Chapter

3 Denmark1

Author(s):
International Monetary Fund
Published Date:
August 2003
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Developing a Sound Governance and Institutional Framework

Objectives

The overall objective of Denmark’s government debt policy is to achieve the lowest possible long-term borrowing costs, consistently with a prudent degree of risk. The authorities pursue this objective while taking various factors into account, including the objective of a well-functioning domestic financial market. Recently, more emphasis has been placed on the discipline of risk management.

Scope of debt management

The debt of the central government is compiled as the nominal value of domestic and foreign debt minus the central government’s account with the central bank, Danmarks Nationalbank (DNB), and the assets of the Social Pension Fund (SPF). All administrative functions related to government debt management are undertaken by the DNB.

Two conditions establish a dividing line between fiscal and monetary policy in Denmark. First, government borrowing is subject to a set of funding rules based on an agreement between the government and the DNB. Second, the prohibition on monetary financing in the Maastricht Treaty regulates the central bank’s role as a fiscal agent and bank to the government.

Since the early 1980s, central government borrowing has been subject to funding rules for both domestic and foreign borrowing. The present funding rules were stipulated in a 1993 agreement between the government and the central bank, which replaced the informal agreement from the early 1980s, when the Danish fixed exchange rate regime was implemented.

In overall terms, the domestic rule ensures that domestic borrowing in Danish kroner matches the central government’s gross domestic financing requirement for the year. Thus, the domestic rule sterilizes the liquidity impact from government payments for the year as a whole. The rule for foreign borrowing states that new foreign loans are normally raised to refinance the redemptions on the foreign debt. If the level of foreign exchange reserves is considered inappropriate, a decision can be made to reduce or increase the level of foreign debt. Foreign exchange reserves are owned by the DNB, and the central government’s DNB account provides the link between government foreign debt and foreign exchange reserves.

In accordance with the Maastricht Treaty’s prohibition of monetary financing, the central government’s account with the DNB may not show a deficit. The government’s borrowing is therefore planned to ensure an appropriate balance on its account.

The central government receives interest on its account with the DNB. This interest rate is equal to the discount rate set by the central bank. The discount rate is equivalent to the current-account rate (folio rate), which is the interest rate for the banks’ and mortgage-credit institutions’ current-account deposits with the DNB. This arrangement implies, together with the fact that the surplus of the central bank after reserve allocations is transferred to the government, that the government receives an interest rate on the account that is comparable to what would be obtained if the account were placed in a commercial bank.

Legislative basis for central government borrowing

The legal authority for the central government to borrow is stipulated in legislation enacted in 1993. It allows the minister of finance to borrow in the name of the government. It also empowers the minister of finance to raise loans on behalf of the central government, up to a maximum of DKr 950 billion, which is the limit for the total domestic and foreign government debt. Moreover, it empowers the minister of finance to transact swaps and other kinds of financial instruments.

Before the beginning of a new fiscal year, a finance bill is adopted by parliament. It authorizes the minister of finance to raise loans to finance the central government’s projected gross financing requirement, which is the sum of the current central government deficit plus redemptions on domestic and foreign debt. The borrowing is obtained according to the domestic and foreign norm. During a fiscal year, changes may occur in the gross financing requirement. This happens primarily because of changes in the central government deficit or because of buybacks that increase the amount of redemptions. Changes in the gross financing requirement are similarly financed by government loans. These loans are authorized by an act of supplementary appropriation of the finance bill at the end of the year or by the Financial Committee of the Parliament during the year.

Besides the government debt, the central government guarantees the borrowing and financial transactions related to the borrowing of a number of public entities. The entities are mainly related to infrastructure projects, for example, the Great Belt Bridge and subway construction in Copenhagen. The board of directors and the management of the individual entity are responsible for the financial transactions of the entity, but the central government establishes borrowing limits and guidelines for the borrowing activities. The guidelines are determined in a set of agreements between the DNB and the ministry of finance or the ministry of transport and between the relevant ministry and the individual entity. The agreement between the central bank and the relevant ministry sets out the main tasks and responsibilities of the parties involved. The set of agreements also includes a list of acceptable types of loans. The list describes which kind of financial transactions and currency exposure the entity is allowed to incur.

The entities publish their own annual report and are covered by the general legislation applied to private firms.

