# Part 2: Performance and Outcomes

## Introduction

This part of the annual report is presented in two sections: Section 1 comprises the PGPA Act Annual Performance Statement requirement; and Section 2 gives context to outcomes achieved through the AOFM’s operations in support of its principal functions. Section 2 includes discussion of the relevant market environment in which the AOFM operates.

## Section 1: Annual Performance Statement

The 2020-21 Annual Performance Statement of the Australian Office of Financial Management (AOFM) is presented as required under paragraph 39(1)(a) of the Public Governance, Performance and Accountability Act 2013 (PGPA Act).

In my opinion as accountable authority of the AOFM the statement accurately reflects the performance of the Australian Office of Financial Management, is based on properly maintained records, and complies with subsection 39(2) of the PGPA Act.

Rob Nicholl

Chief Executive Officer

25 October 2021

### Purpose

The AOFM’s purpose is to fully meet the Government’s debt financing and cash needs and achieve its policy objectives to support the domestic lending market. The AOFM will take account of the potential for its operations to impact Australian financial markets.

The following key functions underpin the AOFM’s role:

• issuing AGS to meet the Government’s financing task and in accordance with government policy objectives (such as facilitating sovereign bond market liquidity);
• settlement and payment of Government financial obligations on AGS;
• managing the cash account to meet the Government’s commitments at all times;
• undertaking cost effective management of the debt and asset portfolios;
• where appropriate, supporting efficient operation of the Australian financial system; and
• managing the ABSF and SFSF investment portfolios consistent with related policy objectives.

The AOFM balances cost and risk considerations but its overriding aim is to ensure financing requirements of the Government are met at all times. The AOFM has minimal appetite for failure in any function associated with debt issuance, settlement and payment obligations, and cash management. The design and conduct of core business processes (including business continuity arrangements) reflects this low-risk appetite.

The AOFM monitors its performance against the indicators presented in Table1, which are sourced from the AOFM’s Corporate Plan 2020-21 and Portfolio Budget Statements 2020-21. Sections 2 and 3 of this part of this report provide detail on a range of outcomes towards the AOFM’s annual and longer‑term aims. This detail is provided separately to the Performance Statement because it is aimed at financial market participants as the relevant audience.

Table 1: Performance Information 2020-21

Target

Zero

Result

Target met

### Objective 2: Facilitate the Government’s cash outlay requirements as and when they fall due

Indicator 4

Use of overdraft facility: Number of instances the RBA overdraft facility was utilised to the extent that it required Ministerial approval during the assessment period

Target

Zero

Result

Target met

The RBA overdraft facility was not utilised in 2020-21.

#### How AOFM achieves this objective

This objective is achieved through appropriate management of the cash portfolio, with the AOFM using information from the ATO and spending agencies to forecast daily revenue collections and expenditure outlays. Throughout the year there are time of significant mismatches between expenditure needs and revenue collected. The AOFM uses short term funding (through Treasury Notes) and cash portfolio assets to manage these mismatches.

### Objective 3: Be a credible custodian of the Australian Government Securities (AGS) market and other portfolio responsibilities, including the Australian Business Securitisation Fund (ABSF) and Structured Finance Support Fund (SFSF).

Indicator 5

A liquid and efficient secondary market: Annual turnover in the secondary market for Treasury Bonds and Treasury Indexed Bonds

Target

Greater than previous year

Result

Target met

AGS liquidity remained strong in 2020‑21. Turnover of Treasury Bonds totalled $2.1 trillion (a 36 per cent increase from the previous year). Annual Treasury Indexed Bond turnover increased by 19 per cent, to$58 billion. Strong secondary market liquidity is a key consideration for most investors because it reflects an ability to transact (either through buying or selling AGS) in a timely manner and in volumes to meet their needs, without market prices being materially moved by those transactions. It reflects a range of factors. including: regular AOFM issuance that, among other factors, takes account of prevailing market conditions; the presence of a range of active ‘price makers’ in AGS; good access to interest rate risk hedging; and a diverse (and active) investor base. The AOFM also plans issuance with the aim of supporting (ASX) Treasury Bond futures (risk hedging) contracts.

The AOFM also supports liquidity through: restricting the number of individual bond lines so each can have greater volume outstanding including consideration of RBA holdings; clear communication about and transparency regarding AOFM issuance; and a long‑standing focus on maintaining a functional and resilient AGS market.

