Debt Management Office

Transcription

1 House of Commons Treasury Committee Debt Management Office Oral and written evidence Wednesday 25 April 2012 Robert Stheeman, Chief Executive, Jo Whelan, Deputy Chief Executive and Joint Head of Policy and Markets, and Jim Juffs, Chief Operating Officer, Debt Management Office Ordered by The House of Commons to be printed Wednesday 25 April 2012 HC 420 Published on 20 July 2012 by authority of the House of Commons London: The Stationery Office Limited 5. 50

2 The Treasury Committee The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue and Customs and associated public bodies. Current membership Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Michael Fallon MP (Conservative, Sevenoaks) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Rt Hon Pat McFadden MP (Labour, Wolverhampton South West) Mr George Mudie MP (Labour, Leeds East) Jesse Norman MP (Conservative, Hereford and South Herefordshire) Teresa Pearce MP (Labour, Erith and Thamesmead) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross) Powers The committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No 152. These are available on the Internet via Publication The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at The Reports of the Committee, the formal minutes relating to that report, oral evidence taken and some or all written evidence are available in printed volume(s). Additional written evidence may be published on the internet only. Committee staff The current staff of the Committee are Chris Stanton (Clerk), Lydia Menzies (Second Clerk), Jay Sheth, Renée Friedman, Adam Wales and David Sewell (on secondment from the National Audit Office), Alison Game (Senior Committee Assistant), Steven Price and Lisa Stead (Committee Assistants) and James Abbott (Media Officer). Contacts All correspondence should be addressed to the Clerk of the Treasury Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is ; the Committee s address is [email protected]

3 List of witnesses Wednesday 25 April 2012 Page Robert Stheeman, Chief Executive, Jo Whelan, Deputy Chief Executive and Joint Head of Policy and Markets, and Jim Juffs, Chief Operating Officer, Debt Management Office Ev 1 List of written evidence 1 Debt Management Office Ev 13; Ev 16; Ev 18

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5 Treasury Committee: Evidence Ev 1 Oral evidence Taken before the Treasury Sub-Committee on Wednesday 25 April 2012 Members present: Mr George Mudie (Chair) Mark Garnier Andrea Leadsom Jesse Norman John Thurso Mr Andrew Tyrie Examination of Witnesses Witnesses: Robert Stheeman, Chief Executive, Debt Management Office, Jo Whelan, Deputy Chief Executive and Joint Head of Policy and Markets, Debt Management Office, and Jim Juffs, Chief Operating Officer, Debt Management Office, gave evidence. Q1 Chair: Good afternoon. Thank you for coming. We are very glad to see you. We fixed this date in the knowledge that we needed headlines to take attention away from the Secretary of State, the recession and everything else, so we are set for an interesting hour, because you have to be more controversial than that. Q2 Jesse Norman: Mr Stheeman, thank you very much indeed for coming in today. Your debt financing requirement, I think, has just moved to 162 billion for Is that a realistic amount? Are you entirely comfortable about your ability to raise that amount of capital? Robert Stheeman: It is important to say that no financing remit of that size should ever really be regarded as easy or unproblematic. However, this is effectively the fifth year of what I would call significantly elevated financing remits for the DMO, which we have been able to deliver successfully during that time. Under the circumstances, I am reasonably confident that we will be able to meet that remit. I am fully aware that there are any number of possible headwinds about which we do not know anything at this stage, which could come externally, have nothing to do with the UK and could affect financial markets in general. But the ability of the UK and the ability of the DMO also to raise the money that it has to raise depends fundamentally on our being able to access a very deep and liquid market on a regular basis and with as least a discount as possible to the prevailing market at that time. So far the market has held up remarkably well. Q3 Jesse Norman: Thank you for that. If the Bank stops its policy of quantitative easing, how will that affect your ability to raise the cash? Robert Stheeman: I hope not at all in as much as we have been here before. There was obviously the first round of QE in and we actually were looking at that time at a slightly higher financing requirement than we are now. When that happened, we were able to successfully deliver the remit. What should happen if the Bank were to stop QE is that if necessary the market should adjust, which means potentially higher yields, to ensure that it takes down our supply efficiently. Q4 Jesse Norman: Will it have any specific effects at any points during the yield curve as such, or particular points? Robert Stheeman: That is a very good question. Given the fact that they effectively conducted QE across the entire yield curve, I am not necessarily expecting purely as a result of their stopping QE for there to be any specific point in the yield curve that might potentially be more affected. But the yield curve itself could be affected by other things that, if you like, are significant in terms of the Bank s own policy towards QE or monetary policy in general. If there is a perception in the market, for instance, that rates may have to rise, it is conceivable that you will see a flattening of the yield curve potentially. There are any number of things that might actually happen there, but not directly as a result, if you like, of the purchases ceasing. Q5 Jesse Norman: Have you raised any concerns with the Treasury over the past four years as to the amounts that you have been asked to raise? Robert Stheeman: We have certainly had a much more intensive dialogue with colleagues in the Treasury about the nature of the market and hence our ability to go into that market and raise the financing. Concerns suggest that we on our side might have had a sense that we would not be able to meet the remit. Those concerns we have not raised, but I repeat a little bit what I said earlier, which is that we are fully aware on our side just how large these amounts are and just how much we rely on the good functioning of the market for us to be successful. That is something that we have discussed in detail with the Treasury, and I have discussions also with colleagues in the Treasury on a very regular basis about the health of the market as well. Q6 Jesse Norman: Let s be clear about this. Will they be saying to you, Look, that is the financing number, take it or leave it or will they be saying, Listen, how are the markets looking? Can we get to 162 billion? More thirsty politicians and all that stuff?

6 Ev 2 Treasury Committee: Evidence 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs Robert Stheeman: To a certain extent, it is the former in as much as we do not determine the size of the financing requirement. Q7 Jesse Norman: But do you have any actual involvement? Do they discuss it with you? Do they run it past you? Robert Stheeman: Yes. Q8 Jesse Norman: Do you give market assessments Robert Stheeman: Absolutely. Jesse Norman: or ranges of probability as to where you might be able to raise the money? Robert Stheeman: Well, what we will do in the runup to the remit is we provide advice to the Treasury and to Ministers on, if you like, not just the feasibility of how much we might be able to raise but also on what we think is the best way to go about doing that, which maturities we should be issuing into and all those sorts of things. If you like, it is part of a pattern in terms of an ongoing dialogue, but I would not want to leave the impression that we have said to the Treasury at any time we do not think necessarily that this can be done. I am willing to say that I remember a discussion that we had internally back in early 2008, internally with my colleagues, where we already knew that the numbers were going to look very significant. For us the question then was: what do we honestly think the market can do? But to a certain extent we have to see how the market develops almost on a daily basis. Together with the very high financing requirement, we have also seen a huge improvement in market liquidity. The two have gone hand in hand. Without that improvement, our job would have been much more difficult. Q9 Jesse Norman: Thank you, that is interesting. Obviously, you guys are in the markets one way or another, talking to people, thinking about financing opportunities every trading hour of every day. When you think about the UK s reported position as a safe haven in the current economic climate, how far do you think that that is the case? How far do you think that we are seeing low yields because of technical factors? How far do you think we are seeing them because of economic strategy? Talk to me about what people are saying to you in the markets and how you read that. Robert Stheeman: Clearly, the safe haven theme is one that has become much more talked about in the market, much more pronounced also and observable in the sense that when there are specific market concerns, the way the market is currently run now, when people have very strong concerns about overall international financial issues, the eurozone, whatever, you often will see what are referred to nowadays in language as risk-off moments, which tends to suggest that we will see lower yields in certain core Government bond markets. Nowadays, people regard the gilt market, sterling, as a core Government bond market together with the German Government bond market, the Bund market Q10 Jesse Norman: Right, so if there is a sell-off in French euro-denominated instruments we can sometimes see some of the you will feel that? Robert Stheeman: You can, but to actually scientifically say that three or four basis points of that is safe haven flows and three or four basis points is something else is extremely difficult. I don t think that anyone can actually separate the two out. Q11 Jesse Norman: But there are a lot of technical reasons, is the point you are making, for why yields are so low over and above whatever the political or economic judgments are? Robert Stheeman: Absolutely. Q12 Jesse Norman: What contingency plans have you put in place for a moment where we cease to be seen as a safe haven? Some event hits us, that moment of confidence passes and we click up, as other sovereigns have done. What do we do then? Robert Stheeman: Market access is the most important thing, if you like, from our perspective. In terms of ranking our various objectives and what we try to do, the ability to access the markets, if necessary the cash markets, on a daily basis, if we cannot borrow in term markets I should say that I regard that as an extremely far-fetched scenario, but it is one that arguably one should consider is key to what we do. In the event that markets become very difficult, in the event that we are no longer perceived as a safe haven, my guess is what you will generally see is a rise in yields; and probably even across the curve, although I think it would be more pronounced in the short end simply because safe haven flows, international flows, tend to favour the short end rather than the longer end. But even those countries that are facing the most egregious financing or refinancing problems at the moment do not fundamentally have a problem in actually raising the cash in the market. They may have to do so at very elevated levels, but actual market access is not a problem. Q13 Jesse Norman: Final question: it is obviously true that the state of the eurozone, concerns about currencies being linked together, is causing an enormous amount of disquiet Robert Stheeman: Absolutely. Jesse Norman: in our potential, as it were, competitor countries from the point of view of being able to fund? Robert Stheeman: It is. For instance, I talk to my peers in other Debt Management Offices also around Europe very regularly and they have real challenges and they are very much aware of them. But it is also worth noting that a number of eurozone countries are already so far this calendar year very far ahead, further ahead I think than some people would have expected, in terms of actually raising the money that they need to raise. Q14 Jesse Norman: So they are praying for independent currencies so they can deflate and get on with the job? Robert Stheeman: I am not so sure it is a question of inflating anything, but I do think that one of the things