The Danish debt office is placed within the central bank

The responsibility to parliament for central government borrowing rests with the ministry of finance. Since 1991, the central bank has undertaken all administrative functions related to government debt management. The division of responsibility is set forth in an agreement between the ministry of finance and the DNB. By power of attorney, DNB officials are authorized to sign loan documents on behalf of the minister of finance.

Before 1991, the debt office was part of the ministry of finance. In 1991, the debt office was moved to the central bank—the structural change occurring partly as a consequence of a report prepared by the public auditors. The report indicated that most of the assignments related to the central government debt were already carried out by the DNB, but duplication of assignments occurred between the central bank and the ministry of finance. Furthermore, the report suggested that a stronger coordination between the management of the foreign exchange reserve in the DNB and the central government’s foreign debt would be beneficial. Finally, it suggested that attracting and maintaining staff with the relevant skills for the debt office would be easier if the debt office were placed in the central bank. The move to the central bank has helped to centralize the retention of knowledge of most aspects of financial markets within a single authority.

The relation between the debt office and the ministry of finance

At quarterly meetings, the ministry of finance and the DNB determine the overall strategy for government borrowing on the basis of written proposals from the DNB. The adopted strategy is authorized and signed by the ministry of finance. In December each year, the overall strategy for the next year is determined, as well as the detailed strategy for the first quarter of the next year. At the following quarterly meetings, amendments to and specifications of the main strategy for the subsequent quarter are decided.

The strategy specifies the expected domestic and foreign borrowing requirements and includes a set of decisions for the next year. Among the decisions are

  • bands for duration of the central government debt,

  • a list of on-the-run issues for the domestic debt,

  • the borrowing strategy for foreign debt,

  • a list of government securities eligible for buy-backs or switch operations,

  • a list of government securities in the securities lending facility, and

  • maximum amounts of buybacks and use of interest rate swaps.

The first four items are published after the meeting in December. If changes in these decisions occur during the year, these are published as well. Maximum amounts of buybacks and use of interest rate swaps are not made public.

On the basis of these conclusions, the central bank handles the necessary borrowing transactions and the ongoing management of the debt. Besides the formal meetings, the DNB is in regular contact with the ministry of finance, and ad hoc adjustments in the strategy may occur during the year.

Structure of the debt office within the central bank

Within the DNB, four departments are involved in the management of the central government debt—the Government Debt Management unit of the Financial Markets Department, the Market Operations Department, the Accounting Department, and the Internal Audit Department. The division of the management of government debt into a front, middle, and back office structure was implemented in 1996 to diminish operational risk.

The Government Debt Management unit is responsible for middle office functions and constitutes the Danish debt office. It formulates the principal aspects of the debt management strategy and carries out analysis and risk management. The unit also formulates guidelines for the Market Operations Department on sale of domestic bonds, buybacks, swap transactions, and the amount of foreign borrowing.

The Market Operations Department is responsible for front office functions, such as sale of securities and issuance of foreign loans. Responsibility for back office functions, such as settlement and bookkeeping, is handled in the Accounting Department and Government Debt Accounting.

The Internal Audit Department in the central bank assists the Auditor General (the national audit office) in the auditing of government debt management. In handling the government debt, the departments involved in the process also draw on resources from other departments in the central bank, for example, the legal experts.

Information policy

The Danish government debt strategy is aiming at a high degree of transparency toward the general public and the financial markets. Therefore, the DNB compiles and publishes a wide and frequent range of information on central government borrowing and debt.

The information policy is based on several announcements to the public. Some of them follow a fixed annual schedule. The most important announcements and publications are the following:

  • Before the beginning of each half year, normally in June and December, the central bank sends an announcement to the Copenhagen Stock Exchange (CSE) and market participants with details of central government benchmark issues concerning July and January, respectively. The announcement also presents more general information on the plans for the central government’s domestic borrowing.

  • Before the opening of new government securities series, an announcement is sent to the CSE with details of the coupon, maturity, and opening day of the new loan.

  • On the first banking day of each month, the DNB sends an announcement to the CSE and other interested parties on the sale and buyback of domestic government securities during the preceding month. On the second banking day of each month, the DNB issues a press release with details of the government’s actual borrowing requirements and other important financial details of the preceding month.

  • Details of the sale and buyback of domestic government securities are issued daily via the DNB’s web site2 and an electronic information system (DN News). Most of this information is reproduced directly by Reuters, for example. Further information on prices and circulating amounts of government bonds is available from the CSE.