High levels of secondary market turnover and feedback from investors attesting to their capacity to buy and sell large parcels of AGS at acceptable prices are strong indicators of liquidity for 2020‑21.

Indicator 6

Market commitments: Number of times the AOFM failed to take actions consistent with public announcements

Target

Zero

Result

Target met

The AOFM’s actions remained consistent with its public announcements throughout the year.

This included announcements in July and December 2020, and at Budget in May 2021. These announcements progressively updated planned AGS issuance, including for new lines and weekly issuance rates. At all times issuance remained consistent with the most recent public guidance. The unusual frequency in changes to public (market) guidance was driven by updates to the Government’s COVID-19 response package and uncertainty surrounding the potential impact on the underlying Budget position following initial lockdowns that commenced during 2020.

The AOFM considers the above actions were consistent with public announcements, but notes revisions were necessarily made multiple times throughout the year (a departure from the preferred and traditional approach of only updating guidance at official Budget updates). Market feedback indicates the AOFM’s adopted approach of regular issuance updates, given the circumstances, was a welcome departure from established practice.

#### How AOFM achieves this objective

The AOFM is judged by financial markets to be a credible and predictable major participant in the AGS market and uses its operational flexibility responsibly. It is important to note the AOFM does not have any regulatory or statutory authority - any influence it has is by virtue of its guidance and issuance operations (although it recognises the potential for this influence to be significant).

Indicator 7

ABSF rate of return Accrual earnings (net of losses) divided by average drawn (invested) amount.

Target

Greater than or equal to the investment mandate benchmark(Bloomberg AusBond Treasury 0-1 year index)

Result

Target met

The ABSF achieved a return on average drawn funds of 1.63 per cent for the financial year ending 30 June 2021, versus a benchmark return of 0.18percent.

Indicator 8

SME loan level data template in use for securitisation sector SME loan level data template was: agreed to by the industry body; and populated by sponsor of ABSF investment.

Target

1. Agreement by 31March 2021;
2. data collection commenced by 30 June 2021.

Result

Target not met

Progress toward agreement on the template was suspended due to the onset of the pandemic. Work recommenced in the second half of the year culminating in agreement of a draft template published by the ASF in August 2021.

#### How AOFM achieves this objective

Central to the AOFM’s strategy for developing the SME lending sector of the securitisation market is coalescence around a standardised data template, so investment performance can be readily assessed by ratings agencies and investors. The AOFM sought and received assistance from the ASF to sponsor a working group of industry participants (including AOFM staff) to design the template. Publication of the template represents a key milestone for the ABSF program. The AOFM can now use ABSF investment to support adoption of this reporting standard by SME lenders.

A key driver of the ABSF’s financial outperformance was the yield on short term debt instruments, which fell sharply in 2020 as a direct consequence of the RBA’s monetary policy response to the pandemic. The initial investment made by the ABSF had a return commensurate with the risk of the investment. No subsidy was provided on this investment as the originator could not adopt the (as then unfinished) standardised SME loan level data template.

Indicator 9

SFSF warehouse proposals processed. Number of warehouse proposals recommended to the delegate

Target

Up to 20 per quarter while there are, at any time, outstanding proposals with AOFM for consideration

Result

Target met

A total of 32 warehouse applications from lenders were considered by the SFSF delegate during the 2020-21 financial year. Q1 was the period of peak activity (and thus when the target for the performance indicator was most relevant) in which 22 applications were considered by the delegate (of which 15 were approved). As market conditions improved, calls for assistance abated, and seven proposals were considered in Q2 (four of which were approved), one in Q3 and two in Q4.

Indicator 10

SFSF leverage ratio Private sector investment in primary transactions of small lenders, in which AOFM was engaged, divided by SFSF monies applied to public (primary + secondary) investments.

Target

> Four in the year overall

Result

Target met

In Q1, the multiplier was over 40, as only a very small volume of SFSF investment was required to support primary market activity. In subsequent quarters the multiplier was either infinite or not applicable because no SFSF investment was required due to further improvements in market conditions. While contingent support was sought by issuers in Q2 that was ultimately not called on, no requests for this kind of support were received in the second half of 2020-21.

#### How AOFM achieves this objective

The AOFM’s objective for implementing the SFSF has been to fill gaps in the market created by liquidity and other constraints arising from the pandemic induced market disruption as well as supporting lenders granting loan forbearance through establishment of the Forbearance Special Purpose Vehicle.

