Summary of Comments – Debt Strategy 2005/06 Consultations
In October 2004, officials from the Department of Finance and the Bank of Canada sought views from Government Securities Distributors and institutional investors on a number of issues related to the design and operation of the domestic debt programs. The consultations served as input to the development of the 2005/06 debt strategy and were in keeping with the government's ongoing commitment to consult with market participants. The debt strategy consultations focused on the strategic direction of the domestic debt programs in order to maintain a well-functioning market for Government of Canada securities. The consultations also addressed operational improvements to current debt programs. This document provides a summary of the views received during these consultations.
Market participants recognized that the government faces certain challenges in maintaining well-functioning markets in the context of lower borrowing requirements and the move towards a lower fixed-rate share of the government debt. They were in favour of maintaining the buyback programs to help support gross bond issuance. Participants were provided with a list of potential measures that could be employed by the government over the medium term in the event that buyback operations proved insufficient to maintain gross issuance. Most participants were of the view that a slight decrease in auction and benchmark sizes could be implemented if gross bond issuance needed to be reduced. Almost all dealers emphasized the importance of maintaining liquidity in the medium-term part of the curve. Some market participants suggested changing the maturity and coupon payment dates to a June/December cycle for the 5-year maturity to maintain issuance in other sectors.
Bond and Buyback Programs
In general, market participants were of the view that the Government of Canada securities market is functioning well. Participants recognized the challenges faced by the government in supporting liquidity and the well-functioning operation of the domestic fixed-income market in the context of lower borrowing requirements and the strategic decision to lower the fixed-rate share of the debt.
In this regard, the bond buyback program has played a critical role in maintaining gross issuance of Government of Canada bonds in recent years. While a number of modest adjustments to help improve the operation of the program can be made, most participants indicated that there is uncertainty as to whether the program can continue to be effective in the future.
Views from market participants varied with respect to the adjustments that should be made to the bond program if gross bond issuance needs to be reduced in the future. In general, market participants stressed the importance of maintaining large benchmarks and the current issuance cycles, but suggested that there may be some scope for modest reductions in issuance and benchmark sizes. They indicated that it is difficult to measure the impact of reduced issuance on market liquidity and that it is not possible to determine the minimum issuance levels required for the market to continue to function well.
The maintenance of liquidity in the medium-term part of the curve is regarded as very important to a large number of market participants, since these sectors support markets for swaps and futures and are used as international benchmarks. Market participants had mixed views on the importance of other maturity sectors.
If issuance is reduced slightly for a particular maturity, some participants stated that they would prefer quarterly auctions with smaller amounts, while others would prefer less-frequent auctions with larger amounts.
Other alternatives for maintaining bond issuance emerged from the consultations. One suggestion was that the maturity and the coupon cycle be switched from March/September to June/December for new 5-year benchmarks, in order to allow for a reduction in the issuance size of 5-year bonds when they would become fungible with existing old benchmarks. The possibility of using an interest rate swap program to maintain gross issuance and benchmark sizes was also raised by a number of dealers and investors. However, there was a wide variety of views as to the possible size of a potential swap program and its impact on the market.
Dealers and institutional investors who provided comments on the transparency of the market indicated that, in general, price transparency on Government of Canada securities is now satisfactory for institutional investors. There was a recognition that price transparency needs to be improved for corporate bonds and for retail investors, but wholesale market participants did not offer any specific suggestions for improvements on these fronts. A number of participants were concerned about how higher levels of transparency on trade volumes would affect market liquidity.
Treasury Bill and Cash-Management Bill Programs
The increase in the outstanding amount of treasury bills, resulting from the gradual reduction in the fixed-rate share of the debt, has been well received by the majority of market participants. They were comfortable with the additional issuance of treasury bills because of lower issuance in alternative money market instruments such as bankers' acceptances. According to dealers, moving treasury bill auctions from 12:30 p.m. to 10:30 a.m. has increased participation, especially from international investors.
For cash-management bills (CMBs), dealers generally preferred a minimum issue size of $1 billion, with a maximum of $2 billion. The removal of the maximum bidding limits on non-fungible CMBs raised some concerns on the potential concentration of holdings of non-fungible CMBs, which could hurt the liquidity of these issues. However, Policy No. 5 of the Investment Dealers Association of Canada, which sets out a code of conduct for trading in domestic debt markets, is seen as helping to ensure that the CMB market continues to function effectively.
When asked to explain why the adoption of a more current benchmark for the 30-year maturity had been slower than in other maturity sectors, market participants suggested that the 30-year swap market is far less active than the 2-, 5-, and 10-year sectors and indicated that the need to have a current benchmark for the pricing and hedging of 30-year swaps is not as critical.
Market participants indicated that demand for Real Return Bonds remains strong. If the issuance amount does not change, some dealers suggested increasing the auction sizes near coupon payment dates (June and December) and reducing them in the other quarters.
Holding bond and buyback auctions earlier in the day, especially if it is the same day as a U.S. auction, was considered the most important operational improvement that could be made to the buyback programs. Reduction in the time between the auction deadline and the deadline for buybacks also received broad support.
Since dealers participate in cash buybacks primarily to manage inventory risks, they indicated a preference to keep cash buyback operations after the bond auction. The idea of additional cash-buyback operations was proposed by some market participants. These could be held (if deemed necessary) in order to maintain gross issuance.
To maintain the liquidity of off-the-run benchmark bonds, dealers indicated that they would prefer no reduction in the floor of $6 billion for bonds eligible for buybacks. However, most dealers recognized the potential need to reduce the floor to maintain gross issuance. Dealers had mixed views as to whether a decrease in the floor (if one was introduced) should apply across all maturities or be limited to maturities of less than 10 years.
As a means of maintaining the vitality of the buyback program, the inclusion of the most recent off-the-run benchmarks received the support of market participants, but a number of them suggested taking into account the potential impact on the basket of deliverable bonds for the 2-year and the 10-year futures contracts.
The idea of conducting cash-management bond-buyback operations with only one security (the next bond to mature) in order to help reduce required cash balance peaks shortly before coupon payments was also brought forward and discussed with a number of market participants during the consultations.
Participants were complimentary about the recent progress in lowering turnaround time for the publication of auction and buyback results, noting that this has reduced market risk significantly. The consensus was that further reductions in turnaround time would be beneficial, but should be managed to take account of operational risk to the government and to participants.
A number of U.S.-based investors mentioned that allowing for block trading in futures markets would improve the efficiency and the attractiveness of the Canadian fixed-income market.