5 Sovereign Liability Management: An Irish Perspective

D. Folkerts-Landau, and Marcel Cassard
Published Date:
July 2000
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Paul Sullivan

To set in context the discussion of Ireland’s approach to debt management, we start with a brief outline of the history and main features of Ireland’s national debt. Against that background, we will go on to discuss the main elements of debt management in Ireland, outlining both the institutional approach and the main policy and constraint issues that impact Ireland’s debt management.


First, to put the discussion in context, I will outline briefly the main features of the Irish national debt. As can be seen in Figure 5.1, the debt amounted to about IR£29,912 million at the end of 1996, then equivalent to about US$44,569 million. Having risen sharply during the first part of the 1980s, with foreign currency-denominated debt accounting for a disproportionate share of the growth, the debt has grown relatively little in recent years and actually declined slightly between the end of 1995 and the end of 1996.

Figure 5.1.Irish National Debt

(In billions of Irish pounds)

Source: National sources.

Reflecting both this lower growth and the strong real growth of the Irish economy in recent years, the ratio of debt to GDP has declined substantially since 1990 (see Figure 5.2).

Figure 5.2.Irish Debt-to-GDP Ratio

(In percent)

Source: National sources.

Note: The debt/GDP series on a Maastricht basis only goes back as for as 1990.

In comparative international terms, Ireland’s indebtedness is now in line with the EU average; this reflects both the substantial decline in Ireland’s debt-to-GDP ratio, but also the fact that the EU average itself has increased from about 60 percent to about 70 percent over the past few years. See Figures 5.3 and Figures 5.4.

Figure 5.3.General Government Debt-to-GDP Ratios of EU Member States, 1996

(In percent)

Source: European Commission.

Figure 5.4.Ireland’s Debt Relative to EU Average


Source: European Commission.

The cost of servicing the debt is shown in Figures 5.5 and 5.6, both in absolute terms and, perhaps more meaningfully, as a percentage of government current expenditure.

Figure 5.5.Debt-Service Costs

(In billions of Irish pounds)

Source: National sources.

Figure 5.6.Interest Bill as Percent of Total Government Current Expenditure

(In percent)

Source: National sources.

Note: The 1995 and 1996 figures exclude the extra nonbudgeted IR£75 million and IR£100 million payments to the National Savings Interest Reserve.

Figure 5.6 clearly shows the decline in the drain on national resources caused by the debt in recent years.

Finally, Figures 5.7 and 5.8 show the composition of the debt in terms of the main constituent elements and the currency breakdown.

Figure 5.7.Composition of National Debt at the End of 1996

(In percent)

Source: National sources.

Figure 5.8.Currency Composition

(In percent)

Source: National sources.

Figure 5.7 shows the recent substantial improvement in Irish public finances. However, it also shows the much less favorable developments of the earlier 1980s, when with high annual budgetary deficits, the debt was growing at a rapid rate, both in absolute and in relative terms. The rapid growth in the foreign currency portion of debt in that earlier period gave rise to a particular increase in the market risk of the debt.

It was in this context that the Irish government decided to consider alternative institutional approaches to the management of the debt, which ultimately led to the establishment of the National Treasury Management Agency, as well as to implement significant changes in fiscal policy.

Debt Management in Ireland

It was against this background of a rapidly growing and more complex debt that the National Treasury Management Agency was established in December 1990. Staff for the new agency were recruited from financial institutions both in Ireland and abroad as well as from the Department of Finance. The Chief Executive of the agency reports directly to the Minister for Finance and is the Accounting Officer, responsible to the Dáil (Parliament).

The agency’s principal functions are to fund maturing national debt and to fund the annual Exchequer Borrowing Requirement, in such a way as to protect both short-term and longer-term liquidity, contain the level and volatility of annual fiscal debt-service costs, contain the Exchequer’s exposure to risk, and outperform a benchmark or shadow portfolio.


A key requirement of the agency is to ensure that future funding needs, arising from refinancing maturing debt as well as new Exchequer borrowing, can always readily be met. Ultimately, the protection of liquidity is the agency’s most critical task. By consciously limiting the amount of debt maturing in any particular period as well as the cumulative level of maturities in the next several years, the agency seeks to contain the exposure to liquidity risk that might result from a shock to the financial markets, either domestic or foreign, arising from events having their origins related to or unrelated to events in Ireland.

