Australian Government, the Australian Office of Financial Management

Organisational Models for Sovereign Debt Management

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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

Australian Office of Financial Management

Australian Office of Financial Management

· Rationale for establishing the AOFM

· Overseas experience in institutional arrangements for sovereign debt management

Australian Office of Financial Management

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

Australian Office of Financial Management

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

A Risk Management Framework

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

Financial Market Deregulation and Innovation

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

Financial Market Deregulation and Innovation

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

Public Sector Financial Management Reforms

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

Public Sector Financial Management Reforms

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

A Risk Management Approach to Debt Management

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

Debt Management Review

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Organisational Reform - a Framework

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

Australian Office of Financial Management

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

Australian Office of Financial Management

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

Conclusion

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