7 Treasury Committee: Evidence Ev 3 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs that we benefit from and makes our lives easier and I choose my words carefully because I know that there is an argument somehow that the UK could potentially devalue its own currency. That is not an impression that I would want to leave you with. I think that where we have an advantage is that the perception of the entire framework that we have here in the UK is that there are not just strong institutions but there is a framework that allows the Central Bank to pursue monetary policy for the needs of this particular economy in this country. Jesse Norman: Thank you very much. Q15 Mark Garnier: If I could concentrate on quantitative easing, but before I start on the bulk of my questions can I just follow up on one from Mr Norman, which is your relationship with the Treasury and how you go about issuing gilts. You have 166 billion to issue this year. Who determines the timing of when you actually sell a new gilt? Does the Treasury say, We need some money in April to pay for a new hospital? How does it actually work in terms of timing? Do you determine that? Robert Stheeman: We do not actually determine the timing. We provide funding for central Government on a daily basis and that is done through our so-called cash management operations. If you like, we know in advance. We receive forecasts from the Treasury in terms of the cash needs of central Government over a longer period of time and that forms the basis of our cash management transactions. At a time when the Government is in deficit, we know that over time, if you like, there is a shortfall. The gilt issuance programme is overlaid on that, but on any given day Government will either be in surplus and actually that does happen or in deficit, and it is the role of the cash management function to smooth those peaks and troughs out throughout the year and to ensure that any Government expenditure is fully funded. Q16 Mark Garnier: But from the point of view of the markets, your actions within the markets in terms of issuing gilt is based entirely ultimately, the day-to-day timing is basically your choice? Robert Stheeman: To a large extent. The remit that we just spoke about is given by Ministers. It is based on advice that we give to the Treasury. We discuss it in detail with Treasury colleagues; it is then discussed with Ministers. In that, we draw up in the DMO a proposed auction calendar for the entire year. That auction calendar, which is also published at the time of the Budget, has very specific dates and stipulates whether we are going to do a conventional nominal gilt issue or an index-linked gilt issue. But the exact choice of which stock we will actually be issuing, that is a choice that the DMO makes on a quarterly basis following consultation with the market, with giltedged market makers, and with end investors. We hold consultation meetings quarterly. Once we have completed that process, we will then announce in advance, usually six weeks in advance, a calendar for the following quarter, and the exact amount that we issue, the exact size of that issue, we determine a week in advance. Q17 Mark Garnier: Okay. So the markets are well prepared for you to Robert Stheeman: They are very well prepared, and I would also say that the UK probably has one of the, if not the, most predictable issuance regimes of any major sovereign debt manager. Q18 Mark Garnier: One of the great criticisms of a previous Chancellor was that he announced to the gold market that he was going to sell off a substantial amount of gold, and that in itself drove the price down. Is there not a potential that just the fact the market knows you are coming is going to change the shape of the yield curve or, indeed, raise yields? Robert Stheeman: I am sure to some extent that does happen, absolutely, but there are so many independent analysts and forecasters. All the banks put out all their research pieces usually in advance of the Budget or the Autumn Statement saying what they expect us to be doing in the coming year. You are absolutely right; the market has largely discounted those movements well in advance. We sell them Q19 Mark Garnier: So a gilt trader is not going to suddenly pick up a kind of little depression? Robert Stheeman: No, unless the market gets something wrong, in the sense that they have anticipated a different number to what is actually published. Q20 Mark Garnier: No, okay, fair enough. Great. If we can get on to quantitative easing. You were interviewed by the Telegraph in April this year where you were asked if more QE would risk pushing up the cost of Government debt. You said that it could. I am slightly confused about that. Do you mean that it could push up the cost of the gilt or push up the cost of the yield? Robert Stheeman: Well, both effectively because Q21 Mark Garnier: Really? It cannot be both. Robert Stheeman: No, sorry, I think there was a slight misinterpretation in one of the headlines and what was in the actual story. I did not say this, and if you read the actual article carefully, the point that I was trying Mr Tyrie: You sound like a politician, just briefly. Robert Stheeman: I will take that as a compliment. The point that I was keen to make is that if there were to be so much QE that it would act disruptively to the market and the market were not to function well, that could hypothetically push up the cost of Government borrowing. Q22 Mark Garnier: So the yields and push down the price of Robert Stheeman: Push down the price, exactly. Q23 Mark Garnier: Let me interpret that, if I have this right. What you are essentially saying is that ultimately it means the marketplace as a whole loses faith in the stability of the market because QE has basically hashed it up and people are stepping away. It is a very counter-intuitive statement that you are

8 Ev 4 Treasury Committee: Evidence 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs Robert Stheeman: It is slightly counter-intuitive, and, as I say, I was not very happy with the headline because it suggested that I was indirectly criticising QE for something that it has not done. The point that I was trying to make is that we keep an extremely close eye, as, to be fair, the Bank does too, on the smooth functioning of the market. Anything that proves to be disruptive to that is a concern to us because we need the smooth-functioning market to be able, as I say, to access on a regular basis. If liquidity were to dry up in specific gilts to such an extent that they were no longer liquid, that could become a problem and could be an expensive one. Q24 Mark Garnier: Why would liquidity dry up? Robert Stheeman: If the Bank has taken out of the market so much of what is referred to as the free float, then liquidity could. Q25 Mark Garnier: If you are saying you have a 5 billion gilt issue and the Bank owns four of it, 1 billion is not a liquid enough free float for Robert Stheeman: The gilts in issue tend to be larger. I should say that the Bank has itself put a rule into the market, which is that they will not buy more than 70% of an individual gilt to avoid precisely that situation arising. Q26 Mark Garnier: Is that the right limit? Robert Stheeman: It is exceptionally hard to say. To be fair, they have got very close to 70% in certain gilts, and the market is still working well. But if I can mention one other point, you may be aware that in 2009 we agreed with the Bank of England that we would lend out into the market, into the repo market, the gilt portfolio that they themselves have bought in. Why? Because one of the major factors supporting liquidity in the market is a very healthy repo market, as it is called, behind that. Because the Bank in the first round of QE initially was sitting on that gilt portfolio and not lending it out, liquidity was drying up. We then had a very specific concern around that. Q27 Mark Garnier: That is very interesting. There is essentially 300 billion-worth of gilts being lent out? Robert Stheeman: Yes. I do not know the exact amount. Jo Whelan: It is a smaller proportion; it is about a third. Robert Stheeman: It is a smaller proportion, but we have it ready Mark Garnier: So about 100 billion, potentially? Jo Whelan: It can be. It depends on market demand. Robert Stheeman: People can come to us and ask us to lend them the gilts. Q28 Mark Garnier: When the Bank wants to intervene through asset purchasing, what sort of relationship do you have with them? Because as I understand correct me if I am wrong the Bank will buy new issues, or is that not the case? Robert Stheeman: No. Well, the Bank will buy anything that is in the market. They will not buy new issues, certainly not directly from us; that is not permitted under the Maastricht criteria. If we have announced an auction of a particular issue, they will exclude that from their buybacks for a period to avoid even the perception that there is any kind of monetary financing. But once that issue is in the market, in the secondary market, they will a week later reinstate their purchases to buy those issues that we have issued as well, but they will also buy all the gilts, too. Q29 Mark Garnier: No, sure. They are basically managing what amounts to a 325 billion gilt portfolio? Robert Stheeman: Absolutely. Q30 Mark Garnier: Do you have any sort of relationship with the Bank at all when it comes to the gilt market? Do you speak to the MPC at all? Robert Stheeman: I speak to individual MPC members, but those members are, if you like I speak to them solely about operational matters. I do not speak to them about monetary policy and I would not ask them what they think their future decisions are going to be. Just to give an example, I had a meeting on Monday with Paul Fisher of the MPC, but he is also the Executive Director of Markets. What we talked about were market matters that are of mutual interest and it has been noted publicly by the Governor on several occasions that were the Bank to decide to do anything with their QE portfolio they would be talking to us about the operational aspects of any disposals. Q31 Mark Garnier: Of course, the effect of QE, as Mr Norman was alluding to a bit earlier, is to drive down the cost of Government borrowings and actually have a direct effect on it. But, of course, the key question is that at some point in the future there is a 325 billion seller of gilts. How do you see the unwinding of the QE book happening in the future? Robert Stheeman: A couple of points that I can make on that. The Bank itself has said that were they to unwind QE, first of all it would be preceded by increases in interest rates. Secondly, were they to unwind QE, it would be done in what they describe as a programmatic fashion. Paul Fisher himself has said that publicly. In other words, they will also try, in a very predictable fashion I imagine, to say that they will be selling X amount over a certain period of time. I am presuming, and this is only a presumption, that the MPC would decide in, if you like, the flipside of what they are doing now in a programmatic fashion to buy, then also to sell. But if I can express a personal opinion, and I stress this is a personal opinion, for them to sell parts of the gilt portfolio may potentially who knows be far off. If the Bank has described, as they have, QE as being unconventional monetary policy, in other words unconventionally loose monetary policy, presumably any selling of gilts would represent unconventional monetary policy tightening. I think it is a fair assumption for somebody to make that the scenario in which they feel the need to tighten monetary policy in an unconventional way, i.e. not just through the increase of the Bank rate, could be a scenario from

