Part 2: Operations and Performance
- 1 Introduction
- 2 Treasury Bond and Treasury Indexed Bond issuance
- 3 Cash management
- 4 Minimising debt servicing costs subject to acceptable risk
- 5 Residential mortgage‑backed securities
- 6 Investor relations
- 7 Public Register of Government Borrowing
- 8 Information technology operations
- 9 Enterprise risk
- 10 Assurance
- 11 Settlement operations
- 12 Agency financial performance
- 13 Cooperation with other debt managers
The principal functions of the AOFM are:
- issuance of Commonwealth Government Securities (CGS) to support the Government’s financing task (including maturing debt) and in accordance with broader Government policy objectives (such as promoting liquidity);
- managing the Government’s daily cash balances through borrowings and investments;
- undertaking investments in financial assets according to policy directives, or as part of broader portfolio management;
- developing risk assessments that support the effective cost management of the debt and asset portfolios; and
- where appropriate, supporting the efficient operation of the Australian financial system through its debt issuance choices.
This section outlines the activities undertaken in 2013‑14 and reports on AOFM performance against these functions.
Treasury Bond and Treasury Indexed Bond issuance
One objective of Treasury Bond and Treasury Indexed Bond issuance is to raise monies to fund the Australian Government Budget.
Another objective is to support the efficient ongoing operation of Australia’s financial system. This second objective is achieved in the following ways:
- Treasury Bonds, Treasury Indexed Bonds and Treasury Bond futures are used by financial market participants as benchmarks for the pricing of other capital market instruments and to manage interest rate risk; and
- the existence of active and efficient physical and futures markets for sovereign debt strengthens the robustness of the financial system and reduces its vulnerability to shocks.
Achieving the objective
The 2013‑14 debt issuance programme was successfully completed in the context of continued strong investor demand for CGS. The length of the yield curve was extended to around 20 years, and liquidity was built in several new and existing lines.
In August 2013, the Reserve Bank of Australia (RBA) reduced the target cash rate to a record low 2.50 per cent. Over the course of 2013‑14, CGS yields ended the year relatively unchanged; however, there was significant variation in yields within the year. In the first half of 2013‑14, CGS yields moved higher, and the yield curve steepened, in line with United States (US) Treasury yields in the lead up to the announcement by the US Federal Reserve of its ‘tapering’ programme of quantitative easing — which it commenced in December 2013. US Treasury yields subsequently fell in January due largely to the expectation that the terminal Fed funds rate may be lower than anticipated. While in Europe, financial markets expected the European Central Bank to maintain rates at record low levels for longer amid low inflation and growth forecasts.
The higher yields on Australian bonds relative to other similarly rated sovereign bonds were attractive to offshore investors, especially in the second half of 2013‑14. The strong offshore demand for CGS resulted in the 10‑year spread to US Treasury yields contracting sharply to near seven‑year lows in June 2014.
Non‑resident holdings were on average around 70 per cent of the total CGS outstanding during 2013‑14. The proportion of CGS held by offshore investors has been relatively steady during recent years, as illustrated in Chart 1.
Gross Treasury Bond issuance for the year totalled approximately $80 billion. The bulk of issuance was into existing bond lines in order to enhance their liquidity and in turn, the attractiveness of the CGS market. This was particularly important to international investors. In addition, three new Treasury Bond lines were launched in 2013‑14:
- a new bond line with a maturity date in April 2026 was opened in order to support the operation of 10‑year Treasury Bond futures contracts;
- a new bond line with a maturity date in October 2018 was opened in order to support the operation of 3‑year Treasury Bond futures contracts and to assist in reducing the amount outstanding in future years in surrounding bond lines, which will make it easier to manage maturity of those bonds; and
- a new April 2033 bond line was issued to increase the length of the yield curve to around 20 years.
In selecting the bond lines to issue each week, the AOFM took account of prevailing market conditions; information from financial market contacts about investor demand; relative value considerations; the aim of increasing the liquidity of outstanding bond lines; and the need to manage the maturity structure to limit refinancing risk. Two tenders were held most weeks, typically comprising a tender of a long‑dated bond line and a tender of a short‑dated bond line, with the amount being offered at each tender in the range between $600 million to $1.5 billion.
Chart 2 shows the Treasury Bonds outstanding as at 30 June 2014 and issuance during the 2013‑14 financial year.
During the year, the total volume of Treasury Bonds outstanding increased by around $57 billion, to $290 billion. At the end of the year, there were 15 Treasury Bond lines with over $10 billion on issue.
Treasury Indexed Bonds
Gross Treasury Indexed Bond issuance for the year totalled $7.29 billion.
Tenders for the issue of Treasury Indexed Bonds were conducted twice a month, in most months. The volume of each line outstanding, relative yields and other prevailing market conditions were all considered in the selection of which line to offer. Following consultation with indexed bond market participants, tenders for the issue of Treasury Indexed Bonds were held on a multiple price basis rather than a single price basis from July 2013.
There was one syndicated offer of a new Treasury Indexed Bond maturing in August 2035, which extended the length of the real yield curve. In addition, a new Treasury Indexed Bond maturing in November 2018 was issued by tender. The new bond provides the AOFM with additional issuance flexibility in the short end of the curve and supports market development.
Holders of the August 2015 Treasury Indexed Bond were given the opportunity to convert their holdings in that bond to the November 2018 bond. The conversion offer revealed investor support for the new 2018 maturity and was well subscribed, with $2,039 million face value of the August 2015 bond converted to the November 2018 bond. The conversion offer allowed the new 2018 bond line to be quickly built up to a liquid size and for investors to exit the 2015 bond, which due to its short remaining period to maturity is of limited use as an inflation hedge.