  • Terms and conditions for treasury bill auctions and results are announced via the CSE and the electronic auction system.

  • The ministry of finance regularly publishes information on the development in the government budget.

  • Other information on Danish government borrowing and debt appears in the DNB’s annual report.

The DMO in the central bank publishes an annual report (Danish Government Borrowing and Debt), usually in February. The annual report is the cornerstone of the implementation of the information policy. The report informs the public, market participants, parliament, and ministry of finance about all activities related to Danish debt management in the preceding year. Since 1998, the report has also been published in English. The report describes considerations and factors concerning borrowing and debt management. It also includes sections on special topics of relevance to government debt management. Finally, it includes a comprehensive appendix of tables with detailed central government borrowing and debt statistics, including a list of all government loans.

Enhancing quality and reducing operational risk
Procedures manual

A procedures manual ensures proper government debt administration for the relevant units in the departments working with government debt. The manual describes authorities and obligations of the unit. The central bank’s Audit Department is responsible for any changes to the written procedures, which are then passed on to the ministry of finance. Developing and maintaining the procedures manual is a key element in enhancing quality and reducing operational risk, and it is thus an area of high priority in debt management.

Work descriptions are used in daily work as a supplement to the procedures manual. A work description is a detailed description of a particular task that is regularly carried out. For example, there are work descriptions for such factors as the opening of a new government bond, a buyback auction, calculations of duration and CaR, and monthly releases of public information on the government debt. The use of work descriptions contributes to consistency and accuracy in the administration of the government debt.

Guidelines for acceptable loan categories are set out for the central government’s foreign borrowing. The guidelines stipulate requirements of the overall loan structure, including both the underlying loan and any related derivatives. The purpose of these guidelines is to minimize the political, legal, and operational risks.

Codes of conduct

The DNB staff must adhere to internal codes of conduct based on the guidelines on speculation set by the Danish Financial Supervisory Authority and the legislation against insider trading. In short, this means that the staff is allowed to invest only personal capital and only in nonspeculative investments.

Recruiting and maintaining highly skilled staff

The placement of the DMO within the central bank has helped the office in recruiting highly skilled staff. Contributing to this is the fact that the DMO is a part of a larger environment, where finance, financial markets, and policy are major areas. Therefore, it is able to recruit both internally from other departments and externally, offering new employees an opportunity to be part of a large and highly skilled organization that is well known to the public.

The staff in the Government Debt Management unit (middle office) consists of a mix of senior staff, who have worked with debt management for a number of years, have worked in other areas of the bank, or both, and young economists recently employed in the DNB.

Including employees working in the front and back offices, around 20 staff are working mainly with tasks related to the central government debt.

Management information system and use of IT

Strong and reliable IT systems are crucial to limiting operational risk. In the Danish DMO, the current IT strategy is primarily built upon a specially developed back office system (System Statsgæld) combined with the use of other software. All borrowing and swap transactions for the central government debt enter System Statsgæld. Transactions are controlled by the back office.

The back office system generates information on payments to be made or received; input to the central bookkeeping system, which covers all government entities; and data for analytical purposes.

During 2002, the plan was to implement a new middle office system. The purpose of this system is to automate important calculations used on a regular basis, for example, duration calculations, market value, and various risk factors on the debt. The new system will draw data directly from the back office system. The implementation of the new middle office system will further reduce operational risks.

Debt Management Strategy and the Risk Management Framework

Limiting country vulnerability

The objective and strategy for government debt management focuses on reducing the risk of negative spillover effects from the government debt to the surrounding economy. In that respect, interest rate risk and exchange rate risk are considered the most important risk factors.

To reduce country vulnerability, it is important to limit interest and exchange rate risk. In Denmark, this is done primarily through steering the duration and redemption profile on the debt and by borrowing only in euros or Danish kroner.

Borrowing strategy

Domestic debt

The strategy for domestic borrowing involves building up large government security series in the internationally important 2-, 5-, and 10-year maturity segments. The liquidity premium resulting from this strategy contributes to low borrowing costs for the central government. A range of government debt instruments is applied to ensure large liquid benchmark issues. This includes domestic interest rate swaps, buybacks, and swaps from Danish kroner to euros. The domestic borrowing strategy also includes a treasury bills program with monthly issues of bills with maturity up to 12 months.

