THE CHANGING INVESTMENT UNIVERSE

STRUCTURAL CHANGES IN THE INVESTOR BASE FOR

GOVERNMENT SECURITIES:

TRENDS AND POLICY CHALLENGES

Dr. Hans J. Blommestein

G 20 CONFERENCE

on

GLOBAL FINANCE IN TRANSITION

7-8 May 2013, Istanbul

TURKEY

• Global Finance in Transition? From non-conventional conditions to new normal? What is new normal? Increasingly important role for LCBMs? Anything else? (e.g. new paradigm for central banking and public debt management?)

• Well-functioning government debt markets important building block for local currency bond markets in all circumstances but especially during non-conventional conditions

• Supply of government debt remains strong (OECD Borrowing Outlook 2013)

30-Apr-2013 2

1a. Background

• Absorption capacity of markets (demand for government debt) is crucial for governments

• Focus presentation: drivers of changes in investor base (demand) for government debt. This brings together:

– Sovereign borrowing (uninterrupted market access at lowest borrowing costs and ‘safe’ maturity structure debt);

– Monetary policy (including QE and exit with impact on maturity)

– Fiscal policy (debt sustainability with implied maturity dimension)

– Financial stability (global liquidity; market fragmentation/home bias; borrowing costs; foreign currency borrowing; home bias; maturity)

• Hence, integrated macroeconomic view of great importance (Blommestein and Turner,2012)

• What are the implications for OECD leading practices? 30-Apr-2013 3

1b. Overview

• The changing investment universe: structural changes in the investor base for government debt

• High Level G20 Seminar on “Public Debt Management under Non-Conventional Conditions on Debt Markets”, Moscow, April 2-3, 2013

• Changing investment base for government debt important part of these non-conventional conditions

• G20 Communiqué (18-19 April 2013). Reference in par.8 to OECD leading practices for (1) raising, (2) managing and (3) retiring public debt

• This presentation focuses on (1) “raising public debt”

30-Apr-2013 4

1c. Why changing investment

universe?

DRIVERS OF CHANGES IN INVESTOR BASE (DEMAND) FOR GOVERNMENT DEBT

30-Apr-2013 5

(A) Investors’ response to the crisis related challenges and policies

– Quantitative Easing

– Securities Market Programme followed by Outright Monetary Transactions

– Changes in the relative riskiness of developed and emerging market assets

– Emphasis on individual country risk instead of asset classes

– Unfolding crisis in the Euro area

– Regulatory changes

(B) Opportunities in new (frontier) markets (e.g. Africa) (LCBMs)

(C) Greater use of renminbi for sovereign borrowing (both Dim Sum issues and Panda bonds) (LCBMs)

2. Drivers structural changes in the

investor base for government debt

30-Apr-2013 6

MAIN PLAYERS

30-Apr-2013 7

• Main players are:

– Large asset managers

– Pension funds

– Insurance companies

– Central banks

• Domestic

• Foreign

– Government owned companies/ Sovereign wealth funds?

• In general, investors can be categorized as domestic and foreign investors

• Each investor may have different preferences and investment strategies

3. Main components investor base

30-Apr-2013 8

RESPONSE BY DEBT MANAGERS

30-Apr-2013 9

• Global crisis increased borrowing operations

• Response by DMOs to increase in competition for funds among sovereigns

• Changes in investor base affect policies of DMOs? – Increasing importance of “Investor Relations and

Communication Strategy” in order to

• Ensure demand

• Diversify the investor base

4. Response by DMOs to structural

changes in the investor base for public

securities?

30-Apr-2013 10

5. Issuance of new instruments in the

OECD area

0

50

100

150

200

250

300

350

2007 2008 2009 2010 2011 2012 2013

Index linked Variable rate

Source: OECD Sovereign Borrowing Outlook 2013

30-Apr-2013 11

INCREASE IN HOME BIAS?

30-Apr-2013 12

6. Higher degree of home bias?

Source: Update of OECD Sovereign Borrowing Outlook 2013

Non-resident holdings of government securities (2007 vs. 2012) (%)

30-Apr-2013 13

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2007

2012 (latest)

7. Higher degree of home bias in

Ireland, France, Spain and Italy?