Chart 3 shows seven Treasury Indexed Bond lines and amounts outstanding as at 30 June 2014, together with issuance during the 2013‑14 financial year.
Domestic debt registry services
In 2012‑13, debt registry services were procured to support the securities exchange trading of CGS and to replace the domestic debt registry service provided by the RBA. Work to transition the domestic debt registry service to the new service provider was completed in February 2014.
Commonwealth Government Security Buyback Facility
The RBA closed the small investor bond facility in May 2013. From February 2014, small investors were able to sell their holdings of CGS back to the Australian Government via the Commonwealth Government Security Buyback Facility (Buyback Facility). The Buyback Facility is operated by Computershare Investor Services Pty Limited under a contract managed by the AOFM on behalf of the Australian Government.
Funding the Budget
The Government’s budget financing requirement in 2013‑14 was fully met, together with around $4 billion in pre‑funding for 2014‑15.
The budget underlying cash deficit for 2013‑14 was higher than estimated at the time of the 2013‑14 Australian Government Budget due to lower than forecast taxation revenue and increased spending, which included a grant payment of $8.8 billion to the RBA to increase the RBA’s capital reserve. The larger than expected budget financing task was managed primarily by increasing Treasury Bond issuance.
Market liquidity and efficiency
The Treasury Bond and Treasury Indexed Bond markets operated smoothly throughout 2013‑14 with liquidity again being maintained throughout the year.
Financial market liquidity has a range of interpretations, however one indicator of liquidity is turnover in the secondary market. Charts 4 and 5 show the evolution of total secondary market turnover from 1997‑98 through to 2013-14. Turnover has steadily increased since 2008-09 and was around $1,050 billion per annum in 2013‑14 for Treasury Bonds (5 per cent higher turnover than in 2012‑13) and $55 billion per annum for Treasury Indexed Bonds (21 per cent higher than in 2012‑13). Strong liquidity is attractive to investors and reflects favourably on a sovereign bond market.
Turnover in the Treasury Bond futures market is significantly higher than in the underlying Treasury Bonds. The 3‑year Treasury Bond futures contract is amongst the 10 most traded interest rate futures products in the world.1 Treasury Bond futures continued to display strong liquidity in 2013‑14 with the turnover of 3‑year Treasury Bond futures contracts increasing by 1 per cent over the previous year and turnover of the 10‑year contracts increasing by 20 per cent. Turnover in recent years is illustrated in Chart 6. All Treasury Bond futures contract close‑outs in 2013‑14 occurred smoothly.
The AOFM’s securities lending facility allows market participants to borrow Treasury Bonds and Treasury Indexed Bonds for short periods when they are not otherwise available. This enhances the efficiency of the market by improving the capacity of intermediaries to make two‑way prices and reducing the risk of settlement failures and supporting market liquidity.
Continued settled market conditions during the year resulted in a relatively low usage of the securities lending facility. The facility was used 18 times for overnight borrowing in 2013‑14 compared with 14 times during 2012‑13 and 66 times during 2011‑12. The face value amount lent in 2013-14 was approximately $135 million compared with $225 million in 2012‑13.
Efficiency of issuance
The AOFM used competitive tender, syndication and a conversion offer as the means by which issuance of CGS was undertaken in 2013‑14. The use of competitive tenders remains the mainstay of the AOFM’s issuance operations.
Tenders held during 2013‑14 were well supported. Table 1 summarises the results of Treasury Bond tenders conducted during the year. The results are shown as averages for each half‑year and grouped by the maturity dates of the bonds offered.
|Period||Maturity||Face value amount allocated ($m)||Weighted average issue yield (%)||Average spread to secondary market yield (basis points)||Average times covered|
|July – December 2013||Up to 2019||17,100||2.9707||-0.56||4.12|
|2020 – 2033||18,700||4.0420||-0.01||3.04|
|January – June 2014||Up to 2019||14,400||3.1501||-0.64||4.48|
|2020 – 2033||16,900||4.0324||-0.38||3.84|
The average ratio of the volume of bids received to the amount of stock on offer was 3.82 for Treasury Bonds in 2013‑14, a slight decrease from 3.99 in 2012‑13. The average tender size in 2013‑14 of $780 million was higher than previous years due to the large issuance programme. Shorter‑dated bond tenders generally received a greater volume of bids.
The strength of bidding at tenders was reflected in issue yield spreads to the secondary market. At most Treasury Bond tenders, the weighted average issue yields obtained were below prevailing secondary market yields.
The average ratio of the volume of bids received to the amount of stock on offer was 4.56 for Treasury Indexed Bonds in 2013‑14, an increase from 3.43 in 2012‑13. At most tenders, the weighted average issue yields were below prevailing secondary market yields.
Full tender details are available in Part 5 of this annual report.
The AOFM manages the daily cash balances of the Australian Government in the Official Public Account (OPA).2 The AOFM’s primary objective in managing these balances is to ensure that the Government is able to meet its financial obligations as and when they fall due. Other objectives are to minimise the cost of funding the daily cash balances and to invest excess cash balances efficiently. In minimising cost, the AOFM seeks to avoid any use of the overdraft facility provided by the RBA.3
Achieving the objective
Achieving the cash management objective involves undertaking appropriate short‑term investments and debt issuance.
Cash balances not required immediately were invested in term deposits at the RBA, with the magnitudes and tenors of the term deposits determined by the AOFM. Maturity dates of term deposits were selected to efficiently finance large outlays. Interest rates for term deposits at the RBA reflect the rates earned by the RBA in its open market operations.
Treasury Notes are issued to assist with management of the within‑year funding requirement. The volume of Treasury Notes on issue ranged from zero to $10 billion during 2013‑14.
