- International Monetary Fund
- Published Date:
- August 2003
The management of the national debt in Ireland was delegated to the National Treasury Management Agency (NTMA) by legislation enacted in 1990. This delegated authority includes issuance, secondary market activity, and all necessary ancillary activity, such as, for example, arranging for clearing and settlement.
Debt Management Objectives and Coordination
Objectives of debt management
The key objectives of the NTMA in managing the national debt are, first, to protect liquidity to ensure that the exchequer’s funding needs can be financed prudently and cost effectively and, second, to ensure that annual debt-service costs are kept to a minimum, subject to containing risk within acceptable limits. It must also have regard to the absolute size of the debt insofar as its actions can affect it (deep discounts and currency mix).
Although the broad objectives of debt management have remained more or less unchanged, the emphasis on how best to achieve these objectives has changed, particularly in response to Ireland’s adoption of the euro.
Debt management activity covers both the issue and the subsequent management of the central government’s short-term and long-term debt as well as the management of its cash balances. The management of the debt is concerned with both the annual cost of debt service, in the traditionally understood sense of measuring and controlling the total value of interest and debt issuance costs each year, as well as with the economic impact, over the life of the debt, of all debt management activity. This latter aspect of debt management is captured by measuring the net present value (NPV) of the debt and comparing it with a benchmark.
Coordination with monetary and fiscal policy
The annual debt service cost, in terms of cash flows, is a major part of the overall expenditure in the budget of the ministry of finance (MoF) and is framed to be consistent with the general level of borrowing or surplus envisaged by that budget. Monetary policy is the prerogative of the European Central Bank (ECB), and before the introduction of the euro, it was under the control of the Central Bank of Ireland (CBI). Debt management policy is not coordinated with the ECB’s monetary policy. Before 1999, neither was there any formal coordination of debt management policy with the monetary policy of the central bank, even though there was a nonstatutory exchange of information and views with the CBI on the main thrust of debt management policy. In managing the debt, the NTMA was conscious of the need to avoid any conflict with the central bank’s monetary and exchange rate policies. The advent of the euro in 1999 ended the scope of and need for such policy sensitivity.
Treasury service and advice to other arms of government
The debt management activity of the NTMA relates only to the debt of the central government. The debt of other arms of the government, such as local government authorities, regional health boards, and state bodies, remains the responsibility of those bodies, subject to approvals and guidelines issued by the department of finance. The NTMA has been empowered, however, to offer a central treasury service, in the form of deposit and loan facilities, as well as treasury advice to a range of designated local authorities, health boards, and local education committees. It has also been authorized to advise ministers on the management of funds under their control and, where the requisite authority is delegated, to manage such funds on behalf of those ministers. The NTMA currently manages the assets of the Social Insurance Fund under such delegated authority. It has also been mandated to manage the National Pensions Reserve Fund under the direction of the National Pensions Reserve Fund Commissioners, who are appointed by the minister of finance.
Transparency and accountability
The minister of finance approves the budget for annual debt-service costs, and the NTMA is obliged under legislation to achieve that budget as near as may be. Its performance relative to this budget is reported to the MoF, as is the performance in NPV terms against a benchmark portfolio. However, all debt-service payments, including redemptions, are a first charge on the revenues of the government and, under the provisions of the legislation that authorizes the raising of debt, are not subject to annual approval by the minister or by parliament. The NTMA also reports to the MoF on the very broad outlines of its borrowing plans for each year, indicating how much it intends borrowing in the currency of the state and how much in other currencies. The minister gives directions to the NTMA each year in the form of widely drawn and prudentially intended guidelines covering the major policy areas, such as the mix of floating- and fixed-rate debt, the maturity profile, foreign currency exposure, and other financial data. The public auditor, the comptroller and auditor general, carries out an audit each year on the agency’s compliance with these guidelines.
The debt managers and the CBI have distinct and nonoverlapping roles from both a legal and an institutional perspective in that the central bank has no role in debt management policy. The introduction of the euro in 1999 did not essentially alter the relationship, except to the extent that it removed the necessity for the degree of informal exchange of information and views that had existed before that date in the interest of the smooth operation of both monetary policy and debt management policy. At present, the NTMA cooperates with the central bank’s actions in implementing the liquidity management policy of the ECB by maintaining an agreed level of funds in the exchequer account in the central bank each day. The CBI also maintains the register of holders of Irish government bonds. In December 2000, the clearing and settlement function for Irish government bonds was transferred from the central bank to Euroclear.
The NTMA’s annual report and accounts include a full statement of its accounting policies. In addition, it publishes at the beginning of each year a calendar of its bond auctions for that year, together with a statement of the total amount of issuance planned for the year. The NTMA’s bond auctions are multiple-price auctions and are carried out by means of competitive bids from the recognized primary dealers. At present, there are seven such dealers who are obliged to quote electronically indicative, two-way prices in designated benchmark bonds within maximum bid/offer spreads for specified minimum amounts from 8:00 a.m. to 4:00 p.m. each day. In addition, primary dealers are required to be market makers in Irish government bonds on the international electronic trading system, Euro MTS, and on the domestic version of it, MTS Ireland.
