Extending the Frontier of the Euro Market? Analysing the Potential of a 50-year OAT. February 2005

Extending the Frontier of the Euro Market? Analysing the Potential of a 50-year OAT February 2005

The Need for Ultra-long-dated Bonds Investor Feedback The AFT Approach 1

Population ageing increases the need for long-dated investments Population ageing is expected to reduce potential growth and bring lower real interest rates Smaller labour force Higher pension and health care expenditures Lower investment needs and increase the need for long-dated investments Greater number of pensioners Longer life expectancy Declining trend in real interest rates a significant portion of which could be invested in fixed income 3

Population ageing... The median population age will rise significantly in all developed countries by 2050: European Union: 38 in 2000, 49 in 2050 United States: 36 in 2000, 39 in 2050 Japan: 41 in 2000, 53 in 2050 2,2 2,0 1,8 1,6 1,4 1,2 1,0 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 Fertility rate 1990 1995 2000 2005 2010 2015 2020 2025 2030 Dependency rate (over 65 yrs / 25-64 yrs) 1990 1995 2000 2005 2010 2015 2030 Source: OECD US Japan Germany France Italy Spain 4

puts downward pressure on potential growth Declining labour force growth 0.7 0.5 0.3 0.1-0.1-0.3-0.5 Population growth rates between 1995 and 2050 will increasingly dampen potential growth Effect of population ageing on economic growth rates in Europe, the United States and Japan 3.20 2.80 2.40 2.00 1.60 1.20 0.80-0.7-0.9 1995-2000 France Italy Spain 2000-2005 2010-2015 2020-2025 Germany Netherlands 2045-2050 0.40 2000 2007 2014 2021 2028 2035 2042 2049 EU US Japan Source: European Commission Source: United Nations 5

and upward pressure on public spending which will increase the demand for long-dated investments 35.00 Public spending linked to ageing population, in GDP % 30.00 25.00 20.00 15.00 2000 2005 2010 2020 2030 2040 2050 Denmark Germany Spain France Italy Netherlands Finland Source: EU Economic Policy Committee, before the 2003 and 2004 reforms N.B. Pension, Health, Dependency, Education and Unemployment Benefits 6

European household savings will have to fit these new prospects European households are switching from short-term savings products to longer-term products Breakdown of financial wealth held by European households % 30 25 1995 2000 2003 20 15 10 5 0 Currency and deposits Time deposits, saving deposits and others Money market funds Life insurance Securities other than shares Listed shares Non-listed shares Mutual funds Pension funds Others Sources: OECD Statistics, 2003: BNP, Barclays, DB and HSBC-CCF 7

New regulations in Europe REFORM FTK IAS19 / FRS17 FSA Rules PS04/16 Country Netherlands Europe / UK Denmark UK Institutional Investor Life Insurance and Pension Funds Pension Funds Life Insurance and Pension Funds Life Insurance Type Liability of liability Typology Defined benefits, traditionally long and inflation-linked Defined benefits, traditionally long and inflation-linked Defined benefits, traditionally long and linked to the asset portfolio performance Mix of guaranteed and inflation-linked annuities, with profits Asset Valuation Market Value Market Value Market Value Market Value Liability Valuation Fair Value* Financial flow discounted at the AA long term rate Fair Value* Fair Value* Need in regulatory Capital Revaluation of the balance sheet following extreme market moves (e.g. +/- 100bp on the rate curve) Revaluation of the balance sheet following extreme market moves (e.g. +/- 100bp on the rate curve) Revaluation of the balance sheet following extreme market moves (e.g. +/- 100bp on the rate curve) * Financial Flows discounted at the government curve including valuation of embedded options 8

will likely lead to a change in asset allocation Regulatory changes: Impose additional balance sheet requirements Uncover an interest rate risk on the liability side which needs to be hedged Ultra-long-dated bonds can provide a natural hedge 100 source : CSFB 60 20-20 -60-100 2004 2024 2044 2064 2084 Bonds Alternative investments Equity Speculative equity Fixed liabilities Inflation-linked liabilities 9