The size and volatility of the within‑year funding requirement are indicated by changes in the short‑term financial asset holdings managed by the AOFM, after deducting Treasury Notes on issue. Chart 7 shows movement in the funding requirement in 2013‑14.
The objective of meeting the Government’s financial obligations as and when they fall due was met, with the overdraft facility provided by the RBA accessed only twice in 2013‑14 (in September 2013 and June 2014, with the facility cleared the next business day).
During 2013‑14, the AOFM placed 304 term deposits with the RBA. The stock of term deposits fluctuated according to a range of factors influencing the AOFM’s cash portfolio management needs and decisions. Term deposits ranged from a minimum of $6.5 billion in July 2013 to a maximum of $46.1 billion in June 2014.
The average yield obtained on term deposits during 2013‑14 was 2.53 per cent, compared with 3.11 per cent in 2012‑13. The decrease in average yield reflects the lower average level of interest rates that prevailed during 2013‑14.
A total of $19.5 billion of Treasury Notes were issued in 2013‑14 (in face value terms). The tenders were well supported with an average coverage ratio of 3.85. Yields averaged around 19 basis points less than bank bill yields of corresponding maturities (compared to 14 basis points less than bank bill yields in 2012‑13). Yields were on average around three basis points lower than Overnight Indexed Swap rates for corresponding tenors. Details are available in Part 5 of this annual report.
The movement in total short‑term financial asset holdings managed by the AOFM (OPA cash balance plus term deposits with the RBA), together with the volume of Treasury Notes on issue, during 2013‑14 are shown in Chart 8.
In undertaking its cash management activities, the AOFM was required to maintain the 91‑day moving average of the daily OPA cash balance within operational limits. In 2013‑14, these limits were the same as applied in recent years, with operational upper and lower limits of $1,000 million and $500 million respectively. There is also a Ministerially approved upper limit of $1.5 billion.
The 91‑day moving average OPA cash balance was maintained within operational limits, and within the Ministerial limit, throughout the year.
Movements in the 91‑day rolling average OPA cash balance over the year are shown in Chart 9.
Minimising debt servicing costs subject to acceptable risk
In managing the Commonwealth’s debt portfolio, the AOFM seeks to minimise debt servicing costs over the medium term at an acceptable level of risk, by which is meant an acceptable level of variability in debt servicing cost outcomes. As debt servicing costs have an impact on the Budget, a greater degree of confidence in estimated cost outcomes is taken to be preferred over alternative outcomes. The AOFM also seeks to maintain liquid bond lines to facilitate the issuance of debt at acceptable cost and to manage the refinancing risk that arises when bond lines mature, while also managing the impact of its issuance on the CGS market.
In order to meet its objective, the AOFM uses cost and risk measures that appropriately reflect the costs and risks faced by a sovereign debt manager. The primary cost measure used is historic accrual debt service cost. This includes interest payments made on CGS, realised market value gains and losses, capital indexation of indexed debt and the amortisation of any issuance premiums and discounts. Total accrual debt service cost can be expressed as a percentage of the stock of debt outstanding to provide the effective yield of the portfolio. This measure of cost is the most appropriate in circumstances where financial assets and liabilities are intended to be held or, in the AOFM’s case, to remain on issue until maturity. The use of an historic accrual debt service cost measure excludes unrealised market value gains and losses.
An alternative measure of cost is ‘fair value’, which takes account of unrealised gains and losses resulting from movements in the market value of physical debt and assets. Debt service cost outcomes are presented in the AOFM’s financial statements on this basis. A comprehensive income format is used that allows revenues and expenses on an historic basis to be distinguished from the effects of unrealised market value fluctuations, that is ‘re‑measurements’.Fair value is useful in circumstances where it is possible that changes in market value may be realised in the future.
Variability in cost outcomes, or risk, can be measured in several ways. The AOFM calculates and compares several metrics to assess risk. In general, an acceptable level of risk can be characterised as an acceptable level of variation in cost outcomes over time. Debt issuance decisions made today have an impact on the variability of future cost outcomes because of their influence on the maturity profile of the portfolio, and hence the amount of debt that needs to be refinanced and therefore ‘re‑priced’ through time.
Achieving the objective
The AOFM influences the cost and risk profile of the portfolio primarily through its decision making on the composition and maturity structure of the debt securities it issues. These decisions are framed through an annual debt issuance strategy approved by the Treasurer, which identifies the overall scale of the issuance task and its breakdown into different instrument classes. Within these broad strategy parameters, the AOFM separately determines issuance weightings (specified as a range) applicable to different segments of the yield curve. Operational issuance decisions such as determining if, when, how much and what lines to issue each week, are made by the AOFM over the course of the year and are influenced by a range of factors including general market conditions, relative value considerations and feedback from market intermediaries. It is the AOFM’s standard practice to regularly test the ongoing suitability of its overarching strategy with the AOFM Advisory Board, which is chaired by the Secretary to the Treasury. Strategic decision‑making regarding the portfolio is supported by an ongoing research programme focused on exploring the cost and risk characteristics of alternative portfolio structures and issuance strategies. Informed by this research and related judgments, the AOFM continued to lengthen the nominal debt portfolio in 2013‑14.
Chart 10 shows that the AOFM’s issuance of Treasury Bonds undertaken in 2013‑14 had an average term to maturity of 8.59 years and a funding cost of 3.69 per cent. This had the effect of simultaneously lengthening duration and average term to maturity while lowering the effective cost of funds on the Treasury Bond portfolio as a whole. All else being equal, longer‑dated issuance reduces uncertainty in future funding costs, however, this will typically come at a higher cost than short‑dated issuance.