Given that the central government is a dominant issuer on the domestic bond market, the measurement of performance does not encompass comparison of the cost relative to that of a specific benchmark portfolio constructed on the basis of domestic bond issues.

The Danish domestic government bonds are priced on a competitive financial market, which consists of both domestic and international investors. Furthermore, the bonds are comparable to other domestic and foreign bonds and are issued in the internationally most important maturity segments. In that respect, the pricing is based on market conditions.

In the case of buybacks, the government determines whether buybacks are advantageous as seen from a broad government debt perspective. Buybacks are used to concentrate government debt in liquid bonds, in cash management, and to control the redemption profile. Buybacks take place at market prices. Comparing prices with theoretical prices calculated on the basis of zero-coupon yield curves drawn from the market ensures that buybacks will be purchased at the market price.

Over the years, there has been a gradual change in the domestic borrowing strategy toward a concentration of borrowing on a reduced number of benchmark bonds and an increase in the use of interest and currency swaps. The changes have been carried out to ensure the outstanding amount and the liquidity in the bonds in a time with reduced borrowing needs as a result of budget surpluses since 1997.

The issuance of bonds takes place only in the 2-, 5-, and 10-year maturity segments. The 5- and 10-year bonds are on average open for issuance for 2 years, and the 2-year bonds are open for about 1 year. The issuance in the 30-year segment was effectively stopped by the end of 1997. By the end of 2001, 99 percent of the total outstanding amount in domestic bonds and treasury bills were distributed on 11 bonds and 4 treasury bills. The bonds are among the leading bonds on the CSE. Three of these bonds are considered benchmarks; the benchmark in the 10-year segment is the most important.

Foreign debt

All foreign borrowing takes place directly in euros or via loans swapped to euros. All central government foreign currency exposure, including swap transactions, is in euros. In 2002 and the coming years, the borrowing strategy is now based on raising primarily bigger loans, preferably directly in euros. The strategy is supplemented by the opportunity to issue domestic bonds combined with currency swaps to euros.

The strategy for foreign borrowing has changed gradually over the years, from small loans and, in some cases, structured loans to a mixture of smaller and bigger loans with end exposure in euros. The present strategy, focusing on bigger bullet loans directly in euros, is in line with this development toward a more standardized foreign borrowing.

When foreign exchange reserve considerations entail an immediate need for foreign currency borrowing, the central government may issue short-term commercial paper (CP). The central government can use short-term CP programs in periods when the balance of the central government’s account with the DNB is expected to be low.

The euro interbank offered rate (Euribor) serves as a reference in the assessment of borrowing costs for the foreign government debt. In addition, the cost of different instruments is compared, for example, direct borrowing in euros is compared with borrowing in other currencies swapped to euros. The borrowing costs for the foreign debt are also compared with the levels achieved by peer countries.

Main types of risk

The main risks for the government debt portfolio are interest rate, exchange rate, credit, and operational risks:

  • Interest rate risk is the risk that the development in interest rates will lead to higher borrowing costs. The concept of interest rate risk also covers refinancing risk, which is the risk that existing debt will have to be refinanced at a time with unfavorable market conditions or particularly unfavorable borrowing terms for the central government. Interest rate risk is relevant for the domestic debt and the foreign debt.

  • Exchange rate risk is the risk that the value of the debt will increase as a consequence of development in exchange rates.

  • The central government undertakes a credit risk when it enters into swap transactions. A swap is an agreement between two parties to exchange payments during a predetermined period. Thus, there is a risk that the counter-party will default on its obligations. Credit exposure is included in the management of the credit risk as soon as the swap is transacted.

  • The central government is also exposed to other risks, such as the risk of error in the administration of the debt by itself or by counter-parties.

Managing the risks

As described above, the government debt comprises four subportfolios: the domestic debt, the foreign debt, SPF assets, and the central government account with the DNB.

The four subportfolios that make up the government net debt are all subject to management by the central bank as an agent of the central government.

Interest rate risk

Management of interest rate risk is based on the net debt as a whole. This is a direct consequence of the subportfolios being more and more integrated. An example of more integration among the portfolios is the use of currency swaps from Danish kroner to euros to raise foreign loans, which at the same time affect the interest rate risk on domestic and foreign debt.

