AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT The Australian Government Bond Market Peter McCray Deputy...

AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT

The Australian Government Bond Market

Peter McCrayDeputy Chief Executive Officer


Introduction

• Australia today enjoys well-developed financial markets across all major product lines– a result of a longstanding pursuit of market-

based policies– a concerted program of financial sector

deregulation and reform


Introduction

• Three broad areas to cover:– Australia’s financial markets today,

emphasising the current government bond market

– snapshot of pre-deregulation market environment

– operational and infrastructure reforms that have underpinned development of today’s government bond market


Australian Government Bond Market

• Domestic government bonds are the most liquid segment of the Australian market

– corporate outstandings now comparable

– secondary market turnover in government sector far greater


Australian Government Bond Market

• Boosting liquidity in the physical market are:

– deep and liquid derivatives market for fixed interest products

– consolidation of Australian government bonds into benchmark lines


Government Bond Market - Looking Back Twenty Years

• Australia’s financial system was heavily regulated up until the early 1980s:

– fixed exchange rate / exchange controls

– regulated interest rates and lending in the banking sector



– fixed price ‘tap’ system for issuance

– unclear separation between monetary policy and debt management

– domestic investor base

• Australia’s government bond market reflected this regulated environment:



– ‘buy and hold’ market - little secondary market activity

– no derivatives markets

– ‘captive market’ arrangements


Development of Government Bond Market

• The broad context:– removal of exchange controls and floating of

Australian dollar– removal of regulated interest rates and other

controls; introduction of foreign bank competition

– separation of Debt Management and Monetary Policy



• ‘Operational’ reforms

– issuer behaviour– primary issuance mechanism– captive market arrangements– issuer support of bond secondary market and

derivatives markets



• ‘Infrastructure’ reforms

– clear separation of debt management and monetary policy responsibilities

– clearing and settlement systems– regulatory framework


Operational Reforms - Issuer Behaviour

• Requirement to act responsibly– perceptions of market integrity– maintain a high reputation for financial

management competency– transparent and predictable debt management

activities– maintain regular and open communication with

markets• but not totally mechanical in approach


Operational Reforms - Issuance Mechanism

• A market-based issuance mechanism to replace the tap system– auction approach– ‘dealer panel’ arrangement

• Bond auctions introduced in August 1982


Operational Reforms - Issuance Mechanism

• An auction mechanism not always the most appropriate approach, at least initially– nature of investor base– stage of market development

• Australia has used other mechanisms to introduce new debt instruments– dealer panels & underwriting syndicates– cost an important consideration


Operational Reforms - Captive Investors

• Captive investor arrangements influenced the bond market until the early to mid 1980s

– prudential aspect

– guaranteed a growing demand for government bonds


Operational Reforms - Captive Investors

• But ultimately a costly and inefficient approach

– removes an important fiscal discipline

– distorts flow of investment funds

– inhibits secondary market development


Operational Reforms - Secondary Market Development

• Most potent influence on liquidity is the volume of new issuance and bond outstandings

– ultimately beyond the control of the government debt manager


Operational Reforms - Secondary Market Development

• Meet investors demands

• Encourage specialist market makers

• Direct secondary market participation

• Short-selling of government bonds permitted

• Encourage liquid and efficient repo and derivatives markets


Infrastructure Reforms - Separation from Monetary Policy• Move to bond auctions and floating

exchange rate permitted independent monetary and debt policies

• Separation of responsibilities between the RBA and AOFM– Transactions based on a commercial arms

length basis


Infrastructure Reforms - Clearing & Settlement Systems

• Reliable and timely clearing, transfer of ownership and settlement arrangements are essential

– electronic transfer and settlement system for government securities (RITS)

– Real Time Gross Settlement (RTGS)


Infrastructure Reforms - Clearing & Settlement Systems

• Desirable features of robust clearing and settlement infrastructure – clear, unambiguous regulations– a sound legal basis– sound risk management procedures– well established contingency arrangements– explicit identification of government regulator


Infrastructure Reforms - Regulatory Framework

• A well-functioning debt market requires a regulatory system which:– prescribes a level playing field– clearly defines property rights– has transparent information flow– a capable and appropriately empowered

prudential authority


Conclusion

• A review of Australia’s experience suggests a number of strategies to promote bond markets


Conclusion

• Issuers must act responsibly

• Issuance arrangements need to take account of market development

• Captive investor arrangements are not recommended


Conclusion

• Markets require a steady supply of new securities to sustain liquidity

• Authorities can support secondary market activity

• Clear separation of debt management and monetary policy is essential


Conclusion

• Reliable and timely clearing and settlement arrangements are essential

• A prudential/regulatory regime to provide legal certainty and a level playing field– flexible enough to adapt to a dynamic market

environment


Conclusion

• Ultimately, need an economic case for intermediaries and investors to participate in the government bond market

– Strength of Australian markets reflects their local financing role in the Australia economy and investors desire to be part of this economy



Domestic Bonds Outstanding

Bond Market Turnover(daily average)

0

20

40

60

80

100

120

90/1 91/2 92/3 93/4 94/5 95/6 96/7 97/8 98/9

$ billions

Australian Government

State Government

Non-Government

0

1

2

3

4

5

90/1 91/2 92/3 93/4 94/5 95/6 96/7 97/8 98/9

Australian Government

State Government

Non-Government

$ billions


0

1

2

3

4

5

6

7

84/5 85/6 86/7 87/8 88/9 89/90 90/1 91/2 92/3 93/4 94/5 95/6 96/7 97/8 98/9

Futures Market Physical Market

$ billions

Turnover in Physical & Futures Markets(daily average)


0%

20%

40%

60%

80%

100%

Au

str

alia

Be

lgiu

m

Ca

na

da

De

nm

ark

Fra

nc

e

Ge

rma

ny

Ita

ly

Ja

pa

n

Ne

the

rla

nd

s

Sp

ain

Sw

ed

en

UK

US

JP Morgan Liquidity Ratio(as at 31 December 1999)


0

20

40

60

80

100

84/5 85/6 86/7 87/8 88/9 89/90 90/1 91/2 92/3 93/4 94/5 95/6 96/7 97/8 98/9

0

1

2

3

4

5

6

7

Bonds Outstanding (LHS) Turnover (RHS)

$ billions$ billions

Daily Average Turnover Versus Bonds Outstanding


0

1

2

3

4

5

6

7

7% A

pr

00

13%

Ju

l 00

8.75

% J

an

01

12%

No

v 01

9.75

% M

ar

02

10%

Oct

02

9.5%

Au

g 0

3

9% S

ep

04

7.5%

Ju

l 05

10%

Fe

b 0

6

6.75

% N

ov

06

10%

Oct

07

8.75

% A

ug

08

7.5%

Se

p 0

9

5.75

% J

un

11

$ billions

Benchmark Bond Issues(as at 24 March 2000)


Bond Auctions: Range of Accepted Bids

0

20

40

60

80

100

120

140

1 9 17 25 33 41 49 57 65 73 81 89 97 105 113 121 129 137 145 153 161

basis points

Tender Number

1982 1987 1992 1997 19991995

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