The government’s budgetary forecasts for the coming year and the two following years are published annually in December. These forecasts include figures for the overall budget surplus or deficit of the government for each year. The preliminary out-turn for the current year is also shown. In addition, the finance accounts published each year by the government contain detailed information on the composition of the debt, including the type of instrument, the maturity structure, and the currency composition. During the course of the year, the MoF publishes detailed information on the evolution of the budgetary aggregates at the end of each quarter, together with an assessment of the outlook for the remainder of the year. The NTMA publishes an annual report that contains its audited accounts as well as a description of its main activities. It also publishes information during the year on the details of all the markets on which it operates and the amount outstanding on the various debt instruments used in these markets. Also, information on the amount outstanding on each of the bonds it has issued is released each week to the public.
The NTMA has a control and a compliance officer who reports to the chief executive. It also engages a major international accounting firm to undertake an internal audit of all data, systems, and controls. In addition, the annual accounts are audited by the state auditor, the comptroller and auditor general, before their presentation to parliament within a statutory deadline of six months after the end of the accounting year. The comptroller and auditor general reports the findings to parliament.
The National Treasury Management Agency Act of 1990 provided for the establishment of the NTMA “to borrow moneys for the Exchequer and to manage the National Debt on behalf of and subject to the control and general superintendence of the Minister for Finance and to perform certain related functions and to provide for connected matters.”
The 1990 Act enabled the government to delegate the finance minister’s borrowing and debt management functions to the NTMA, such functions to be performed subject to such directions or guidelines as he or she might give. Obligations or liabilities undertaken by the NTMA in the performance of its functions have the same force and effect as if undertaken by the minister.
The chief executive, who is appointed by the MoF, is directly responsible to the minister and is the accounting officer for the purposes of the Dáil’s (lower house of parliament) Public Accounts Committee. The NTMA has an advisory committee, comprising members from the domestic and international financial sectors and the MoF, to assist and advise on such matters as are referred to it by the NTMA.
The main reasons behind the decision to establish the NTMA were outlined as follows by the minister of finance when he introduced the legislation to the parliament in 1990:
… debt management has become an increasingly complex and sophisticated activity, requiring flexible management structures and suitably qualified personnel to exploit fully the potential for savings.
… it has become increasingly clear that the executive and commercial operations of borrowing and debt management require an increasing level of specialization and are no longer appropriate to a Government Department. Also, with the growth of the financial services sector in Dublin, the Department [of Finance] has been losing staff that are qualified and experienced in the financial area and it has not been possible to recruit suitable staff from elsewhere.
… [in the agency] there will be flexibility as to pay and conditions so that key staff can be recruited and retained; in return, they will be assigned clear levels of responsibility and must perform to these levels: the agency’s staff will not be civil servants.
It was considered that locating all debt management functions within one organization, which had a mandate to operate on commercial lines and had the freedom to hire staff with the requisite experience, would lead to a more professional management of the debt than would be possible within the constraints of the civil service system.
To ensure the complete independence of the NTMA from the civil service, the legislation establishing it expressly precludes its staff from being civil servants. However, political accountability is maintained by having the NTMA’s chief executive report directly to the minister of finance and by making the chief executive the accounting officer responsible for the NTMA’s activity before the Public Accounts Committee of parliament.
The overall borrowing and debt management powers of the minister have been delegated to the NTMA and further annual parliamentary or legislative authority to borrow or engage in other debt management activities is not required. However, the NTMA is required to present to the MoF each year a statement setting out how much it intends to borrow in the currency of the state and in other currencies during the course of the year. Broadly speaking, it is empowered to use transactions of a normal banking nature for the better management of the debt. This broad power includes the use of derivatives as well as power to buy back debt or, where the borrowing instrument permits, to redeem it early.
The NTMA’s structure reflects the fact that it has a number of other functions in addition to debt management, namely the management of the National Pensions Reserve Fund, under the direction of the National Pensions Reserve Fund Commissioners, and the processing of personal injury and property damage claims against the state, in which role the NTMA is known as the state claims agency.
Directors report to the chief executive on funding and debt management and IT, risk and financial management, legal and corporate affairs (including retail debt), the National Pensions Reserve Fund, and the state claims agency. The NTMA also has an advisory committee, appointed by the MoF, to advise on the chief executive’s remuneration and such matters as are referred to it by the NTMA.
The separation of the front office function (funding and debt management) from the middle office function (risk management) and the back office function (financial management) is in accordance with best practice and ensures an appropriate separation of powers and responsibilities.
The NTMA retains key staff through its employment contracts and remuneration packages, which are flexible and designed to attract qualified permanent or temporary personnel as required. This freedom to recruit and pay staff in line with market levels was a key element in the government’s decision to establish the NTMA. Because the NTMA is a relatively small organization, the training of staff is generally outsourced as the most efficient option. Its IT department has built the back office IT support systems to provide straight-through processing of trades from front office to back office and also to generate the required management reports. Temporary IT expertise was contracted as necessary to achieve this objective. The NTMA is a member of the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and the TransEuropean Real-Time Gross Settlement Express Transfer (TARGET), which enables real-time processing of payment transactions.