9 Treasury Committee: Evidence Ev 5 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs which we are now a long way away still. But that is not for us, I should say. Q32 Mark Garnier: No, it is not, but from the conversations we have had with members of the MPC here there seems to be, I think, a number of points that are relevant to this conversation. The first is that, of course, they hold gilts fairly evenly spread across the yield curve, which, of course, does give them the potential to just let them mature Robert Stheeman: Absolutely. Mark Garnier: so they do not have to have an intervention. But on your substantive point about the unconventional monetary policy, it has been made, I think, perfectly clear to this Committee by members of the MPC that that is absolutely how they see it. Then when you run out of room on the baseline rate you have very limited alternatives to do. Possibly right at the very beginning quantitative easing was about getting money into the system where there was a lack of liquidity. But certainly since then the most recent intervention seems to be very much, as you say, this unconventional monetary policy. It has also been said, and I hesitate to quote the Governor because I cannot remember his exact words, but certainly the sense was that as the economic conditions pick up that there will come a time when, of course, they will be wanting to start tightening monetary policy. But I think the key thing that is relevant to this conversation now is that there could easily be a situation in the future where the Government, through you, is trying to raise funds to borrow, 100 billion, 150 billion a year, at the same time that the Bank of England is exercising unconventional monetary policy and pushing up gilt yields, which of course will make you, the DMO, in competition with the Bank of England. How do you see that playing out when it inevitably happens? Robert Stheeman: My guess and it goes back to something that we mentioned a little while ago is that the market will have probably discounted that before the actual sales take place. In other words, our assumption is that the price adjustment process required by the market to deal with effectively two very large sellers of gilts simultaneously, will have occurred in advance of the Bank actually selling, or certainly in parallel to. I do not foresee, if you like, a rapidly escalating yield level while the Bank is selling. As soon as an announcement were to be made by the Bank that they will be selling gilts, if not before, it seems to me reasonable to expect that yields will have already adjusted to the possibility of that happening. Q33 Mark Garnier: I would not disagree with that apart from one point, which is can you think of any other example when there has been an unwinding of an asset purchase scheme that the markets can look back on to see what happens? Robert Stheeman: Not on this scale. I agree with you, we are in uncharted territory not on this scale because the Bank is now a very, very large investor in the market and participant in the market, which goes back to my point. That is that I could potentially foresee a scenario where some of these gilts do run off and do mature before they are actually sold into the market. That, as I say, if I am allowed, is a personal opinion. It is not an official opinion of the DMO. Mark Garnier: No, sure. It is going to be a very interesting situation when it develops. Robert Stheeman: It will. Q34 Andrea Leadsom: The Governor of the Bank of England has said that quantitative easing is a monetary tool like any other. Do you agree with that? Robert Stheeman: Like any other is probably an interesting expression. He also said, as I mentioned, that it is unconventional, so I suppose by definition if it is unconventional it is not really like any other. But I do accept that it has been done for monetary policy reasons and in the same way as interest rate decreases and increases have effects on the yield curve and on the level of yields, certainly QE does, too. Q35 Andrea Leadsom: But would you agree that when you are intervening in what is an open and an unfettered and highly liquid market that it is not the same as simply changing interest rate levels? For example, the Governor has told this Committee that the day that we all pray for when the economy turns around and is in danger of overheating because we are all growing so fast and doing so well economically is the day he will raise interest rates by quarter of a per cent and then start unwinding the asset purchases. Would you agree that unwinding the asset purchases is not exactly the same as raising interest rates? Robert Stheeman: Yes, I do. Q36 Andrea Leadsom: What do you think is the difference? What do you think is the difference between him raising interest rates by quarter of a per cent and then another quarter and then another quarter, versus him raising them by quarter of a per cent and then saying, Right, hey, I m now going to offload, whether it is on a programme trade or whatever, a third of the entire debt of the UK Government? Robert Stheeman: Were he to do that or were the MPC to decide to do that, that to me seems to represent a very strong form of monetary policy tightening, and quite a dramatic form of monetary policy tightening. Q37 Andrea Leadsom: That is what he has told this Committee he will do. When challenged on that point, he has said it is the same as raising interest rates. You do not agree with that? It is not the same? I do not agree with that and I would be interested to know do you think that it would have the effect, if the market saw that the Bank of England was a seller of a third of the outstanding gilt debt of the UK, that that would dramatically change the yield curve overnight? Robert Stheeman: If there were an announcement that the Bank of England intended to sell the entire asset purchase facility portfolio, which they have now accumulated with gaps over a period of three years, that would most certainly have an effect on the market. But I would assume that he would want that effect on the market, otherwise it is not quite clear to me why they would want to sell all of it in one go.

10 Ev 6 Treasury Committee: Evidence 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs Q38 Andrea Leadsom: Only because the Governor has told us that would be his strategy. He has very clearly said that he would raise rates and then he would unwind. Obviously I am putting you under a lot of pressure here. We had a bit of a discussion about the fact that if I buy a gilt for 98 pence in the pound and then I sell it at 92 pence in the pound, I would appear to have made a loss of six pence in the pound. The Governor says that that is not, in fact, the case because it is all circular. I wonder if you could explain why the taxpayer does not make a loss in that scenario or whether I am just misunderstanding and, in fact, the price will not go down if the yield goes up. Robert Stheeman: To a certain extent, I really must say that is probably one for the Bank, but there are a couple of points on that. If you like, there is some economic theory behind that and I am not an economist, and presumably the benefits to the overall economy, and that I believe was the point that he was trying to make, through increased economic growth, which in itself has necessitated selling the portfolio and tightening monetary policy, cancel out the potential losses to the Exchequer that would occur because the Treasury has indemnified the Bank for any losses arising out of the QE portfolio. Q39 Andrea Leadsom: Okay. I feel that he meant it more mechanically than that. I wonder if you could talk us through the accounting changes. Because, in fact, what the Governor was saying was that because the Bank of England s purchase of gilt assets was against an electronic credit to the seller, so in other words that is where the creation of money comes from, therefore when you come to sell the gilts you are simply cancelling off something that was only a book entry anyway and that it is all circular. I wonder if you can just talk through that because presumably the DMO as an alternative could buy the gilts back from the Bank of England itself. Is that correct? When he comes to be a seller, you could say, We will buy that debt, if the UK was in a position to redeem some of its own debt. Is that technically correct or is that not right? Robert Stheeman: I do not think it is in as much as what the Bank has done; is that it has conducted its purchases in the secondary market. We are active in the primary market as the issuer so Q40 Andrea Leadsom: Yes, but issuers can always buy back their own debt from the market, can t they? Robert Stheeman: We could, but if we have a financing requirement we are going to have to refinance those purchases somehow. Q41 Andrea Leadsom: Yes, that is certainly true, but if the UK economy was in a position to redeem some of that debt rather than sell it back into the secondary market, as a technical point you could buy it. Robert Stheeman: You mentioned the accounting factors. To be honest, I would have to discuss those with colleagues in the Treasury. I honestly don t know and, as I say, presumably we would have to be in a surplus position, and a considerable surplus position, to be able to do that in the first place. That would be my presumption. I would suggest we are a long way from that at the moment. Q42 Andrea Leadsom: Yes, absolutely. What I am trying to get at, though, is the fact that the Governor says there will not be a loss. What I am failing to understand is how, if I am the Governor and I have bought gilts at 98 and then I sell them at 92 or 95 or whatever I sell them at, why have I then not made a loss? You cannot shed any light on that. Robert Stheeman: I can t. I think that question really should be put to probably the Bank and the Treasury as well. Q43 Andrea Leadsom: Okay. Then to Mr Garnier s point about you would not feel at all uncomfortable because the key point here is that if, as we all assume, the UK is still going to need to be borrowing and, therefore, you are not being wound up and told, Thanks very much; we no longer need you because we have no more debt to issue, therefore, you will still be issuing debt the day that the Governor is selling gilts into the secondary market because you cannot buy them. You cannot simply redeem them and then reissue something on behalf of the UK Government, is that correct? Robert Stheeman: In theory, I suppose we could, but for us to repurchase debt and just to reissue debt seems to be a very circular thing, and I am not convinced it would be the most efficient way of us also achieving our debt management objective of minimising the cost of what we are currently having to issue. Q44 Andrea Leadsom: No, but I think what I am getting at is surely you should be considering it. Because if, as I think you agreed, a programme trade to sell a third of the outstanding gilt debt of the UK into the market is going to have a significant impact on the yield curve at a time when we are just now rejoicing that the economy is recovering, so the alternative is that the DMO redeems it, buys it back from the Bank of England or simply waits until it matures. We have not discussed what the average maturity date is of the debt. But then presumably, if you redeemed it, you could then in a more orderly fashion increase your gilt auctions, could you not, or am I completely missing the point? Robert Stheeman: Well, what I would say is again it would add to our own financing requirements, so my guess is that the impact on the overall level of yields would be the same regardless of whether we were buying these back in the market or whether the Bank was selling them. You would have to just add it to our overall borrowing programme, and it seems to me that you are looking at a high-yield scenario either way. Q45 Andrea Leadsom: Okay, so has the DMO assessed with the Bank of England the mechanisms and the choices for unwinding the QE programme when the time comes? Robert Stheeman: We have only discussed on a very basic operational level what potentially might have to be done because those are decisions that the MPC reserves entirely for itself, and they will not discuss

