Review by the Chief Executive Officer

Context

Core to the AOFM’s responsibilities are financing the Government’s budget requirements (through debt issuance), managing its daily cash balances in the Official Public Account (OPA) and managing the Commonwealth Government Securities (CGS) portfolio. Sharply changing market conditions and appreciable shifts through the year in the financing task combined to present challenges in achieving the 2013‑14 issuance task while balancing cost and risk considerations. There were times throughout the year when the broader longer‑term objective for the portfolio of issuing longer‑dated maturities was challenged by weekly issuance judgments that needed to take account of prevailing demand for shorter-dated bonds. By year end however, there had been sufficiently consistent strong overall demand for CGS to facilitate smooth absorption of a large issuance programme ($87 billion in gross terms). Opportunities were also taken to further extend the Treasury Bond and Treasury Indexed Bond yield curves.

CGS yields rose over the early part of the year and this trend continued into the middle of the year, being most pronounced during November 2013 to January 2014. Although the United States (US) Federal Reserve had in early 2013 signalled an intention to adjust its accommodative monetary policy stance, it did not announce a wind‑down of its asset buying programme until December of that year. Speculation about the impact it would have in global bond markets led to a general market sell‑off. Yields and currency levels in emerging markets were particularly impacted around this time. As CGS yields tend to track changes in US Treasury bond yields, the increase in CGS yields during this period was consistent with global events. As had been the case the previous year, market expectations about a prolonged period of low RBA cash rates ‘anchored’ short‑dated CGS yields relative to the large rises for longer dated securities. Together, these influences resulted in a steeper yield curve. Through the second half of the financial year, bond markets ‘rallied’ in response to weak US GDP data and expectations of continued very weak economic growth across most of Europe. As a result, 10-year CGS yields were around 70 basis points lower by June 2014 compared to what had been observed in December 2013.

At the end of the financial year, CGS yields remained at historically low levels and management of the debt portfolio though the year was again progressed through extending both the length of the yield curve (this time to around 20 years) and the duration of the portfolio.

Market engagement consistently indicates that a sovereign issuer that is transparent and consistent in its operations, and uses market feedback and engagement with investors to determine its issuance pattern and market development decisions, is highly regarded by investors. The AOFM remains mindful of these operational considerations.

Issuance to support the financing task

The Government’s budget financing requirement in 2013‑14 was fully met with the issuance programme effectively having been completed around the announcement of the 2014‑15 Budget. As regular supply through weekly competitive tenders of bonds is recognised as an important feature of the AOFM’s operations, issuance was continued (at lower weekly tender volumes) until the end of the year; resulting in around $4 billion in pre‑funding for the 2014‑15 financing task.

Gross Treasury Bond issuance for the year totalled approximately $80 billion, most of which went into existing bond lines to enhance liquidity. The AOFM understands that liquidity is a core determinant of investor preferences when investing in sovereign bond markets and the CGS market enjoys a reputation for strong liquidity relative to its size (particularly amongst offshore investors). The CGS market exhibits a diversity of investor types (and a wide geographic spread of them) and has attracted strong ‘price making’ competition amongst a large number of (intermediary) banks.

In terms of market development, favourable market opportunities were used to establish three new Treasury Bond lines: October 2018 and April 2026 maturities (to support the 3-year and 10-year Treasury Bond futures contracts); and an April 2033 maturity (to extend the yield curve and establish a 20-year benchmark). The two longer maturities were launched via syndication, and both deals attracted very strong demand, with total bids received in each case substantially in excess of the volumes issued.

For Treasury Indexed Bonds, gross issuance for the year totalled approximately $7 billion. To further develop this market, a new August 2035 maturity was established to extend the length of the real yield curve (to around 20 years). In addition, a new November 2018 maturity was issued and this will provide the AOFM with additional issuance flexibility in the short end of the indexed curve.

