1. Debt Management - in the UK and Overseas
International Consulting Economists’ Association
London, May 2004

2. Debt Management in 2004 Debt management objectives
The debt management “office”
Policy framework
Governance
Building the office
“Challenges” for the Consultant

3. What is Sovereign Debt Management?
“The process of establishing and executing a strategy for managing the government’s debt in order to:
Raise the required amount of funding
Achieve its cost and risk objectives
Meet related goals – e.g. developing an efficient market for government securities.”
IMF/World Bank, Guidelines for Public Debt Management, March 2001

4. Why is it Important? Fiscal sustainability; problems include
Size and growth of indebtedness (debt/GDP)
Poorly structured - maturity, currency or interest rate composition (excessive focus on short-term or FX debt)
Large and unfunded contingent liabilities
Exposure to economic shocks (lack of liquidity)
Asymmetry of risk
Weaknesses exacerbate economic crises
Contagion and feedback effects
Sound debt management policies not a substitute for good economic policies – but reduce feedback effects and provide resilience

5. No shortage of examples….
The emerging market debt crises of the 1990s…
Mexico 1994
Asia
Russia 1998
Brazil
…were characterised by vulnerabilities arising from
poor debt structures
crystallisation of contingent liabilities

6. Building Debt Management Capacity
Establishing objectives and priorities
Developing the analytical framework for risk management – and the necessary capability
Ensuring consistency with
macro-economic policies
financial market development policies
Establishing an organisational structure with
clear accountability and transparency of responsibilities
a relevant legal and governance framework
Recruitment of trained staff, systems investment etc

7. Objectives
“The main objective of public debt management is to ensure that the government’s financing needs and its payment obligations are met at the lowest possible cost over the medium to long term, consistent with a prudent degree of risk… It should encompass the main financial obligations over which the government exercises control.”
IMF/World Bank, Guidelines for Public Debt Management, March 2001

8. Portfolio Risk Objectives
In 1990s models focussed on optimising liability portfolio
Historical distributions of interest and exchange rate to generate efficient cost risk frontier associated with different issuance strategies
Stochastic simulations - Markowitz models, VAR, Cost at Risk etc
In 2000s focus on whole government balance sheet – ALM framework – main government asset is power to tax
Matching financial characteristics of assets and liabilities
Direct matching or e.g. currency assets and liabilities
Debt servicing ratio to annual budget or GDP (proxy for power to tax)
Integrate with macro models to create internally consistent scenarios
Include contingent liabilities, on-lending to SOEs etc
Importance attached to “tax smoothing”
Fiscal resilience in face of adverse economic shocks
Develop stress tests, or upward bounds

9. Other Debt Management Objectives
Developing a liquid and efficient government bond market
Ensure ability to borrow in size at short notice
Issuance policy open predictable and transparent
Generating a benchmark premium
Maturity and composition taking account of :
Investors’ demand
Government's attitude to risk
Shape of the yield curve
Need for liquid Treasury bill market
Adjusting maturity by issuance, also switch auctions, conversions, buy-backs and , in some cases, derivatives

10. Performance Measurement
Risk models underpin strategic target
Often expressed as duration target (although maturity profile important)
Derivatives allow separation between funding decision and portfolio decisions
Eurozone countries issuing at 10 years, and using IRS to reduce duration (France, Finland, Belgium)
Reinforced through performance benchmarks
Assumes active trading
Measures cost of actual portfolio against strategic target (Ireland) or a short-term optimised portfolio (Quebec)
Strategic target may in practice become performance benchmark – Austria, Portugal
Active trading may be confined to FX portfolio where Government is a price taker – Denmark, Sweden

11. [No] Performance Benchmark in the UK
Risk of Active trading
Limited inside information (and no wish to capitalise on it)
Concern to avoid actions being interpreted as market signals
Concern to avoid opportunistic behaviour – adding to market uncertainty
Benchmark not independent of DMO’s actions
Status as part of HM Treasury risks adding to market uncertainty and damaging DMO’s credibility
A strategic target remains a relevant indicator - for explanatory and monitoring purposes
Formal targets for secondary measures – efficiency and service