11 Treasury Committee: Evidence Ev 7 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs with us, if you like, timing or speed or quantum of their sales were they so to choose. All we have discussed, if you like, are the actual mechanisms, but what they have said, and I repeat and I think Paul Fisher been on record as saying this, too is that any sales would be conducted in a programmatic fashion. In other words, to try to condition the market; rather than just dumping all the gilts in one go, that they will have a programme, if you like, the mirror of what we have, a programme in terms of selling gilts as well. Q46 Andrea Leadsom: Are you saying that you have or you have not discussed with the Bank the way in which that will be done so as to fit in with what you yourselves are trying to do? Robert Stheeman: Not in any great detail, no. Q47 Andrea Leadsom: Do you think that it would be a good idea to do that? Robert Stheeman: Closer to the time I am sure, and we stand ready on our side to speak to the Bank when they choose to talk to us about it. Q48 Andrea Leadsom: Isn t it the case that if you are getting yourself into uncharted territory on a programme that no Government has ever done before you should think about the exit before you walk down the blind alley? All we are doing is more and more QE and still it appears nobody has actually considered the mechanism by which you get out of it. Robert Stheeman: Again, I accept the point but I really think it has to be directed towards the MPC and to the Bank and not to us. Andrea Leadsom: Okay. I would just like to make the comment that I think the DMO is absolutely integral to all of this and I think it should be as incumbent upon you to raise this with the Bank as vice versa because it will impact on your ability to fulfil your programmes when the time comes, whenever it is. Q49 Mr Tyrie: We get so much change in our exchanges with you, you see, that we feel you are the people for the job to help take us through this very complex area. You must internally have developed a view on the subject. You must have held meetings with your senior colleagues and said, Well, what would we like? Do you have an institutional view? Robert Stheeman: We have an institutional view and certainly it does match this idea, if you like, that sales would be conducted in a programmatic fashion. I apologise if it sounds a bit as if I am repeating myself, but I think, as I say my personal view unless we have rampant inflation I find it personally hard to visualise a situation where the Bank will want to sell a large part of the portfolio that they have bought. I would imagine that it is conceivable, almost to demonstrate that it can be done, to decide at one point when they want to tighten monetary policy and withdraw liquidity from the market that they will want to start to say, Right, there is a certain amount that we will be selling over a three or six-month period in small amounts. To me, that sounds from the perspective of actually going about selling the most sensible way for them to be doing it as well, but again that is a question that really must be directed at them. Clearly, we do not want anything that looks like a disorderly market. That is not in our interests. That would affect the DMO and it affects what we do. But in fairness, the Bank has no interest in that either. The mere fact that the market knew that they were about to sell I imagine would have had the desired effect on rates that they are hoping for. Q50 Mr Tyrie: If you were the Bank of England and had just seen a triplication of your balance sheet with prospect of more, you would develop an institutional view, too, wouldn t you? Robert Stheeman: Yes. Q51 Mr Tyrie: Do you think that that view would always be the same as the DMO s institutional view? Robert Stheeman: The honest answer is I don t know. I really don t know because we have different objectives. Q52 Mr Tyrie: But you agreed with Andrea that we need to start thinking about this because these sums are not trivial. Robert Stheeman: Yes, and I accept that and I think that is a very valid point but Mr Tyrie: These sums are huge. Robert Stheeman: They are. Mr Tyrie: Three hundred billion. Andrea Leadsom: And, of course, the only historical records of printing money have resulted in hyperinflation, so it is interesting you say, We don t anticipate high inflation, but there is very little past precedent and the only one that there is it is why Germany did not want to allow the ECB to print money for that very reason, because they remember their post-war hyper-inflation. There is a history here. Robert Stheeman: Forgive me again if I sound almost defensive. We are not responsible for monetary policy. Sometimes in my dreams I wish I was, but those are dreams only. Q53 Mr Tyrie: No, you are playing with a very straight bat throughout this. I would just like, if I may, Chairman, to develop one or two of these points a little. Maybe one way of looking at this, maybe we go back to some of the questions that were being asked a moment ago by Mark. You say you have discussed this in general operational terms with the Bank, and presumably you have had some preliminary discussions with the Treasury. Do the three of you meet? Robert Stheeman: In terms of formal meetings to discuss these things, no. Q54 Mr Tyrie: Do you think that might be a good idea? Robert Stheeman: It could be. Q55 Mr Tyrie: What a cautious man. Could you possibly supply the Committee with a note of your institutional relationship with both the Bank and the Treasury, who you are meeting, how often, how formally, not in any way that could in any way imperil

12 Ev 8 Treasury Committee: Evidence 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs any of your operations but just to give us a feel for exactly how these discussions are being conducted? Robert Stheeman: I am happy to. Q56 Mr Tyrie: If we crossed a couple of noughts off these numbers, we would not be going through all these conversations, but these are very large numbers indeed. Can I take you back to before we move off QE, just one more question on QE: do you have, and you very kindly expressed a personal view earlier, a personal view on whether and, if so, how the Bank should go about unwinding QE? Robert Stheeman: The notion of the programmatic sales programmatic sounds a very technical word let me explain why I think this is important. It is very similar to what we try to do. I mentioned earlier how much emphasis, and I have said this previously to the Committee, we place on being predictable and transparent. I think it is vital that any QE sales are done in a predictable and transparent way, too. That is of fundamental importance for the overall health of the market. As long as that happens and it happens in a controlled fashion, I believe that the market will be able to deal with that in an orderly way and presumably in the way that ultimately the MPC wants it to deal with it. That to me is fundamentally key. I also think that it should be done, rather as we do as well, in terms of completely, if you like, nondiscretionary when it comes to when we have an auction we don t normally, unless there is something very unusual such as an uncovered auction, look to exercise any form of discretion. We will accept bids at the market price. Similarly, I would expect the Bank to accept bids for their sales at the market price. I think all those things are fundamental to maintaining confidence in the smooth running of the market and I would very much hope that the Bank would follow that and I have no reason to think that they would do anything else other than that. Jo Whelan: Well, they do it themselves. Q57 Mr Tyrie: While you just touched on uncovered auctions, it would just be helpful if you could tell us why it is we seem to be doing so much better than our European counterparts? Robert Stheeman: If you are talking specifically about uncovered auctions, I should say each country has different auction formats and different ways of conducting auctions and different rules. I would love to say that we think our rules are so much better or superior. I don t know whether that is the case. What I do feel is that we have a so-called primary dealer system, the gilt-edged market makers that we appoint, which I think works exceptionally well where they feel incentivised because of the depth and liquidity of the market to turn up regularly at each of our now very frequent auctions and take down the gilt supply as necessary on a frequent basis. I think that that has worked very well. Other countries do not necessarily have a primary dealer system, or they have variants of a primary dealer system. If I just mention Germany, there is often a lot of talk about Germany having what is referred to in the market as technically uncovered auctions. Apparently there was another one even today. When they have an uncovered auction it does not cause much in the way of headlines compared to when we have an uncovered auction here, but their system is fundamentally different. I am trying not to sound arrogant or self-serving. I do not want to convey the impression that our system is vastly superior. I think it works exceptionally well for the UK gilt market, but the key to our success, I think, is the improved depth and liquidity of the market overall. I would like to think that it is also because we engage very, very closely with the market, which means with investors. It means also with the gilt-edged market makers to understand what their needs and their preferences are, not just through formal consultation meetings but also informal dialogue, dialogue that takes place almost on a daily basis through the dealing desk, with my colleagues at different levels, so that we have a pretty good idea of what the market genuinely needs and what the concerns might be. That also forms the basis of the remit advice that we give to the Treasury, which then turns into the remit that we ultimately get. I think that that has worked better. Sometimes also I should say that if we have an uncovered auction in the UK we benefit from that in as much as and it sounds an extraordinary thing to say the market will suddenly adjust very quickly and speedily to a new price equilibrium. That can actually act as a catalyst for further buying and I think that has helped us. Q58 Mr Tyrie: It sounds as if you have something to tell some of your European counterparts on how to run debt service. Are you in contact with your counterparts? Robert Stheeman: Very frequently. Q59 Mr Tyrie: What do you tell them? They are having a very bumpy time, some of them. Robert Stheeman: Some of them are, but I don t think Mr Tyrie: I noted instead that you have said that at a price the market is still clearing. Robert Stheeman: Yes, and in fairness I do not think that some of the challenges and the difficulties that some of our European counterparties, especially in the periphery, are experiencing is necessarily because of what the Debt Management Offices or the debt agents are doing in those countries. I think there are much bigger forces the eurozone and much bigger factors at the moment that are influencing what is happening with their debt sales. I referred to Germany and the uncovered auctions. One of the problems I think that the Germans have at the moment specifically is nothing to do with the Financing Agency in Frankfurt. It is that the level of yields in Germany are so low that you will see that the market has pushed them to such a level that end investors are not always willing to turn up and buy them. That is possibly because futures prices have risen and pushed yields to unsustainable levels on that day. I suppose what I am saying is I do not want to create the impression that we are vastly better than our European counterparts because we all talk about these issues in huge detail and I have genuinely terrific