Internal operational risk is controlled by rigorous policies and procedures governing payments and the separation of duties, in line with best practice in the financial sector generally, including:
Segregation of duties between front office and back office functions: This practice is enforced by logical and physical controls over access to computer systems and by the application of office instructions and product descriptions.
Office instructions describe detailed procedures for key functions and assign levels of authority and responsibility.;
Product descriptions set out a description of the particular product and detailed processing instructions and highlight inherent risks.
Bank mandates are established with institutions with whom dealing is permitted.
Third-party confirmations are sought for all transactions.
Reconciliations and daily reporting.
Monitoring of credit exposures arising from deposits and derivative transactions, which are managed within approved limits.
Voice recording of certain telephones.
Head of control function/internal audit/external audit.
Code-of-conduct and conflict-of-interest guidelines
Disaster recovery plans are also in place that would enable the NTMA to resume its essential functions from a back-up site within one to four hours. This plan is tested regularly and is made possible by the arrangements for complete back-up of all computer data and their storage off-site three times each day.
Debt Management Strategy and Risk Management Framework
The overall debt management strategy is to protect liquidity so as to ensure that the exchequer’s funding needs can be financed prudently and cost effectively and at the same time ensure that the annual costs of servicing the debt are kept to a minimum, subject to an acceptable level of risk.
The main risks associated with managing the debt portfolio, apart from operational risk, which has been discussed, are credit risk, market risk, and funding liquidity risk.
Credit limits for each counter-party are proposed by the risk management unit and approved by the chief executive. The credit exposures are measured each day, and any breach is immediately brought to the attention of the chief executive.
In setting credit limits for individual counter-parties, there is a single limit on the consolidated business with the counter-party—that is, all businesses are brought together under one limit. Each limit is divided into short-term (up to one year to maturity) and long-term (more than one year to maturity). In determining the maximum size of an exposure to a counter-party that the NTMA is willing to undertake, account is taken of the size of the counter-party’s balance sheet and the return on capital, as well as the credit rating and outlook assigned by Moody’s, Standard and Poor’s, and Fitch, the major credit-rating agencies. The market value of derivatives is used in measuring the credit risk exposures. The credit risks are also assessed by reference to potential changes in the exposures as a result of market movements and the position is kept under continuous review.
The NTMA manages the cost and risk dimensions of the debt portfolio from a number of perspectives, including (a) managing the performance of the actual portfolio relative to the benchmark portfolio on an NPV basis and (b) managing the debt-service budget. Both interest rate risk and currency risk are controlled, measured, and reported on.
The benchmark reflects the medium-term strategic debt management objectives of the exchequer and encapsulates the NTMA’s appetite for market risk. When the benchmark has been agreed upon with its external advisers, it is then approved by the minister of finance. The minister decides whether it is consistent with his or her overall guidelines on the management of the debt. Revisions to the benchmark are made from time to time (subject to approvals by the NTMA’s external advisers and the Department of Finance) to take account of significant changes in structural economic relationships but not in response to short-term market movements.
The benchmark portfolio is a computer-based notional portfolio representing an appropriate target interest rate, currency mix, maturity profile, and duration for the portfolio. The benchmark is based on a medium-term cost/risk trade-off derived from simulation analysis. Cost is defined in terms of the mark-to-market value of the debt, and risk is defined in terms of the likelihood that debt-service costs will exceed the budget provision of the minister of finance. The simulations lead to the choice of a benchmark portfolio, which is robust under a range of possible out-turns rather than highly dependent on one set of assumptions regarding the future evolution of interest rates and exchange rates.
One of the major risks that must be controlled is the possibility that the annual debt-service cost will fluctuate wildly from year to year and exceed the target level set out by the minister of finance. In tandem with this, the benchmark seeks to minimize the overall cost of the debt in terms of its mark-to-market value. In constructing the benchmark, the simulation exercises seek to find a portfolio that minimizes the mark-to-market value (the cost) while ensuring that the annual debt-service cost is at the minimum level consistent with not fluctuating wildly from year to year. The stability of the debt-service budget over time is more important than minimizing the cost in any one year. Overall, the benchmark seeks to strike a balance between the potentially conflicting objectives of minimizing the NPV of the debt while maintaining the lowest possible stable debt-service costs over the medium term.
The fiscal budget for annual debt-service costs is sensitive to exchange rate and interest rate risks. Each month, two estimates are produced and reported to quantify the level of this risk:
Sensitivity of the fiscal budget to a 1 percent movement in interest rates: The interest composition of the outstanding debt and the expected funding requirements are taken into consideration while assessing the possible gains or losses that could be incurred were interest rates to move by 1 percent.
Sensitivity of the fiscal budget to a 5 percent movement in exchange rates: This takes into consideration the currency composition of the debt. It looks at the possible gains or losses to the debt-service budget in the event of exchange rate movements.
A set of internal monthly fiscal risk limits is put in place early each year. These limits reflect the prudent risk limit for the fiscal budget. The sensitivity reports are compared to these limits to check for compliance.