12. A Debt Management “Office”
Clarity and transparency
Internally, with focus on the debt management task
Externally, in the perception of the markets in relation to objectives and intent
Linked with accountability and governance
Improving capacity, efficiency and effectiveness
Getting decisions right
Emphasis on portfolio risk management
Integrating dispersed functions
Expertise, professionalism

13. Autonomous Offices: Objectives
Kalderon & Blommerstein, OECD 2002
Motives for Separate office
Autonomy from political sphere
Emphasises separation between debt management & monetary policy
Greater transparency between government functions
Ability to concentrate expertise
Staff recruitment and retention (pay flexibility)
Linked with improved transparent and accountable framework
Accountability must be supported by governance framework
Needs high level political support for transparency and accountability
But: major administrative task – beware of diversion of effort

14. Different Institutional Arrangements
Operational independence from MoF & Central Bank
Responsibilities often include cash management, also asset management, contingent liabilities and on-lending
Spectrum of institutional arrangements
Part of Treasury / MoF (Italy, Greece) or another ministry (Spain)
“Bureau” within Treasury / MoF (Finland, USA)
Independent agency within Treasury or MoF (Australia, New Zealand, Netherlands, UK, Belgium, France)
Agency within central bank (Denmark)
Autonomous agency within government (Sweden, Austria, Portugal, Ireland - Irish Agency manages structural investment funds)
Company owned by Government (Germany)
Some use Central Bank as agent; all use Bank for some services

15. Formation of the UK DMO
Established in April an Agency of HM Treasury
Corollary of interest rate setting responsibilities for the Bank of England announced in May 1997
Legally part of HM Treasury
some operational and managerial independence
but a strong governance framework
With the aim
“…to minimise the Government’s debt financing costs over the long term, taking account of risk, and manage the aggregate cash needs of the Exchequer in the most cost-effective way, while being consistent with monetary policy objectives.”

16. The DMO’s Functions The Government’s debt manager
issuing gilts (and Treasury Bills), managing the gilts market
The Government’s cash manager
balancing daily the net cash flow into/from Government
issuing Treasury bills; borrowing and lending in the money markets
The Government’s (short term) asset manager
managing of cash surpluses (inc from 3G licences)
DMO also manages Government lending to local authorities and investments of certain public sector funds.

17. Identifying the Policy Framework: Interaction with Monetary Policy
Separation of debt management from monetary policy clarifies objectives and reduces uncertainty
Essential in Eurozone, and most developed countries
More difficult where debt management operations affect interest rates and the capital market
Currency boards adds risk to fiscal and financing policy
Important in UK
avoids given Bank a conflict of interest – or a market perception of conflict – reducing market uncertainty
only a weak link between financing policies and monetary conditions; and money supply growth & inflation

18. Identifying the Policy Framework: Co-ordination with Central Bank
Central Bank’s input to policy
Drawing on market knowledge
Wider market development influencing, and influenced by, debt and cash management policies
Identifying services required
Fiscal agent for auctions etc
Settlement services; debt registration services
Cash account manager (banking services)
[Investment manager – investing structural and longer-term surpluses]
Agree service levels
Backed-up with MOUs or service level agreements

19. Establishing the Governance Framework: Three Levels
High-level policy formation
Setting the debt (and cash) management strategy
Delegations to the Debt Office for meeting that strategy – and its accountability
“External” governance of the Debt Office
Information flows – reporting to Ministers, officials and Parliament
Performance assessment and external audit
“Internal” management and governance structures
Facilitated by (or subject to) the domestic legal framework

20. High-level Policy Formation
Development of the debt management strategy
Taking account of relevant views and responsibilities, especially macro-economists (also Central Bank?)
Benefits of a formal Debt Management Committee
Strategy set for the year ahead, with explicit provision for review
Approved by Ministers
Published
(as necessary) approved by National Assembly/Parliament
Implemented within the agreed institutional framework by the responsible body (the Debt Office)
Agreed co-ordination arrangements with other bodies, including fiscal agent
Operating within the same framework supported by memoranda of understanding (MOUs) etc. Outlaw second-guessing.