13 Treasury Committee: Evidence Ev 9 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs respect for those people who have to operate in conditions that arguably are a lot more difficult ones than we currently face. Q60 Mr Tyrie: The reason or one of the reasons why Parliament considers it is important to keep an eye on what you are doing is that these circumstances can change. We are not short of debt as a country ourselves. Robert Stheeman: Absolutely. Mr Tyrie: When that does change you can end up centre stage very quickly; why on earth are we not able to get the money away? Robert Stheeman: I am very aware of that. Mr Tyrie: It is extremely important that we seek and obtain the reassurance that you are equipped for any stormy period ahead. You are by the sound of it. Robert Stheeman: In terms of strategy I think we have I would say this, wouldn t I the best Mr Tyrie: Still, it is important that we hear it. Robert Stheeman: strategy for the circumstances in which we currently find ourselves. Mr Tyrie: You are thinking ahead to periods when things could get very bumpy. Can I just ask you one more question about the market? I am sorry okay, why don t you come in on that, and then I will come back to my last point. Q61 Andrea Leadsom: It is just a relevant moment, yes, thank you. I just want to ask you about the 100- year-term bonds and what progress has been made on that, because obviously arguably one of the biggest saving graces for Britain has been that we do not have every five minutes to roll over short-term debt. Is there progress on that? Robert Stheeman: I should perhaps be quite clear about what has been announced and what we are going to do. It was announced that we will be consulting on the issuance of what we refer to as super-long and even possibly perpetual debt towards the end of this current quarter. That means probably towards the May/June period. We will have a full consultation, which means the full 12-week period, with the market and we will then discuss the results of that consultation with Treasury colleagues. That does not mean that a decision has been made whether or not to issue them. At this stage, we are just exploring that. You make the very valid point that is about the maturity of the debt, which is that we already have and we are the only major Government borrower anywhere not just to have a very long average maturity but to issue in maturities regularly out to 50 years. What we want to see is can we go beyond 50 years. Does it also make sense from a costeffectiveness perspective? I have no doubt we could issue all sorts of things with all sorts of maturities, but that does not necessarily mean that it would be cost-effective. Q62 Andrea Leadsom: Can you just say, did the GEMMs welcome the idea or not? Robert Stheeman: If they think something is in it for them, I am sure they will welcome it with open arms, which means they are very interested in discussing that with us. I would also like to think that we are, how shall I say we deal with the GEMMs regularly, and we value that dialogue. We would not necessarily be pushed into it just because some GEMMs or any one particular investor group says, We want this or we don t want this. We would have to try to look at the whole array of responses, and we will, I can promise you that, and discuss that in detail with the Treasury and then let the Treasury and Ministers make a separate decision whether or not to proceed; because, as I say, at a level, at a price, I am sure we could sell virtually anything. The key question is does that price make good sense in value for money terms for the Exchequer. Q63 Andrea Leadsom: Sorry to be butting in, but one last thing is do you know offhand I am sure you do what is the average maturity of the debt outstanding that is not in the hands of the Bank of England? Robert Stheeman: I think it is pretty much the same as pretty much, and we can probably get back to you if necessary with the specific figure, the overall average maturity of the portfolio, which is about 14½ years. Because they bought across the curve originally that was not the case but subsequently they have my guess is that it is pretty much that full maturity. But because they have not bought inflationary debt, and inflationary debt is something that tends to be quite long, it won t be significantly different from the average of the existing portfolio. Q64 Mr Tyrie: Just while we are on market conditions, I want to end with a couple of quick points, one institutional and one about the market itself. The 70% the Bank of England s 70% rule were you consulted on that? Robert Stheeman: I believe we were. Jo Whelan: Yes. Robert Stheeman: With the 70% I believe we were, yes, and we have had that now in place Q65 Mr Tyrie: It wasn t a very detailed consultation then, and yet it seems to have acquired some significance. Robert Stheeman: Well, it is significant in as much as we talked to the Bank explicitly about, if you like, the potential dangers of illiquidity, and the Bank itself was very aware of that. Those discussions occurred back in Q66 Mr Tyrie: Yes. It would be very helpful for us to have a detailed sense of the level of institutional exchange. Robert Stheeman: Absolutely. Q67 Mr Tyrie: There is no rush with it, but I think it would be helpful for the Committee. One last question. You have said several times that there has been an improvement in market liquidity in that conditions are better than they were. There are many aspects of dysfunctionality of markets currently, though. I wonder whether you could give us your judgment of how close we are towards being back to normality, what you consider normality in these markets.

14 Ev 10 Treasury Committee: Evidence 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs Robert Stheeman: Are you specifically referring to the gilt market? Mr Tyrie: Yes. Robert Stheeman: Given the fact that when I joined the DMO we had a gilt portfolio that was approximately 290 billion and it is now over 1 trillion, I cannot really say that normality I don t quite know what normality is. What I would say is that the health of the market is in general pretty good, but the way you measure the health of the market is not just liquidity, which is key, it is also turnover and turnover ratios; in other words, how much of the outstanding stock is actually being turned over. It has improved slightly; turnover ratios are not significantly higher than they were five or 10 years ago, but so far so good. Perhaps another sign of the health of the market we talked about uncovered auctions, to me an uncovered auction, as I have said previously, is not the end of the world, but it does suggest some malfunction in the price formation process in the market. The last uncovered auction we had was in March Prior to that the DMO experienced two uncovered auctions; one immediately prior to that was September 2002, and prior to that there was one in In 1999, we were in surplus. There was a budget surplus. In September 2002, I think the annual finance requirement at that time was approximately 22 billion. We had also at that time something in the region of five to 10 auctions a year. We are looking at 44, 45 auctions this year plus all sorts of syndications, which are larger operations. If you think about it, to have had uncovered auctions when we had so little to borrow, it is slightly counterintuitive but it perhaps suggests that if anything the functioning of the market has probably improved since then. It is more liquid. There is more activity. We have more gilt-edged market-makers. Q68 Mr Tyrie: One very, very last question; it is a very long shot and I think I know what I am going to get in reply but it is worth a go. Have you been consulted at all about the Basel regime and the effects of change in the regulatory regime on the demand for Government securities? The refrain and the complaint all the time is we are being forced to stuff all this on our balance sheets because, of course, it is what the Government has to get out of the door. Robert Stheeman: In that sense, no. We certainly have talked about regulation and about the impact of regulation and the potential negative impact of regulation. We discussed that in detail with the Treasury. Mr Tyrie: Just take me through that a little. Robert Stheeman: Again, it goes back to the point about how important we think liquidity is. There have been all sorts of initiatives in Europe and also in the US, regulatory initiatives, arising out of the financial crisis but quite often driven understandably by political considerations. Mr Tyrie: These all the liquidity requirements that are going to come in 2015, although they are already having a big effect on the market. Robert Stheeman: Yes, arguably that is almost, you could say, a positive. I do not want to create the impression that there is some cunning master-plan by Governments to get the markets, and get effectively banks to load up on what it is that we have to issue. I think if you were saying that you would be ascribing a level of cunning sophistication that we do not have. The point that I wanted to make about regulation is that there are also the unintended consequences of that which are potentially quite negative for us and for market liquidity. Those worry us and we will discuss those with Treasury colleagues. Mr Tyrie: Thank you. That is very helpful. Q69 Chair: Mr Tyrie would not let me in to ask you the question I wanted while he was discussing buying back his debt, but I thought there was a sad coyness about you, or an ultra-politeness. You say we have just gone through a hell of a trouble. We are changing the regulatory system because the FSA did not speak to the Bank, and the Bank did not speak to Treasury. When trouble broke, they had nothing prepared and they were all looking at one another. We know there can be big problems when the monetary people started pulling back in the market. It could cause you great difficulty. It has to be done with some finesse. The only thing that I get coming across the table is you hope it will be, and that this independence in the Monetary Policy Committee is the major factor in this. You may not feel able to tell one how to do it, but surely from your position you have told them how not to do it as it affects your good self. That is the first question. The second question is there is another party to this tripartite agreement, and it is the Treasury. Have you alerted them to the possible fears and started in some way any sort of discussion, even if it is about how you must not do this? But this business of very polite up to the Monetary Policy Committee, despite the fact you fear it could have handled you get my point, yes. Robert Stheeman: I understand what you are saying. It is not just that we are polite or coy; it is also that the Bank will, with justification, regard monetary policy entirely as their fiefdom, and that is something that we are aware of. Again, it is why we will Chair: But they have the second part of the mandate that is financial stability in the economy, and it is not just inflation rate or the interest rate that they have to regard to, damaging you and damaging the economy right, go on then. This independence is not working totally in a vacuum. Robert Stheeman: No, it is not, and it is a fair point. Chair: Mervyn thinks it is, but it is not. So carry on. Robert Stheeman: It is a fair point. They are pretty smart people and the people who work also in the markets area have, not least through the experience of QE over the last few years, developed probably a greater feel for the markets than they had for the most part of the first decade of this century. They have a very good idea of how the markets work. They are in a much closer dialogue like we are and we have been inevitably with the market, and I would venture to say I think that they are a lot more circumspect perhaps than one might give them credit for, so just on that point.

