1. 9 th Forum on African Public Debt Management SESSION 3: RISK MANAGEMENT, THE RESPONSIBILITIES AND NEW CHALLENGES FACING MIDDLE OFFICES Sturla Palsson, Director, Treasury and Market Operations Central Bank of Iceland

2. Institutional setup Framework for borrowing set in the budget law presented in parliament before the fiscal year Debt management mandate given to Ministry of Finance (MF) by parliament MF can assign the task of borrowing to the Central Bank of Iceland (CBI) –CBI act as funding agent for MF –Similar setup in Denmark, Norway and many African countries Division of responsibilities between MF and CBI –Agreement between FM and CBI on Treasury debt management Guidelines for debt issuance issued by MF –Medium Term Debt Strategy

3. Allocation of responsibilities Responsibility for the DM lies with the MF –CBI has a relatively narrow mandate compared to other Nordic DMO´s Number of measures taken to prevent a conflict of interest –Debt policy vs. monetary policy MF makes final decisions on the most important issues –Recommendations presented to Debt Management Committee (DMC) DMO advises the MF on everything relating to the DM The MO unit within the DMO prepares the necessary material and presents it the DMC –DMC discusses scenarios and proposals put forward by the DMO MTDS guidelines set by the MF provide the framework for the debt strategy –MTDS outlines a 4 year debt strategy and is updated every year The DMO at the CBI is responsible for ensuring that borrowing and debt management issues are carried out in accordance with the strategy

4. MTDS - Debt management objectives To ensure that the Treasury’s financing need and payment obligations are met at the lowest possible long-term cost that is consistent with a prudent risk policy; To ensure that the debt repayment profile accords with the Treasury’s long-term debt service capacity and minimizes refinancing risk; To maintain and encourage further development of efficient primary and secondary markets for domestic Treasury securities; To broaden the investor base and diversify funding sources.

5. MTDS - Debt management guidelines Debt portfolio structure –Non-indexed debt 70-90% –Indexed debt 15-30% –Foreign debt 0-10% Borrowing guidelines Repayment profile: –The aim is to have the long-term repayment profile of Treasury securities as smooth as possible and the individual issuances of similar final size.

6. MTDS - Debt management guidelines Benchmark series: –Benchmark issues will be structured so that each series is large enough to ensure effective price formation in the secondary market. The number and size of the series shall take account of Treasury debt. The goal is for each series to have a final size of ISK 40-100 billion, except for two-year bonds, whose minimum final size will be ISK 15 billion. Refinancing percentage: –The ratio of Treasury redemptions in any calendar year shall not exceed 15% of GDP. Maturity: –The average time to maturity of the debt portfolio shall be at least five years. Deposits: –The Treasury’s domestic deposit balance with the Central Bank of Iceland shall average ISK 60-70 billion.

7. DMO Structure within CBI Front Primary Issuance Secondary market Bond lending Relationship management Market makers Investors Middle Policy Strategy Reporting Risk management Processes and controls Compliance monitoring Back Transaction recording Reconciliation Conformation and settlement Debt servicing and payments Debt data for accounting Debt Management Committee (DMC) Treasury and Mkt. Op.Accounting

8. DMO Structure in Nordic region Front Primary Issuance Secondary market Bond lending Relationship management Market makers Investors Middle Policy Strategy Reporting Risk management Processes and controls Compliance monitoring Back Transaction recording Reconciliation Conformation and settlement Debt servicing and payments Debt data for accounting Debt Management Committee (DMC) Treasury and Mkt. Op.

9. Middle office tasks Policy Outlined in MTDS Updated on annual basis Prepared by the DMO (MO) Discussed by the DMC Confirmed by the MF Strategy Annual issuance calendar Quarterly issuance plan Formulated and designed by the DMO Presented to DMC Confirmed by the FM New product development Research Reporting Monthly bulletin Detailed picture of government debt Annual risk report to FM Only in Icelandic for FM Regular DMC meetings with MO presentations

10. Middle office tasks Risk Parameters defined in MTDS Market risk Refinancing risk Operational risk Modeling Monitored by DMO Reported to DMC Process Annual/Quarterly issuance plan DMO acts as Secretariat to DMC who advises FM Monitoring Compliance Risk limits Trade limits Collateral management Primary dealer performance Annual risk report to MF Regular meetings with DMC Debt sustainability analysis

11. Required MO skills Market experience Issuance Trading Sales Technical skills Finance Risk Portfolio man. Mathematics and modeling Public policy skills Economics Public sector finance Budget process Communication skills Market makers Investors Front/Back MF/DMC IT skills Software Bloomberg/Reuters Spreadsheets Treasury system

12. Rep. of Iceland treasury debt

13. Investors in T-bonds

14. Auction results

15. 15 Primary Surplus: Major Step Towards Fiscal Consolidation Gross Expenditures on the Decline (1) Iceland Fiscal Consolidation: A Global Comparison Surplus Achieved in 2014 Expected to Continue Continuous Growth and Improved Debt Levels  Positive primary balance since 2012 – 5% of GDP in 2014 – 3.2% estimated in 2015 (due to one-offs)  Overall surplus achieved in 2014  Accumulated surplus of over 8% of GDP expected during the forecast period (2016-19)*  Expenditures peaked at 34% in 2009 – Expected to reduce to 26% by 2019* % of GDP (1) Excluding irregular items. Sources: Ministry of Finance and Economic Affairs – Medium-Term Fiscal Outlook 2015

16. 16 Government Debt Ratio on Declining Trajectory Overview of Government Debt Forecast Gross Interest Payments Source: Ministry of Finance and Economic Affairs - Medium-Term Fiscal Outlook 2015 Notes: Figures exclude loans from IMF and Norway (Central Bank is Borrower and covered within Central Bank reserve fund); and unfunded pension liabilities (ISK408 bn at year-end 2013); adjusted for impact of Nordic drawdown Forecast

17. 17 Overview of Government Funding Domestic Debt and Local Currency Largest Parts of Government Debt  ISK debt represents 72% of the debt portfolio in Dec 2014  Less need for domestic issuance due to better fiscal outcome  Accumulated debt due to funding of fiscal deficit is ISK360bn  Key investors in domestic securities are: – Financial institutions (29%) – Foreign investors (20%) – Pension funds (28%) – Mutual funds (10%) Central Bank FX Reserves Interest Rate Composition of Debt Portfolio (Dec 2014) Source: Ministry of Finance and Economic Affairs - 2015 ISK mn

18. Thank you! For more information:  Central Bank: www.cb.is/  Statistics Iceland: www.statice.is/  Iceland bond market: www.bonds.is/  Ministry of Finance: www.fjr.is/www.fjr.is/  DMO: www.lanamal.is/