Chart 11 shows how both duration and average term to maturity of the Treasury Bond portfolio increased throughout 2013‑14 by 0.3 years to 5.98 years and 4.93 years respectively. Meanwhile, the average yield on new issuance lowered the effective cost of funds on the Treasury Bond portfolio from 4.41 to 4.19 per cent. This outcome was influenced by several factors, not least the continuing favourable funding environment with low outright yields and strong investor demand for CGS.
By lengthening issuance in a low interest rate environment, the AOFM has been able to cost‑effectively reduce the inherent risk levels of the portfolio. That is to say, the AOFM now has greater certainty around future debt servicing cost outcomes (because funding has been locked in over a longer time horizon), while future gross borrowing programmes will be generally smaller as less issuance will need to be allocated to refinancing maturing debt. Chart 12 demonstrates the progressive decline in refinancing risk in terms of the proportion of the Treasury Bond portfolio maturing within 3‑ and 5‑year windows.
A key component of the AOFM’s lengthening strategy in 2013‑14 was the launch of the new April 2033 bond line. The new line represented the third consecutive year where the AOFM has extended the yield curve, as shown in Chart 13. Notably, the issuance of the 2033 bond line established a new 20‑year benchmark for the nominal CGS curve. The AOFM will maintain this benchmark and intends to adopt a pattern of issuing slightly beyond 20 years in order to allow time for successive bond lines to roll in before being replaced. The creation of a 20‑year benchmark and the resulting pattern of maturities across the curve will reduce the need to separately maintain a 15‑year benchmark.
The AOFM’s alternative long‑term funding instruments to Treasury Bonds are Treasury Indexed Bonds. Indexed bonds, with a capital value adjusted periodically with changes in the Consumer Price Index, typically attract a different class of investor to nominal bonds and are a source of diversification in the AOFM’s funding base. The AOFM re‑commenced issuance of indexed bonds in 2009‑10 following an extended period of absence from this segment of the market. It has issued regularly in the period since. Indexed bonds now comprise around 9 per cent of the long-term funding base. While the indexed portfolio has been relatively stable as a share of total debt, in absolute terms the stock of indexed bonds has been growing steadily (as shown in Chart 14).
Chart 14 shows that the average term to maturity of Indexed Bonds is currently around 9.5 years, which is broadly in line with the average across the last five financial years (since the AOFM re‑entered the market). There were two significant events during the year: the extension of the curve with a new 2035 indexed bond line, and an offer for investors to convert existing 2015 holdings into the newly issued 2018 bond line. There was a strong take‑up of the conversion offer, with around $2 billion face value of 2015 indexed bonds being converted into holdings of 2018 indexed bonds. This has reduced the refinancing task for the 2015 bond line to just over $1 billion in face value terms.
Reducing debt servicing cost at an acceptable level of risk
The debt servicing cost4 of gross debt managed by the AOFM in 2013‑14 was $13.58 billion. This represented a cost of funds of 4.42 per cent for the financial year. Table 2 provides further details of the cost outcomes for the combined portfolio by instrument and portfolio for 2012‑13 and 2013‑14.
The debt servicing cost of gross debt increased in dollar terms by $1.36 billion compared to the previous year. This was due to an increase in the average volume of debt on issue from $266.65 billion in 2012‑13 to $307.28 billion in 2013‑14. In percentage terms however, the funding cost of gross debt declined by 16 basis points (4.58 per cent to 4.42 per cent) during 2013‑14. This improvement was principally driven by the issuance of new bonds through the year at yields that were below the average of pre‑existing (and maturing) debt. Lower rates also reduced the yield on funds invested in term deposits from 3.11 to 2.53 per cent and RMBS investments from 4.62 to 4.15 per cent.
The return on gross assets for the period was just over $1 billion, an increase of $214 million compared to 2012‑13. The interest income from RMBS actually declined as the portfolio matured and sales were made. Income from state housing advances normalised in 2013‑14 after declining sharply last year due to a Government decision to waive $320 million in state housing advances.5
The net servicing cost of the combined portfolio of debt and assets was $12.53 billion. This was higher in dollar terms compared to 2012‑13, due to the volume of debt on issue being higher over the course of the year. The 2013‑14 net servicing cost represents 4.59 per cent of the combined debt and asset portfolio. This was an improvement on the 2012‑13 result of 4.79 per cent, which confirms that significant cost savings were achieved during 2013‑14 by taking advantage of the low interest rate environment. The reduced servicing cost in percentage terms was complemented by an increase in asset returns, in particular the earnings on state housing advances returning to normal levels.
The difference between the return on gross and net CGS debt narrowed to 17 basis points in 2013‑14 from 21 basis points in 2012‑13. This was despite higher average term deposit holdings and lower returns through the year, which would normally have increased the gap. The fact that it has narrowed can be primarily attributed to the impact of the 2012‑13 waiver of a component of the state housing advance balances, which inflated the gap in that year.
|Interest expense||Book volume||Effective yield|
|Contribution by instrument|
|Treasury fixed coupon bonds||(10,570)||(11,811)||(228,365)||(274,666)||4.63||4.30|
|Treasury inflation indexed bonds||(1,174)||(1,650)||(22,872)||(27,661)||5.13||5.97|
|Foreign loans (a)||(1)||(0)||(5)||(6)||18.44||6.89|
|Gross physical CGS debt||(12,225)||(13,583)||(266,654)||(307,275)||4.58||4.42|
|Term deposits with the RBA||500||608||16,060||23,996||3.11||2.53|
|Investments in bank paper||–||–||–||–||0.00||0.00|
|Term investments (c)||–||–||–||–||0.00||0.00|
|State Housing Advances||(135)||128||2,532||2,455||-5.32||5.20|
|Net CGS debt||(11,383)||(12,527)||(237,717)||(273,094)||4.79||4.59|
|Contribution by portfolio|
|Long-Term Debt Portfolio||(11,745)||(13,462)||(251,243)||(302,332)||4.67||4.45|
|Cash Management Portfolio||19||486||649||19,054||2.89||2.55|
|Housing Advances Portfolio||(135)||128||2,532||2,455||-5.32||5.20|
|Total debt and assets||(11,383)||(12,527)||(237,717)||(273,094)||4.79||4.59|
|Total after re-measurements||285||(16,198)||(237,717)||(273,094)|
Note: Sub totals and totals are actual sum results, rounded to the nearest million dollars. Effective yields are based on actual results before rounding, rounded to two decimal places. Book volume is a through the year average.