15 Treasury Committee: Evidence Ev April 2012 Robert Stheeman, Jo Whelan and Jim Juffs To your other point, which I think is important, yes, of course we have spoken to the Treasury, and already back in 2009 even before QE started we had conversations about what a potential exit strategy might look like. If they have not been very detailed, and have not gone very far it is also potentially because that exit strategy and its implementation is a long way away. Were it suddenly to look much more closer, then I am sure that that level of dialogue that we have with Treasury colleagues would step up quite dramatically. Chair: You are sure? Robert Stheeman: I would make sure from my side that we would be very active on that side, yes. Q70 Chair: You have been running for some time now independently. Is there a case for you going back into the Treasury, especially when faced with a very independent Bank of England with great powers? Robert Stheeman: We are not independent in the true sense. We do not have the same sort of statutory independence that the Bank has. We are an executive agency with Treasury, and also we are answerable to Ministers. I am a Treasury official. My contract is with the Treasury. It is not with the DMO. My colleagues are all employees of the DMO. The current arrangements that we have, I think, are probably just about right because the Treasury and, again, this is my observation is fundamentally a policy department. It is not a major operational department. It sets very major and important Government policy. It made the conscious decision back in 1997 when the decision was made to take debt management out of the Bank of England that the Treasury itself did not want to be involved in the operational implementation of debt management policy. They wanted debt management to be carried out by, if you like, a specialised agency that deals directly in the market. That was not just because they do not do operations or they focus purely on policy, but because I think they realised the importance of having a specialist organisation carry out this function. They also realised the importance of having a market-facing entity that in itself gives credibility to the activities of Government in debt markets. I think that was the right decision. That is my opinion. I think that has stood the test of time, and it has stood a dramatic increase in our financing requirement relatively well. Chair: I hear what you say but when they gave the Bank independence that had some effect on the structure of the Treasury that to my mind weakened their ability to see certain things emerging and to be able to talk with technical equality with the Bank. Robert Stheeman: The Treasury, you mean? Q71 Chair: Yes, and this division is another example of weakening the Treasury, but I hear what you say. Just one last thing as a layman: I always come to these hearings with a view that we are looking at you that you are accountable to us. You mentioned the Minister. Have you discussed with a Minister some of your possible forebodings on the question of QE? You do not have to tell us the details but has it been put on his desk as a policy matter he should be asking you about? Robert Stheeman: Let me say this because I am not quite sure what the rules are about saying what one discusses with Ministers Chair: I will forgive you. Robert Stheeman: But I will say one thing, and that is that the current Minister to whom I am directly accountable, the Commercial Secretary to the Treasury, has in his conversations with me always mentioned QE exit and the possibility of that as something that occupies his mind very closely. Q72 Chair: The point I went away from was this: that you have given a very articulate, polished performance, and that is normally the way we bow our heads and say, You are doing very well. We know you are raising the amount of money that is required by the Treasury; how am I going to know you have raised it as cheaply as you should have? Do I? Point me to something that I have overlooked in your annual report that says, That will tell you that somebody could have done it better. Is there? Robert Stheeman: The question is that all debt managers, I also referred to my counterparts, we all struggle with this. Just on that point, and I know it is something that the Committee has been interested in previously, you may recall that the NAO did a report on us back in 2007 that was about performance measurement of the DMO in which they, themselves, and I have literally a quote Chair: Just by chance. Robert Stheeman: Just by chance. It is the obvious question. I would ask the same question, but it just says, Measuring performance against the primary objective, which is minimising cost, is not straightforward, but the DMO s activities are consistent with the Treasury s criteria to achieving the primary debt management objective. Because we are the sovereign debt issuer and we are sovereign in our own market, we are the benchmark. There is very little off which you can benchmark us elsewhere. So to me, performance measurement is one of the reasons why if you look in our report and accounts, you will see all sorts of what appear to be micro-targets on one level, and higher-level objectives on another level, because the micro-targets help to give a sense of what we are doing operationally. To me, measuring performance is not just about saying, Have we achieved X or Y? On one level the most important thing that we do is to raise the quantum of financing required every year, and if necessary every day, but it is also about coming before you and trying to give account of ourselves. It is about being as transparent as we possibly can. It is about being completely open. The amount of information that we actively put out into the market about our activities, about our plans, the information is published on the website, all these sorts of things, is a huge amount. The more information that we put out there, I would see the more accountable we are, and it does not replace a counterfactual in terms of saying X could have done it better, or, Y could not have done it better, but I do not believe that that counterfactual in a meaningful way really exists. But there is something that I would venture to say around the credibility that we enjoy in the market.

16 Ev 12 Treasury Committee: Evidence 25 April 2012 Robert Stheeman, Jo Whelan and Jim Juffs My personal opinion is that we have relatively high credibility, and that in itself should be reassuring that we are doing what we can to meet our objectives. Q73 Mr Tyrie: You started what promised to be a very interesting answer to the question that I asked earlier, but foolishly I brought you back to the question I was intending to ask rather than the one that I think you thought I might have asked. I asked you whether discussions were going on with respect to forthcoming regulations, financial regulations, and you said there were some pretty intensive discussions going on on one or two things. Then I said I am really referring to what the banks are telling us with respect to Basel, and that was not what you had in mind. You might have said something completely different. Robert Stheeman: You are right, it was, and I realised that so I tried to change tack. Mr Tyrie: But let us have the original course. Robert Stheeman: I suppose the original or the main point is that we have very serious discussions with the Treasury whenever we think that there is the potential for regulation that is devised for the best possible reasons, we are not trying to question that but, if you like, causing unintended consequences. We felt that very strongly in particular around and just to mention two things that have been in the public domain over the last couple of years. One has been the short selling ban that the European Parliament is very keen on introducing. The Commissioner is keen on introducing. That has gone through any number of iterations. It has not still been completely defined yet. It is constantly being revised, not least because we are speaking to the Treasury and to the FSA about very specific issues that we feel could be negative arising out of this. The short-selling ban was originally, at its inception, something that I believe the German Government suddenly announced back in May 2010, literally overnight. It was also picked up by others as being a good thing, because somehow short selling was perceived as being a negative. Our concern is that short selling bans could, for instance, impact negatively I am sorry if this is very technical on the repo market. I have mentioned the repo market before. A well functioning, deep and liquid repo market is absolutely essential for a well functioning deep and liquid government bond market. Anything that undermines liquidity of government bond markets is bad news ultimately for Governments who have to borrow money. So that is just one example where we have been in intensive dialogue with the Treasury. Q74 Mr Tyrie: You had a couple on the tip of your tongue; why do you not give us the headings of some more? Robert Stheeman: Volcker rule is one that has been mentioned a lot and where we have spoken intensively to the Treasury about that. It is in the public domain. You may be aware that the Chancellor has written to Bernanke on this subject. That is something that causes us considerable concern because a potential ban on proprietary trading could seriously undermine liquidity in the bond markets. Financial transaction tax is another, just as an example. Now that one seems a long, long way from coming to fruition but it would be something that could potentially alarm us, and I want to stress, not because we have a view, or a political view, of anything about that. Our angle is purely about the smooth functioning of the markets. Something that undermines liquidity must be a concern. Q75 Mr Tyrie: Why don t you reflect and, without needing to give us very much detail, send us a list with one or two lines of explanation on each? Robert Stheeman: Happy to. Mr Tyrie: Were we to need a great deal of detail on something, I do not think we need to put you to that trouble at the moment, but were we to need to we would then be able to come back to you at some subsequent time. I am thinking of the FTT for example. You say we are a long, long way away from it at the moment. Nobody seems to know what the proposal is because that changes, never mind how you are going to spend the money. Most people are interested in seeing how you spend it before we have even got it in, if indeed there is any money to collect. When we do get to a proposal, then we might come back to you. Robert Stheeman: Yes. Chair: Mr Stheeman, thank you very much for a very, very helpful and informative session. Thank you.

