This handbook is a comprehensive and authoritative reference for both senior policymakers—those responsible for the development of government bond markets in their own countries—and all individuals responsible for guiding the market development process at the operational level—those who have a substantial need to understand the policy issues involved.

Copyright © 2001 The International Bank for Reconstruction and Development / The World Bank

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Copyright © 2001 International Monetary Fund

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All rights reserved

Manufactured in the United States of America

First printing July 2001

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Library of Congress Cataloging-in-Publication Data

Developing government bond markets: a handbook.

p. cm.

Includes bibliographical references.

ISBN 9780821349557

1. Government securities — Handbooks, manuals, etc. 2. Bond market — Handbooks, manuals, etc. I. World Bank.

HG4715.D48 2001



Cover Design: Rock Creek Publishing Group.

Photo Credit: Salomon Brothers Fixed Income Trading Floor, New York, USA, circa 1997.


  • Preface

  • Foreword

  • Handbook Team and Acknowledgments

  • 1. Developing a Government Bond Market: An Overview

    • 1.1 Introduction

    • 1.2 Benefits of Developing a Bond Market

    • 1.3 Basic Prerequisites for Successful Development of Government Securities Markets

    • 1.4 Money Markets and Monetary Policy Operations

    • 1.5 Government Securities Issuance Strategy and Market Access

      • 1.5.1 Government Securities Issuance Strategy and Debt Management

      • 1.5.2 Government Securities Instruments and Yield Curve

      • 1.5.3 Primary Market Structure and Primary Dealers

    • 1.6 Investor Base for Government Securities

      • 1.6.1 Banks as Investors of Government Securities

      • 1.6.2 Contractual Savings and Government Securities Markets

      • 1.6.3 Collective Investment Funds and Government Securities Markets

      • 1.6.4 Retail Investors and Government Securities Markets

      • 1.6.5 Foreign Investors and Government Securities Markets

    • 1.7 Secondary Markets for Government Securities

      • 1.7.1 Transactions and Trading Procedures in Secondary Government Securities Markets

      • 1.7.2 Market Intermediaries in Secondary Government Securities Markets

      • 1.7.3 Trading Systems and Conventions in Secondary Markets for Government Securities

      • 1.7.4 Related Markets and Secondary Markets

    • 1.8 Securities Settlement Infrastructure for Government Securities Markets

      • 1.8.1 Securities Accounts and Government Securities Markets

      • 1.8.2 Depository Arrangements for Government Ssecurities

      • 1.8.3 Securities Settlement Procedures for Government Securities Markets

    • 1.9 Legal and Regulatory Framework for Developing Government Securities Markets

      • 1.9.1 General Considerations

      • 1.9.2 Elements of Legal Framework for Government Securities Markets

      • 1.9.3 Market Regulation of Government Securities Markets

    • 1.10 Taxation Policy and Development of Government Securities Markets

    • 1.11 Linkages of Government Securities Markets to Subnational and Private Sector Bond Markets

    • 1.12 Sequencing Development of Securities Markets

  • Annex 1.A Some Elements of a Macroeconomic Framework

  • Annex 1.B Some elements of Financial Sector Reform

  • Annex 1.C Key Strategic Steps in Government Securities Market Development

  • Bibliography

  • 2. Money Markets and Monetary Policy Operations

    • 2.1 Introduction

    • 2.2 Developing the Interbank Market

      • 2.2.1 Creating Incentives that Stimulate Trading in the Money Market

      • 2.2.2 Avoiding Excessive Volatility in Excess Reserves and Money Market Rates

      • 2.2.3 Central Bank Interaction with Market and Interest Rate Volatility

      • 2.2.4 Resources for Central Bank Open Market Operations

      • 2.2.5 Infrastructure and Capacity

    • 2.3 Coordination Between Government Debt/Cash Management and Central Bank Open Market Operations

