Organisational Models for Sovereign Debt Management
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Peter McCray
Australian Office of Financial Management
Australian Office of Financial Management
· Australian Office of Financial Management established 1 July 1999:
- specialist office to manage Australian government's net debt position
- independent agency within Treasury portfolio
· though important practical linkages with parent department remain
Australian Office of Financial Management
· Rationale for establishing the AOFM
· Overseas experience in institutional arrangements for sovereign debt management
Australian Office of Financial Management
· Risk
- the need to recognise, measure, monitor and manage the full range
of financial risks bearing on the longer term cost performance of the
debt portfolio
- market risk, funding/liquidity risk, credit risk, operational risk
A Risk Management Framework
· Rationale for a risk management approach:
- impact of financial deregulation and technological innovation
· increasingly mobile international capital flows and integrated
capital markets
- broader reforms to public sector financial management
Financial Market Deregulation and Innovation
· The nature of the operating environment facing sovereign debt management has changed fundamentally:
- markets are far more integrated globally
· investors have no special allegiance to the currency, the market or the issuer
- financial innovation has made available new financial products and modes of service delivery
· currencies and interest rates have become substantially more volatile
Financial Market Deregulation and Innovation
· These developments present both opportunities and challenges for debt managers:
- opportunities lie in a truly global and expanded market for debt and potentially lower cost of debt
- risks lie in increased financial market volatility and internationally mobile investors, increasing
· the vulnerability of debt service costs
· the market exposure of the debt portfolio and, ultimately
· the exposure of balance sheet net worth
Public Sector Financial Management Reforms
· Australian government introduced accrual budgeting and accounting:
- and an outcomes-oriented approach to performance reporting
- increasing emphasis on public sector transparency and accountability
- increased focus on net worth and risks to net worth
Public Sector Financial Management
Reforms
· A risk management framework provides the basis for a coherent,
objective and generally quantifiable basis for performance reporting
· Is also consistent with the increased emphasis on balance sheet net worth and the risks to net worth accompanying accrual reforms
A Risk Management Approach to Debt Management
· Forces the debt manager to recognise the full range of financial risks involved across all debt management operations
- funding, market, credit, liquidity and operational risks
· Obliges conscious decisions about the extent of risk that governments are willing to bear and the balance to be struck between different risks
· Makes it clearer that risks are not independent and provides a basis for selecting efficiently from among different risks so as to minimise risk overall
Debt Management Review
· The basic organisational structure, staffing numbers and skill
set, financial resourcing, delegations and accountability arrangements
essentially unchanged from those that applied 20 years ago
· Undertook a major review of existing debt management arrangements
Organisational Reform - a Framework
· Defined a four-tiered management framework as a basis for taking
decisions on organisational reform:
- philosophical approach
- operating framework
- measurement and reporting framework
- organisational and resource structure
Organisational Reform - a Framework
· Philosophical approach
- objectives of debt management
- relevant cost and risk concepts
- broad strategic principles governing the way in which the debt manager pursues those objectives
· Operating framework
- establishes the policy and practices employed in implementing the management philosophy
· degree of operational/funding flexibility, transactional capability, use of derivatives
· frameworks of internal delegations and accountabilities
Organisational Reform - a Framework
· Measurement framework
- governs not only how risk is measured and monitored
- but also how the debt manager's performance is measured against those objectives
· Organisational structure
- establishes the resource, management and skills base appropriate to implementing the overall debt management strategy
Organisational Reform - a Framework
· A natural hierarchy linking these four elements:
- and an overriding need for consistency between all elements of the
hierarchy
· Choice of overall philosophy the primary determinant of the way in which other elements should be approached
Organisational Reform - a Framework
· Review of overseas experience:
- wide range of reasons/backgrounds behind different philosophical approaches observed
· reform arising from financial pressures
· wider economic and public sector reforms
· competitive pressures on inefficient domestic markets
· established history and practice
Organisational Reform - a Framework