By seeking to limit its investment to the minimum required to allow transactions to occur, and thus maintain the flow of finance to eligible lenders, the AOFM has avoided crowding out private sector investment, while maintaining confidence that additional capital can be deployed if required.

As market conditions improved the AOFM was able to step back from the market while maintaining the SFSF apparatus.

## Section 2: Outcomes

### Debt issuance

#### Aims

The AOFM currently issues three debt instruments: Treasury Bonds; Treasury Indexed Bonds (TIBs) and Treasury Notes. The primary objectives of issuance are to cost‑effectively meet the Government’s budget funding task (including both deficit financing and repayment of maturing debt obligations) and to assist managing interest rate, liquidity, and debt refinancing risks.

Treasury Bonds are used as the primary funding tool to meet the budget funding task. TIBs issuance is used primarily to support the inflation‑linked market. Treasury Notes are typically issued for within‑year financing purposes.

Through its operations the AOFM is aware that:

• AGS and the (ASX) Treasury Bond futures act as key reference points for the pricing of other capital market instruments and to manage interest rate risk; and
• active and efficient sovereign debt markets (both physical and futures markets) are important for the resilience of the broader financial system to economic and financial market shocks.

A key element of market efficiency important to issuers, intermediaries and investors is market liquidity. Liquidity is broadly taken to mean the ability to trade bonds at short notice and low cost without materially moving prices. Strong liquidity is attractive to investors and reflects favourably on a sovereign bond market but will vary across maturities along the yield curve. There is no single measure of liquidity because it is an assessment by individuals (and institutions) based on several considerations, including, but not restricted to the following indicators: turnover in secondary markets; frequency of primary market activity; bid‑offer spreads; and the time it takes to execute ‘large’ transactions.

#### Approach to achieving these aims and market influences

The AOFM uses competitive tenders and syndications for debt issuance (with tenders the mainstay of issuance operations). In 2020-21 there were 75Treasury Bond tenders, 18 TIB tenders and 47Treasury Note tenders. Five new Treasury Bond lines were launched by syndication and there was one syndicated tap of an existing bond line.

The Government’s funding requirements were considerably higher than last year due to COVID‑19 associated fiscal response packages. However, due to an improvement in Australia’s economic performance against initial forecasts, budget outcomes were better than expected and the financing task was lower than initially forecast.

In the second half of 2020-21 global financial markets reflected an emergence of rising inflation expectations due to accommodative monetary and fiscal policies. Rising inflationary expectations were reflected in a sharp sell-off in bond markets in which yields on 10‑year Treasury Bonds increased rapidly, particularly through the third quarter of the financial year. The result was yields rising to around 90 basis points above the trading range observed through the first half of the year. With the RBA’s yield curve control operations anchored yields on short term bonds at around 10basis points, the AGS yield curve steepened considerably as a result.

#### Outcomes

The financing task for 2020-21 was fully met through a combination of Treasury Bond and TIB issuance. There was a reduced reliance on Treasury Notes with outstandings decreased (by $31.5billion) to a level around$27billion compared with 2019-20. The improved underlying Budget position throughout the year allowed for lower issuance than planned at the (delayed) 2020-21 Budget release. At that time an issuance task of around $240 billion had been forecast for the year. ##### Treasury Bonds Gross Treasury Bond issuance for the year totalled$207.3 billion, a significant increase from the $128.2 billion issued in 2019-20. New bond lines maturing in November 2025, September 2026, November 2031, November 2032, and June 2051 were established. Around 60 per cent of total Treasury Bond issuance for the year was into these new bond lines. In selecting the bond lines to issue each week, the AOFM takes account of prevailing market conditions, liaison with financial market contacts, relative value considerations, and liquidity of outstanding bond lines. The AOFM refrained from issuing into any bond lines forming part of the RBA’s yield curve control operation and continued suspension of the regular (short) bond buyback program. Between July 2020 and June 2021, up to three tenders were held each week. Issuance via tender continued to be concentrated into bonds in the 10-year futures basket and shorter, which is consistently the most liquid part of the AGS market and therefore, best able to absorb larger issuance volumes. At the end of the year, there were 29 Treasury Bond lines: 14 having over$30billion on issue and a further 6 having over $20 billion on issue. Chart 1 shows Treasury Bonds outstanding as at 30June2021 and the allocation of issuance across bond lines during 2020-21. Chart 1: Treasury Bonds outstanding at 30 June 2021 and issuance in 2020-21 Table 2 summarises results of Treasury Bond tenders conducted during the year. These are averages for each half‑year and grouped by maturity dates of the bonds offered. Table 2: Summary of Treasury Bond tender results  Period Maturity Face value amount allocated ($m) Weighted average issue yield (%) Average spread to secondary market yield (basis points) Average times covered July - December 2020 Up to 2028 32,000 0.4106 -0.82 5.17 2029 - 2033 36,200 0.9152 -0.49 4.18 2034 - 2051 1,300 1.3348 -1.02 2.91 January - June 2021 Up to 2028 12,800 0.5399 -0.85 4.69 2029- 2033 26,300 1.5583 -0.45 3.66 2034 - 2051 700 2.2115 -0.58 3.19