    • 2.4 Conclusion

  • Bibliography

  • 3. A Government Debt Issuance Strategy and Debt Management Framework

    • 3.1 Introduction

    • 3.2 Market-Oriented Funding Strategy

      • 3.2.1 Market Discipline, Broad Market Access, and Transparency

      • 3.2.2 A Suitable Issuance Strategy

      • 3.2.3 A Proactive Government Approach

    • 3.3 Sound Debt Management Framework and Operations

      • 3.3.1 Clear Objectives of Debt Management

      • 3.3.2 Coordination with Monetary and Fiscal Policies

      • 3.3.3 Prudent Risk Management Framework

      • 3.3.4 Institutional Framework

    • 3.4 Conclusion

  • Bibliography

  • 4. Developing Benchmark Issues

    • 4.1 Introduction

    • 4.2 Country Experiences with Benchmark Issues

    • 4.3 Building a Benchmark Yield Curve: Strategy and Implementation

      • 4.3.1 Standardizing Debt Instruments

      • 4.3.2 Developing Appropriate Maturity Distribution for Benchmark Issues

      • 4.3.3 Determining Appropriate Size and Frequency of Benchmark Issues

    • 4.4 Reopening and Buyback Operations to Build Benchmark Issues

    • 4.5 Conclusion

  • Annex 4.A Reopening Operations and Their Role in Developing Benchmark Issues

    • 4.A.1 Reopening Operations

  • Annex 4.B Buyback Operations and Their Role in Developing Benchmark Securities

    • 4.B.1 Buyback Operations

      • 4.B.1.1 Reverse Auction

      • 4.B.1.2 Outright Purchase

      • 4.B.1.3 Bond Conversion

    • 4.B.2 Choice of Buyback Program(s)

  • Bibliography

  • 5. Developing a Primary Market for Government Securities

    • 5.1 Introduction

    • 5.2 Techniques for Marketing Government Securities

      • 5.2.1 Auctions

      • 5.2.2 Syndication of Government Securities Issuance and Underwriting of Government Securities

      • 5.2.3 Tap Sales of Government Securities

      • 5.2.4 Private Placement of Government Securities with Banks and Other Market Participants

      • 5.2.5 Combination of Government Securities Issuance Techniques

    • 5.3 Role of Primary Dealers in the Issuance of Government Securities

      • 5.3.1 Obligations of Primary Dealers

      • 5.3.2 Incentives/Privileges for Primary Dealers

      • 5.3.3 Eligibility Criteria for Primary Dealer Designation

    • 5.4 Conclusion

  • Bibliography

  • 6. Developing the Investor Base for Government Securities

    • 6.1 Introduction

    • 6.2 Captive Sources of Government Funding and a Diverse Investor Base

      • 6.2.1 Pitfalls of Reliance on Captive Sources of Government Funding

      • 6.2.2 Advantages of a Diverse Investor Base

    • 6.3 Financial Investors of Government Securities

      • 6.3.1 Commercial Banks

      • 6.3.2 Contractual Savings Sector—Pension Funds and Insurance Companies

      • 6.3.3 Collective Investment Funds—Mutual Funds

      • 6.3.4 Impact of Institutional Investors on Capital Market Development

      • 6.3.5 Policies to Promote Institutional Investors

    • 6.4 Nonfinancial Investors of Government Securities

      • 6.4.1 Nonfinancial Corporations

      • 6.4.2 Retail Investors of Government Securities

    • 6.5 Foreign Investors in Government Securities

      • 6.5.1 Growth of Foreign Investors in Government Securities Markets

      • 6.5.2 Impact of Foreign Investors on Capital Market Development

      • 6.5.3 Risks Associated with Foreign Investors in Domestic Financial Markets

    • 6.6 Conclusion

  • Annex 6.A Growth of Institutional Investors

  • Annex 6.B International Diversification of Securities Portfolios

    • 6.B.1 Growth of Foreign Institutional Investors in Emerging Markets

    • 6.B.2 Importance of Foreign Investors in Domestic Government Securities Markets