Where, for particular reasons, there may be a concentration of maturities in a particular period, the agency will over time generally look to refinance a portion of such debt to spread more evenly the pattern of maturities.

The maturity profile as of end 1996 is shown in Figure 5.9.

Figure 5.9.Maturity Profile

(In billions of Irish pounds)

Source: National sources.

Liquidity risk relates to short-term liquidity as well as to the longer-term risk outlined above. The intrayear short-term liquidity risk is monitored and managed on an ongoing basis through a regular tracking process taking account of specific debt maturity dates and the expected seasonal profile of the Exchequer Borrowing Requirement. Detailed funding plans and related liquidity balances are prepared, reviewed, and updated regularly. In addition, short-term deposits as well as short-term paper issuance facilities, in both Irish pounds and foreign currency, are available to facilitate cash management.

Debt-Service Volatility

Notwithstanding the recent downward trend, debt-service costs still represent a significant call on Exchequer resources. As a result, containing the level and stability of such costs is an important policy objective. Inevitably, there is a trade-off between potential volatility of annual debt-service cost on the one hand, and volatility of the net present value (NPV) of the debt on the other hand. As the proportion of fixed rate and longer-duration debt is increased, the greater is debt-service stability over time; however, NPV volatility will increase.

There is no unique solution to this dilemma, and it is an area where the solution in practice may reflect the relative significance of the debt and the related debt-service costs to the Exchequer’s financial position. In the case of Ireland, taking account of both the level of debt-service costs as well as the decline that has taken place in Irish and international interest rates and bond yields over the past few years, there is a bias toward increased reliance on fixed rate debt, and some 64 percent of the debt was denominated in fixed rate liabilities at the end of 1996. The breakdown of the debt between fixed and floating is shown in Figure 5.10.

Figure 5.10.Fixed/Floating Interest Breakdown of Debt

(In billions of Irish pounds)

Source: National sources.

The duration of the portfolio is shown in Table 5.1.

Table 5.1.Portfolio Duration(Years)
Including STP*Excluding STP*

STP = Short-term paper.

STP = Short-term paper.

In managing the interest rate profile of the debt, the agency makes use of the derivative markets, particularly for the foreign currency portion of the debt, to achieve the desired fixed/floating mix while at the same time targeting the desired final maturity structure to achieve its liquidity objectives.

Given liquidity considerations and the long-term nature of the portfolio, it is to be expected that of the floating rate debt outstanding, most is of medium as opposed to short final maturity, with interest rate swaps being used to transform the interest rate profile of longer-dated, fixed rate liabilities as necessary. While the agency has, to date, primarily used interest rate swaps to effect desired interest rate transformations, it is currently also introducing the use of bond futures contracts for this purpose.

Risk Exposure

The nature of the agency’s debt management activities makes the management of risk a central and critical element of the agency’s business. In addition to liquidity and debt-service risk considered above, the principal categories of risk arising from the agency’s activities are:

  • market risk;

  • counterparty credit risk; and

  • operational risk.

In all of these categories, the agency has put in place limits and control procedures to monitor and manage the risks involved.

Market Risk

Market risk is the risk of a rise in debt-service costs and in the total market value of the debt owing to changes in interest rates or exchange rates. In conducting its debt management activities, the agency has to have regard both to medium- and short-term objectives, given its task of controlling not only near-term fiscal debt-service costs but also the present value of all future payments of principal and interest arising from the debt.

Liabilities in currencies that are within or closely related to the European exchange rate mechanism (ERM) normally carry less exchange rate risk than other currencies and, appropriately, account for the major portion of the foreign currency portfolio. However, exchange rate fluctuations within the permitted ranges of the ERM can give rise to material short-term fluctuations in the value of the foreign currency debt. Non-ERM currencies are also important in the portfolio and can be expected to remain so for reasons of current or expected cost, market presence, economic linkage, and portfolio diversification.

Borrowings in Irish pounds also carry market risk. Irish pound fixed interest rate borrowings are subject to a market valuation risk in the event of a decline in interest rates. While carrying less market valuation risk than fixed rate debt, floating rate borrowings carry a higher risk to the near-term fiscal cost of servicing the debt. The balance between fixed and floating rate liabilities has, therefore, to be managed for both the domestic and foreign currency portfolios.

