Organisational Models for Sovereign Debt Management

1 November 1999

Peter McCray
Australian Office of Financial Management

Organisational Models for Sovereign Debt Management

Australian Office of Financial Management

· 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

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Australian Office of Financial Management

· Rationale for establishing the AOFM

· Overseas experience in institutional arrangements for sovereign debt management

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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Last updated: 7 November 2013