21. Delegating Operational Policy
Ministers delegate implementation to Debt Office
Specified parameters or objectives, e.g. portfolio or duration benchmarks, targets for cash balances
Related objectives (e.g. for Treasury bills, contingent liabilities)
Identifying
Decisions that
Must be taken by Ministers
Can be taken by officials
Circumstances that require a revision, e.g. unanticipated changes in fiscal position or wider economy
Parameters of delegation widen as confidence and capacity builds

22. Delegating Managerial Policy
Policy delegation backed by:
Longer term management objectives (capacity, administrative costs, investment)
Preparation of an annual business plan
Agreed operational and managerial delegations – subject to legislation and government service practice
Management reports, publications and other information
Benefits from defined delegation in terms of
Transparency and accountability
Faster decision-making
Less risk of challenge from other bodies
Increase sense of purpose and authority within Debt Office, contributes to capacity building

23. External Accountability
Reporting outturns against the published objectives
Managerial and operational reports
Within the Ministry of Finance
Formally to Parliament
To market, on website etc
Performance assessment
High-level – is it the right objective
Achievement of portfolio objectives
Meeting management objectives
External Audit
Both propriety and cost-effectiveness

24. UK DMO’s Relationship with Ministry of Finance (HM Treasury)
Ministers set objectives and targets
Co-ordination with macro policy within HM Treasury
Set annual strategy objectives (“remit”)
Approve Business Plan and targets
Chief Executive responsible for operational decisions within parameters of remit
Reports direct to Parliament on expenditure and accounts
DMO advises on its remit and portfolio objectives; but HM Treasury integrates with wider economic advice (on fiscal and balance sheet policies)

25. UK DMO Governance Framework

26. Building the Office Building a professional and committed team
Developing debt management strategy
Procuring systems and establishing business processes
Controlling operational risk
Managing stakeholder relationships
Employees
Central Bank, regulators,
Market-makers, investors, exchanges
Others in Ministry of Finance and government
Reform must be “seamless” to market

27. Internal Specialisation
Separate front, middle and back-office
Allows specialisation
Avoids duplication
Contributes to risk management
Distinguish between key responsibilities
Senior management
Front Office: primary issuance and execution, internal and external, secondary market transactions (debt and cash)
Middle office: policy and portfolio strategy development and accountability reporting
Middle office: risk management: policies, processes and controls
Back-office: transaction recording, reconciliation, confirmation and settlement
Internal audit and compliance – reporting to CEO / Head of Office

28. Debt (& Cash) Office: Systems
Government Expenditure Monitoring and Control
disbursement authority
receipt collection
monitoring
cash flow
Published Financial Accounts
Government cash flow Forecasting and Reporting
Bank Accounts
central bank
other
Government Cash Management Forecasting
flow profiles
modelling
Debt Management
Modeling and analytics
Securities Issuance
Treasury bills
Bonds
Repos
Transaction Processing and Recording
Database
Links to settlement
Debt Database
Market Feeds
Market Notices
Published transactions Account

29. Capacity and Resources
Staff recruitment and retention
Even without pay flexibility, greater authority and accountability improves job satisfaction.
Delegation allows greater flexibility to respond to changes in the economic environment
Greater visibility as a centre of excellence, with the support of Ministers, helps improve the status of staff
Secondments can close gaps
Importance of Training
May be only route to closing gaps
Means to professionalism – link to business plan
Enhance individuals’ commitment
[along with golden handcuffs]
Make skills available to others in Government

30. Some Lessons from the UK
Establish respective roles and responsibilities (in relation to rest of MoF, Central Bank etc) and publish them
Manage stakeholders (Ministers, market, BoE, Parliament)
Manage as a project: dedicated manager, business plan
Involve staff
Horizontal decision-making structures
Communication, including through change and integration processes
“Rewarding” professionalism
Change programme
Signal what matters
Delivery
Professionalism
Risk management, inc operational risk
Effective internal project management

31. “Challenges” for the Consultant
Relevance of OECD experience to emerging economies
The legal framework
How separate is the Debt Office?
Cash management and budget execution
Interaction with Central Bank
Operational risk