The exposure to interest rate and currency risk, both for debt service and for the market value of the portfolio, is controlled through limiting the currency and interest rate concentration of the portfolio. The agency seeks to achieve the best trade-off between cost and risk over time. As conditions in financial markets change, the appropriate interest rate and currency profile of the portfolio is reassessed.

Counterparty Credit Risk

Derivatives, deposits, and foreign exchange transactions represent the principal product categories that give rise to counterparty risk exposures. Procedures are in place that provide for the approval of risk limits for all counterparties. For beyond one-year exposures, credit risk is normally restricted to AA-rated names or better. Exposures under these limits, calculated according to the nature of the underlying credit risk, are updated and reported daily to management. A review of all limits is undertaken periodically to take account of changes in the credit standing of counterparties or in economic and political events.

Operational Risk

Comprehensive controls have been established to ensure that operational risk is managed in a prudent manner. These controls include the segregation of duties between dealing, processing, payments, and reporting. Prior to dealing in any new product, a product description must be prepared and approved by management; this product description identifies the product’s inherent risks and documents appropriate processing and reporting procedures.


In carrying out its debt management activities, taking account of the liquidity, fiscal cost, and risk issues discussed above, the agency also has to pay particular regard to its performance and risk relative to the benchmark. The benchmark represents a shadow portfolio against which the cost of the real portfolio is measured. This measurement takes account not just of the payments actually made in the year in question but also the mark-to-market value, in Irish pound terms, of all future principal and interest payment liabilities that are undertaken by each portfolio. As such, the benchmark seeks to measure the full economic cost of all portfolio decisions rather than just their cash cost over a single year.

In using a benchmark, particularly if used for performance measurement purposes in addition to being used as a guide to portfolio management decisions, it is important to ensure that there is consistency between the rules governing the activity of the benchmark portfolio and the policy constraints and objectives that impact on the management of the actual portfolio. Given the importance of the annual debt-service budget, it is critical that the debt-service cost of the benchmark portfolio be consistent with the annual debt-service budget within which the agency must operate.

In the National Treasury Management Agency’s case, the benchmark embodies a strategic target portfolio, which is reviewed annually and which represents a diversified and low-risk portfolio, aligned with the changing economic linkages of the Irish economy and the currency. Similarly, reflecting both the bias in favor of greater debt-service stability discussed above, as well as the view that the downward trend in global interest rates had already reached a relatively advanced stage, the benchmark incorporates a strategic bias toward a lengthening of its interest rate profile. The benchmark is, therefore, designed to be normative and to represent an inherently appropriate target portfolio profile. The benchmark should, therefore, in normal circumstances, serve as a strategic guide to the portfolio decision-making process.

For this reason, it is important to keep the benchmark portfolio profile under review as circumstances change. As the benchmark is designed to represent appropriate strategic direction, it is not adjusted in line with “normal” changes in market conditions, such as fluctuations in yields or exchange rates. It is, however, reviewed from time to time to reflect more fundamental changes in the context in which debt management is being carried out. Consequently, there is no fixed frequency for changing the benchmark. Toward the end of last year, a major review was undertaken, taking account of the planned introduction of EMU in 1999. A number of different EMU scenarios were considered, with the objective being to find portfolios that had cost and risk characteristics that were robust across a range of scenarios. The approach used in Ireland, therefore, is not one of looking for an “optimal” portfolio in a particular scenario, as such an approach can be dependent on scenarios and assumptions. Rather, by looking for a satisfactory combination of cost and risk across a range of scenarios, the analysis looks to establish a robustness in the benchmark, which we believe is important given its role as representing strategic policy direction.

In the above analysis to determine the appropriate currency and duration profile of the benchmark, it is necessary to define both “cost” and “risk.” In the case of the Irish benchmark, cost, on the one hand, is measured in terms of net present value cost in Irish pound terms over a medium-term time horizon rather than in conventional government accounting terms. Risk, on the other hand, is measured in terms of ensuring a high probability that annual debt-service costs will not exceed budget, with an adjustment to take account of the impact of foreign exchange movements on the value of the debt.

The benchmark also takes on board the many reductions in the cost of debt achieved by the agency through its restructuring of the domestic market and its domestic and foreign portfolio switching and refinancing activities over the past five years. Because of this and the many efficiencies already implemented over the past few years, it will, however, be increasingly difficult to outperform the benchmark in the future. Finally, it should be clearly understood that any benchmark remains an artifice that must reflect specific expectations as to the future market and strategic environment. Should the actual environment be materially different from what was expected, closely following any benchmark could result in suboptimal decisions.

