Summer 2003 Consultation Document

Overview

The purpose of these consultations is to obtain the views of market participants on issues relating to the design and operation of the government Real Return Bond (RRB) program. The government will seek input from Primary Dealers, Government Securities Distributors, institutional investors, and other interested parties.

Although the summer consultations will focus on the RRB program, participants are welcome to provide feedback on other programs at this time. However, as it does every year during the fall/winter consultations, the government will seek views from market participants on a wide range of topics related to Government of Canada borrowing programs.

Context

The Government of Canada began issuing RRBs in December 1991. The ultimate goal of the program is consistent with the government's overall debt strategy of raising stable, low-cost funding. At the inception of the program, the government outlined a number of objectives for the RRB program:

  1. Cost-effectiveness compared with other sources of funds
  2. Diversification of the marketable bond program for the government
  3. Broader selection of instruments provided to investors and diversification of the investor base
  4. Secondary Market development
  5. Anti-inflationary stance signal to the market
  6. Indicator of real return and long-term inflation expectations

The government performs regular evaluations of major areas and initiatives in the domain of debt management. As part of this, the government is conducting a review of the value of the RRB program in light of the evolution of the macroeconomic environment, the new debt structure target, and the market demand for inflation-indexed securities. Considerations for this evaluation include expected market demand and the achievement of the above-listed objectives. The results of these consultations will be assessed in the context of the government's broader debt strategy.

To complement the questionnaire below, the Department of Finance and the Bank of Canada are publishing a joint work that highlights preliminary analysis on the past and potential future cost-effectiveness of RRBs compared with nominal bonds as well as the performance of RRBs in the primary and secondary markets. Market participants are encouraged to consider the Real Return Bond Funding Review while answering the following questions.

Real return bond program

Demand for RRBs

The demand for RRBs has been variable since they were first introduced but has been solid over the past couple of years or so as compared to other fixed-income asset classes. The first set of questions focuses on the current demand for RRBs.

  1. How do you explain the recent increase in the demand for RRBs? Is the demand currently motivated by strategic reasons (structural portfolio shifts) and/or tactical reasons (short-term views or other factors)?
  2. Why are RRB yields typically higher than the real interest rates that are implied by removing expected inflation rates from nominal bond yields?

The second set of questions is primarily aimed at the buy-side clients (investors, money managers, plan sponsors, etc) although other market participants are welcome to respond to questions they deem relevant.

  1. What is the primary reason for holding RRBs? Do you hold RRBs for the purpose of liability-matching requirements, improving your portfolio's risk/return profile, or trading purposes?
  2. Are you required to hold RRBs in your portfolio? Do you view RRBs as a core holding of your portfolio? Please explain.
  3. Do you have allocation limits for the holding of RRBs? Are benchmark limits a constraint?
  4. Have the reasons for holding RRBs changed with the development of the RRB market? If so, why?
  5. Do you consider RRBs as a separate asset class? How do you measure performance of RRBs?

The next set of questions focuses on the potential demand for RRBs looking forward.

  1. What are your future potential portfolio needs for inflation-indexed securities?
  2. What factors can you foresee determining the aggregate demand for inflation-indexed securities going forward?
  3. If RRBs are a core holding for liability-matching purposes, do you plan to eventually sell RRBs closer to maturity in order to buy a longer-dated maturity?
  4. Do you hold, or do you plan to hold inflation-linked securities issued by other sovereign issuers? If so, what factors dictated your decision to buy other sovereign inflation-linked securities (opportunistic, liability-matching purposes, hedging, currency diversification)?
  5. Have you bought or would you buy inflation-linked issues of a Canadian province or corporation? Why? How important is credit risk in your decision-making process with respect to inflation-indexed bonds?
  6. What type of asset would you buy as a substitute if RRBs weren't available?

RRB Market Conditions

Primary Market

  1. Do you have any suggestions that you would like to share regarding Canada's approach to primary markets for RRBs? What is your view on the format of the auction process for RRBs?
  2. If there are new RRB issues, would you prefer that the coupon be set in advance, as is currently the case, or that the coupon be set during the allotment process, as is the case for nominal bonds?
  3. Are there features that you would like the Government of Canada to consider in the design of RRBs to improve the merits of holding and trading RRBs?

Secondary market

  1. Do you feel that the level of liquidity of RRBs in the secondary market is sufficient for your specific needs?
  2. Do you find that liquidity has improved over the past few years?
  3. Do you have any suggestions to improve liquidity in the secondary market?