  • Bibliography

  • 7. Developing Secondary Market Structures for Government Securities

    • 7.1 Introduction

    • 7.2 Types of Transactions in Secondary Markets

      • 7.2.1 Spot Transactions

      • 7.2.2 Repurchase Agreements

      • 7.2.3 Derivatives and Risk Management Instruments

    • 7.3 Features of Market Structures

      • 7.3.1 Periodic Versus Continuous Markets

      • 7.3.2 Dealer Versus Auction-Agency Markets

      • 7.3.3 Automation and Electronic Market Structures

    • 7.4 Efficiency and Liquidity Issues in Market Structures

      • 7.4.1 Trading Frequency

      • 7.4.2 Consolidated Versus Multiple Markets

      • 7.4.3 Degree of Security Fragmentation

      • 7.4.4 Wholesale Versus Retail

      • 7.4.5 Competition Among Market Intermediaries

      • 7.4.6 Execution Risk and Secondary Market Liquidity

      • 7.4.7 Liquidity Risk

      • 7.4.8 Transparency

      • 7.4.9 Development Strategies

    • 7.5 Conclusion: Suitability and Selection of Market Structure

  • Annex 7.A Risk Management Issues in Derivatives Market Structures

  • Bibliography

  • 8. Developing a Government Securities Settlement Structure

    • 8.1 Introduction

    • 8.2 Securities Accounts

      • 8.2.1 Need for Securities Accounts

      • 8.2.2 Legal Features of Securities Accounts

      • 8.2.3 Transition Issues

    • 8.3 Depository System for Securities Accounts

      • 8.3.1 Registration Function of the Depository System

      • 8.3.2 Organization of the Depository System

      • 8.3.3 Depositories

    • 8.4 Settlement Procedures

      • 8.4.1 Settlement in the Central Depository

      • 8.4.2 Settlement in Sub depositories

      • 8.4.3 Settlement of Stock Exchange Transactions of Government Securities

    • 8.5 The Depository System as Source of Data

    • 8.6 Conclusion

  • Bibliography

  • 9. Legal and Regulatory Framework

    • 9.1 Introduction

    • 9.2 Government Borrowing Authority

    • 9.3 Details of Legal Borrowing Authority

      • 9.3.1 Borrowing Limits

      • 9.3.2 Internal Management

      • 9.3.3 Transparency and Accountability

      • 9.3.4 Disclosure

      • 9.3.5 Access

    • 9.4 Terms of the Instruments

    • 9.5 Legal and Regulatory Framework for the Secondary Bond Market

      • 9.5.1 Regulation of the Secondary Bond Market

      • 9.5.2 Authority to Establish a Regulator

    • 9.6 Market Structure and Regulation

    • 9.7 Market Conduct

    • 9.8 Regulation of Market Intermediaries

    • 9.9 Role of SROs

    • 9.10 Legal and Regulatory Framework for Payment and Settlement of Government Securities

    • 9.11 Conclusion

  • Bibliography

  • 10. Development of Government Securities Market and Tax Policy

    • 10.1 Introduction

    • 10.2 Tax Treatment of Capital Income

      • 10.2.1 Taxation of Interest: Schedular Versus Integrated Approach

      • 10.2.2 Withholding Tax

      • 10.2.3 Treatment of Capital Gains

      • 10.2.4 Accrual Versus Realization in Income Taxation

      • 10.2.5 Tax Treatment of Inflation Adjustment of Government Securities

    • 10.3 Tax Treatment of Different Financial Instruments

      • 10.3.1 Favorable Tax Treatment of Government Bonds

      • 10.3.2 Tax Treatment of Repurchase Agreements (Repos)

    • 10.4 Taxation of Different Government Securities Holders

      • 10.4.1 Taxation of Nonresident Government Securities Holders

      • 10.4.2 Taxation of Collective Investment Funds (CIFs)

      • 10.4.3 Taxation of Pensions

    • 10.5 Tax Incentives for Financial Instruments to Stimulate Savings

    • 10.6 Transaction Taxes on Financial Instruments

    • 10.7 Conclusion

  • Bibliography

  • 11. Development of Subnational Bond Markets

    • 11.1 Introduction

    • 11.2 Subnational Bond Markets in Perspective

      • 11.2.1 Importance of Subnational Debt Markets in Developing and Transition Countries