17 Treasury Committee: Evidence Ev 13 Written evidence Supplementary written evidence submitted by the Debt Management Office INSTITUTIONAL RELATIONSHIPS BETWEEN THE DMO, HM TREASURY AND THE BANK OF ENGLAND 1. This note has been prepared in response to Mr Tyrie s request Could you possibly supply the Committee with a note of your institutional relationship with both the Bank and the Treasury, who you are meeting, how often, how formally, not in any way that could in any way imperil any of your operations but just to give us a feel for exactly how these discussions are being conducted? (A) Formal Relationships 2. There are a number of formal institutional arrangements and policies that shape the relationships between the DMO, HM Treasury and the Bank of England, these are summarised in the section below. DMO HM Treasury 3. The overarching description of the bilateral relationship between HM Treasury and the DMO is set out in the Executive Agency Framework Document 1 (the most recent version being dated April 2005). The Framework Document sets out the roles and responsibilities for debt management of Treasury Ministers, Treasury s Permanent Secretary and the DMO s Chief Executive. It also sets out how Treasury Ministers will exercise their responsibilities relative to the DMO (including setting the terms of the annual financing remit having regard to advice from the DMO s Chief Executive, the DMO s business plan, its strategic objectives and performance targets), delegation of operational responsibility for debt and cash management to the DMO s Chief Executive and accountability arrangements. 4. An unpublished Memorandum of Understanding 2 sets out a more detailed description of the respective responsibilities, arrangements and procedures governing the relationship between the DMO and its policy sponsor team in HM Treasury, the Debt and Reserves Management team (DRM). It includes a description of how the DMO will put the remit into operational effect, the frequency and nature of reporting obligations by the DMO to DRM, the role of DRM as primary advisor to Ministers and the reciprocal undertakings of DRM and the DMO. At regular intervals, the DMO provides HM Treasury with high level reporting on credit risk exposures in rating bands but does not disclose individual counterparty names or limit sizes. 5. The Permanent Secretary to the Treasury as the Department s Principal Accounting Officer has delegated via a formal letter (15 September 2009), Accounting Officer responsibilities to the DMO Chief Executive in respect of: (i) the Debt Management Account; (ii) the DMO as an agency of HM Treasury (including the DMO s administrative costs as well as its operational and financial performance as recorded on the Debt Management Account and subsequently published in the DMO/DMA Annual Report and Accounts); and (iii) administration of the Government s guarantee schemes. DMO HM Treasury Bank of England 6. The Government s formal debt management objective is to minimise, over the long term, the costs of meeting the Government s financing needs, taking into account risk, while ensuring that debt management policy is consistent with the aims of monetary policy. This means that HM Treasury and DMO will seek to ensure that debt management policy formulation and implementation does not cut across the objectives of monetary policy and/or its implementation. For example, a key element of the UK s debt management policy framework is the requirement that ex ante the Government fully funds its projected annual financing requirement (the full funding rule). A key rationale for this is to avoid the perception that financial transactions of the public sector could affect monetary conditions, consistent with the institutional separation between monetary policy and debt management policy There is an explicit separation in the responsibility for and conduct of debt management and monetary policy, the latter being the preserve of the Monetary Policy Committee of the Bank of England. In line with this at the time of the implementation of the Bank of England s Asset Purchase Facility (APF) there was a published exchange of letters between the Chancellor of the Exchequer and the Governor of the Bank of England. In particular, the Chancellor s letter of 3 March 2009 concluded by confirming that: the Government will not alter its issuance strategy as a result of the asset transactions undertaken by the Bank of England for monetary policy purposes. 1 Available at: 2 The most recent version being dated June With the exception of a small and stable balance on the Debt Management Account held at the Bank of England and the Ways and Means Advance (a government account at the Bank of England), the short-term net cash position of the Exchequer will be held with market counterparts. This means that, in practice, financial transactions of the public sector would not affect monetary conditions.

18 Ev 14 Treasury Committee: Evidence 8. The Governor and other senior managers at the Bank have gone on record as saying that the Bank will co-ordinate with the DMO over any sale of its gilt holdings acquired under the APF (a recent example being in the Governor s evidence to the Lords Economic Affairs Committee on 27 March 2012). This kind of coordination is explained in more detail below. (B) Informal/Working Relationships DMO HM Treasury Chief Executive meetings/contact with Ministers/senior officials on financial markets, debt management and DMO related business 9. The DMO s Chief Executive as direct contact on a fairly regular basis with the Treasury Minister responsible for debt management (currently the Commercial Secretary). There is occasional contact via phone and face to face meetings as necessary (eg in connection with remit decisions or major consultation exercises). 10. The Chief Executive also attends weekly meetings with senior management colleagues at HM Treasury (chaired by the Permanent Secretary) and is in frequent contact with those members of the senior management team at HM Treasury whose range of responsibilities includes, or touches on, issues of mutual interest. The Chief Executive also has a monthly informal bilateral meeting with the Permanent Secretary at which a broad range of policy and operational issues are discussed; there also exist informal channels of communication with non-executive members of the Treasury Board, including with the Chair of the Treasury Audit Committee. The DMO s Chief Executive and senior management colleagues at HM Treasury also jointly attend events and meetings with the DMO s primary dealers, in particular after fiscal events (Budget, Autumn Statement) to explain the financing remit and wider fiscal context. Working level contacts 11. Contact takes place on a daily basis between officials at all levels in DMO and HM Treasury, (mainly DRM team) on a wide range of issues including operational results, market developments and emerging policy issues. DMO officials liaise with relevant HM Treasury officials on a frequent but ad hoc basis to provide advice/agree common lines on the UK authorities response to emerging national and international regulatory initiatives/proposals see the separate note on current regulatory issues. DMO staff also have frequent contact with the Exchequer Funds and Accounts (EFA) team in HM Treasury, regarding forecasts of financial flows, for cash management purposes. There is also ad hoc contact with other relevant policy teams at HM Treasury as issues arise that have implications for the gilt market or other aspects of the DMO s responsibilities (such as local government lending). DMO HM Treasury Bank of England 12. Working relationships are maintained across all three bodies at all levels in respect of matters of mutual interest. There have been a number of specific areas in which the DMO, HM Treasury and the Bank have worked closely together: Financial market schemes 13. Since 2008 officials at the DMO have as occasion required worked closely with HM Treasury and or the Bank of England to help implement a number of schemes designed to support financial markets and stabilise the banking sector, such as: In the capacity as agent for HM Treasury: Credit Guarantee Scheme (CGS), launched in October 2008 and administered by the DMO as agent for HM Treasury. The Scheme closed to new applicants in February 2010, but some guaranteed liabilities may be rolled over to April Asset-backed Securities Guarantee Scheme (ABS), launched in January The DMO were responsible for administering the scheme on behalf of HM Treasury. Now closed. National Loan Guarantee Scheme (NLGS), launched in March The DMO administers the scheme on behalf of HM Treasury, in particular issuing Guarantee certificates for each qualifying debt instrument. In the capacity as facilitator for the Bank of England: Special Liquidity Scheme (SLS), launched on 21 April New access closed in January 2009 but renewals were allowed until March The DMO lent Treasury bills to the Bank as required. Discount Window Facility (DWF), launched in October 2008 as successor to the SLS. The DMO lends gilts to the Bank of England as required. Asset Purchase Facility (APF) (initial phase), launched in January 2009, financed by the DMO via Treasury bill sales and cash management operations. Succeeded in March 2009 by the current arrangements with asset purchases financed by the Bank of England.

19 Treasury Committee: Evidence Ev 15 APF gilts lending facility In the summer of 2009, in order to alleviate frictions in the market as a result of stock shortages arising from the Bank s gilt purchases, officials at the DMO and Bank of England negotiated a facility via which the Bank agreed to lend to the DMO amounts of gilts it had purchased under the APF for on-lending to the market via the DMO s usual repo market activity. The facility was launched on 6 August Financial stability issues and debt management policy and implementation 14. From the Bank s wider financial stability perspective, it has an interest in ensuring that the gilt market is deep and liquid, and that it works efficiently (eg the price adjustment process works smoothly to match supply with demand) which dovetails with the interests of HM Treasury and the DMO. Any concerns in this respect would as necessary be raised via the established channels of communication between the DMO, HM Treasury and or the Bank. Other 15. The DMO also has in place reciprocal business continuity planning (BCP) arrangements with the Bank of England and participates in City-wide BCP exercises with the Bank and with HM Treasury. DMO Bank of England Chief Executive dialogue with Bank senior management/executive MPC members 16. From time to time the Chief Executive informally meets with Bank senior management (including executive members of the MPC) to discuss matters of mutual interest in connection with the financial markets, such as operational issues relating to the conduct of debt management policy arising from the Bank of England s activities in the gilt market, and in connection with services the Bank provides the DMO (eg clearing and settlement (see below)). Money Market Liaison Group 17. DMO representatives attend the Money Market Liaison Group (MMLG) meetings chaired by the Bank of England that also include representatives of market participants, trade associations and the public authorities. The MMLG provides a forum for the discussion of structural issues concerning the money markets and its minutes are published by the Bank. Liaison on market matters 18. The DMO s and Bank s Markets areas liaise from time to time on matters of mutual interest about developments in the gilt and money markets. The DMO s gilt and cash management dealers maintain a regular dialogue with their dealing counterparts at the Bank of England on day to day matters relating to their activities in their respective markets eg DMO access to the Bank s stock of gilts purchased under the APF for repo purposes. Cash management 19. Dialogue takes place at least weekly, and on an ad hoc basis more frequently, at working level regarding the DMO s target cash balance at the Bank of England (eg if the outturn differs from target). There is a daily dialogue regarding sterling transactions on the Exchange Equalisation Account in connection with the Bank s management of the Foreign Exchange Reserves. In its capacity as the DMO s settlement agent (see below) the Bank also provides the DMO, on a weekly basis, with ISIN codes for upcoming issues of Treasury bills. Settlement 20. The DMO and the Bank of England are in continuous dialogue regarding the Bank s role as Custodian for the DMO via which the Bank provides to the DMO settlement services to clear/settle all DMO trades (including sales of gilts and Treasury bills, payment of gilt coupons and redemptions). Risk management 21. The DMO occasionally discusses risk procedures and evaluation methodology with the Bank of England to share good practice, but does not discuss the details of risk limits or the size of limits of particular counterparties. QE operational co-ordination 22. Decisions about the quantity and duration of quantitative easing, like all monetary policy decisions, are made by the MPC and the DMO is not party to them. Officials at the Bank have responsibility for the implementation of MPC decisions. Where relevant as in the case of the Bank s Asset Purchase Facility (APF) scheme which involved the gilt market dialogue may take place between DMO and the Bank at working

