1. AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT The Australian Government Bond Market Peter McCray Deputy Chief Executive Officer

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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:

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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)

21. 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

22. 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

23. AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT Conclusion A review of Australia’s experience suggests a number of strategies to promote bond markets

24. 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

25. 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

26. 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

27. 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

28. AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT

29. Domestic Bonds OutstandingBond Market Turnover (daily average)

30. AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT Turnover in Physical & Futures Markets (daily average)

31. AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT JP Morgan Liquidity Ratio (as at 31 December 1999)

32. AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT Daily Average Turnover Versus Bonds Outstanding

33. AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT Benchmark Bond Issues (as at 24 March 2000)

34. AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT Bond Auctions: Range of Accepted Bids