Australian Government, the Australian Office of Financial Management

AOFM Activities for 2006-07

CEO Presentation to Australian Business Economists
Sydney, Australia

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Australian Business Economists

AOFM – Activities for 2006-07

Presentation by Neil Hyden
Chief Executive Officer, AOFM

5 July 2006

Outline

  • Bond Issuance and Market Efficiency.
    – CGS Tender Arrangements.
  • Interest Rate Swaps.
    – Swap Activity 2005-06.
    – Benchmark review.
    – Swap Activity 2006-07.
    – Use of discretion.
    – Swap arrangements.
  • Communications Fund.

Bond Issuance – Objectives

  • Bond issuance is targeted to maintain the Treasury Bond and bond futures markets.
  • We issue:
    – Mid-curve bonds to support the 3-year futures contract.
    – Long-dated bonds to support the 10-year contract.
  • Each bond line is built up to around $5 billion.

Bonds on Issue
End June 2005

Bonds on Issue
July 2005 maturity

Bonds on Issue
February 2006 maturity

Bonds on Issue
2017 issuance

Bonds on Issue
2010 issuance

Bonds on Issue
2019 issuance

Bonds on Issue
End June 2006

Bonds on Issue
End December 2006

Bonds on Issue
End June 2007

Bond Market Efficiency

  • We are concerned to maintain the efficiency of the Treasury bond and bond futures markets.
    – Welcome feedback from market participants.
    – Monitor market conditions and developments.
    – Maintain close contact with RBA, AFMA and SFE.

Bond Market Efficiency

  • During 2005-06:
    – Fine two-way pricing was maintained.
    – Some instances of tightness in the repo market.
    • But not protracted or unusual.
    – Usage of Securities Lending Facility (37 times) was less than in 2004-05.
    • Mostly May 2013 or April 2015 bonds.
    • Mostly for one day.
  • Most participants report that liquidity is generally available.

Bond Market Efficiency

  • Turnover of Treasury Bonds has declined.
    – Although turnover of Treasury bond futures has increased.
  • Overall, the markets appear to be operating efficiently.

Tender Arrangements

  • We are introducing a new tender system for the issue of CGS.
    – Bloomberg Auction System.
  • Benefits include:
    – Bidders can view their bids and amend them up till close of tender
    – Plausibility limits.
    • 5 basis points from mid market.
    – Potential to further reduce the announcement window.

Tender Arrangements

  • First Treasury Bond tender using the new system is scheduled for 10 October 2006.
    – Documentation will be sent to all price makers and other current RITS members shortly.
    – Users will need to sign a new registered bidders agreement and conditions of operation.
    – Test tenders will be conducted using the new system.
    – Training will be available from Bloomberg.

Outline

  • Bond Issuance and Market Efficiency.
    – CGS Tender Arrangements.
  • Interest Rate Swaps.
    – Swap Activity 2005-06.
    – Benchmark review.
    – Swap Activity 2006-07.
    – Use of discretion.
    – Swap arrangements.
  • Communications Fund.

Interest Rate Swaps

  • We use interest rate swaps to manage the expected cost and risk of the portfolio.
  • Use a benchmark as a guide to indicate a desirable balance between cost and variability of cost (risk).
    – The benchmark has a medium term focus and is reviewed annually.

Swap Activity 2005-06

  • Last year we announced a programme of interest rate swaps for 2005-06 of:
    – around $2 billion in short-dated swaps to pay fixed; and
    – up to $1 billion in longer-dated swaps to receive fixed.
  • Subject to market conditions.

Swap Activity 2005-06

  • This indicative programme took account of the planned transfer of assets to the Future Fund.
  • This transfer:
    – acted to reduce the duration of our net debt portfolio; and
    – reduced the need for swaps to receive fixed.
  • This was a one-off effect that won’t occur again.

Swap Activity 2005-06

  • Our execution of the swap programme was affected by market conditions.
    – Executed short-dated swaps to pay fixed in the period up to end February 2006 and longer-dated swaps to receive fixed in May and June 2006.
    – Did not undertake swaps where conditions were significantly out of line with the assumptions underlying the benchmark.
  • Will talk more about market conditions and swap execution in a moment.