20 Ev 16 Treasury Committee: Evidence level to inform the design of the operational details. The objective of the operational level discussions in the case of APF was to minimise the risk that the activities of the Bank and the DMO in the gilt market might conflict with one another, thereby adversely impacting the implementation of either or both of monetary policy or debt management policy. For example, in order to prevent the Bank s secondary gilt market purchases negatively impacting the DMO financing operations, dialogue took place that informed the Bank s decision to exclude from its operations any gilt being sold outright by the DMO within a week either side of the DMO operation. 23. There continue to be working level contacts relating to the implementation of the Bank s Asset Purchase Facility primarily between the respective markets teams regarding operational timetables, and technical features of the buyback operations, eg the definition of respective short-, medium- and long-dated maturity baskets used by the Bank. June 2012 Supplementary written evidence submitted by the Debt Management Office REGULATORY ISSUES OF RELEVANCE TO THE GILT MARKET Engagement between the DMO and HM Treasury on Regulatory Issues 1. The DMO has a role in providing advice and analysis to HM Treasury on the implications in particular for the gilt market of individual regulatory initiatives emerging from the European Commission and internationally. If it is aware of specific areas of concern, it will raise those pro-actively with the Treasury. The DMO may also from time to time produce analysis for the HM Treasury and the FSA concerning issues with gilt market implications to support negotiations over the technical standards for implementation of new regulations. The Treasury or the FSA remain in the lead regarding negotiations over regulatory changes (eg at the European Commission) with technical input from the DMO. The following topics are ones that the DMO has already actively discussed with Treasury colleagues. Short Selling Regulation 2. In November 2011 the Council and the Parliament voted on the short selling Regulation, which was published in November 2011 and should be applicable from 1 November The objective of the regulation is to lay down a common regulatory framework to harmonise requirements and powers related to short selling of both equities and sovereign debt and some aspects of credit default swaps. The intention is to prevent the creation of obstacles to the proper functioning of the internal market, and reduce the risks to both the viability of short selling itself, and systemic failure as a result of such market practices, in exceptional circumstances. 3. In the period of negotiations prior to publication of the agreed Regulation, the DMO had a role in advising HM Treasury on the gilt market implications of the proposals. The DMO had concerns that the regulation could impact negatively on liquidity in the gilt market and damage the capacity of market participants to price and trade gilts. These concerns have been shared with and echoed by HM Treasury and a joint paper was submitted to the EC outlining these concerns. 4. The Regulation required the European Securities and Markets Authority (ESMA) to submit its technical standards for the implementation of the Regulation to the Commission by 31 March Public consultations on technical standards and delegated acts, following a compressed timetable, took place following publication of the Regulation, with ESMA s advice to the Commission published on 19 April The DMO had a role in advising the FSA/HM Treasury during the consultation on technical standards about appropriate metrics to support effective implementation of the Regulation that would not result in inappropriate regulatory intervention. Dodd Frank Wall Street Reform and Consumer Protection Act (DFA) including the Volcker Rule 5. The Volcker Rule is a specific section of the DFA. 4 The aim of the Rule is to prevent banking entities from undertaking proprietary trading or owning hedge funds/private equity, while still permitting marketmaking, hedging and underwriting. The Rule s impact will not be confined solely to the US because of its extraterritorial provisions. 6. The DMO has made HMT aware of its concerns about the Volcker rule because, as currently drafted, the rule would appear to make it more difficult and costly for banks to provide market making services in sovereign bond markets outside the US. The Chancellor has written to the chairman of the US Federal Reserve, Ben Bernanke, expressing these concerns. 4 The Dodd Frank Wall Street Reform and Consumer Protection Act is a federal statute in the United States that was signed into law by President Barack Obama on 21 July, 2010.

21 Treasury Committee: Evidence Ev 17 Financial Transaction Tax (FTT) 7. As currently specified, the FTT would be a tax on financial transactions of 0.1% on cash transactions (including bonds) and 0.01% on derivatives. It is proposed that the tax would capture most financial instruments. The purpose of the tax is to raise EU own funds and improve financial system stability. 8. Given that the tax is transaction based, it could have severe consequences for gilt market liquidity. Markets in Financial Instruments Directive (MiFID II) and Markets in Financial Instrument Regulation (MIFIR) 9. MiFID II is the second version of the MiFID directive. It aims to update and build on the reforms introduced by the 2007 directive, which included directives on pre and post-trade transparency requirements and reporting requirements for equity markets, new capital requirements and other provisions intended to facilitate cross-border business. The intention in MiFID II is to extend the scope of the existing MiFID equity transparency regime to include bonds, structured products and derivatives. 10. Given the new transparency and reporting requirements for bond markets under MiFID II, the DMO is considering the potential implications for the gilt market liaising with colleagues in HM Treasury that lead for the UK on MiFID. Basel III and Capital Requirements Directive (CRD) IV 11. Basel III is a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed to by the G20 in November It is designed to strengthen bank capital requirements and introduce new requirements on bank liquidity and bank leverage. In Europe, it is being implemented through CRD IV. In the UK, the FSA s Policy Statement PS 09/16, Strengthening Liquidity Standards, has forerun Basel III in specifying the assets that banks should hold in their liquidity buffers. 12. The new requirements are likely to result in banks adjusting their liability profiles, as well as increasing their holdings of high quality assets. Since the FSA s new liquidity regime was announced, banks have significantly increased their holdings of gilts. Solvency II 13. The Solvency II Directive is an EU Directive that codifies and harmonises the EU insurance regulatory regime. It aims to establish a revised set of EU-wide capital requirements and risk management standards that will replace the current solvency requirements. Primarily this concerns the amount of capital that EU insurance companies must hold to reduce the risk of insolvency. 14. The DMO is monitoring the implementation of Solvency II as the new regulatory regime could alter the overall balance of assets held by insurance companies, including gilts. European Market Infrastructure Regulation (EMIR) 15. The DMO is keeping a watching brief on EMIR. EMIR has been introduced to increase the stability of the over-the-counter (OTC) derivative markets throughout the European Union (EU). Under EMIR, standardised OTC derivative contracts will be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCPs). OTC derivative contracts are to be reported to trade repositories. Non-centrally cleared contracts will be subject to higher capital requirements. 16. EMIR has the potential to impact upon the demand for gilts, and other sovereign bonds, because it could significantly increase demand for high quality assets for use as collateral in derivative contracts. Central Securities Depositories Regulation (CSD) 17. The CSD regulation, proposed by the European Commission, aims to harmonise the securities settlement period in the EU and to strengthen rules relating to CSDs. Amongst other things the current draft regulation proposes a maximum settlement period of two days and calls for the compulsory dematerialisation of paper securities (including gilts) by The DMO is monitoring the progress of the regulation which could impact the wider gilt market and its operational activities including the activities of Computershare Investor Services which acts as gilt registrar. HMT is leading on negotiations with the EC and the DMO has engaged with HMT representatives to feed back its concerns. June 2012

22 Ev 18 Treasury Committee: Evidence Supplementary written evidence submitted by the Debt Management Office Debt Portfolio Maturity Statistics 1. Information was requested at the DMO appearance before the Sub-Committee on 25 April on the impact on the maturity of the gilt market portfolio of excluding gilts held by the Bank of England. 2. The table below shows maturity breakdown of the UK Government marketable debt portfolio in gross and net terms (ie excluding holdings by central government, predominantly the DMO). These data are those typically used when quoting a portfolio average maturity of 14½ years. Gilt portfolio (total): years Gross Net Portfolio average maturity inc Tbills: Portfolio average maturity exc Tbills: conventional gilts: index-linked gilts: The table below adjusts the maturity breakdown of a smaller portfolio which has been adjusted to exclude those gilts held by the Bank of England via the Asset Purchase Facility (APF) at the end of March The effect is to marginally increase average maturity of the whole portfolio, by 0.16 years (1%) to years. Gilt portfolio (excluding APF holdings): years Gross Net Portfolio average maturity inc Tbills: Portfolio average maturity exc Tbills: conventional gilts: index-linked gilts: The average maturity of the gilt portfolio increases, however by 0.45 years (3%) to years, reflecting the fact that index-linked gilts (which are on average significantly longer-dated than conventional gilts and which are not eligible for purchase via the APF) account for a larger proportion of this adjusted portfolio. 5. The average maturity of the conventional gilt portfolio falls by 0.16 years (3%) to years, indicating that the average maturity of the Bank s holdings of conventional gilts is slightly longer than the overall market (reflecting the fact that APF purchases cannot be for gilts with a residual maturity of less than three years). June 2012 Printed in the United Kingdom by The Stationery Office Limited 07/

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