AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT The Australian Government Bond Market Peter McCray Deputy...
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AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
The Australian Government Bond Market
Peter McCrayDeputy Chief Executive Officer
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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 OFFICE OF FINANCIAL MANAGEMENT
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 OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
Government Bond Market - Looking Back Twenty Years
– 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:
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
Government Bond Market - Looking Back Twenty Years
– ‘buy and hold’ market - little secondary market activity
– no derivatives markets
– ‘captive market’ arrangements
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
Development of Government Bond Market
• ‘Operational’ reforms
– issuer behaviour– primary issuance mechanism– captive market arrangements– issuer support of bond secondary market and
derivatives markets
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
Development of Government Bond Market
• ‘Infrastructure’ reforms
– clear separation of debt management and monetary policy responsibilities
– clearing and settlement systems– regulatory framework
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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)
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
Conclusion
• A review of Australia’s experience suggests a number of strategies to promote bond markets
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
Conclusion
• Issuers must act responsibly
• Issuance arrangements need to take account of market development
• Captive investor arrangements are not recommended
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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)
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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)
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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
AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
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)