Operationally, the benchmark portfolio is computerized and the performance and market risk of the actual portfolio relative to the benchmark is networked daily to the desktop personal computers of portfolio managers and to senior management.

In addition to measuring NPV sensitivities to movements in market rates, there is a separate risk analysis tool, used by the agency in managing its exposures to movements in interest rates and exchange rates—-a personal computer model that captures the sensitivity of fiscal debt-service costs in any particular period to any selected movement in particular interest rates or exchange rates. As a result, the agency can analyze the potential impact on interest costs of a number of scenarios and take action, as appropriate, to reduce the level of exposure in a particular period.

Foreign Currency Debt

Foreign currency liabilities accounted for about 28 percent of the debt at the end of 1996. This compares with 35 percent at the end of 1990, and 38 percent at the end of 1992. The reduction in the proportion of foreign currency-denominated debt reflects the policy of making net repayments of foreign debt in each of the past few years to the extent of maturing foreign currency debt.

Within the foreign currency liability portfolio, and reflecting the considerations outlined in the earlier discussion on risk and the benchmark, the currency composition is well diversified. The selection of currency mix, as with the benchmark, in large part reflects the considerations of risk, with the heaviest collective weighting being in EU currencies. Within that grouping, there has been a greater level of diversification and over the four-year period to the end of 1996, the proportion of debt denominated in sterling and French francs was increased from less than 2 percent to 42 percent. Over the same period, the proportion of debt in deutsche marks, Dutch guilders, and Swiss francs fell from 69 percent to 27 percent. In managing the currency risk associated with the foreign debt, the agency seeks to strike a balance, taking account of linkages with the Irish pound, between the cost and risk of different currencies.

Figure 5.11 shows the currency composition and interest rate mix of the debt.

Figure 5.11.Foreign Debt Currency Composition at the End of 1996

(In billions of Irish pounds)

Source: National sources.

To a considerable extent, the target currency profile is set independently of near-term maturities and borrowing opportunities, although these considerations do impact the pacing at which any desired currency profile is achieved in order to contain both transaction costs and credit exposure associated with derivatives. In looking to generate liabilities in a particular currency, the agency will usually examine both direct and indirect ways of doing so and frequently takes advantage of swaps or other arbitrage-driven structures to achieve both currency and pricing targets.

Domestic Bond Market

A major focus of the agency continues to be on the further development of the liquidity and efficiency of the Irish pound bond market. Toward this end, the agency has introduced a number of measures in recent years including the establishment of benchmark issues and, more recently, the introduction of a primary dealer system. Benchmark bonds exist in, or close to, the 5-, 10-, and 20-year maturities with new benchmark bonds being introduced periodically. During the course of 1995, two new benchmark bonds—5-year and 10-year—were launched, while in 1996, a further new 5-year bond was introduced.

Market Making in Government Bonds

In December 1995, the agency introduced a formal primary dealer system to replace the agency broker system for dealings in government bonds. The purpose was to bring the bond market structure in Ireland more in line with competitor countries and to improve liquidity, thereby reducing funding costs.

Each primary dealer dedicates between IR£5 million and IR£8 million capital to market making in Irish government bonds on an ongoing basis and is expected to contribute to the agency’s gross funding program broadly in line with its share of retail market turnover. Primary dealers quote firm bid and offer prices in a specified list of bonds within agreed size and spread parameters. Investors can be confident in obtaining buy and sell prices on a continuous basis.

Investor Relations

With regard to both Irish pound and foreign currency funding, the agency plays an active role in developing and maintaining investor relations. The agency, both independently and also together with both Irish and foreign-based brokers and investment banks, has held a number of investor marketing meetings in a wide range of locations in Europe, Japan, and the United States. With approximately 50 percent of the debt held by nonresidents, the agency recognized the importance of maintaining active contact with all major international investor groups. The agency also maintains close communications with all the major rating agencies to ensure they are kept fully informed of all major developments in the Irish economy and on Ireland’s economic and debt management policy. The growing importance of the Irish government bond market to global investors is underlined by the inclusion of the bonds in major international bond indices.

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