(a) Interest expense and effective yield on foreign loans incorporates foreign exchange revaluation effects.
(b) Re‑measurements refer to unrealised gains and losses from changes in the market valuation of financial assets and liabilities.
Movements in market interest rates increased the market value of the portfolio in 2013‑14. As a result, unrealised losses from re‑measurements amounted to $3.67 billion. This compares to a gain of $11.67 billion in the previous year. The re‑measurement loss was primarily driven by a $2.99 billion increase in the market value of Treasury Bonds, which constitute the vast majority of the portfolio. As the bond prices driving these re‑measurements move in opposite directions to bond yields, it can be seen that the same favourable, low interest rate environment that prevailed through 2013‑14 was also the driver of this negative re‑measurement impact.
As re‑measurement items are highly volatile from one year to the next, they have no bearing on the AOFM’s debt issuance strategy. Indeed were the AOFM to adopt a strategy designed to minimise the ‘noise’ from re‑measurements, issuance would be limited to only very short‑term debt securities, for example Treasury Notes, creating a portfolio structure that would maximise expected variability in debt servicing costs when measured in cash, accrual and public debt interest terms while also maximising exposure to refinancing risk. In practice, the AOFM has been seeking to reduce refinancing risk by allocating a greater proportion of issuance to long dated lines. In 2013‑14, over half of all new issuance was allocated to maturities underpinning the 10‑year Treasury Bond futures contract or longer maturities.
Residential mortgage‑backed securities
The Australian residential mortgage‑backed securities (RMBS) market is acknowledged as a critical source of funding for smaller mortgage lenders. The global financial crisis that started in 2007‑08 reduced the availability of funding through the Australian RMBS market, which limited mortgage lenders’ access to funding.
During the period October 2008 to April 2013, the AOFM was directed to invest up to $20 billion in eligible RMBS.
On 10 April 2013, the Treasurer directed the AOFM to cease investment in new RMBS, but the Direction continued to allow the AOFM to consider sale opportunities. The AOFM has since been managing the existing portfolio to maturity and has sold RMBS to assist with price discovery or to adjust the portfolio in line with the Directions.6
Achieving the objective
The Australian RMBS market continued to strengthen throughout 2013‑14 following on from the relatively buoyant conditions of 2012‑13. Prime RMBS issuance for the year reached the highest volumes since 2008 and, as further indication of strong investor demand, several transactions were oversubscribed and up‑sized. Other positives included relatively strong offshore demand and tightening margins. Consistent with the Treasurer’s Directions issued in April 2013, the AOFM continued to manage the existing portfolio and undertook periodic sales to assist with price discovery and/or to adjust the portfolio in line with Directions. Sales undertaken in 2013‑14 are summarised in the following table.
|TRANCHE||AMORTISED FV ($m)||CLEAN VALUE ($m)||GAIN ($m)|
|IDOL 2011-1 A1||99.71||100.51||0.80|
|IDOL 2012-1 A1||75.80||77.14||1.34|
|APOLLO 2011-1 AB||61.08||63.00||1.92|
|APOLLO 2012-1 AB||16.50||17.50||1.00|
|CONQUEST 2010-2 AB||4.97||4.99||0.02|
|FIRSTMAC 1-2009 AB||40.50||40.62||0.12|
|FIRSTMAC 1-2010 AB||21.36||21.58||0.22|
|HBS 2011-1 AB||17.87||18.06||0.18|
|PINNACLE 2010-1 AB||10.63||10.74||0.11|
|PROGRESS 2010-1 AB||26.94||27.15||0.20|
|PROGRESS 2012-1 AB||29.33||30.78||1.45|
|RESIMAC 2009-2 AB||9.11||9.15||0.04|
|RESIMAC 2011-1 AB||9.05||9.08||0.03|
|TORRENS 2010-3 AB||14.07||14.15||0.07|
|TORRENS 2011-1 AB||27.37||27.50||0.13|
|WIDE BAY 2009-1AB||0.74||0.74||0.00|
|WIDE BAY 2010-1 AB||21.81||22.08||0.27|
|CHALLENGER 2009-1 AB||13.73||13.74||0.01|
|LIBERTY 2010-1 AB||10.38||10.40||0.02|
|FIRSTMAC 2-2011 AB||11.16||11.70||0.54|
|FIRSTMAC 1-2012 AB||12.61||13.40||0.79|
|PINNACLE 2010-1 A2||74.75||75.50||0.75|
|GBS 4 A1||37.00||37.40||0.40|
|LIGHT TRUST 3 A3||176.38||178.00||1.62|
|BARTON 2011-1 A2||49.54||50.10||0.56|
Note: Clean Value provides a measure of market value, adjusting for any accrued interest that has yet to be paid.
In February and March 2014, the AOFM divested the entirety of its mezzanine or AB note holdings, which made up slightly more than five per cent of the overall portfolio, or $359 million, in amortised face value terms. Due to the relatively high coupon margins on some of these notes, and the improvement in valuations for this type of note in particular, the AOFM booked a gain on disposal of around 1.99 per cent of the amortised face value of the notes sold. In June 2014, further improvements in market conditions enabled the AOFM to divest a cross section of RMBS from the credit union and building society sector, with weighted average lives between 2.0 years and 4.2 years. In this case, the sale of around $338 million of notes was sold to produce a gain on disposal of around 0.98 per cent of their amortised face value.