Source: Update of OECD Sovereign Borrowing Outlook 2013

Non-resident holdings of government securities in Ireland, Italy, Spain, and France

30-Apr-2013 14

0%

20%

40%

60%

80%

100%

2007 2008 2009 2010 2011 2012

Ireland France Spain Italy

15

8. Non-resident holdings of

government securities in selected

countries

Source: Responses to the “2012 Survey of the OECD Working Party on Public Debt Management”, The Central Bank of Ireland, Agence France Tresor, U.S. Department of the Treasury: Financial Management Service, Bundesbank, Bank of Italy, The Spanish Treasury, Bank of England & ONS, Central Bank of Turkey, Ministry of Finance Japan, OECD staff calculations

13.6%

24.2%

49.0%

36.9%

85.8%

55.4%

45.8%

26.0%30.2%

5.5% 8.7%

68.4%

59.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2006 2007 2008 2009 2010 2011 2012 2013

Turkey Spain Ireland Germany

UK Japan US

9. Non-resident holdings of government

securities in Spain, Ireland and Italy(2012-2013)

Source: OECD Sovereign Borrowing Outlook 2013 30-Apr-2013 16

33.03% 30.45%

36.86%

76.57%71.71%

37.06%

33.48%

20%

30%

40%

50%

60%

70%

80%

Spain Ireland Italy

OMT

THE HUGE IMPACT OF NON-CONVENTIONAL MONETARY

POLICY

30-Apr-2013 17

10. Major Central Bank’s non-standard

monetary policy programmes

-30

-20

-10

0

10

20

30

40

50

60

70

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Per

cent

age

Panel AUS FED purchase of total net Treasury issuance

0

5

10

15

20

25

30

0

50

100

150

200

250

300

350

400

2009 2010 2011 2012

Perc

enta

ge

Bill

ion

ster

ling

Panel BAmount of gilts in the Bank of England's asset purchase

facility (APF) operations

APF (LHS) APF, % of total long-term marketable debt, (RHS)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0

50

100

150

200

250

2010 2011 2012

Per

cent

age

Bill

ion €

Panel CECB Securities Market Programme (SMP)

SMP (LHS)

SMP, % of euro area long-term marketable debt (RHS)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0

5

10

15

20

25

2010 2011 2012

Per

cent

age

Trill

ion

yen

Panel D BOJ Asset purchase programme (APP)

APP* (LHS) APP*, % of long-term marketable debt (LHS)

Note: * Japan APP figures cover only purchase of Japan Government Bonds (JGBs). Source: OECD Sovereign Borrowing Outlook 2013

30-Apr-2013 18

30-Apr-2013 19

11. BoJ Asset Purchase Programme

(APP)

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

-

10

20

30

40

50

60

70

80

2010 2011 2012 2013

APP (trillion Yen)*

APP % of long-term marketable debt (trillion Yen)*

Note: * Japan APP figures cover only purchase of Japan Government Bonds (JGBs). Source: OECD Sovereign Borrowing Outlook 2013 and BoJ

• Doubling monetary base in coming 2 years

• Increase longer term assets on BoJ balance sheet

• Support for new phase? G20 Finance Ministers and Central Bank Governors indicated they will be mindful of unintended negative side effects stemming from extended periods of monetary easing

30-Apr-2013 20

12a. “New Phase” of Japanese QE

Programme

• Volatility in the JGB market has eased during the week of April 22

• Purchasing JGBs to encourage local financial institutions to invest into riskier assets with higher returns:

– Evidence that local investors lower JGB holdings and buy abroad?

• What can be expected?

– Increase demand US government bonds?

– Demand for other non-Japanese government bonds such as euro area but also Turkish lira and other EMEA currencies ? Core euro or peripheral countries?

30-Apr-2013 21

12b. “New Phase” of Japanese QE

Programme

13. Government security holdings of US and UK central

banks (% of total central government long-term marketable

debt)

Source: Update of OECD Sovereign Borrowing Outlook 2013 22

0

10

20

30

40

50

60

70

2007 2008 2009 2010 2011 2012

Held by the Federal Reserve

Held by foreigners (official + private)

0

5

10

15

20

25

30

35

2007 2008 2009 2010 2011 2012

Held by Bank of England

Held by foreigners (official+private)

Panel A

Distribution of Gilt holdings

Panel B

Distribution of US Treasury holdings

ASSET ALLOCATIONS BY CENTRAL BANKS

30-Apr-2013 23

14. Asset Allocations of Foreign

Exchange Reserves

Source: Update of OECD Sovereign Borrowing Outlook 2013

Foreign central banks' holdings of US Treasury debt

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2007 2008 2009 2010 2011 2012

