In November 2007, officials from the Department of Finance and the Bank of Canada sought views from government securities distributors, institutional investors, and other interested parties on the design and operation of the Government of Canada domestic debt program for the fiscal year 2008/09 and beyond. This year's debt strategy consultations focused on measures that could be taken to allow the government to pursue its strategic debt-management objectives, in a declining debt environment, while promoting the efficient functioning of the domestic market for government securities. Views were also requested on the functioning and liquidity of Government of Canada domestic debt and related fixed-income markets in light of recent turbulence in the financial markets.

The consultations served as input to the development of the 2008/09 debt strategy and were in keeping with the government's ongoing commitment to consult with market participants. This document provides a summary of the views received during these consultations.

In Brief

Overall, market participants indicated that the market for Government of Canada securities continues to function well, despite recent turbulence in the financial markets, and the continuing decline in federal borrowing needs.

A clear majority felt the government should maintain issuance in the four benchmark nominal bonds and the 30-year Real Return Bond (RRB). Maintaining ample issuance in the 10-year sector was viewed as critical to assuring a well-functioning government bond market. Strong demand for long-term assets was again highlighted by institutional investors, while the 5-year sector and, to a slightly lesser extent, the 2-year sector, continued to be viewed as the maturities where issuance could be reduced further if required.

As in last year's consultations, market participants mentioned that the bond buyback program and the use of fungible bonds contribute to a well-functioning Government of Canada securities market.

The consolidation of the domestic borrowings of three Crown corporations into the government's domestic debt program was viewed as a positive development for the government securities market.

Most participants indicated that the market could accommodate some variation in issuance in the annual bond program relative to that announced in the annual Debt Management Strategy. Market participants were also supportive of the government's proposal to vary the bond auction sequence from one quarter to the next for treasury management reasons, as long as, in setting the overall program and making any changes, the government maintains transparency and regularity.

Market Conditions

Market participants mentioned that the market for Government of Canada securities continues to function well, including during the challenging and turbulent conditions experienced in global credit markets since last summer.

Participants said that the recent volatility had increased the demand for Government of Canada securities because of their risk-free status and their importance in the pricing of other fixed-income securities. However, it was reported that the bid/ask spreads and yield volatility on government securities had increased, and that trading activity for certain government bonds and futures had decreased. Specifically, participants mentioned that liquidity has been most affected in short-term treasury bills.

In this environment, participants noted some decline in electronic trading activity, with clients having an increased preference to transact directly over the telephone for larger trades, although most also noted that electronic trading continues to be used fairly actively and remains competitive.

Despite increased market volatility in the secondary markets, all participants thought that the auction process continued to work very well during this period, and auctions of Government of Canada securities continued to be strongly supported.

Bond Program

Market participants strongly favoured maintaining issuance in the four benchmark nominal bonds and in 30-year RRBs. Most indicated that additional flexibility in the bond program could be obtained, with limited impact on the market, by either reducing the size or even eliminating a 5-year auction or a 2-year benchmark. Overall, participants expressed a slight preference to first reduce or eliminate a 5-year auction. Several participants also mentioned that the supply of other fixed-income products in the sectors should be taken into account in making any decision.

A clear majority of participants expressed the view that the federal debt strategy should continue to support the 10-year bond sector, which was considered critical to assuring a viable bond market. They noted that increased volumes in the 10-year Canada Government Bond (CGB) interest rate futures contract in recent years had enhanced liquidity in the 10-year sector and in the Government of Canada securities market more generally.

Market participants indicated that the increase in long-term bond issuance in 2007/08 was well received, particularly by institutional clients with long duration mandates. Some participants mentioned that current market conditions had affected the short-term demand for RRBs, although the underlying demand has remained strong.

The planned consolidation of the domestic borrowings of the Business Development Bank of Canada, Farm Credit Canada, and the non-CMB issuance of the Canada Mortgage and Housing Corporation, was viewed as a positive development for the government securities market. Most participants supported the proposed approach to include borrowings on behalf of these Crown corporations as part of the government's bond program. With respect to uncertainty related to the amount and term of Crown corporation borrowings, most participants indicated that the market could accommodate some variation in issuance in the bond program relative to the plan announced in the annual Debt Management Strategy.

Bond Buybacks

Most participants viewed the bond buyback program as an important feature of the Government of Canada borrowing program, as it supports gross issuance in a declining debt environment, and provides additional liquidity to the market around the time of bond auctions. Nevertheless, participants acknowledged that the size of the buyback program is constrained by the amount of bonds available for the government to repurchase, given that the majority of remaining existing issues are relatively liquid and in demand by investors.

Most participants were in agreement with the suggested improvements to the design of the buyback program. These included: lowering the bound for bonds eligible for 2-year bond buybacks from 18 months to 12 months; adding a bond fungible with a new benchmark to the list of securities that can be repurchased at switch operations; and widening the range of bonds targeted at each operation in the various maturity sectors.

Short-Term Program

Participants indicated that the uncertain and volatile environment during and prior to the consultations had heightened the demand for treasury bills and that this appetite for short-term, high-quality paper would probably persist going forward.

Participants' views were mixed with regards to the addition of a 1-month treasury bill. Although many thought that 1-month bills would be a low-cost source of funding for the government, several suggested that fungible and non-fungible cash-management bills provided more flexibility and would do a better job of meeting the government's cash-management needs than 1-month treasury bills.

Participants thought that the market would be able to absorb more variability in terms of both the treasury bill auction tranche allocation and the individual auction sizes, as long as reasonable advance notice was provided.

Adjustments to the Bond Auction Schedule

Market participants were mostly supportive of the proposal to allow flexibility to rebalance the bond auction schedule intra- and inter-quarter to facilitate cash-management requirements, with any changes to be communicated either through the Debt Management Strategy or the Quarterly Bond Schedule.

The proposal to change the schedule of 30-year bond auctions, from the second and fourth quarter of each fiscal year to the first and third quarter, received support. Participants generally preferred three 30-year auctions as opposed to one during the transitional calendar year, in light of the continued strong structural demand for long-duration assets. A majority of participants also recommended conducting 30-year nominal auctions close to the dates of large coupon payments and maintaining RRB auctions close to these dates.

There was a range of views on the optimal timing for bond auctions, with market participants supporting times between late morning and midday. Participants noted that the government should be mindful of a number of factors, including the timing of important economic and statistical releases as well as corporate and provincial issuance, should it be decided to change the timing of bond auctions.