      • 11.2.2 Agency Problems and Subnational Debt Markets

    • 11.3 Developing Subnational Debt Markets: Policy Issues

      • 11.3.1 Moral Hazard

      • 11.3.2 Fundamental Constraints in Developing Subnational Bond Markets

    • 11.4 Linkages Between Government Securities Markets and Subnational Bond Market Development

      • 11.4.1 Relationship Between Domestic Bond Market and the Subnational Bond Market Development

      • 11.4.2 Role of the Subnational Bond Market in Diversification of the Domestic Fixed-Income Market

    • 11.5 Issuance of Subnational Bonds

    • 11.6 Development of the Secondary Subnational Bond Market

    • 11.7 Regulatory and Supervisory, Legal, and Tax Framework for the Subnational Bond Market

      • 11.7.1 Regulatory and Supervisory Framework for Subnational Bond Market

      • 11.7.2 Legal Framework for the Subnational Bond Market

      • 11.7.3 Tax Treatment of Subnational Bonds

    • 11.8 Credit Enhancement and Credit Pooling in Subnational Bond Markets

      • 11.8.1 Credit Enhancement for the Subnational Bond Market

      • 11.8.2 Bond Pooling by Subnational Entities

    • 11.9 Priorities for Policy Reform for Subnational Bond Market Development

      • 11.9.1 Establishing a Foundation for Subnational Bond Market Development: A Policy Matrix

      • 11.9.2 Strengthening Subnational Bond Market Architecture in Developing and Transition Countries

    • 11.10 Conclusion

  • Bibliography

  • 12. Development of Private Sector Bond Markets

    • 12.1 Introduction

    • 12.2 Benefits of Private Sector Debt Issuance

      • 12.2.1 Benefits to the Economy and Financial Sector of Private Sector Bond Markets

      • 12.2.2 Private Sector Financing—Equity Versus Debt and Bonds Versus Bank Loans

    • 12.3 Overview of Corporate Bond Markets

      • 12.3.1 Corporate Bond Markets in Developed Countries

      • 12.3.2 Corporate Bond Markets in Developing Countries

    • 12.4 Changes in Public Policy and New Financial Technology and Development of Private Sector Bond Markets

      • 12.4.1 Infrastructure Financing

      • 12.4.2 Housing Finance

      • 12.4.3 Privatization and Deregulation

    • 12.5 Issues in Developing Private Sector Bond Markets

      • 12.5.1 Linkages Between Private Sector and Government Bond Markets

      • 12.5.2 Distinctive Characteristics of Private Sector Bond Markets

      • 12.5.3 Impediments to Private Sector Bond Market Development

    • 12.6 Conclusion

  • Bibliography

  • Glossary


This handbook is designed to serve as a reference source for two distinct user groups involved in the development of government bond markets: (i) senior government officials responsible for the development of the government bond market (i.e., senior officials in ministries of finance, central banks, and securities regulatory and banking supervisory institutions) and (ii) individuals responsible for guiding the market development process at the operational level, and who have a substantial need to understand the policy issues involved. The handbook is structured as follows. Chapter 1 provides an overview of certain policy considerations relevant to the development of a government bond market. This overview considers key issues, but at a level of generality appropriate for senior government officials responsible for making key strategic decisions. The remaining eleven chapters present more detailed discussions of key policy issues, including substantive considerations relating to implementation. The handbook’s primary emphasis, however, focuses on the policy dimension of developing medium- and long-term bond markets. It is not intended as a technical manual for use by individuals engaged in day-to-day implementation or operations. The handbook also provides bibliographic and website references for those interested in pursuing further the issues covered. A comprehensive glossary of terms related to securities markets appears at the end of the handbook.

In planning the structure and content of the handbook, the authors were mindful of existing literature on the subject which addresses specific elements of government bond markets, both with respect to their creation as well as their functioning. However, it was determined that a gap existed with respect to a reference publication that comprehensively covers a wide range of relevant elements in one volume. The handbook is intended to address this need. It presents an integrated view of the government bond market in a manner that will enable policymakers and operational staff to better understand how different elements related to developing such a market are linked, and how they can best be sequenced to achieve the desired result—an efficient and liquid market for government securities.