The average tender coverage ratio for Treasury Bond tenders in 2020-21 was 4.29, an increase from 3.67 in 2019-20. The average tender size of $1.46 billion was higher than in 2019‑20 ($1.2 billion). A total of 75 tenders were held in 2020-21, compared with 79 in 2019-20.

Shorter‑dated bond tenders generally received higher than average coverage ratios, which reflected core investor interest and a greater willingness, and ability of, intermediaries to warehouse the risk associated with shorter dated bonds.

The strength of bidding at tenders was also reflected in issue yield spreads relative to secondary market yields. At most Treasury Bond tenders the weighted average issue yields were below prevailing secondary market yields (a better price outcome than at mid-market).

##### Treasury Notes

Treasury Notes on issue decreased by $31.5 billion in 2020-21. A total of 47 Treasury Note tenders were conducted. Treasury Notes were primarily used for within‑year financing throughout 2020-21. Issuance tenors were focused around 3 and 6 month maturities. The volume of Treasury Notes outstanding gradually declined throughout the financial year as those issued between March and June 2020 (to fund the initial increase in Government COVID-19 related expenditure) matured. Treasury Notes totalling$94.5billion were issued in 2020-21 (in face value terms), an increase of $4.6 billion on 2019-20. Chart 2: Treasury Notes outstanding (by maturity) at 30 June 2021 and issuance in 2020-21 Table 3 summarises Treasury Note tender results during the year. Averages for each half‑year and grouped by tenor. Issuance was met with strong demand as accommodative monetary policy created substantially increased banking system liquidity. The average coverage ratio at tenders was above 6, an increase from 3.96 in 2019-20. Yields were on average 1 basis point higher than Overnight Indexed Swap (OIS) rates for corresponding tenors (compared to around 20 basis points higher than OIS rates in 2019-20). This reflected lower spreads across Australian short‑dated funding rates. Table 3: Summary of Treasury Note tender results  Period Maturity Face value amount allocated ($m) Weighted average issue yield (%) Average spread to Overnight Indexed Swap (basis points) Average times covered July - December 2020 Up to 120 days 32,500 0.1150 1.56 5.05 121 days to 210 days 15,500 0.1079 3.04 5.41 Longer than 210 days 15,000 0.1508 5.17 5.81 January - June 2021 Up to 120 days 18,450 0.0140 -1.83 6.77 121 days to 210 days 13,050 0.0196 -1.58 6.83 Longer than 210 days - - 0.00 -

TIB issuance for the year totalled $2.50 billion over 18 tenders. Feedback from market participants and prevailing market conditions were considered in issuance decisions. Chart 4 shows the amount outstanding in each of the 8 TIB lines at 30 June 2021, and allocation of issuance during the 2020-21 year. Chart 3: Treasury Indexed Bonds outstanding at 30 June 2021 and issuance in 2020-21 TIBs comprise around five per cent of the long-term debt portfolio (in face value terms). The capital value of TIBs are adjusted with changes to the CPI; they typically attract a different (and predominantly domestic) class of investor compared to Treasury Bonds. While the Indexed Bond portfolio has declined as a share of long-term funding overtime, the total stock outstanding of indexed bonds has continued to grow broadly in line with the past issuance trend. Tender coverage ratios were slightly lower in 2020-21 (4.52 compared with 4.70 in 2019-20). This is in part a function of the higher overall issuance volume in 2020-21. In 2019-20 the decision was taken to reduce tender sizes in response to deteriorating market conditions arising from market disruption associated with the onset of the pandemic (the average tender size was$138 million in 2020-21 compared with $118 million in 2019‑20). However, the weighted average issue yield was below prevailing secondary market yields at most tenders (a reflection of the AOFM restricting tender volumes). ##### AGS market liquidity and efficiency Market liquidity was generally good in 2020-21 with efficient price discovery and tight bid‑offer spreads available through most of the year. Turnover of Treasury Bonds was 36 per cent higher than the 2019-20 level. Annual turnover reported in AOFM’s survey was$2.1 trillion for 2020-21. This was influenced by the large increase in AOFM primary issuance in 2020-21.