In summary, conditions in 2013‑14 allowed the AOFM to sell a total of around $872 million in RMBS notes, with a gain on disposal of around $12.6 million, or 1.44 per cent of the amortised face value of the notes sold. This compares with sales between March 2010 and the end of 2012‑13, in which the AOFM sold a total of around $629 million worth of notes, in amortised face value terms, with an associated gain on disposal of $5.3 million, or 0.84 per cent of the value of the notes sold.
Due to both sales and capital amortisation, the book value of the portfolio reduced in size from $9.1 billion to $6.0 billion over the course of the financial year. Furthermore, the average margin over the one month bank bill rate (weighted by each of the AOFM’s investments) for the book outstanding as at 30 June 2014 fell by six basis points over the financial year to 127 basis points, due largely to the divestment of all remaining higher yielding mezzanine notes.
Interest income in 2013‑14 was $308.4 million. In addition, sales through the year contributed a further $12.6 million in incremental income. Total accrual income of $321.0 million represented an annualised return of 4.15 per cent on the portfolio’s average book value of $7.7 billion.
Losses or gains in the mark‑to‑market value of the portfolio change with prevailing conditions and therefore vary at any particular point in time. These are not realised returns and so are excluded from the accrual returns, but are included as re‑measurements within the AOFM’s comprehensive accounting treatment.
The RMBS securities held by the AOFM are valued using indicative ‘bid’ margins for secondary market trading as estimated by an independent valuation service provider. The RMBS portfolio was valued at $6.1 billion as at 30 June 2014. The cumulative unrealised gain on the portfolio was $32 million as at the end of the financial year, an improvement of around $15 million over the year before.7 Thus, the total return on the RMBS portfolio for 2013‑14, including re‑measurements, was around $336 million, or around 4.35 per cent of the portfolio’s average book value.
Further information on the AOFM’s investments in RMBS up to 30 June 2014 is available in Part 5 of this annual report.
The AOFM investor relations activities contribute to meeting the budget financing task in a cost effective manner by focusing on growth and diversification of demand for CGS.
This involves informing and updating new and existing institutional investors about the Australian economy, the CGS market and the AOFM’s issuance activities. The strategy also focuses on managing the relationships with existing long term investors as well concentrating on potential or new investors, thus encouraging further diversity in the investor base.
A diverse investor base can benefit the CGS market through added liquidity from trading supporting issuance and achieving a lower cost of borrowing through a higher and more stable aggregate demand. The CGS market continues to attract a wide range of investors from across different geographies, sectors and investment policies.
The AOFM continued to maintain an understanding of investors’ mandates, strategies and perceptions regarding the CGS market through market engagement. Engagement with investors was achieved via a range of regular activities such as one‑on‑one meetings, presentations and through group forums (typically ‘roundtable’ events). These activities are summarised in Table 5.
|Conferences, speaking engagements and investor roadshows||15 events.|
|Approximate total audience size: Large Presentations||400 attendees.|
|Individual meetings||124 investor meetings.|
|Hosted roundtable/small presentations||3 presentations with 27 investors.|
|Individual cities visited||27 cities.|
|Two AOFM staff members travel on each overseas trip||CEO, Head of Investor Relations, Director of Financial Risk,
Head of Portfolio Strategy and Research,
Senior Analyst from Investor Relations, Senior Dealer from Treasury Services.
|Hosting banks: Investor roadshows||ANZ, Barclays, Citi, Commonwealth Bank of Australia, Deutsche Bank,
JP Morgan, Royal Bank of Canada, UBS, Westpac.
|Hosting banks at Australian Government Fixed Income Forum, Tokyo||ANZ, Citi, Commonwealth Bank of Australia, Daiwa Securities, Deutsche Bank,
JP Morgan, Nomura, UBS, Westpac.
Consistent with past years, the AOFM visited a range of centres of international financial importance, meeting with investors familiar to the AOFM as well as new and potential investors. Opportunities to present or speak at investor conferences continued to prove an efficient means of updating the market.
In 2013‑14, the AOFM undertook more investor related visits and presentations than the previous year, holding around 20 per cent more meetings. Overall, this resulted in the AOFM holding 124 face to face meetings through the year (with 34 of these as ‘first time’ investor engagements), 26 more than in 2012‑13. The regions visited were throughout Europe, the US and Asia. Table 6 provides a timeline of the investor engagement activities undertaken during the year.
|September 2013||South East Asia: 18 investor meetings.|
|October 2013||Paris: OECD Sovereign Debt Managers Conference, 1 luncheon presentation to 12 attendees.
United Kingdom/France/Luxembourg: 13 investor meetings.
|November 2013||North Asia: 23 investor meetings.
Sydney: CBA Fixed Income Conference, 1 presentation to 80 attendees, participated in the Kanga News Round Table.
China: 4 investor meetings.
|December 2013||Tokyo: Australian Government Fixed Income Forum, 1 presentation to 53 attendees.
Sydney: 1 investor meeting.
|February 2014||Sydney: Westpac Inflation Linked Roundtable with 9 attendees.
Hong Kong: Official Monetary and Financial Institutions Forum Conference, 1 paper given, 2 investor meetings.
Paris: OECD Sovereign Debt Managers Conference.
Middle East stopover: 1 investor meeting.
Sydney: ANZ Central Bank and Sovereign Wealth Fund Conference, 1 presentation to 100 attendees, 4 investor meetings.
|March 2014||Canberra: Deutsche Bank Investor Mission, 1 presentation to 30 attendees.|
|March/April 2014||Northern/Eastern Europe: 17 investor meetings.|
|May 2014||North America: 26 investor meetings.|
|June 2014||Sydney: Australian Business Economists luncheon, CEO speech to 100 attendees.