Pension funds and insurance companies are currently highly invested in equities Balance Sheet of Insurance Companies & Pension Funds in the Eurozone in 2004 Q3 (EUR bn) ASSETS LIABILITIES Deposits with euro area MFIs 565.4 Loans 69.6 Loans 335.3 Securities other than equities 12.7 Short-term securities other than 52.8 Quoted shares 154.2 equities Net equity of life insurance 3150.3 reserves and pension fund reserves Long-term securities other 1484.3 Prepayments of insurance 543.3 than equities premiums and reserves for outstanding claims Equities 1371.9 Others 120.5 TOTAL 3930.2 TOTAL 3930.2 Source: ECB 10

implying significant potential for re-allocation to longdated bonds of high credit quality Proportion of equities held in European pension funds in 2002 Austria Belgium Denmark Equity proportion % 13.4 14.6 27.6 Amount in bn 2.1 2.0 11.6 European pension funds hold almost 1 trillion in equities If 25 per cent of these assets are re-allocated into long-dated bonds, the potential demand would be over 200bn This amount does not take into account the potential growth of funds under management Finland 13.7 1.5 France 20.0 10.7 60 Germany 15.8 54.0 50 Italy 8.6 2.9 40 Netherlands 47.8 207.9 30 Portugal 16.7 2.4 20 Spain 19.6 8.8 10 UK Source: OECD 53.8 591.2 0 UK Denmark Spain Germany Finland Italy 11

On top of their duration, long-dated bonds have attractive convexity Bonds with higher convexity will outperform if interest rates rise or fall The potential for volatility to rise from current low levels increases the attractiveness Duration of a 50yr bond will be close to 22 years. Convexity of such a bond will be far higher than for a 30yr bond 8 7 6 OAT 2015 OAT 2019 OAT 2023 OAT 2035 50-yr OAT Duration 8.22 9.57 10.77 16.33 22 Convexity 0.87 1.28 1.70 4.04 >7 CONVEXITY +80% 50-yr BOND 5 4 3 +34% 2 1 0 DURATION 0.0 5.0 10.0 15.0 20.0 25.0 12

The current supply of long-dated sovereign bonds is insufficient The majority of new issues are short-dated and the imbalance continues to grow Maturity breakdown for new sovereign issues within EU15 in 2004 EU15 sovereign new issues evolution by maturity from 1980 to 2003 400,000 10 years or less More than 10 years Less than 5 years 24% > 10 years 28% 350,000 300,000 250,000 200,000 150,000 Between 5 and 10 years 48% Source: Bondware EU15 sovereign new issues remain concentrated in the up-to-10-year area (76% of new issues in 2004 had a maturity of up to 10 years inclusive) This trend has accelerated sharply since the late 1990s 100,000 50,000 0 1980 1984 1988 1992 1996 2000 Source : Bondware 13

A large number of investors were polled 550 investors worldwide were polled during the week of 7-11 February regarding their interest in a new nominal 50-year OAT 400 of the investors are active in longer-dated maturities Breakdown by Geography Breakdown by Investor Type UK/Ireland 18% Asia 2% Greece 1% Germany/Austria 21% Pension Fund 10% Other 1% Switzerland 5% Belgium 3% Insurance Company 20% Asset manager 41% Spain 8% Holland 11% Hedge Fund Mid East 2% 1% Scandinavia 5% Italy 10% US 2% France 13% Corporate 1% Central bank 5% Bank 20% Source: Barclays, BNPP, Deutsche Bank & HSBC 15

A large proportion of investors expressed interest in a 50-year nominal OAT When asked: Do you have a potential interest for a new 50-year nominal OAT?, 49% of the polled investors demonstrated an interest, whilst 17% did not comment Yes 35% Maybe 14% No answer 17% No 34% Source: Barclays, BNPP, Deutsche Bank & HSBC 16

A wide range of investors expressed interest Breakdown by Geography* * within the 49% of investors who expressed interest Others 4% Germany/Austria 16% UK/Ireland 29% Holland 17% Euro zone: 59% United Kingdom/Ireland: 29% Scandinavia: 6% United States: 3% Spain 4% Scandinavia 6% Italy 11% US 3% France 10% Source: Barclays, BNPP, Deutsche Bank & HSBC 17

A wide range of investors expressed interest (2) Breakdown by Investor Type* * within the 49% of investors who expressed interest Pension fund 11% Insurance Company 13% Hedge Funds 2% Asset manager 48% Corporate 2% Central Bank 3% Bank 21% Source: Barclays, BNPP, Deutsche Bank & HSBC 18

Investor interest has various drivers Pension Funds Insurers Banks (ALM) Asset Managers Hedge Funds Swap desks Matching of long-dated assets Arbitrage: -convexity -duration 19

Demand characteristics For 74% of the investors polled, the bond should be launched with a benchmark size. For 71 % of investors, interest will not be limited to a single issuance Investors also request the bond to be included in the main indices 20