Interest rate risk is primarily managed by a duration target and a duration band for the total central government debt (net). Historically, each subportfolio had a separate duration target, but this practice was abolished by the end of 1999.

One important consequence of targeting only the duration on the net debt is that a reduction in duration may be achieved by, for example, using either domestic or foreign interest rate swaps. A reduction in duration on the net debt can also be achieved by an increase in the duration of the central government asset portfolio. Therefore, targeting only the duration of the net debt brings higher flexibility to the management of the duration.

Smoothing the redemption profile is also a part of the interest rate risk management, and this is applied separately to domestic and foreign debt. Ensuring a smooth redemption profile, whereby a more or less constant proportion of the debt is redeemed each year, reduces the risk of being obliged to refinance the debt at a time when market conditions in general are unfavorable or when the borrowing terms for the central government are particularly unfavorable.

The SPF portfolio, which is a subasset portfolio of the net government debt, contains mortgage bonds. These mortgage bonds can be redeemed at par value at any time, that is, they include an option. For these bonds, an option-adjusted duration is used in the calculation of the duration on the government net debt.

Exchange rate risk

The Danish exchange rate policy is based on maintaining a stable rate for the Danish krone against the euro within the ERM II framework. As a result of this policy, the exchange rate risk on the foreign government debt is handled by taking only foreign loans with an end risk in euros (that is, borrowing takes place directly in euros or via loans that are swapped to euros).

From 1991 to 2000, the exchange rate risk on the foreign government debt was handled together with the exchange rate risk on the foreign exchange reserve in the central bank in a formalized set-up. In this way, the exchange rate risk for the government debt and the central bank was measured on a net basis. The formalized set-up was abolished by end of 2000 as a result of the decision that all foreign government debt should be in euros. Also, the central bank has only a very small amount of exchange reserves in currencies other than the euro, thus there was no need for a formalized arrangement by the end of 2000.

Credit risk

Credit risks exist on the swap portfolio of the central government. Therefore, risk principles for credit risk management of the portfolio have been laid down. Significant elements of credit risk management are high ratings for the counter-parties and credit exposures within relatively tight credit lines. New transactions take place only with counter-parties that have signed a collateral agreement. By the end of 2001, 80 percent of the swap portfolio consisted of collateralized agreements.

Cash management risk

As mentioned above, the government has an account with the DNB. According to the Maastricht Treaty, the government is not allowed to overdraw this account. To ensure that this requirement is fulfilled, there is a minimum deposit requirement for the government’s account of DKr 10 billion (1.3 billion), and, at certain times, the requirement is higher. Every year, a detailed forecast of the government’s payments in the next year is made. On the basis of this forecast, an estimate is made concerning the daily deposits to the government’s account in the DNB. Because redemptions on the government debt are usually placed toward the end of the year, liquidity on the government’s account is front loaded during the first part of the year to meet the redemption requirements. The amount of front-loading is reduced by buybacks of bonds redeemed in the current year.

Operational and legal risks

The separation of the various debt management functions (front, middle, and back offices) is a measure against administrative errors and operational risks. As described above, procedure manuals and internal procedures ensure a clear division of authority and responsibility allocated to the three functions. The use of simple, well-known, debt management instruments also contributes to minimizing the operational risks. Finally, the central government debt management area is subject to audit by the Auditor General. Legal risk is minimized by using standardized contracts.

Risks in relation to state guaranties

The government guarantees the borrowing and the financial transactions of a number of public entities. This implies a risk for the government. This risk is limited by setting up guidelines for the borrowing activities of the entities (see the first section of this case study for a discussion of the legislative basis for central government borrowing).

In 2001, the government-guaranteed entities obtained greater access to relending of government loans through the central government. Relending assures the government-guaranteed entities of a cheaper way of funding compared with a situation where they raise all funding individually. The loans offered to the entities are identical to existing government loans, including bonds, which are not benchmark issues. Relending increases the central government’s gross financing requirement and is financed by on-the-run issues. This improves consolidation of the borrowing of the public sector.

Determining the level of risks

At the meetings of the ministry of Finance and the Government Debt Management unit, the overall objective for the interest rate risk of the government debt is determined by weighing borrowing costs against the risk.

In this process, a CaR model is used as a support in selecting the preferred issuing strategy and duration target. In the CaR model, different approaches to issuing strategy, amount of buybacks, and duration target are analyzed. The results are presented to and discussed with the ministry of finance.