The main reports for the ongoing management of the debt-service budget are:
Monthly update of the debt-service forecast for the current year: The forecast is broken down by the various debt instruments and includes a monthly profile of the full year’s debt-service budget.
An analysis of the variances between the debt-service out-turn and the debt-service forecast.
Monthly report on the debt-service budget, analyzing the effect of possible exchange rate and interest rate movements: This report is done for both current year’s fiscal budget sensitivities and future years’ fiscal budget sensitivities.
Benchmarking of the domestic portfolio
When the Irish government debt management operations were carried out in the context of an Irish pound (punt) market, before the introduction of the euro, the benchmarking of performance on the domestic debt portfolio was much more difficult than benchmarking the foreign portfolio. Nevertheless, it was considered beneficial to benchmark domestic performance to provide appropriate incentives for the debt portfolio managers. The benchmarking system was devised to give credit for any structural improvements in the domestic bond market brought about by the portfolio managers (e.g., the introduction of the primary trading system and the concentration of liquidity into a smaller number of benchmark issues). The benchmark was also used to assess the effectiveness of the domestic debt managers in achieving their funding target within previously agreed duration limits. The managers were free to vary the timing of their funding actions compared with the benchmark, depending on their interest rate view. Thus, at all times, the debt managers were required to have a view on interest rates when deciding on their issuance policy.
With the development of a relatively uniform euro-area government bond market, Ireland became a very small part of a large liquid market and thus the benchmarking of the domestic debt management operations became more straightforward.
Funding liquidity risk
The NTMA prepares and manages a detailed multi-year funding plan that shows the amount and timing of funding needs, including the effect of the projected surpluses or deficits on the government’s budget. In light of this plan, it determines the size and timing of its long-term debt issuance and manages its short-term liquidity positions through the issuance of short-term paper or the use of short-term cash balances.
The main reports for the ongoing maintenance of the exchequer’s funding and liquidity requirements are
the weekly updating of the NTMA’s overall funding plan, which includes a review of its underlying assumptions and a review of immediate liquidity requirements; and
regular reports on the main features of the developments in the government’s overall budgetary position to date, and a review of the current outlook.
With the introduction of the euro, the NTMA took a number of steps to enhance the marketability of its bonds and thus reduce funding risk. Broadly speaking, the technical characteristics of Irish government bonds (e.g., day-count convention) have been changed to bring them into line with the bonds of the large, core euro-area issuers. In addition, a number of bond exchange and bond buyback programs have been executed with the objective of concentrating liquidity into a smaller number of large, liquid benchmark issues. At present, virtually all the marketable, long-term, euro-denominated debt with more than one year to maturity is concentrated into five bonds. The NTMA also promotes the openness, predictability, and transparency of the market in Irish government bonds through announcing in advance its schedule of bond auctions, by having a primary dealing system to support the market in the bonds, and by arranging for the listing of the bonds on one of the main electronic trading platforms used for trading euro-area sovereign debt. The deep liquidity thus generated for the market in Irish government bonds reduces the funding risk by making the bonds more attractive to a wider pool of investors. Given that Ireland represents a very small proportion of the total euro-area government debt market (about 1 percent), the NTMA has little difficulty in raising short-term funds to smooth the funding requirement around the time of the redemption of bonds, whose size is quite large by historical standards.
Medium-term focus of debt management
A number of approaches are adopted to ensure that the NTMA’s debt management activities are not focused on short-term advantage at the cost of potential longer-term cost. First, each year, the minister of finance issues a set of guidelines covering policy issues such as the mix of floating- and fixed-rate debt, the maturity profile, the foreign currency exposure, the permissible extent of discounted issues, and the credit rating of counter-parties. These guidelines are drawn relatively broadly and are designed as prudential limits, which the NTMA must observe. Second, the NTMA’s performance in managing the debt is measured by reference to an independent and externally approved and audited benchmark portfolio. This benchmark performance measurement system takes account not just of current cash flows but also of the NPV of all liabilities; in effect, it calculates the impact of the NTMA’s debt management activities not only in the year under review but also their projected impact over the full life of the debt. Under the NPV approach, all future cash flows (both interest and principal) of the notional benchmark debt portfolio and of the actual portfolio are marked to market at the end of each year and discounted (based on the zero-coupon yield curve) back to their respective NPVs. If the NPV of the liabilities in the actual portfolio is lower than the NPV of the notional benchmark portfolio’s liabilities, then the NTMA is deemed to have added value in economic terms. This performance against the benchmark is reported to the MoF and published in the NTMA’s annual report.
Limitations on activities to generate a return
The managers of the debt portfolio are free to manage the debt within certain risk limits relative to the agreed benchmark. The limits are expressed in terms of the possible change in the market value of the portfolio. Value-at-risk (VaR) and interest and currency sensitivity analysis are used to measure the short-term deviations from the benchmark on a weekly basis (or more frequently, if required). Any position that exceeds the agreed limit relative to the benchmark portfolio is immediately brought to the attention of the chief executive.