Sydney/Melbourne/Brisbane: 15 investor meetings.
A new activity undertaken by the AOFM this year was to hold the Australian Government Fixed Income Forum (Forum) in Tokyo. The event was hosted by the AOFM at the Australian Embassy in December 2013, and included presentations from the state government issuers of New South Wales, Victoria, Queensland and Western Australia. Tokyo represents the single largest concentration of investors in the CGS market.
The Forum was opened by the Australian Ambassador to Japan, and proceeded with presentations by the AOFM’s CEO, the CEOs of the larger state borrowing authorities and senior officials from the Treasury and the RBA. In arranging the event, the AOFM was supported (logistically) by nine banks that also attended. Based on a survey held on completion of the Forum and on feedback received in the following days, the investors rated the Forum very highly.
Public Register of Government Borrowing
The Guarantee of State and Territory Borrowing Appropriation Act 2009 requires the AOFM to publish a register recording the beneficial ownership, by country, of all CGS and any Australian State or Territory government securities guaranteed by the Commonwealth.
The Act does not contain any mechanisms to compel the provision of information to the AOFM by the beneficial owners of these securities or persons holding these securities on their behalf. Nominee and custodial services firms have not provided information to the AOFM due to their fiduciary and contractual obligations to clients. Many investors wish for their holdings to remain confidential for commercial reasons.
This situation limits the information available to the AOFM to form an opinion on the extent of beneficial ownership of the securities. Without detail on the country of beneficial ownership, information on the holdings of nominee/custodial firms alone provides a very limited indicator of ‘offshore’ CGS ownership.
During 2013‑14, the AOFM published the register each quarter and following the latest update, the register contains monthly data up to 30 June 2014. The register indicates that around $335.2 billion of CGS, together with State and Territory securities guaranteed by the Commonwealth, were on issue at year end. Country of ownership could be identified for $103.1 billion or 30.8 per cent, of which $55.5 billion was identified as Australian and $47.6 billion was recorded as held offshore. Country of beneficial ownership could not be identified for around $232.1 billion or 69.2 per cent. Most of this unidentified component was held by nominee/custodial firms.
The Australian Bureau of Statistics (ABS) also collects and publishes information on the holdings of securities. The legal powers provided to the Australian Statistician enable the ABS to obtain information from nominee/custodial firms on security holdings; however, there are also set confidentiality requirements that can constrain how and to what extent the ABS publishes such information at the country specific level.
The quarterly ABS publication 5302.0 Balance of Payments and International Investment Position, Australia indicates that 68.0 per cent of Commonwealth Government Securities were held by non‑residents as at June 2014.8
The annual ABS publication 5352.0 International Investment Position, Australia provides information on the country of domicile for portfolio investment in debt securities. This information covers a broader range of debt securities, issued in Australia and overseas, than that covered by the AOFM register (that is, State and Territory securities not guaranteed by the Commonwealth, as well as debt securities issued by financial intermediaries such as banks and those issued by companies).
The publication estimates that there was $969.6 billion of this foreign portfolio investment in debt securities at 31 December 2013. The survey indicated the country of investor domicile breakdown as: the United States, $264.2 billion; United Kingdom, $175.2 billion; Japan, $45.2 billion; Hong Kong, $18.2 billion; Switzerland, $14.1 billion; Singapore, $12.8 billion; Luxembourg, $11.9 billion; Netherlands, $3.9 billion; Germany, $2.9 billion; Belgium, $2.6 billion; France, $2.5 billion; New Zealand, $2.4 billion; Thailand, $1.1 billion; Bermuda, $0.4 billion; Saudi Arabia, $0.3 billion; South Africa, $0.1 billion and China, $0.1 billion. The remainder of holdings were attributed to international bond markets, were unspecified, or were not published for confidentiality reasons.
Information technology operations
The AOFM upgraded its server and switching infrastructure both at its primary and disaster recovery sites during 2013‑14. The replacement of this equipment provides the AOFM with improved functionality, additional bandwidth and greater resilience to the core network. The upgrade of this equipment will provide a reliable and resilient platform for growth.
The AOFM’s Enterprise Risk Management (ERM) framework enables the AOFM to consolidate, evaluate, prioritise and monitor risks from an organisational perspective, and to provide relevant and timely information to the CEO, Executive Group and the Audit Committee in support of their governance and decision‑making roles.
Enterprise risks encompass the AOFM’s strategic, portfolio and operational risks.
- Strategic risks are managed by the Executive Group and impact on the AOFM’s medium to long term strategies.
- Portfolio risks involved in debt issuance, investment and portfolio management are managed pursuant to the AOFM’s Financial Risk Management Framework.
- Operational risks relate to business‑as‑usual activities of the AOFM, and generally arise when opportunities or failures present in relation to internal processes, people, systems, or from external events.
The AOFM manages risks subject to its risk appetite, and cognisant of its business context. The AOFM maintains a culture of prudence and awareness, together with high ethical standards, which are reinforced by regular in‑house training and adherence to the Australian Public Service Code of Conduct and the Australian Financial Markets Association (AFMA) Code of Conduct.
Responsibility for the design, implementation and maintenance of risk and assurance activities resides with the Enterprise Risk and Assurance Group. It maintains the AOFM’s ERM framework and supports the business in understanding and implementing the framework.
Key enterprise risk activities undertaken in 2013‑14 included:
- review and implementation of annual and quarterly enterprise risk assessment processes;
- further integrating the ERM framework into business processes across the AOFM; and
- reviewing the AOFM’s risk appetite against the risks identified in its risk register.