The CaR model is developed in-house by the Government Debt Management unit. The model is used to quantify the interest rate risk by simulation of multiple interest rate scenarios, but it is also used as a scenario model in which specific scenarios are analyzed and discussed more thoroughly. The horizon of the analysis is up to 10 years.

Analyzing specific scenarios has played a major role in determining the overall strategy for the government debt during the last years. By using a scenario model, future developments in the outstanding amount of different bonds, redemption profiles, and the time path for the duration can be analyzed very thoroughly. This can determine whether a certain strategy is feasible, given some exogenous assumptions. Among the most important assumptions in this kind of analysis is the development in the government budget.

The duration target for central government debt has been reduced in the last few years. This reduction is primarily the result of falling debt and reduced interest costs, which have increased the willingness to take on risk. The nominal net debt has fallen from DKr 601 billion in 1997 to DKr 514 billion by the end of 2001, a drop from 54 percent to 38 percent of GDP.

From end-1998 to end-2001, the duration of the central government debt has been reduced from 4.4 to 3.4 years. The exact development in the duration during the previous year is made public in the annual report, which is published in February.

In the process of determining risks and borrowing strategy, normally neither domestic nor foreign borrowing is based on a particular interest rate outlook. Therefore, the managers do not in general actively try to generate excess returns—for example, by having views on the future interest development, which is different from market expectations.

Developing the Markets for Government Securities

Background

The Danish bond market is among the largest in Europe. The market value of the volume of bonds in circulation at the CSE was DKr 2.198 trillion at nominal value by the end of 2001. Besides government bonds, the Danish market has a large volume of mortgage-credit bonds. The large proportion of these bonds is explained by the long-standing tradition of financing construction and private housing by issuing mortgage-credit bonds. All domestic government securities are listed on the CSE. Government bonds make up one-third of the volume, and mortgage-credit bonds make up the remaining two-thirds.

The government bond yield curve

The Danish bond market is relatively large and mature, and, as mentioned above, government bonds make up only one-third of the outstanding value. Issuing bonds along the curve in many different maturity segments is therefore not a necessity under Danish policy to maintain a well-functioning capital market. Instead, in past years, the main focus has been on ensuring liquidity in government bonds by using a strategy of issuing fewer bonds with longer maturities, mainly because of a surplus on the government budget. Furthermore, buybacks have for some time been an important instrument in the Danish policy. Partly as a way of increasing the borrowing needs during the year, and partly as a way of reducing the outstanding amounts in old, non-market-conforming securities (for example, old bonds with a high coupon), the buy-backs are made in a time with surpluses.

In the domestic market, treasury bills are issued in 3-, 6-, 9-, and 12-month maturities and bonds in 2-, 5-, and 10-year maturities. All bonds are bullet loans with a fixed coupon. By the end of 1998, the government had ceased issuing 30-year bonds as a result of low borrowing needs and a reduction in the duration target for the government debt. Government bonds are used as benchmarks on the Danish bond market. Index bonds are not an instrument in the Danish government debt strategy because of their relatively low liquidity: The Danish strategy focuses on liquidity.

If government debt continues to fall, it is expected that mortgage bonds can play a benchmark role again, as was the situation until the beginning of the 1990s.

Issuing mechanisms

Issuing domestic debt

Government bonds and treasury notes are issued on tap by the central bank on behalf of the central government via the electronic trading system, Saxess, of the CSE. All licensed traders on the CSE may purchase government bonds directly from the DNB via the Saxess system.

Tap sales signify that government securities are issued when a borrowing requirement exists. Normally, the DNB does not underbid itself within the same day or within a few days. The sale of government securities on the preceding day is published daily.

The use of tap sales has a long tradition in the Danish mortgage bond market; therefore, it was natural to choose this issuing method when the government bond market was established. The use of tap sales gives the government a flexible system with the opportunity to issue bonds daily. It is the general assessment that tap sales are an appropriate way of issuing domestic government bonds in the Danish bond market.

The planning of tap sales for the year is based on selling nearly the same amount in each remaining month. This means that by the beginning of the year, the assumed expectation with respect to monthly sales is an evenly distributed sale during the year. This strategy is implemented by authorizing the front office to target a specified amount of issuance each month. The target is supplemented by a minimum and a maximum for each individual sale. The front office handles the tap sale within these boundaries. After each month, the expected monthly sale for the rest of the year is updated. Within the month, the dealers at the front office handle the tap sale. It is aimed to “tap” the market when market demands are high. Views on the future development in the interest rates are generally not a part of the planning of the tap sale.