In managing the debt relative to a benchmark it is necessary to take views on movements in interest rates, unless one wishes to passively track the benchmark. However active daily trading simply to generate a profit does not take place. The trades entered into by the NTMA are for the purpose of managing the debt, and in the course of this certain arbitrage opportunities may arise. For example, one area of arbitrage that is exploited by the debt managers is the issuance of commercial paper, mainly in U.S. dollars but also in other foreign currencies, and the swapping of these currencies into euros for an overall lower cost of funds than could be achieved by direct borrowings in the euro-denominated commercial paper markets.
Strict limits are placed on the activities of the debt managers in availing of arbitrage opportunities between different markets. Although it is generally feasible for the debt managers to raise funds in the short-term paper markets at lower interest rates than could be obtained in placing those funds on deposit in the market, the general policy of the NTMA is that borrowing activity will be related to the funding needs of the exchequer. It is, however, desirable to maintain a continuous and predictable presence in the government debt markets, and, in addition, cash surpluses will emerge from time to time on the exchequer account because of mismatches between the timing of government receipts and payments. The surpluses that arise in this way can be placed on deposit in the markets, subject to the constraints of the limits on counter-party credit risk.
The main reports for performance measurement against the benchmark portfolio are
daily performance results and positions, which are electronically circulated to the dealers’ desks;
monthly VaR analysis to ensure that all risk limits are complied with; and
quarterly detailed reports on the attribution of performance.
Models to assess and monitor risk
To assess and monitor risk, the NTMA uses models developed in-house and models purchased externally; the latter are used particularly for mark-to-market valuations as part of the risk assessment process. These systems are used mainly to measure and report on market risk and counter-party credit risk exposures on a daily basis.
The NTMA is not responsible for the government’s contingent liabilities. These contingent liabilities that arise from government guarantees of the borrowings of state companies or other state bodies are monitored and managed by the Department of Finance.
Developing the Markets for Government Securities
Filling out the yield curve
The NTMA issues the following debt instruments:
Commercial paper is issued directly to investors or via intermediate banks. The commercial paper is available in all currencies, with tenors not normally exceeding a year.
Exchequer notes are treasury bills with a maturity range from one day to one year. Each day, the NTMA issues the notes directly through an “open window” facility to a broad range of institutional investors, including corporate investors and banks. The NTMA is prepared to buy back exchequer notes before maturity. At present, there is just a small secondary market. The NTMA is examining the possibility of improving the secondary market by having the notes traded on an electronic trading platform.
Section 69 notes: In Section 69 of the Finance Act of 1985, the MoF provided for the issue of interest-bearing notes to foreign-owned companies in Ireland. The interest on these notes would not be subject to tax in Ireland. This incentive was introduced to encourage these companies to keep their surplus cash in Ireland rather than repatriate funds to their overseas parent companies. Section 69 notes can be issued in any currency (minimum 100,000) for any tenor.
Fixed-rate, euro-denominated bonds with maturities up to 14 years are issued by auctions. The bonds are listed on the Irish Stock Exchange and supported in the market by seven market makers (primary dealers).
Foreign and domestic currency debt
Although issuing debt in foreign currencies is now regarded as appropriate for Ireland, because of the advent of the euro with its deep liquid capital market, it is important to remember that conditions for a small open economy such as Ireland were very different in the 1980s.
The problem essentially arose as a result of the oil crisis of 1979 and the subsequent worldwide recession that, along with the prevailing high international interest rates, had severe adverse consequences for Ireland in terms of
low growth and higher unemployment levels,
high fiscal deficits,
high domestic interest rates, and
fear of “crowding out” on the domestic capital market.
These factors, coupled with the underdeveloped nature of the domestic Irish bond market, led to large-scale foreign borrowing, with a rapid growth in overall indebtedness. In 1991, the position was that foreign currency debt accounted for 35 percent of the national debt and nonresidents held a further 15 percent denominated in Irish currency. Thus, nonresidents held 50 percent of the total national debt.
The NTMA faced a much-changed domestic and international borrowing environment with the gradual abolition of currency controls and the relaxation of the primary and secondary liquidity ratios on banks. During the 1980s, these controls (although hindering the development of the domestic capital market) had ensured something of a “captive market” for Irish government bonds and paper. The NTMA now faced a more competitive environment for attracting investors. Internationally, sovereign names were moving away from the traditional syndicated loans toward capital market instruments.
Priorities for the early years of the NTMA
In the early 1990s, the NTMA identified the following priorities for its borrowing program:
expanding, broadening, and diversifying the investor base through such ideas as marketing Ireland’s name abroad and keeping it visible through road shows and presentations to influential investors (Japanese yen Samurai, CHF private placement, and U.S. dollar Yankee markets were very important for Ireland in the early days of the NTMA);
tapping new markets;
keeping access to retail and institutional investors;
lengthening the duration of the debt and creating a more balanced maturity profile;
targeting upgrades in Ireland’s credit ratings (campaigns to get upgrades ahead of time or that were forward looking);
marketing campaigns to improve the international image of Ireland (emphasizing the rarity value of Ireland’s name); and
opportunistic approach to foreign borrowing.
The payoff from this approach was that Ireland was very successful in terms of pricing new issues and regularly achieved tighter or keener pricing than similar or more highly rated sovereign borrowers.