The ERM framework is complemented by assurance activities (refer below), which together support the CEO in meeting his obligations to maintain a sound system of risk management and internal control.
The AOFM’s compliance with external obligations and internal controls and procedures is monitored internally, and these activities are complemented by the use of internal audit services.
Key assurance activities undertaken in 2013‑14 included:
- auditing the control effectiveness of: contract management; debt issuance, confirmation and settlement processes; human resources (operational and payroll); the registry services associated with retail exchange trading of CGS (post‑implementation); and the domestic debt registry service formerly provided by the RBA;
- internal assurance reviews of the control effectiveness over authorisations, procedures and systems involved in the CGS tender processes (deal capture, settlement and reporting); and change management processes relevant to maintaining the AOFM’s treasury system;
- an external review of AOFM compliance with the Government’s Protective Security Policy Framework;
- preparation of the annual Certificate of Compliance to test the AOFM’s compliance with the financial management framework under the Financial Management and Accountability Act 1997 (FMA Act);
- implementation of an annual compliance assurance plan, with monthly reporting provided to the Executive Group and quarterly reporting provided to the Audit Committee;
- enhancement of the Assurance framework (discussed below); and
- coordinating the transition from the arrangements and delegations under the FMA Act to the Public Governance, Performance and Accountability Act 2013.
In July 2013, the AOFM commenced a project to develop and implement an Assurance framework. The Assurance framework seeks to provide assurance in regard to the effective and/or efficient operation of the governance arrangements, risk management and/or control environment of the AOFM. Critical to achieving this is the ability of the framework to provide timely and relevant information to key stakeholders and risk owners to enable them to have confidence in the design and operation of the controls implemented to manage risk.
The Assurance framework is aligned with the ERM framework to facilitate a risk‑based approach to assurance activities, and to assist the CEO in meeting his risk management and internal control obligations. The framework has been modelled on better practice, whilst being scaled to meet the needs of the AOFM. The concept for the Assurance framework was endorsed by the Audit Committee in June 2014, with final approval and implementation to occur in the first quarter of 2014‑15.
The AOFM is a low transaction volume, high transaction value environment. In 2013‑14, it settled around $55.6 billion of payments of interest and principal on CGS, around $676 billion in financial asset acquisitions (including term deposits with the RBA) and repurchased prior to maturity over $5.1 billion of CGS. The AOFM also ensures that all administered receipts are settled promptly and correctly by its transaction counterparties.
In 2013‑14, the AOFM settled all payment obligations on time for its debt and investment management activities. The AOFM did not need to seek compensation from counterparties because of a failure to settle payment obligations in line with their contractual obligations.
In February 2014, the AOFM assumed the roles of settlement and paying agent for CGS in Austraclear. These roles had been previously performed by the RBA on behalf of the AOFM. However, the AOFM and the RBA have an agreement where settlement activities in Austraclear will be performed by the RBA in the event that the AOFM is unable to do so. The Stand‑in agreement also covers activities in Austraclear relating to the purchase and sale of assets.
Agency financial performance
The AOFM recorded an operating surplus on agency activities of $1.60 million for the 2013‑14 financial year, comprising total revenue of $12.36 million and expenses of $10.76 million. The surplus in 2013‑14 was largely due to lower than anticipated operating costs.
As at 30 June 2014, the AOFM was in a sound net worth and liquidity position, reporting net assets of $25.75 million, represented by assets of $28.12 million and liabilities of $2.37 million.
As at 30 June 2014, the AOFM had unspent appropriations totalling $25.57 million of which $0.10 million was held in cash. Unspent appropriations are available to settle liabilities as and when they fall due and for future asset replacements and improvements.
Cooperation with other debt managers
In 2013‑14, the AOFM continued to support the debt management activities of the Papua New Guinea and the Solomon Islands governments. One staff member is seconded to each of these countries to help develop cash and debt management capabilities. In August 2013, debt management officials from the three countries met in Honiara to discuss their experience with debt management over the year and their progress in capacity development.
In May 2014, a senior official from the AOFM met with officials responsible for sovereign debt management from the Canadian Department of Finance and the Bank of Canada in Ottawa.
The sharing of information and perspectives with other sovereign debt managers has contributed positively to the AOFM’s knowledge and in particular, has enhanced the AOFM’s portfolio research programme.
- Source: Australian Securities Exchange. ↩
- The Official Public Account is the collective term for the Core Bank Accounts maintained at the RBA for Australian Government cash balance management. ↩
- The overdraft facility is more costly than equivalent short‑term borrowing (for example, issuance of Treasury Notes). The terms of the facility provide that it is to cover only temporary shortfalls of cash and is to be used infrequently and, in general, only to cover unexpected events. ↩
- Debt servicing cost includes net interest expenses (measured on an accruals basis and includes realised gains and losses on the disposal of assets or liabilities) plus foreign exchange revaluation gains and losses (now minimal). Unrealised changes in the market valuation of domestic debt and assets are not part of this measure. ↩
- State housing advances are loans that reside in the AOFM’s administered balance sheet. The waiver of this debt generated a realised loss in 2012‑13, equivalent to the book value of the loans at disposal, of $284 million. See 2012‑13 AOFM Annual Report, page 27. ↩
- Full details of each Direction are available on the AOFM website, http://aofm.gov.au. ↩
- Were the AOFM to use ‘mid’ rates for valuation purposes, the cumulative unrealised gain would be expected to be around $40 million to $45 million higher. When sales have been undertaken, they have typically been achieved at levels that are better than mid‑market, from the AOFM’s perspective. ↩
- Note this does not cover Commonwealth guaranteed securities issued by the State and Territory governments under the Act. ↩
Last updated: 31 October 2014