The handbook, therefore, covers a wide range of topics, including: the linkages with money markets and monetary policy operations; the policies needed to develop an issuance strategy and debt management considerations to build credibility; and the reforms necessary to promote institutional investment. Although by design the handbook covers considerable ground, it remains focused throughout on policy considerations, which are the essential building blocks for reform. The policy discussion is based on the experiences and views of practitioners drawn from both the public and private sectors around the world. Their experiences helped shape the recommendations regarding the best way to achieve the desired objectives notwithstanding the existence of various external and internal constraints.

In preparing the handbook, it became clear that there was no single-best way to sequence the chapters. As such, it was decided to follow a sequence most conducive to achieving a better understanding of the government bond market development process, starting with the key linkages with other essential processes such as money market and monetary policy operations, then turning to the essential market participants (issuers and investors), followed by the basic market operations (secondary markets), and finally considering the fundamental infrastructure needed to operate the market (legal and regulatory framework and settlement and depository facilities). The handbook’s two final chapters consider the important linkages between the government bond market and two strategic emerging segments of the domestic securities markets, namely the subnational and the private sector securities markets.

There are three additional considerations worthy of note. First, the reader will find some overlap among the chapters. This was done to highlight the interrelationship among the different elements and to present the subject of securities market development in all its complexity. Second, when considering the target audience from a country perspective, the intent was to make it especially relevant to those countries that are more effectively engaged in the process of extending the term structure of their markets beyond the money market segment. Third, the handbook should be viewed in the nature of work-in-progress, and as an ongoing effort of the World Bank and the IMF to provide countries with a comprehensive reference source for the development of government bond markets. The handbook will be reviewed and revised over time to take into account the latest developments and emerging trends in government bond markets, as well as new perspectives on these markets.

Clemente L. del Valle


There is a consensus between the World Bank and the International Monetary Fund that the development of domestic bond markets deserves high priority on the financial sector development agenda. On the one hand, bond markets are essential for a country to enter a sustained phase of development driven by market-based capital allocation and increased avenues for raising debt capital. On the other hand, the central position occupied by domestic bond markets in markedly increasing the resilience of a country’s financial system and insulating it against external shocks, contagion and reduction of access to international capital markets is established.

Since the recent eruption of wide-spread financial crises in 1997, the World Bank and the International Monetary Fund have dedicated substantial human and financial resources to efforts geared towards restructuring the financial sector and reducing financial vulnerability. A key component in our efforts has been strengthening capital markets, in particular domestic bond markets. This Handbook spearheads our work in this area.

The importance of government bond markets in catalyzing the growth of overall bond markets is recognized and accepted. A survey of the world’s major developed bond markets reveals diverse paths of development. While there is no general development philosophy which can be applied to developing domestic bond markets, the task is too important not to tackle head-on. There are many insights, lessons and strategies which can be gleaned from the market development experience of the developed and emerging markets, and this handbook attempts to capture them to help policy makers and market participants.

As national economies become increasingly open and interlinked with a market-oriented global financial architecture, it is imperative that the domestic financial sectors become market-based as well. Many economies which suffered during the Asian financial crisis were borrowing from international debt markets, but were running semi-controlled local financial sectors. This weakness cost them dearly.

We would like to signal our increased focus on the development of government bond markets by the publication of this Handbook, and look forward to working together with member countries to delve deeper into specific market development issues. The Handbook will be revised over time to reflect comments and suggestions from national authorities and market participants.

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Handbook Team and Acknowledgments

This Handbook was prepared by a group of experts from the World Bank Group and the International Monetary Fund, and coordinated by Clemente del Valle of the World Bank.