Per

cent

age

Tril

lion

US

D

Foreign central banks' holdings of US Treasury debt (LHS) Central government long-term marketable debt (RHS)

30-Apr-2013 24

25

15. Currency Composition of Official

Foreign Exchange Reserves (Claims)

Source: IMF Data and Statistics, COFER Data

4.13% 3.94%

5.69% 6.12%

26.2% 26.6% 26.0% 26.5% 26.7%25.6%

24.7% 24.5% 24.7%23.9% 23.9%

62.5%

61.6%

61.8%

61.0%60.5%

61.6%62.3% 62.3% 62.1% 62.1% 61.9%

55%

57%

59%

61%

63%

65%

67%

69%

0%

5%

10%

15%

20%

25%

30%

20

10

-II

20

10

-III

20

10

-IV

20

11

-I

20

11

-II

20

11

-III

20

11

-IV

p

20

12

-Ip

20

12

-IIp

20

12

-IIIp

20

12

-IV

p

in Japanese yen (LHS) Other currencies (LHS) in Euros (LHS) in U.S. Dollars (RHS)

---QE2--- QE3/4 →

“SHORTAGE” OF SAFE ASSETS?

30-Apr-2013 26

• Increase in the demand for safe assets

• Has the supply of safe sovereign assets drastically decreased?

• Not so easy to answer

• Are sovereign ratings reliable?

30-Apr-2013 27

16a. Demand and supply for safe

assets

28

16b. Supply of Safe Sovereign

Assets

Notes: * Downgrade of Greece (to BBB from A) and Ireland (to AA from AAA) ** Downgrade of Ireland (to BBB from AA), Portugal (to A from AA), Spain (to AA from AAA) and Greece (to non-investment from BBB) *** Downgrade of Italy (to BBB from AA) and Portugal (to BBB from A) **** Downgrade of Spain (to BBB from AA), France (to AA from AAA), Portugal (to non-investment from BBB), Slovenia (to A from AA) and Hungary (to non-investment from BBB) *****Downgrade of UK (to AA from AAA) Source: OECD Sovereign Borrowing Outlook 2013

21.6 23.8

26.8 29.6 29.6 31.2 33.0

1.4

1.5

1.7

2.2 4.7

5.2

5.4

94.04% 94.08% 93.98% 93.1%86.4% 85.6% 86.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

5

10

15

20

25

30

35

40

45

2007 2008 2009* 2010** 2011*** 2012**** 2013*****

Per

cent

age

Tril

lion

US

D

Outstanding Government Debt (Lower Rated) (LHS) Outstanding Government Debt (AAA + AA) (LHS)

(AAA+AA) Share in Total OECD Marketable Debt (RHS)

• Sound domestic macroeconomic fundamentals are essential

• Key challenges for many emerging markets

• Structure of investor base has major impact on the functioning of sovereign debt markets

• A reliable and broad investor base is critical

• Importance of reinforcing investor monitoring capabilities and investor relations

• For countries with highly concentrated Treasury holdings, the challenge is to diversify the investor base

17a. Policy lessons from structural

changes in the investor base

30-Apr-2013 29

• Real-money investors are a relatively stable source of demand for government debt

• Large holdings of government debt by central banks are often associated with higher yields and higher volatility, especially in emerging markets but not in advanced economies?

30-Apr-2013 30

17b. Policy lessons from structural

changes in the investor base

• OECD Sovereign Borrowing Outlook 2013

• Beltran D., Kretchmer M., Marquez J. and Thomas C. (2012), “Foreign Holdings of U.S. Treasuries and U.S. Treasury Yields”, International Finance Discussion Papers, Number 1041, January 2012, Board of Governors of the Federal Reserve System.

• IMF (2012), “Global Financial Stability Report” (Restoring Confidence and Progressing on Reforms), October 2012.

• OECD (2012), OECD Sovereign Borrowing Outlook 2012.

• US Treasury (2011), “Presentation to the Treasury Borrowing Advisory Committee”, 1 February 2011.

18a. References

30-Apr-2013 31

• H. J. Blommestein (2013), Redefining Safe Sovereign Assets in OECD Area May Give Less Gloomy Outlook, Bloomberg Brief (Economics European Edition) 1 March 2013

• H.J. Blommestein, and P. Turner (2012), "Interactions Between Sovereign Debt Management and Monetary Policy Under Fiscal Dominance and Financial Instability", OECD Working Papers on Sovereign Borrowing and Public Debt Management, No. 3, OECD Publishing

30-Apr-2013 32

18b. References