The AOFM is committed to regular engagement with the market and once again, it took account of prevailing market conditions and information from financial market contacts about investor demand in selecting the bond lines to issue each week. Other factors of significance for issuance decisions were relative yield considerations, increasing the liquidity of outstanding bond lines, and the need to manage the maturity structure of the debt portfolio in order to maintain refinancing risks at acceptable levels.

The AOFM is aware that striking the right balance between maintaining flexibility in its issuance task and transparency in its approach, is an important contributing factor to the success of its operations. In this regard, the AOFM continued to update the market through the year with respect to changes to the issuance programme, while not revealing market sensitive decisions until an appropriate time had been determined.

Portfolio management and outcomes

The AOFM continued throughout 2013‑14 with its aim of increasing the duration of the debt portfolio.

A longer average term to maturity of new issuance was again targeted with the aim of continuing to increase the weighted average term to maturity of the portfolio as a whole. The weighted average term to maturity of the stock of nominal bonds outstanding at the end of the year was just under six years. This compares with around five years in June 2010.

The issuance of Treasury Bonds with relatively long terms to maturity in a historically low interest rate environment is a cost‑effective means of reducing risk in the portfolio by giving greater certainty around future debt servicing cost outcomes and reducing refinancing risk. With a large issuance programme, there was always the possibility that volatile market conditions would limit the proportion of the total programme that could be issued into long bonds. However, sufficient periods of favourable market conditions and steadily growing interest by investors for longer dated CGS combined to allow for the overall portfolio objective to be further progressed.

Residential mortgage-backed securities

Although the AOFM has ceased investment in new RMBS, it continues to manage the existing portfolio to maturity.

Australian RMBS market conditions continued to strengthen throughout 2013‑14. The AOFM took four opportunities to sell RMBS notes, totalling around $872 million, with the aim of supporting price discovery in the secondary market or to adjust the portfolio in line with the Treasurer’s Directions regarding the programme. These sales resulted in a gain on disposal over the amortised face value of the notes sold.

Registry services for CGS

The AOFM is now responsible for oversight of the registry services for CGS. This has involved the procurement of debt registry services to support securities exchange trading of CGS, and to replace the existing domestic debt registry service provided by the RBA. Registry services to support exchange‑traded CGS became operational during 2012‑13, while work to transition the domestic debt registry services provided by the RBA to a new service provider was successfully completed in February 2014.

Looking ahead

The 2014‑15 Budget indicated that fiscal policy settings will result in declining issuance programmes over the forward estimates period. The outlook for declining issuance will generate speculation on the part of investors as to what the outright size of the CGS market will be once a return to Budget surpluses has been achieved. An important part of the AOFM’s engagement with investors is to reinforce policy undertakings by successive governments to support liquidity in the CGS market.

The CGS market has undergone a marked transformation in a relatively short period of time. Growing interest in CGS has supported the AOFM’s objective of issuing longer dated maturities and gradually extending the yield curve. We understand that this also assists broader financial market development for Australia.

The AOFM remains mindful of the need to consider further sustainable market developments, for both the Treasury Bond and Treasury Indexed Bond markets, and an important step will be to consolidate the 20-year Treasury Bond benchmark. Issuing new maturities in support of the 3-year and 10-year futures market contracts remains a priority, as does the need to monitor liquidity and how that may be affected by the outstanding size of individual bond lines. We will also continue to assess the prospect of further successfully extending the nominal and indexed bond yield curves and will be monitoring domestic and offshore interest for longer CGS duration to assist in making this judgement.

There is unlikely to be significant new central bank and sovereign wealth fund demand for CGS in the near term because around 75 per cent of the world’s 30 largest institutions, from this group, now participate in the CGS market. While new institutions periodically commence investing in the market, they are now usually small to medium sized reserve managers and so their impact on demand, while positive, is not large. However, a steadily growing interest from fund managers continues. Our investor engagement efforts are taking this into account and we remain aware of the need to meet with new and potential new investors in order to support the objective of increasing the diversity of the CGS investor base.

Rob Nicholl
Chief Executive Officer

Last updated: 31 October 2014