The core group in the World Bank Group, led by Clemente del Valle, included Noritaka Akamatsu, Jose Antonio Alepuz, Juan Costain, Sonsoles Gallego, Tomas Glaessner, Yongbeom Kim, Jeppe Ladekarl, Jeong Yeon Lee, Michel Noel, Dimitri Vittas, David Willey, David Wilton, Xin Zhang, and Tadashi Endo (IFC). They received invaluable support from Pedro Martinez Mendez and David Willey who served as external consultants to this project. The core group in the IMF, led by Piero Ugolini, included Peter Dattels, Jennifer Elliott, George Iden, Robert Price, Jodi Scarlata, Charles Siegman, Mark Swinburne, Howell Zee, and Mark Zelmer.

The core group was ably assisted in the World Bank by Mueen Batlay, Maria Gabriela Gonzalez, Mari Kogiso, and Peter Taylor (IFC), who conducted background research, compiled and analyzed data, prepared tables and graphs, and provided general support in the development of the Handbook. Additional research and guidance was provided by Dafna Tapiero and the Financial Sector Help Desk’s Neesham Kranz and Zeynep Kantur. Invaluable administrative support was provided by Noemi Dacanay.

The team benefited from comments from numerous individuals: special thanks are due to those who provided guidance, substantive input and other constructive suggestions with respect to the development of the Handbook. These included Sarah Calvo, Gerard Caprio, Patrick Conroy, Manolo Conthe, Frederick Jensen, Kenneth Lay, Larry Promisel, and Graeme Wheeler in the World Bank, and Alison Harwood in the IFC. The team also benefited from comments from Laura Burakis, Elizabeth Currie, Gregorio Impavido, Anjali Kumar, Rodney Lester, P.S. Srinivas, C.K. Teng, Antonio Velandia in the World Bank, and Mamta Shah and Jack Glen in the IFC.

From the outside, the Private Sector Advisory Committee, which included Ignacio Garrido (Council of Europe Social Development Fund), Robert Grey (Hongkong Shanghai Bank), Sir Andrew Large (Barclays Bank), Jose Perez (Banco Bilbao Bizcaya Argentaria), Claude Rubinowicz (private consultant), Jeffrey Shafer (Salomon Smith Barney), and Ernest Stem (JP Morgan) offered valuable guidance. The project also benefited from a select group of OECD-area government debt managers (Paul Malvey from the U.S Treasury, Paul Mills from the UK Debt Office, J.T. M Hammers from the Dutch Debt Office, Ove Steen Jensen and Lars Jensen from the Danish Debt Office in the Danish Central Bank, Paul Tucker from the Bank of England, Isabel Ucha from the Portuguese Debt Office (IPDP), Maria Cannata from the Italian Treasury, Ambroise Fayolle from the French Treasury, Carlos San Basilio from the Spanish Treasury and Hans Blommestein from the OECD Secretariat. Loretta Wong and Arthur Yuen from the HongKong Monetary Authority also provided useful comments. In the preparation of the Handbook, important feedback sessions with private sector practitioners were organized in relation to selected chapters. Participants in these sessions included Michel Adler (Columbia University), David Cohen (Goldman Sachs), Frank Fernandez (Securities Industry Association), Robert Kowit (Federated), Douglas Metcalf (Nomura), Michael Pettis (Bear Sterns), Kenneth Telljohann (Lehman Brothers), and Francisco Ybarra (Citicorp). The Handbook team members also received important insights and material from their participation in various workshops and conferences (Second OECD/World Bank Workshop, Development of Fixed-Income Securities Markets in Emerging Market Economies: Enhancing Liquidity and Demand in Emerging Fixed-Income Markets, 24-26 January 2000, Washington DC; Tenth OECD Workshop on Government Securities Markets and Public Debt Management in Emerging Markets, 29-30 May 2000, Warsaw; ADB Conference on Government Bond Market and Financial Sector Development in Developing Asian Economies, 28-30 March, 2000, Manila; ASEM Government Bond Market Conference, August 2000, Singapore; and the Regional Seminar on Public Debt Management, October 18-20, 2000, Santiago, Chile).

Finally, the World Bank and International Monetary Fund teams are indebted to Charles Siegman for his substantial editing and polishing of this text.