In response to the need to diversify the sources of funding, because all markets are not open at the same time, and to broaden and deepen the range and quality of instruments available for debt management, Ireland put in place standardized medium-term notes (MTNs), euro medium-term notes (EMTNs), euro commercial paper (ECP), and U.S. dollar commercial paper (USD CP) programs. By mid-1992, the NTMA had put in place facilities in a range of currencies totaling about US$3 billion, which allowed Ireland immediate and cost-effective access to short- and medium-term funds with maximum flexibility.
These facilities showed their worth in the autumn of 1992, when, because of the shock of the huge extra borrowing needs of sovereign names caused by the turmoil in the exchange rate mechanism of the European Monetary System, large syndicated loans and capital market issues became particularly expensive as spreads widened.
Although in the early years of the NTMA’s existence, there was more focus on achieving cash savings on the debt-service cost because of government budgetary pressures, the liquidity risk due to the uneven maturity profile also required urgent attention.
Moves to smooth the maturity profile occurred in 1991. In 1995, the NTMA arranged a 7-year US$500 million, backstop, multicurrency revolving credit facility to support the issuance of commercial paper. Moreover, it arranged the syndication itself to cut down on fees and achieved the tightest pricing ever by a sovereign.
The NTMA also took steps to ensure that derivative instruments (such as interest rate swaps, cross-currency swaps, caps, floors, futures, and foreign currency forward contracts) as well as spot transactions in foreign currencies were available to be used in the management of the debt. The great advantage of recent financial innovations is not that they can help to lower the cost of funds, but rather that these instruments can help to protect the portfolio against different kinds of risks by, for example, shortening or lengthening the average effective duration of the outstanding debt.
The various strategies produced a positive mix of
cost savings through cheaper funding,
greater flexibility in funding and hedging,
more fiscal certainty on debt service, and
reduced liquidity and rollover risk and greater availability of instruments to deal with market risk more efficiently and dynamically.
The NTMA took the view that the most sophisticated debt managers are not those who achieve the lowest possible cost of borrowing. The goal needs to include minimizing exposure to risk as well as minimizing costs. It is worth paying more to create debt structures that cushion, rather than amplify, the impact of negative shocks. These developments proved positive for credit ratings, investors, and the spreads on Irish sovereign debt as they reduced the relative risk premium.
In 1998, the NTMA decided that, with the imminent introduction of the euro and the relatively positive outlook for government finances, the large euro-area bond and money markets would more than adequately meet Ireland’s funding needs for the foreseeable future; therefore, it was no longer necessary to retain exposure to non–European Economic and Monetary Union (EMU) currencies in the portfolio. Consequently, all noneuro debt, with the exception of a residual 6 percent that was left in pounds sterling, was swapped back into euros during late 1998 and early 1999. This remains the policy today.
The pound sterling exposure was maintained not on the basis of a cost/risk trade-off for debt management purposes, but rather as a macroeconomic hedge for public finances in the event of a sudden and significant weakening of the pound sterling exchange rate. This decision was taken on the basis of a study of the economic links with the U.K. economy of a considerable number of firms whose output is based on relatively low-skilled labor and whose profit margins tend to be low. These firms compete with U.K. firms on the domestic market, the U.K. market, and third markets. Any substantial weakening of pound sterling would lead to a loss of competitiveness and consequential redundancies in this sector, resulting in higher social welfare support payments by the exchequer. This would have been offset to some degree by the lower cost, in Irish pound and euro terms, of servicing the sterling-denominated debt. However, the NTMA is currently reviewing this policy, and it has reduced the pound sterling exposure to about 4 percent of the national debt.
Reduction of fragmented debt stock and issuance of consolidated debt
With the objective of reducing borrowing costs for the government, a number of initiatives have been taken by the NTMA over the years to improve liquidity in the Irish bond market. After the launch of the euro, the NTMA decided that a major initiative was required to ensure that Irish bonds traded effectively in the new, euro-denominated, pan-European market. The initiative taken was the securities exchange program. The rationale underlying the program was the NTMA’s belief that to be competitive in the new euro environment, Irish government bonds that are “on the run” must have a relatively large issue size and technical characteristics analogous to those in other euro-area markets.
In May 1999, the NTMA addressed the above issues, within the constraints of the overall limited size of the Irish government bond market, by launching a securities exchange program that consolidated about 80 percent of the market into four bonds, each with outstanding amounts of 3–5 billion, with coupons around current market yields and technical characteristics similar to bonds in other European markets. In the absence of such an initiative, there was a risk that the bonds would trade at yields inappropriate to Ireland’s credit rating.
The exchange program was launched in May 1999, with the majority of the transactions taking place in three phases—that is, on May 11, 17, and 25. On completion of the third phase, more than 91 percent of the outstanding amount of old bonds covered by the program had been exchanged for new bonds.
As a result of the exchange program, the ratio of general government debt (based on nominal value) to GDP was increased by some 5 percentage points. However, because of the effect of the very rapid growth in GDP, the ratio, which was 55.1 percent at the end of 1998, had fallen to 49.6 percent at the end of 1999, including the effects of the exchange program. The program did not affect the economic value of the outstanding debt. Cash-flow savings represented by the lower annual coupons on the new bonds offset the addition to the capital stock of the debt. The bonds bought back under the program were trading above par, because they had been issued at a time when interest rates were very much higher than in 1999. However, the bonds issued under the program were priced very close to par. Hence, the nominal value of the debt increased as a result of the program.
