National Treasury Management Agency, Statement by the National Treasury Management Agency: Market Making Issuance Procedures and Related Debt Management Arrangements, May 8, 1995.
Prepared by David J. Ordoobadi.
Although the NTMA has not attempted to quantify the reduction in funding costs that would arise from the successful adoption of a market-making system, it expects a doubling of turnover to result. Assuming that this increase in liquidity resulted in a 10 basis point decline in the liquidity premium on IGBs, funding costs would, over time, decline by IR£14 million annually.
Its constituent legislation states in relevant part that the NTMA’s objective is “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.”
These guidelines, which leave a large degree of latitude to the NTMA in its debt management operations, typically indicate financing requirements over the year and preferences of the Department of Finance on the sources of funding, including, for example, the balance between fixed versus floating and domestic versus foreign debt.
Taps are so named because they allow issuers to respond to market demand by opening the tap to permit new amounts of existing bonds to flow into the market. The tap is not opened in falling markets. By periodically reopening existing bonds, the liquidity and depth of benchmark issues can be increased. Bonds not fully subscribed in auctions may also be sold through subsequent taps.
The composition of the shadow portfolio, which is confidential, is determined by the Department of Finance, the NTMA, and J.P. Morgan.
Since the budget is on a cash basis, this benchmark is in practice relatively easy to outperform given the NTMA’s latitude in determining the maturity and coupon profile of new debt issuance. In exercising this latitude, however, the NTMA needs to balance both short- and long-term considerations, a discipline imposed by the shadow portfolio. In practice, the NTMA’s actual annual debt service payments have been kept well below the budgeted target and these “savings” have been accumulated and applied as a source of funds in subsequent budgets.
Benchmarks thus embody both an expectation for debt management cost and acceptable risk.
The pending Stock Exchange Bill will, in accordance with the EU Investment Services Directive, name the Central Bank as the competent authority to supervise the exchange and its members. Under this legislation, the stock exchange (and any other subsequent exchanges) would be incorporated in Ireland with a broadly based board that represented its members’, users’, and the public’s interests.
An efficient secondary market serves many purposes: it provides a basis for pricing of new issues; underpins the NTMA’s continued access to funds; and limits the market impact of the NTMA’s activities.
A deep cash market promoted by concentrating issuance to a limited number of benchmark bonds should also facilitate the development of derivative instruments on these bonds. Thus far, however, the Irish Futures and Options Exchange, which was established in 1990, has been quiescent. Five contracts are traded on the IFOX: short, medium, and long gilt contracts; a DIBOR contract; and a stock index contract on the Irish Stock Exchange.
IGBs are included in the global government bond indices of Salomon Brothers, Lehman Brothers, Bloomberg/EFFAS, UBS Phillips & Drew, Merrill Lynch, and J.P. Morgan.
There are two main instruments of monetary policy in Ireland. The short-term facility (STF) rate at which overnight funds are lent to banks is used to influence money market rates. Repurchase and reverse repurchase agreements are used to make short-term and self-reversing adjustments to domestic liquidity. The Central Bank does not undertake outright purchases and sales of securities in open-market operations.
Because of the potential conflicts between debt management and monetary policy implementation and the close contacts between the central bank and market participants, debt management is undertaken in many countries by a department of the Central Bank.
The IGB market turnover ratio (total turnover divided by market capitalization), which measured 2.6 in 1993, compared unfavorably with Australia (11.4), Belgium (5.3), Finland (3.1), Germany (3.0), New Zealand (3.3), Norway (7.7), Sweden (11.0), and the United Kingdom (5.4), but was at least as high as Austria (1.3), the Netherlands (2.6), and Portugal (0.9).
For example, spreads on 5-year interest rate swaps in Ireland, which are used to price fixed rate mortgages, are high.
In times of extreme market volatility, liquidity may dry up completely (or spreads widen to levels designed to discourage business) as primary dealers temporarily renege on their obligation to make markets.
The NTMA’s estimate of required capital is based on expectations for market turnover and EU capital adequacy requirements for market makers. On the basis of turnover in 1993, the NTMA estimated that the aggregate capital required to support the IGB market would be Ia£11 million (or about IR£2 million for each of five primary dealers). Since the NTMA believes that a significant increase of turnover is both desirable and the likely outcome of its proposed restructuring, of the IGS market, the aggregate capital requirement is estimated at IR£25 million or an average of IR£5 million for each primary dealer.
The NTMA’s proposal envisages adjustments to these spreads as new benchmark bonds are introduced, the duration of existing designated bonds declines, and market conditions evolve.
The NTMA plans to continue its quarterly auction of the long bond and may increase its reliance on auctions over time.
The degree of privileged access to taps and non-competitive bidding at auctions accorded primary brokers would be determined by the success of the market-making system. If the primary broker system fails to develop into an efficient means for placing government debt, the NTMA would limit the access of primary brokers to a proportion of new issues with the balance offered directly to the market.