supply In case of Canada the difference between swap spread and short spread reached 66bp in By 95 the difference diminished to 22bp When a debt management agency enters the market, the swap rate will increase and the cost advantage will diminish gradually

12 IRS in the 90es With the rise on the common currency Euro, the debt management agencies are no more huge players Debt management agencies gained autonomy and were separated from the other institutions Increased transparency Private information, effect of signalling diminished Benchmark portfolios are set as targets More focus on the risks besides the costs

13 The debt management agencies use IRS for three main reasons: 1) Meeting duration targets independently from the issuance strategy 2) Additional mean to meet duration target 3) Reducing the debt service costs IRS in the 90es

14 IRS in the 90es Reducing reissuance risk and the ample need of building up sufficiently large series of securities (to get the required liquidity) resulted in issuing securities with long maturity The relatively high share of long-term notes (especially in case of states with relatively low level of indebtedness) would lead to high duration Reducing the duration is (to satisfy duration benchmark) achievable via IRS Examples include Denmark, Finland, Portugal and Sweden

15 Denmark launched an IRS programme in 1998 France launched an IRS programme in 2001 At the first years both programmes proved to be cost effective After a few years the short spreads and the swap spreads converged, and the cost benefit diminished IRS in the 90es The effect of IRS programme in France short spread swap spread difference

16 In the Central-East- European countries short spreads behave normally In CEE swap spreads behave abnormally Swap rates are close to or under benchmark rates in contrast to developed countries Short spread is positive but swap spread is either negative or close to zero Swap spreads in CEE % 5,9 5,9 5,8 5,8 5,7 5,7 5,6 5,6 5,5 The IRS and the benchmark yield curve in Poland Swap Benchmark 1 year 2 year 3 year 4 year 5 year 10 year 20 year Maturity

17 Swap spreads in CEE 1. One of the possible explanation is the underdevelopment of the IRS market, and the isolation from the securities market 2. The convergence towards Euro zone can also generate discrepancies (swap rates are expected to converge but government bond rates will differ) on long-term swap rates 3. Fiscal policy also effects swap-spreads: the current state and expectations on the future state of the budget has influence on swap spreads (the risks concerning fiscal policy in CEE decreased swap spreads) 4. The slope of the yield curve effects swap-spreads: higher slope results in decreasing swap spreads (the higher the long-term rates are, the bigger the incentive is to convert them into floating rates thus swap rates will increase)

18 5. Last but not least persistent decreasing tendency in the yields also decreases swap rates If someone expects a decrease in yields, he/she would prefer to pay float and receive fixed interest; this generates incentive for entering IRS on the pay float receive fixed side Swap spreads in CEE

19 9,5 9,0 8,5 8,0 7,5 7,0 6,5 %point % 1,5 Swap spreads in Hungary Swap yield curve and benchmark yield curve in Hungary 3-month 6-month 1 year 3 year 5 year 10 year 15 year Maturity IRS spreads in the Hungarian market Swap yield Benchmark yield %point 0,60 0,35 0,10-0,15-0,40-0,65-0, Swap spreads and the slope of the yield curve in the forint market Date year swap spread (ls) Slope of the yield curve (rs) %point ,5 0-0, short spread swap spread 06.02