32. Emerging Economies Additional Problems
High fiscal deficits and high levels of indebtedness
Balance sheets more exposed to shocks <= less diversified economies, weak capital markets, low savings, and susceptibility to contagion effects
Transition countries: inexperienced MoF and Central Bank (but want to join Eurozone)
Lack of instrument independence
Poor accountability and transparency; inadequate legal framework
Failure to account for contingent liabilities
Poor systems, poor operational risk management
Greater salary differentials between MoF & Central Bank and MoF & private sector => difficult to retain staff

33. Emerging Economies Solutions:
Debt management policies take into account public policy dimension – development of domestic debt market, co-ordination with fiscal and monetary policy
Avoid conflict with Central Bank – co-ordination mechanisms Suspend debt issuance by Bank
Principal-agent problems and need for co-ordination implies location of Debt Office in or close to MoF
Minimise political pressure with long-term objectives and benchmarks, and public reporting
Avoid active trading – reduce operational risk and save resources
Need to be creative with incentive compatible pay structures in line with skill needs!

34. Legal Framework Problems Best international practice; the legislation
Laws say only what you can do, not what you can’t
Institutionalised job descriptions
Restrictive limits (gross v net)
Lack of delegated authority; Parliamentary involvement in operational decisions
Best international practice; the legislation
Addresses the state’s authority to borrow and to issue guarantees
Sets appropriate limits and reporting & accountability requirements
Authorises the Minister of Finance to set explicit objectives to be followed [….finance the government’s borrowing needs efficiently … ensure debt servicing obligations are met…ensure debt portfolio is managed according to cost and risk objectives.]

35. How Separate is the Office
Advantages of a separate office
Signals new status to Ministers and officials
Forces rationalisation, and encourages professionalism
Allows pay flexibility
Risks
Principal-Agent problems, especially inadequate accountability, transparency and governance
Cronyism
Diversion of effort
Adds to skill staff requirements (in both purchaser and provider)
Seen an end in itself

36. Debt and Cash Management: Benefits of Integration
Co-ordinating issuance strategies across the full range of instruments
Funding (overview of full risk-free yield curve)
Financial market development
Market signalling
Debt issuance decisions taken in the context of the government’s overall cash flows
Weakens the link between the timing of bond sales and the timing mismatch between receipts and payments
Allows pattern of bond sales to be announced in advance

37. Cash Management: Issues
Integration in debt office risks losing focus on debt management
Linkage with what?
Macro-forecasting
Budget planning and control
Accounting functions
Budget execution – the main problem in practice
Central Bank concerns about monetary policy ops
“market confusion”, “cutting across”, “interference”
Confusion over role of Treasury bills
Debt management, cash management, monetary policy
Perceived need for central bank bills

38. Interaction with Central Bank
Problems
Different objectives
Bank resentment at formation of Debt Office
MoF staff jealousy of higher Bank pay, better systems etc
Solutions
Identify respective roles
Distinguish policy from services
High-level co-ordination and fire fighting
Backed by regular operational level contact and information flows
Suspend Issuance of Central Bank Bills
At request of Central Bank, Debt Office should issue extra Treasury Bills for monetary policy purposes, sterilising proceeds

39. Operational Risk Lack of
skilled risk specialists
understanding of operational risk
Business Continuity Plan & Disaster Recovery Site
acceptance of responsibility
Less important when Central Bank is fiscal agent
main argument for leaving agency function with Bank

40. Internal Control Strategies
Culture
Public sector ethos
Open (‘no blame’) - no personal financial targets
‘Profit’ not an objective
Best Market Practice
Policy and operational control of transactions and projects
Risk polices and appetite regularly reviewed
Separate operational and processing areas; ‘4-eyes’ approvals
Procedure and control manuals “owned” by line mangers
Embedded monitoring, “exception logs”
Management “certification”
Facilitated and analysed by “risk champion” – operational risk specialist – reporting to Board/CEO

41. Conclusion Debt management matters!
There is a recognised international best practice
But no single template
More challenging in emerging and transition countries than in the OECD (although some useful blank slates)
Effectiveness mixes:
Economic policy
Policy execution
Good governance and management