Chart 4: Annual Treasury Bond Turnover

TIB turnover in 2020-21 was around $58 billion, an increase of 19 per cent from the 2019-20 volume. Chart 5: Annual Treasury Indexed Bond Turnover ##### Treasury Bond Futures turnover Turnover in the (ASX) Treasury Bond futures market is significantly higher than in underlying Treasury Bonds. The 3 and 10‑year futures contracts are highly liquid: over 45 million 3‑year contracts (representing$4.5 trillion face value of bonds) and over 65 million 10‑year contracts ($6.5 trillion face value of bonds) were traded in 2020-21. A new 5‑year contract was launched in 2020‑21 with over 1 million contracts ($100 billion face value of bonds) traded. Turnover in the 20‑year contract is considerably lower with around 200,000 contracts (or just over $13.0 billion face value of bonds) traded. Turnover in 3‑year futures was lower than previous years. One factor driving this was the RBA including some bonds from the 3 year futures basket in its yield curve control policy; this reduced usefulness of the contract as a hedging instrument. ##### Securities Lending Facility The AOFM Securities Lending Facility allows market participants to borrow Treasury Bonds and TIBs for short periods when they can’t be obtained in the secondary market. Lending bond lines enhances efficiency of the market by improving capacity of intermediaries to continuously make two‑way prices, reduces settlement risk, and can supports market liquidity. The facility was used 123 times for overnight borrowing in 2020-21, compared with 163times during 2019-20. Volumes borrowed were higher than in 2019-20, with the total face value lent in 2020-21 of$6.02 billion, an increase of $3.37 billion. The April 2023 and April 2024 Treasury Bonds were the most heavily borrowed (by volume). TIBs generally exhibit lower liquidity and have less stock available for trading in the secondary market, which accounts for regular borrowing of these securities. During 2020-21, the RBA implemented its own lending facility. It has accumulated large volumes of some Treasury Bond lines and made these available to facilitate market lending related transactions. This contributed to reduced usage of the AOFM Securities Lending Facility. ### Cost across AOFM portfolios Debt portfolio cost outcomes are presented in this Section. #### Aim The AOFM is tasked with meeting the Budget financing task while managing trade‑offs between cost and risks for the cash and long-term debt portfolios, this being over the medium to long-term. Funds in the investment portfolios earn returns, described later in this section. #### Approach to achieving the aims The AOFM cost and risk measures reflect considerations faced by sovereign debt managers generally. The primary cost measure is historic accrual debt servicing cost. This includes: interest payments made on AGS; realised market value gains and losses on repurchases; capital indexation of TIBs; and amortisation of issuance premiums and discounts. The effective yield of the portfolio is the total accrual debt servicing cost expressed as a percentage of debt outstanding. Historic accrual debt service cost excludes unrealised market value gains and losses. An alternative measure of cost is ‘fair value’, which takes account of unrealised gains and losses from movements in market value. Debt service cost outcomes are also presented in the AOFM’s financial statements on this basis. Fair value facilitates an assessment of: financial risk exposures and changes in those exposures from year-to-year; the value of transactions managed; and the economic consequences of alternative strategies. However, this measure is most useful in the context of ‘trading for profit making’ purposes (which does not relate to the AOFM’s core operations). ### Outcomes The net debt servicing cost[1] of the portfolio managed by the AOFM in2020‑21 was$16.8 billion on an average book volume of $748.8 billion; this represents a net cost of funds of 2.24 per cent. Table 4 provides details of the cost outcomes for the portfolio of debt and assets administered by the AOFM, broken down by instrument and portfolio for 2020‑21 and 2019‑20. Table 4: Commonwealth debt and assets administered by the AOFM  Debt servicing cost Book volume Effective yield 2019-20 2020-21 2019-20 2020-21 2019-20 2020-21$ million $million per cent per annum Contribution by instrument Treasury Bonds (15,538) (15,984) (530,342) (725,243) 2.93 2.20 Treasury Indexed Bonds (1,468) (977) (45,360) (45,130) 3.24 2.16 Treasury Notes (136) (81) (19,963) (49,920) 0.68 0.16 Gross AGS (17,142) (17,042) (595,665) (820,293) 2.88 2.08 Deposits with the RBA 170 104 24,598 67,836 0.69 0.15 ABSF investments - 1 0 47 0.00 1.63 SFSF investments1 (2) 59 142 2,063 -1.41 2.87 State housing advances (50) 88 1,604 1,498 -3.10 5.86 Gross assets 118 252 26,344 71,443 0.45 0.35 Net portfolio (17,024) (16,790) (569,321) (748,850) 2.99 2.24 Contribution by portfolio Long Term Debt Portfolio (17,006) (16,961) (575,702) (770,373) 2.95 2.20 Cash Management Portfolio 34 23 4,635 17,916 0.73 0.13 Investments for Policy Purposes Portfolio1 (52) 148 1,746 3,607 -2.96 4.10 Total debt and assets (17,024) (16,790) (569,321) (748,850) 2.99 2.24 1SFSF investment income is before allowances for expected credit losses ($3 million in 2020-21 and $2 million in 2019-20) Note: Sub totals and totals are actual sum results, rounded to the nearest million dollars. Effective yields are based on actual results before rounding to two decimal places. Book volume is a through the year average. (a) Re‑measurements refer to unrealised gains and losses from changes in the market valuation of financial assets and liabilities. The cost for AGS was slightly lower than the previous year, despite the average volume of debt on issue increasing by$224.6 billion. The funding cost of gross debt declined by 80 basis points to 2.08 per cent. This result was driven by the issuance of new bonds at yields below the average issuance yield of existing bonds, and increased use of Treasury Notes at very low (occasionally negative) yields.