Agence France Trésor Values Our mission: AFT is tasked with handling government debt and cash management under the most secure conditions in the best interest of the taxpayer. Our strategy to achieve this goal is long-term oriented. AFT does not try to beat the market. Our commitments: highest liquidity standard, transparency and innovation. 22

Key Figures (as of 31 January 2005) Negotiable Debt Outstanding: 833bn Long-term (OAT): 560bn Medium-term (BTAN): 177bn Short-term (BTF): 96bn Interest rate Swaps outstanding: 61bn Medium-and-long term net financing Programme: 2003: 111.4bn 2004: 122bn 2005: 111bn 23

A Regular Financing Programme Amounts issued in 2004 ( bn) as of January 1, 2005 Jan Feb Mar April May Jun Jul Sep Oct Nov 2 Y 1.2 6 2.7 3 1.5 1.9 1.9 5 Y 6.4 4.2 3.6 2.3 5.9 3.7 2.8 2.8 5.2 10 Y 3.5 2.7 6.6 3.5 3.4 4.2 5.2 2.4 2.2 15 Y 3.9 2.2 1.8 30 Y 3 3.7 2.9 1.6 OAT i / i 4 1.9 1.9 1.9 2.1 3.4 1.5 1.2 1.3 3.5 120 100 80 60 40 20 0-20 Past Financing Programmes 1996 1997 1998 1999 2000 2001 2002 2003 2004(ytd) 2005 10% of inflationlinked bonds OAT i and i BTAN 2y BTAN 5y OAT 10y (net) OAT 15y OAT 30y ML Term buybacks 24

OATs and BTANs Outstanding as of January 1, 2005 120 100 80 60 40 20 0 2005 2007 2009 2011 2013 2015 2019 2022 2025 2032 BTAN OAT OATi & OAT i 25

All OATs benefit from transparency and liquidity All OATs are issued initially with sufficient liquidity and tapped according to market requirements All 21 SVTs are market makers French bonds are listed on all major electronic platforms They are eligible for major indices They are strippable 26

Stripped OATs provide investors with a tool for better duration management Stripped bonds enable investors to enhance the performance of their bond portfolio due to their greater sensitivity to interest rate movements. Stripped securities also eliminate reinvestment risk inherent in a couponbearing instrument The duration of OAT strips is higher than OATs of the same maturity. Outstandings ( bn) Strippable Stripped % Euroland 1,910.3 98.7 5.2% French stripped bonds represent 50% of total outstanding strips within the Eurozone. France 460.9 48.3 10.5% UK 291.1 3.7 1.3% US 2,926.1 177.0 6.1% 27

AFT has been active in developing the Euro fixed income market 1986: Fungibility of Government Bonds 1989: First 30-year OAT 1991: First stripped OATs 1996: First TEC-indexed OAT 1998: First OAT indexed to French inflation 2001: First OAT indexed to Eurozone inflation 2003: First indexed OAT launched by auction 2005:? 28

Appendices 29

Trends in long-dated swap rates 100 90 80 70 60 50 40 30 20 Spread 10-30 years (LHS) 10 5 0-5 -10 10 Spread 30-50 years (RHS) 0-15 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 30

Press Release AFT LAUNCHES AN EXPLORATORY STUDY WITH INVESTORS ON THE POSSIBILITY OF ISSUING A 50-YEAR OAT As a result of growing interest on the part of investors for very long-term placements, Agence France Trésor has asked a number of primary dealers (SVT) to carry out a survey of French and foreign investors, in order to examine the pertinence of issuing a 50-year euro-denominated OAT. AFT expects an in-depth analysis of the structural demand for very long-term maturities, taking into account both the longterm prospects and the evolution in the allocation of euro-denominated assets. The chosen banks are BNP-Paribas, Barclays Capital, Deutsche Bank and HSBC - CCF; CSFB, IXIS and JP Morgan will also participate in this survey. The result of this survey should be handed in before the end of February 2005 and AFT will inform the market at this moment of whether or not the decision has been taken to proceed with this issuance. Bertrand de Mazières, Chief Executive Officer of AFT, considers that "the current level of interest rates justifies issuing a very long-term maturity OAT, provided that the survey points to a real structural demand on the part of investors for this type of product." Benoit Coeuré, deputy CEO of AFT, emphasises that "by exploring the very long end of the yield curve, AFT is adding a new dimension to the development of the euro-denominated bond market ". Press contact Agence France Trésor Corinne Dromer: +33 (0)1 4004 1550 31

For More Information www.aft.gouv.fr Reuters: <TRESOR> Bloomberg: TRESOR <GO> 32