1. Organisational Models for Sovereign Debt Management Peter McCray Australian Office of Financial Management

2. Australian Office of Financial Management established 1 July 1999: –specialist office to manage Australian government’s net debt position – independent agency within Treasury portfolio though important practical linkages with parent department remain

3. Australian Office of Financial Management Rationale for establishing the AOFM Overseas experience in institutional arrangements for sovereign debt management

4. Australian Office of Financial Management Risk –the need to recognise, measure, monitor and manage the full range of financial risks bearing on the longer term cost performance of the debt portfolio –market risk, funding/liquidity risk, credit risk, operational risk

5. A Risk Management Framework Rationale for a risk management approach: –impact of financial deregulation and technological innovation increasingly mobile international capital flows and integrated capital markets –broader reforms to public sector financial management

6. Financial Market Deregulation and Innovation The nature of the operating environment facing sovereign debt management has changed fundamentally: –markets are far more integrated globally investors have no special allegiance to the currency, the market or the issuer –financial innovation has made available new financial products and modes of service delivery currencies and interest rates have become substantially more volatile

7. Financial Market Deregulation and Innovation These developments present both opportunities and challenges for debt managers: –opportunities lie in a truly global and expanded market for debt and potentially lower cost of debt –risks lie in increased financial market volatility and internationally mobile investors, increasing the vulnerability of debt service costs the market exposure of the debt portfolio and, ultimately the exposure of balance sheet net worth

8. Public Sector Financial Management Reforms Australian government introduced accrual budgeting and accounting: –and an outcomes-oriented approach to performance reporting –increasing emphasis on public sector transparency and accountability –increased focus on net worth and risks to net worth

9. Public Sector Financial Management Reforms A risk management framework provides the basis for a coherent, objective and generally quantifiable basis for performance reporting Is also consistent with the increased emphasis on balance sheet net worth and the risks to net worth accompanying accrual reforms

10. A Risk Management Approach to Debt Management Forces the debt manager to recognise the full range of financial risks involved across all debt management operations –funding, market, credit, liquidity and operational risks Obliges conscious decisions about the extent of risk that governments are willing to bear and the balance to be struck between different risks Makes it clearer that risks are not independent and provides a basis for selecting efficiently from among different risks so as to minimise risk overall

11. Debt Management Review The basic organisational structure, staffing numbers and skill set, financial resourcing, delegations and accountability arrangements essentially unchanged from those that applied 20 years ago Undertook a major review of existing debt management arrangements

12. Organisational Reform - a Framework Defined a four-tiered management framework as a basis for taking decisions on organisational reform: –philosophical approach –operating framework –measurement and reporting framework –organisational and resource structure

13. Organisational Reform - a Framework Philosophical approach –objectives of debt management –relevant cost and risk concepts –broad strategic principles governing the way in which the debt manager pursues those objectives Operating framework –establishes the policy and practices employed in implementing the management philosophy degree of operational/funding flexibility, transactional capability, use of derivatives frameworks of internal delegations and accountabilities

14. Organisational Reform - a Framework Measurement framework –governs not only how risk is measured and monitored –but also how the debt manager’s performance is measured against those objectives Organisational structure –establishes the resource, management and skills base appropriate to implementing the overall debt management strategy

15. Organisational Reform - a Framework A natural hierarchy linking these four elements: –and an overriding need for consistency between all elements of the hierarchy Choice of overall philosophy the primary determinant of the way in which other elements should be approached

16. Organisational Reform - a Framework Review of overseas experience: –wide range of reasons/backgrounds behind different philosophical approaches observed reform arising from financial pressures wider economic and public sector reforms competitive pressures on inefficient domestic markets established history and practice

17. Organisational Reform - a Framework Review of overseas experience: –spectrum of philosophical approaches to funding and market risk management opportunistic or strategic funding versus predictable, transparent approach comprehensive financial risk management approach with particular focus on management of market risk of debt portfolio market risk profile of the portfolio simply the cumulative result of past issuance decisions

18. Organisational Reform - a Framework Range of approaches complemented by variety of operational and organisational frameworks, generally consistent with intensity of philosophy: –less intensive forms of debt management - tightly scheduled issuance programs, little or limited management of portfolio market risk: fairly narrowly defined transactional flexibilities limited delegations required relatively less demanding of resources

19. Organisational Reform - a Framework Other jurisdictions employed a more comprehensive financial risk management approach: –explicit management of market risk typically by reference to a strategic benchmark portfolio structure –scope for intervention in the secondary market for market management purposes for example, stock lending facilities –reasonably intensive use of derivatives and in, some instances, management of financial assets requiring tightly defined policies for the management of credit exposure

20. Organisational Reform - a Framework A philosophy that recognises and seeks to manage financial risk comprehensively requires that: –objectives and strategies are clearly defined –lines of delegation are short, clear and appropriate to an environment in which decisions need to be made and implemented quickly –accountabilities and responsibilities are clear –systems and resources are consistent with the high transactional burden implied –the organisational structure provides maximum flexibility to recruit and retain specialist staff with the full range of requisite skills

21. Organisational Reform - a Framework Our own review strongly endorsed the shift in recent years to such a comprehensive financial risk management approach in Australia, but highlighted: –limitations in the operating framework (inadequate operational flexibility and transactional capability) –a measurement and reporting framework which undermined capacity to deliver the full benefits of philosophical approach –resourcing and organisational arrangements which were inconsistent with other elements of the management framework

22. Organisational Reform - a Framework Decisions on form of organisational structure that would provide a foundation for addressing these inconsistencies were guided by five design criteria: –Adequate resources (human and financial) and a sound basis for their allocation –A strong focus on financial markets and risk management –A strong perception of the separation between debt management and economic policy advisory functions –Mechanisms to ensure an institutional awareness of public policy sensitivities –A sound structure of governance and appropriate flexibility and accountability in decision making

23. Organisational Reform - a Framework Elements of these criteria essential to any form of sovereign debt management operation: –clear separation of debt management and monetary policy –clear objectives and governance frameworks –an operating culture that recognises the public policy constraints on debt management operations Additional considerations become increasingly pressing as the intensity of the risk philosophy increases

24. Australian Office of Financial Management Australian Office of Financial Management established 1 July 1999: – independent agency within Treasury portfolio significant additional resourcing own appropriations, financial accounts and annual report capacity to recruit and retain specialist skills –an approximate doubling of staff is envisaged, with significant investment in debt management systems and information technology

25. Australian Office of Financial Management Important practical linkages with parent department remain: –A reporting line to the Treasurer via the Secretary to the Treasury –An Advisory Board with both Treasury and private sector representation

26. Australian Office of Financial Management Essential logic of this form of relationship with Treasury is to provide both additional resourcing and significant day-to-day operational independence, while providing absolute surety regarding: –institutional awareness of public policy issues and the Government’s risk preferences –appropriate judgements as to the public policy constraint threshold in a wide range of transacting and relationship management situations Sovereign debt management requires a blend of public policy and technical financial management skills and awareness

27. Conclusion Single most important insight to emerge from Australian experience: –define a debt management philosophy consistent with circumstances and objectives not necessarily a case of ‘one size fits all’ –answers to questions regarding appropriate organisational arrangements emerge naturally from consideration of the transactional, governance/accountability, systems and resourcing implications of sustaining that philosophical approach