The licensed traders on the CSE are obliged to report transactions that take place outside the Saxess platform. Transactions should be reported within five minutes. Of the total turnover, 10 percent are reported to the CSE and take place over the Saxess system. The remaining 90 percent are transacted by telephone sale between the market participants. Telephone sales are based on price indications from an electronic system at the CSE.

Treasury bills are sold at monthly auctions via an electronic system at the central bank. All licensed traders on the CSE and the DNB’s monetary policy counter-parties may bid at the auctions. Bids are made for interest rates. All bids at or below the fixed cutoff interest rate are met at the cutoff interest rate (uniform pricing). Bids at the cutoff interest rate may be subject to proportional allocation.

Issuing foreign currency debt

Foreign loans have normally been established on the basis of concrete approaches from foreign investment banks, which are in contact with investors with special placement requirements. The currency swaps from Danish kroner to euros are established on the basis of competitive bidding from different investment banks.

As described above, the foreign strategy for 2002 and beyond focuses primarily on obtaining larger syndicated loans directly in euros, using one or more lead managers.

Primary dealers, market makers, and lending schemes

Primary dealers are not used in issuing domestic government securities in Denmark. All licensed traders on the CSE may buy government bonds and treasury notes directly from the DNB via Saxess on the CSE. Licensed stock exchange traders and the DNB’s monetary policy counter-parties may participate in the treasury bill auctions.

There are two voluntary market maker schemes for government securities under the auspices of the CSE and the Danish Securities Dealers Association, respectively. Participants in these schemes are obliged to quote two-way prices for a certain amount of appropriate bonds at any time. Under the CSE, scheme prices are set only in the 10-year benchmark, whereas the scheme of the Danish Securities Dealers Association comprises other liquid government securities as well. The central bank does not take part in the market maker plans.

To support liquidity, securities lending schemes have been set up. Two lending schemes exist, one held by the central government and one held by the SPF. A lending scheme supports the liquidity in the government bond market because situations involving any shortage of bonds are prevented. The lending scheme held by the government was introduced in 1998, and the SPF lending scheme was introduced in 2001. In both plans, Danish government bonds are accepted as collateral.

The lending scheme held by the government comprises mainly benchmark issues not held by the SPF. The SPF lending scheme consists of government bonds in the portfolio of the government bullet-loan type. The two lending schemes do not overlap with respect to bonds. Together, they consist of lending in most government bonds, including treasury bills.

Financial market contact

A regular and close contact with the financial market community is important for the government debt policy and is therefore given high priority. In regular meetings, different aspects of the management of the central government debt are discussed with market participants. At these meetings, market participants get the opportunity to discuss the management of the government debt with representatives of the Government Debt Management unit, including discussion of the potential need for changes or introduction of new financial instruments.

Clearing and settlement system

Government bonds, treasury notes, and treasury bills have been registered electronically in the Danish Securities Center (VP-system) since 1983. Danish government securities may also be registered in Euroclear and Clearstream. A direct link between Euroclear and VP-system aids easy transfer of securities between them without loss of trading days. Government securities trades are normally settled in VP-system, but may also be settled in Euroclear and Clearstream. Foreign loans are registered in Euroclear or Clearstream. All three systems adhere to the principles set forth in the Committee on Payment and Settlement Systems (CPSS)–International Organization of Securities Commissions (IOSCO) standards of November 2001 on securities settlement systems. The DNB as overseer conducted a formal assessment of VP-system against these standards during the first half of 2002.

Tax issues and effects on trading off government securities

Danish government bonds are treated equally to other bonds on the Danish bond market. No discriminatory tax rules exist. This means that the general legislation for taxation of bonds applies to government bonds. Foreigners investing in Danish bonds do not pay withholding tax.

For noncorporate investors who pay taxes to the Danish government, a minimum coupon rule exists for domestic bonds. This rule implies that capital gains on bonds with a coupon higher than the minimum coupon are free of taxation. The minimum coupon is normally revised semiannually according to the development in the general interest rate level.

The case study was prepared by the Government Debt Management Office of Danmarks Nationalbank.

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