Swap Activity 2005-06

  • As a result:
    – Total swap activity in 2005-06 was less than planned:
    • $1.3 billion in short-dated swaps to pay fixed.
    • $0.3 billion in longer-dated swaps to receive fixed.
    – Portfolio duration remained above benchmark for most of 2005-06, although it ended the year slightly below benchmark.

Duration Profile 2005-06

Benchmark Portfolio

  • Recent annual benchmark review concluded no change to benchmark.
    – Modified Duration 2.5.
    – Short Dated Exposure 35%.

Swap Activity 2006-07

  • 2006-07 indicative programme:
    – Up to $2 billion in short-dated swaps to pay fixed (up to 3 years).
    – Between $1 billion and $3 billion in longer-dated swaps to receive fixed (at least 4 years).
    – Subject to market conditions.

Repricing Profile

Use of Discretion

  • ‘Subject to market conditions’ means we will continue to exercise discretion in undertaking swaps.
  • Execution of the programme at the upper end of the ranges would allow us to follow the benchmark closely.
  • But we will not follow the benchmark blindly at times when there is a high chance that the benchmark term premium assumption won’t be realised.

Use of Discretion

  • Our approach is tilted towards reducing absolute risk when conditions are unfavourable.
    – And against increasing risk to take advantage of favourable conditions.
  • In particular, we will be cautious about:
    – executing swaps that would increase the absolute risk of the portfolio when the expected benefits are significantly less favourable than the benchmark assumptions; and
    – executing short-dated swaps to pay fixed rates when the expected cost is significantly higher than the benchmark assumption.

Use of Discretion

  • In assessing market conditions we compare current conditions with the assumptions in the benchmark, rather than seeking to forecast movements in rates.
  • There is an important difference between identifying that something is expensive and taking a view that it will get cheaper at a later date.

Use of Discretion

  • At the beginning of the year we announce the overall scale of the swap programme and the areas of the curve where we will pay and receive fixed.
  • This prevents round-tripping:
    – We cannot pay and receive fixed at the same tenor in the same financial year.
    – Helps ensure that our activities are consistent with promoting market efficiency and are not perceived as ‘trading’.

Swap Arrangements

  • We will continue in 2006-07 to ask for prices from four counterparties when undertaking swaps.
  • Swap counterparties are rotated each tender.
    – But the successful counterparty from the previous swap tender will be included, provided it has a collateral agreement with us.

Swap Arrangements - Collateral

  • The introduction of collateral arrangements has proceeded smoothly.
  • CSAs have been signed with 17 counterparties and others are well advanced.
  • From the beginning of the 2007 calendar year a signed CSA will be an eligibility requirement to execute new swaps with the AOFM.

Outline

  • Bond Issuance and Market Efficiency.
    – CGS Tender Arrangements.
  • Interest Rate Swaps.
    – Swap Activity 2005-06.
    – Benchmark review.
    – Swap Activity 2006-07.
    – Use of discretion.
    – Swap arrangements.
  • Communications Fund.

Communications Fund

  • The Communications Fund has been established and will be used to deliver an income stream to fund Government responses to the recommendations of future reviews into regional telecommunications.
  • The AOFM was asked to manage the $2 billion fund on an interim basis, as agent for the Department of Communications, Information Technology and the Arts, using term deposits with the Reserve Bank until longer-term arrangements were decided.

Communications Fund

  • The AOFM has now been invited to manage the Fund for DCITA on a continuing basis.
  • It is proposed to invest in a portfolio of short term low risk assets, including:
    – Bank bills/NCDs.
    – Commercial paper.
  • Performance benchmark to be the UBS bank bill index.

Communications Fund

  • An investment dealing panel will be established with membership criteria:
    – Banking licence, AFMA membership and short term S&P rating of at least A1.
    – Austraclear member.
    – Significant market player.
  • Documentation available for potential members shortly.
  • The new arrangements should be fully implemented within 6 months.

Australian Business Economists

AOFM – Activities for 2006-07

Presentation by Neil Hyden
Chief Executive Officer, AOFM

5 July 2006

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