In January 2002, the NTMA conducted its first major bond switch since the 1999 securities exchange program. Two of Ireland’s existing benchmark bonds (the 3.5 percent 2005 and the 4 percent 2010) were now “off the run” in terms of their euro-area peer group.
The NTMA wished to launch two new benchmark bonds that would have a good shelf life and would be of sufficient critical mass (€5 billion) to join the Euro MTS electronic trading system by mid-2002. The intention was that the two new bonds would be reopened by way of auctions in 2002. The best way to achieve these strategic aims was to offer the market switching terms out of the former 2005 and 2010 bonds into to new benchmark issues (a 2007 and a 2013 bond).
The switch was successfully conducted via the NTMA’s primary dealers. The 2005 and 2010 bonds ceased to be designated as benchmarks, because, under NTMA rules, once 60 percent or more of the amount in issue has been bought back, a bond loses its benchmark status. This stipulation acts as in incentive for investors via the primary dealers to take part in the switch, because most investors do not wish to be in non-benchmark stocks with the resultant price illiquidity.
Between February and November 2002, subject to normal market conditions prevailing, the NTMA has held a bond auction on the third Thursday of each month. Each auction is normally in the €500 million–700 million range and involves the new 2007 and 2013 benchmark bonds (and the 2016 bond, which was first issued in 1997). The primary dealers have exclusive access to the auctions, which add further depth and liquidity in these issues. Five business days before each auction, the NTMA announces to the market the bond to be auctioned and the amount through Bloomberg and Reuters. The Bloomberg auction system is used to conduct the auction. This reduces the time between the close of the bidding and the release of the auction result to about three minutes, thus reducing the risk for bidders.
The auction results are published on Bloomberg (page NTMA, menu item 2) and Reuters (page NTMB) simultaneously within about three minutes of the cutoff time for bids.
Up to 48 hours after the announcement of the auction results, the NTMA will accept bids in a noncompetitive auction from primary dealers at the weighted average price in the competitive auction. The amount on offer in the noncompetitive auction will not exceed the equivalent of 20 percent of the amount sold to the primary dealers in the current competitive auction.
Structure of the Irish Government Bond Market
Primary dealer system
The Irish government bond market is based on a primary dealer system to which the NTMA is committed. Seven primary dealers recognized by the NTMA make continuous two-way prices in designated bonds in minimum specified amounts and within maximum specified spreads. There are also a number of stockbrokers who match client orders. However, the primary dealers account for about 95 percent of turnover. This system, which was introduced at the end of 1995, has brought improved depth and liquidity to the market while the bond repo market has grown in tandem, adding to the liquidity in the bond market. Primary dealers are members of the Irish Stock Exchange, and government bonds are listed on the exchange.
With the switch to electronic trading and the listing of the new 2007 and 2013 benchmark bonds on the Euro MTS in the middle of 2002, the current system has been augmented by six new institutions, which are purely price makers in the new 2007 and 2013 bonds. These new institutions are not to be primary dealers and do not have access to supply at the monthly auctions.
The liquidity of the Irish government bond market is underpinned by the primary dealer system. However, to further enhance the liquidity of the market, the NTMA provides these facilities to primary dealers:
a continuous bid to the market in Irish government benchmark bonds,
switching facilities between the benchmark bonds, and
repo and reverse repo facilities in benchmark bonds.
To enhance the liquidity of the market, the NTMA is prepared to buy back amounts of illiquid, nonbench-mark, euro-denominated Irish government bonds that have relatively insignificant amounts outstanding. It is also prepared to buy back amounts of foreign currency–denominated Irish government bonds as opportunities arise in the market. This improves the debt profile, eliminates certain off-the-run and illiquid bonds, and facilitates greater issuance in the liquid benchmark bonds.
The NTMA maintains a secondary trading function to trade in its bonds with other market participants. The role of the secondary trader is to provide liquidity to the market and act as a source of market intelligence for the NTMA. The secondary trader is mandated to deal as a retail customer with market makers and brokers in Irish government bonds. The secondary trading is separated from the primary bond desk activity by means of “Chinese walls.”
Move to electronic trading of Irish bonds
The NTMA listed the new benchmark 4.5 percent 2007 and 5 percent 2013 Irish government bonds on the Euro MTS electronic trading system at the end of June 2002. A domestic version of MTS was established at the same time, on which the existing 2016 benchmark bond is listed; this bond does not yet meet the 5 billion issue size requirement for listing on the main Euro MTS system. The listing of the bonds on these systems has greatly enhanced turnover, price transparency, and liquidity, and it ensures that Irish bonds are maintained in the mainstream of the euro-area government bond market.
Standard market conventions
All Irish benchmark bonds have a day-count convention based on actual number of days (actual/actual). The bonds trade on a clean price basis, with prices quoted in decimals. The business days for trading are TARGET operating days, and bond dealings settle in full on a T+3 basis, but deferred settlement can be arranged upon request. These are standard features of euro-area bond markets. Irish government bonds are eligible for use as collateral in ECB money market operations.
