The Australian Government Bond Market

28 March 2000

Peter McCray
Deputy Chief Executive Officer

The Australian Government Bond Market

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

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    (1) Market risk arises as soon as one has committed to a market position through either debt or derivatives transactions

    (2) Managing market risk is all about making explicit, informed decisions about this risk, before committing to a market position

    (3) Unlike the situation for many sophisticated financial market participants (banks and financial intermediaries), for sovereigns market risk is not optional, it can’t be hedged only managed

    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

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    (1) Market risk arises as soon as one has committed to a market position through either debt or derivatives transactions

    (2) Managing market risk is all about making explicit, informed decisions about this risk, before committing to a market position

    (3) Unlike the situation for many sophisticated financial market participants (banks and financial intermediaries), for sovereigns market risk is not optional, it can’t be hedged only managed

    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

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    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

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    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

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    Government Bond Market – Looking Back Twenty Years

  • Australia’s government bond market reflected this regulated environment:
    • fixed price ‘tap’ system for issuance
    • unclear separation between monetary policy and debt management
    • domestic investor base

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    Government Bond Market – Looking Back Twenty Years

    • ‘captive market’ arrangements
    • ‘buy and hold’ market – little secondary market activity
    • no derivatives markets

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    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

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    Development of Government Bond Market

  • ‘Operational’ reforms
    • issuer behaviour
    • primary issuance mechanism
    • captive market arrangements
    • issuer support of bond secondary market and derivatives markets

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    Development of Government Bond Market

  • ‘Infrastructure’ reforms
    • clear separation of debt management and monetary policy responsibilities
    • clearing and settlement systems
    • regulatory framework

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    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

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    Operational Reforms – Issuance Mechanism

  • A market-based issuance mechanism to replace the tap system
    • auction approach
    • ‘dealer panel’ arrangement
  • Bond auctions introduced in August 1982This image is described by preceding text

    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

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    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

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    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

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    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

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    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 marketsThis image is described by preceding text

    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

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    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)

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    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

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    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

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    Conclusion

  • A review of Australia’s experience suggests a number of strategies to promote bond marketsThis image is described by preceding text

    Conclusion

  • Issuers must act responsibly
  • Issuance arrangements need to take account of market development
  • Captive investor arrangements are not recommendedThis image is described by preceding text

    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 essentialThis image is described by preceding text

    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

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    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

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    Domestic Bonds Outstanding

    Bond Market Turnover (daily average)

    Domestic Bonds Outstanding and Bond Market Turnover (daily average)

    Turnover in Physical & Futures Markets (daily average)

    Turnover in Physical & Future Markets (daily average)

    JP Morgan Liquidity Ratio (as at 31 December 1999)

    JP Morgan Liquidity Ratio (as at 31 December 1999)

    Daily Average Turnover Versus Bonds Outstanding

    <B>Daily Average Turnover Versus Bonds Outstanding</B>

    Benchmark Bond Issues (as at 24 March 2000)

    <B>Benchmark Bond Issues (as at 24 March 2000)</B>

    Bond Auctions: Range of Accepted Bids

    <B>Bond Auctions: Range of Accepted Bids</B>

Last updated: 7 November 2013