Asia Risk 15: Philip Combes, New Zealand Treasury

The New Zealand Debt Management Office (NZDMO) has managed both assets and liabilities on behalf of the New Zealand government. Here, deputy secretary to the New Zealand Treasury and head of the NZDMO, Philip Combes, explains how a prudent approach to risk can lead to rewards for taxpayers and society

philip-combes-nztreasury

For much of the first decade of this century, the New Zealand Debt Management Office (NZDMO) looked after both the New Zealand government’s debt and asset management operations in a steady state environment, running an annual bond issuance programme of around NZ$2.5 billion ($1.8 billion) and bond outstandings of approximately NZ$20 billion.

Our philosophy was to maintain the issuance programme – even though the government had been running surpluses for well over a decade and had no need to borrow – to promote market liquidity and maintain a government bond yield curve. The proceeds of the borrowing were held in cash reserves and other liquid financial assets to provide value-added returns to the Crown. During 2007–08, the total value-added for the financial year amounted to NZ$68 million.

Prior to the escalation of the global financial crisis in September 2008, the NZDMO was managing reserves of around NZ$10 billion and fiscal surpluses were forecast to continue into the foreseeable future. This state of affairs turned around abruptly as the crisis unfolded and the newly-elected government’s Budget update in December that year, in common with the books of most other countries, foreshadowed a rapidly deteriorating fiscal situation

By the time of the Budget in May 2009, instead of facing a ‘voluntary’ bond programme of a modest NZ$2.5 billion, we found ourselves staring down the barrel of NZ$6.5 billion, something the New Zealand market had not had to contemplate, much less digest, for more than 15 years. Moreover, we had to face up to the prospect of total issuance of NZ$50 billion during the next four years.

Such a major and unprecedented turnaround demanded a major and unprecedented change in strategy. A five-point plan was developed during 2009 to facilitate substantially higher borrowing programmes during the next four years.

Five-point plan

1. Increase tender frequency. With effect from the January 15, 2009 tender, we moved from fortnightly to weekly bond tenders. This initiative was part of a strategy to better align bond supply with investor demand.

2. Improve market consultation. During 2009, we increased the resources devoted to consulting with market participants and analysing feedback from those consultations. Discussions are now held on a weekly basis with all participants in bond and bill tenders, enabling us to vary the size of weekly tenders in line with market demand.

3. Change tender timing. We moved to a 2pm tender closing time (from 12pm). This measure was designed to encourage greater tender participation from investors in the Asian time zone. Investor feedback indicates that this objective is being achieved.

4. Pre-fund the government’s borrowing requirement. Given the very difficult funding conditions in early 2009, a key part of our debt management strategy was to borrow ahead of the government’s cash requirement. As a result, the 2008–09 bond programme was raised from NZ$4.5 billion to NZ$5.5 billion in May 2009 and the 2009–10 programme was revised up twice from NZ$8.5 billion to NZ$12.5 billion.

5. Develop an international marketing campaign. With most sovereign borrowers now competing aggressively for international investors, another key part of our debt management strategy was to market the ‘New Zealand story’ directly to investors in major financial centres. During 2009 this involved NZDMO participation in two investor missions by the Minister of Finance covering Asia, the US and UK. Numerous other trips were made by NZDMO staff to international investor events, often working alongside the Australians to promote interest in Australasian bonds.

Another useful initiative was to increase the size of individual lines to cope with the twin demands of increasing issuance and investor demand for liquidity. As a result, tranche sizes for New Zealand government bonds have risen from NZ$2.5 billion (prior to the global financial crisis) to NZ$8 billion currently.

A major element of the new debt management strategy revolves around pre-funding. Our approach is to press ahead with funding while market conditions are favourable.

Pre-funding deficits is expected to save money for New Zealand taxpayers for several reasons:

  • the recent cost of borrowing has been historically low, particularly for short-to-medium bond maturities;
  • borrowing costs are likely to increase in future years as a result of the significant volume of global sovereign debt to be raised; and
  • there may be further pressure on borrowing costs arising from the current focus on some European governments’ credit risk.

For all of these reasons, the cost to taxpayers of servicing New Zealand’s stock of government debt is likely to be lower if more bonds are issued now (under relatively favourable market conditions).

Pre-funding has also enabled us to build up a substantial stock of liquid financial assets. For example, Chart X shows a significant increase in average cash holdings over the past 18 months or so. In addition, by purchasing a range of sovereign-guaranteed, supranational and bank financial securities at healthy margins over the cost of our own debt, we have been able to increase total value-added throughout the global financial crisis, as shown in Chart Y.

Market events during the past two years have highlighted the far greater funding risk now faced by all sovereign debt issuers. With this in mind, we have worked with our peer organisations in Canada and Australia to develop a range of indicators colloquially referred to as the ‘dashboard’. The dashboard is a collection of performance measures that will indicate how well the sovereign debt manager is meeting its funding challenges. 
In the NZDMO’s case, we have taken the dashboard concept quite literally, and developed the following prototype (Chart Z).

While the numbers in Chart Z are illustrative rather than real at this stage, we look forward to further developing this approach to funding risk management with our colleagues in other 
sovereign debt offices.

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