Preface and Introduction
The government's debt distribution framework encompasses the auction rules and surveillance of participants in the primary market for Government of Canada securities.
The current distribution framework follows from the review of the framework conducted in 1996-98. The framework is outlined in the Terms of Participation in Auctions for Government Securities Distributors and Terms of Participation in Auctions for Customers. Additional information is also available in the Standard Terms for Auctions of various Government of Canada securities.
This review is being undertaken as part of the government's regular review of its debt management policies and programs to ensure that the framework continues to function effectively over a medium-term horizon.
The purpose of the government's debt strategy is to raise stable, low cost funding to meet its financial requirements. To achieve this objective, the government pursues a number of strategic objectives: maintaining a prudent debt structure; maintaining a well-functioning market for Government of Canada securities; and maintaining a diversified investor base.
The debt distribution framework is the method by which the government distributes or issues its debt securities to market participants, including securities dealers and investors. The debt distribution framework is designed to ensure that the government can sell its securities on a reliable basis at the best price. It is also designed to support the well-functioning operation of the government securities market by promoting participation of dealers and investors.
A well-functioning government securities market benefits the broader Canadian fixed-income market by providing a range of credit risk-free assets to investors and intermediaries, which serve as effective pricing benchmarks and hedging tools. In this regard, the market for Government securities should be active, competitive, and accessible by interested parties.
The government's debt distribution framework has evolved over the years. An important change was the gradual move from syndicated issuance of its securities to auctions. Syndicated issuance involved the sale of securities, at negotiated prices including a fee, to a group of underwriting dealers who then redistributed the securities to their client investors. Issuance through auctions involves the sale of securities at multiple prices bid by dealers and investors participating in the auction, without payment of any fees. Dealers earn revenues from direct access to securities that supports trading activity with their client investors.
The move towards multiple-price auctions began with the issuance of two-year bonds in 1983, followed by a gradual expansion to other maturities, with the last syndicated offering for regular coupon-bearing bonds taking place in December 1991 for 30-year bonds. 1 The move to auctions by the government for the issuance of securities denominated in its domestic currency was in line with the evolution of practices of other major sovereign countries.
Another important change to the government's debt distribution framework came in 1998 when the government introduced modifications to the framework designed to enhance the reliability of funding through auctions and to encourage participation by reducing the potential for manipulative behaviour prior to and during the auction. To achieve these two objectives, participants at auctions were classified in three main categories (Government Securities Distributors (GSDs); a subgroup of GSDs defined as Primary Dealers (PDs); and customers), each with defined terms and conditions for participation.
The reliability of access to funding for the government was improved by enhancing the rules for dealers. Prior to the modifications to the framework, there were no formal obligations for large market participants to participate at each auction and the government faced the risk of holding an "uncovered" auction in which it could not sell all of the securities it offered to meet its financial obligations. Another risk faced by the government was that bids at auctions could significantly differ from the fair market price of securities. Changes to the framework granted PDs a higher level of access to government securities at auctions but also gave them the formal responsibility of bidding at each auction for minimum amounts and at reasonable price levels. To promote more diverse participation and active bidding, customers were granted the ability to submit bids through all GSDs.
The 1998 modifications sought to enhance participation by ensuring that the auction process would not result in undue concentration of securities or unfair competitive advantage for any particular market participants. The following conditions were put in place to reduce the potential for manipulative trading behaviour surrounding the auctions. All GSDs and customers are required to report their net positions in the auctioned security prior to participating at auctions. To prevent undue concentration of holdings following an auction, maximum bidding limits were changed for GSDs and customers to take account of each participant's pre-auction holdings in the auctioned security.
A further modification was made to support the secondary market for government securities. GSDs are now expected to support secondary-market trading, as distributors' bidding limits at auctions are tiered in line with both their performance in auctions and their trading activity in secondary markets. GSDs are also required to support the integrity of the secondary-market by providing the Bank of Canada with information on fixed-income prices and trading.
Balance of Interests
In designing a framework for the distribution of Government of Canada securities, the government seeks to balance a number of interests:
- the government's interest in ensuring that auctions are consistently covered and well bid, which is the product of active participation by a diverse group of participants;
- large dealers' interest in substantial direct access to securities to support trading businesses and a desire to be aware of client trading activity and investment flows;
- small dealers' interest in access to auctions to allow them to support and develop their businesses and a desire to be aware of client trading activity and investment flows; and
- customers' interest in access to government securities at reasonable prices.
The balance of interests is reflected in the design of the current framework. Broad participation is encouraged by allowing market intermediaries (i.e., GSDs) and customers to bid at auctions. Distributors enjoy a privileged status at auctions by virtue of the fact that customer orders must be submitted through distributors. As a result of knowledge of customer orders, distributors gain market information that can help them in making more informed bids at auctions. Customers submitting orders through distributors are assured access to the auctioned securities and at the prices they bid. Customers may use as many distributors as they choose to submit bids. Customers receive indirect assured access, but must divulge their investment activities to the dealer(s) submitting their bids. Primary dealers are awarded higher bidding limits relative to other GSDs on the basis of their performance in auctions and their trading activity in secondary markets. With the higher bidding limits come mandated bidding obligations for PDs, to ensure the success of auctions from one auction to the next.
Review of the Framework
The debt distribution framework in recent years has broadly met its goals (see below). Treasury bill and bond auctions have been consistently well bid, with good auction coverage (i.e., total bids received comfortably exceeding auction sizes) and competitive bidding in terms of prices offered for securities (see Debt Management Report 2002/03).
The goals of the debt distribution framework are to support an:
Effective auction and intermediation processes promote the government's debt strategy objective of stable, low-cost funding and a well-functioning market for its securities.
More broadly, a well-functioning and competitive Government of Canada securities marketplace is maintained to support the borrowing and investment activity of a wide range of participants in the domestic capital market.
The review is being undertaken to seek the views of interested parties on the current and future effectiveness of the framework.
The next section describes trends of note. Given the potentially significant impact of these trends and the fact that the framework has not been reviewed since 1998, this review is considered to be warranted and timely. The final section of the paper discusses, at a thematic level, potential adjustments to the debt distribution framework. Interested parties are encouraged to comment on these potential adjustments and to identify any other changes that may enhance the distribution of Government of Canada securities and the functioning of the domestic fixed-income market.