· Review of overseas experience:
- spectrum of philosophical approaches to funding and market risk management
· opportunistic or strategic funding versus predictable, transparent approach
· comprehensive financial risk management approach with particular focus on management of market risk of debt portfolio
· market risk profile of the portfolio simply the cumulative result of past issuance decisions
Organisational Reform - a Framework
· Range of approaches complemented by variety of operational and
organisational frameworks, generally consistent with intensity of philosophy:
- less intensive forms of debt management - tightly scheduled issuance programs, little or limited management of portfolio market risk:
· fairly narrowly defined transactional flexibilities
· limited delegations required
· relatively less demanding of resources
Organisational Reform - a Framework
· Other jurisdictions employed a more comprehensive financial risk management approach:
- explicit management of market risk
· typically by reference to a strategic benchmark portfolio structure
- scope for intervention in the secondary market for market management purposes
· for example, stock lending facilities
- reasonably intensive use of derivatives and in, some instances, management of financial assets
· requiring tightly defined policies for the management of credit exposure
Organisational Reform - a Framework
· A philosophy that recognises and seeks to manage financial risk comprehensively requires that:
- objectives and strategies are clearly defined
- lines of delegation are short, clear and appropriate to an environment in which decisions need to be made and implemented quickly
- accountabilities and responsibilities are clear
- systems and resources are consistent with the high transactional burden implied
- the organisational structure provides maximum flexibility to recruit and retain specialist staff with the full range of requisite skills
Organisational Reform - a Framework
· Our own review strongly endorsed the shift in recent years to such a comprehensive financial risk management approach in Australia, but highlighted:
- limitations in the operating framework (inadequate operational flexibility and transactional capability)
- a measurement and reporting framework which undermined capacity to deliver the full benefits of philosophical approach
- resourcing and organisational arrangements which were inconsistent with other elements of the management framework
Organisational Reform - a Framework
· Decisions on form of organisational structure that would provide a foundation for addressing these inconsistencies were guided by five design criteria:
- Adequate resources (human and financial) and a sound basis for their allocation
- A strong focus on financial markets and risk management
- A strong perception of the separation between debt management and economic policy advisory functions
- Mechanisms to ensure an institutional awareness of public policy sensitivities
- A sound structure of governance and appropriate flexibility and accountability in decision making
Organisational Reform - a Framework
· Elements of these criteria essential to any form of sovereign debt management operation:
- clear separation of debt management and monetary policy
- clear objectives and governance frameworks
- an operating culture that recognises the public policy constraints
on debt management operations
· Additional considerations become increasingly pressing as the intensity of the risk philosophy increases
Australian Office of Financial Management
· Australian Office of Financial Management established 1 July 1999:
- independent agency within Treasury portfolio
· significant additional resourcing
· own appropriations, financial accounts and annual report
· capacity to recruit and retain specialist skills
- an approximate doubling of staff is envisaged, with significant investment in debt management systems and information technology
Australian Office of Financial Management
· Important practical linkages with parent department remain:
- A reporting line to the Treasurer via the Secretary to the Treasury
- An Advisory Board with both Treasury and private sector representation
Australian Office of Financial Management
· Essential logic of this form of relationship with Treasury is to provide both additional resourcing and significant day-to-day operational independence, while providing absolute surety regarding:
- institutional awareness of public policy issues and the Government's risk preferences
- appropriate judgements as to the public policy constraint threshold in a wide range of transacting and relationship management situations
· Sovereign debt management requires a blend of public policy and technical financial management skills and awareness
Conclusion
· Single most important insight to emerge from Australian experience:
- define a debt management philosophy consistent with circumstances and objectives
· not necessarily a case of `one size fits all'
- answers to questions regarding appropriate organisational arrangements emerge naturally from consideration of the transactional, governance/accountability, systems and resourcing implications of sustaining that philosophical approach