In December 2000, the settlement of Irish government bonds was transferred from the domestic settlement system, the Central Bank of Ireland Securities Settlements Office (CBISSO), to Euroclear, Brussels. Ireland was the first European country to transfer the settlement of government bonds from its central bank to an international securities depository. The CBI remains the registrar.
The objectives of the transfer to Euroclear were
increased liquidity of Irish government bonds in the international capital markets as a result of improved access to a broader range of investors;
a simplified and cost-effective settlement infrastructure, in which safekeeping and settlement of domestic and cross-border transactions are centralized within the same entity;
optimized settlement efficiency, due to the integration of the settlement activity into an international real-time settlement environment; and
access to a wide range of markets for the former CBISSO members through the Euroclear system.
Inclusion in indices
The following indices have an Irish Government bond component:
J.P. Morgan Irish Government Bond Index,
Lehman Brothers Global Bond Index,
Merrill Lynch Global Government Bond Index 11, and
Salomon Smith Barney World Government Bond Index.
Ireland has the top long-term credit rating of AAA from Standard and Poor’s, Moody’s, Fitch, and the Japanese credit rating agency, Rating and Investment Information, Inc. (R&I). Ireland also has the top short-term credit ratings of A-1+, P-1, F1, and A-1+ from Standard and Poor’s, Moody’s, Fitch, and R&I, respectively.
Tax treatment of Irish government bonds
There is no withholding tax on Irish government bonds. Nonresident holdings are exempt from all Irish taxation. However, the provisions of the European Union (EU) Savings Directive may affect this position in relation to nonresident personal investors. The objective of the EU directive is to ensure a minimum of effective taxation of savings income in the form of interest payments within the EU. The directive applies to individuals (not corporations) who are resident in an EU member state and receive interest income from their investments in another member state. Each member state would be obliged to provide information on such interest payments to the member state in which the beneficial owner of the interest resided.
To date, Ireland has not issued any index-linked debt.
Establishing and maintaining contacts with the financial community
Despite all the technical and market innovations of the last two decades, financial markets are still a people-driven business, and by maintaining and developing strong contacts, Ireland has traditionally been able to obtain more favorable borrowing costs than one might have expected, given its credit rating. This active engagement with the market has also helped the staff of the NTMA enhance and deepen their knowledge and understanding of market developments and keep abreast of the latest financial market innovations. Provision of accurate and timely information is also part of Ireland’s strategy to keep its name visible in capital markets. To this end, the NTMA makes active use of the following:
the NTMA web site (www.ntma.ie), which is updated regularly with the latest available information;
an Ireland Information Memorandum published and distributed annually in March and available on the NTMA web site;
The NTMA annual report, which is published annually in June;
regular press conferences and relevant press releases to update the market on important developments;
the NTMA Reuters pages (ntma/b/c);
an annual reception in December for all NTMA’s banking contacts;
credit lines for financial institutions;
regular road shows and marketing campaigns to keep Ireland’s name visible, particularly in advance of any major issuance program;
regular contact with the credit-rating agencies (Ireland has the top, AAA rating from Moody’s, Standard and Poor’s, R&I, and Fitch.);
active use of the Bloomberg messaging system to seek quotes in non-price-sensitive instruments such as deposits and foreign exchange forward points (This ensures both optimum pricing and that every bank the NTMA has a line with has a chance to quote.); and
listing Irish government bonds on the major electronic trading platform, Euro MTS.
CPSS and IOSCO standards
The IMF Financial Sector Assessment Program mission reported, “Ireland observes the CPSS core principles for systemically important payment systems. The only systemically important payment system is IRIS, the Irish real-time gross settlement system. This is facilitated by ECB actions to ensure that national payment systems participating in the Trans-European Real-time Gross Settlement Express Transfer (TARGET) embody all the features necessary for the smooth functioning of cross-border transactions.” The NTMA operates a securities settlement system as issuer, registrar, and settler of its exchequer note program in accordance with the core principles of the IOSCO standards. The CBI is the registrar for Irish government bonds, which are settled at Euroclear. Both the CBI and Euroclear operate in accordance with the core principles of the IOSCO standards.
The challenge of the euro
The EMU and the advent of the euro have led to a greater degree of intra-euro-area portfolio diversification as the disappearance of foreign exchange risks and transaction costs and deregulation of the various domestic euro-area member domestic markets have resulted in an ever-greater redistribution of assets within euro-area portfolios. Hence, in the case of Ireland, nonresident holdings of Irish government bonds have risen from about 21 percent to 60 percent in June 2002 as domestic investors who were heavily invested in the Irish bond market diversified and were replaced by new, predominantly fellow euro-area investors.
With no exchange risk, unidirectional yields, and lower spreads stemming from convergence (due to more equalization in the sovereign credit ratings of member countries of the euro area), investors’ motivations may be reduced to questions of price liquidity, transparency, and market efficiency.
The case study was prepared by Oliver Whelan, Funding and Debt Management, National Treasury Management Agency.