20 November 2008
Unwind of Interest Rate Swaps
Operational Notice No 5/2008 of 22 July 2008 indicated that the AOFM did not plan to undertake new interest rate swaps in 2008-09 and that swaps on its books would be allowed to mature without replacement. It also indicated that existing swap positions may be unwound if market conditions permit.
The AOFM is now looking to unwind up to $4 billion of interest rate swaps over the remainder of 2008-09. This will reduce the exposure of its swap portfolio to fluctuations in market value and reduce its credit exposure.
The AOFM will invite counterparties to negotiate terms for selected swaps and will terminate the swaps where agreement is reached. Unwinds will generally be conducted at a rate of one or two per week, subject to operational convenience.
The AOFM undertook interest rates swaps in managing its portfolio between 1997 and 2007. Over this period, the swaps generated direct savings of around $2 billion to the Australian Government. The savings resulted from there being a positive term premium between the market interest rates on longer and shorter term debt. However this term premium has declined over recent years and in the 2008 annual review of its portfolio, the AOFM decided to stop executing new swaps.
The AOFM's existing interest rate swaps have a notional principal value of $20.65 billion. Of these, $3.175 billion are due to mature before end June 2009. With the unwinds now envisaged, the notional principal value of the swaps remaining at the end of June is likely to be below $14 billion.
The AOFM's swap portfolio currently has a positive market value. Reflecting this, the termination of swaps is likely to generate a small net positive flow of funds to the Government.