Return on gross assets for the period was $252 million, an increase of$134 million. Extremely low short-dated interest rates resulted in interest income from cash deposits falling despite an average level of asset balances over $40 billion higher. Income on state housing advances was positive following a loss in 2019-20 related to the waiver of Tasmanian housing loan advances (a policy decision taken by the Australian Government). There was$59 million of income from the SFSF, which was established towards the end of 2019-20. In percentage terms the return on gross assets decreased from 0.45 per cent to 0.35 per cent.

### Long‑Term Debt Portfolio management

#### Aims

In managing the Long-Term Debt Portfolio (LTDP) and meeting the Government’s financing requirements, the AOFM aims to minimise debt servicing costs over the medium to long-term while effectively managing interest rate and refinancing risk. It also seeks to support efficient operation of the AGS market through debt issuance.

#### Approach to achieving the aims

The AOFM influences the cost and risk profile of the LTDP through the maturity structure of securities issued (and to a lesser extent, the mix between nominal and inflation‑linked securities). Issuing longer‑term securities will typically involve paying higher debt servicing costs, compensated by a reduced risk of variability in future interest cost outcomes and lower exposure to annual refinancing risk.[2]Shorter‑term borrowing will typically incur lower interest costs but result in higher variability in cost outcomes through time and a greater debt refinancing task each year. Striking the right balance between these cost and risk considerations, while not adversely impacting market functioning through issuance operations, requires constant judgement.

Developing a medium‑to‑long term view on appropriate portfolio management and then translating that into annual issuance strategies is informed by ongoing research. This explores the cost and risk characteristics of alternative portfolio structures and issuance strategies under a range of scenarios; the program considers prevailing fiscal and economic conditions, as well as an assessment of broader market trends. A range of complementary thresholds limits and targets in support of the annual issuance strategy is put to the Secretary to the Treasury for endorsement.

Weekly issuance decisions focus on volume and maturities. These decisions are influenced by prevailing market conditions, progress toward achieving the annual issuance strategy, relative value considerations, and feedback from intermediaries.

#### Long‑Term Debt Portfolio issuance strategy

When formulating the Treasury Bond issuance strategy for 2020‑21 the AOFM aimed to maintain a long-dated issuance bias. Low yields, the unknown impact of the pandemic and a deteriorating fiscal outlook provided strong support for the long-dated issuance bias. At the time the strategy was set, the unprecedented size of the annual financing task and limits to investor appetite for duration risk were viewed as possible constraints to achieving a weighted average maturity to match previous years.

The AOFM avoided issuing bonds subject to the RBA’s yield target operations because it did not want to appear to be acting in conflict with the RBA’s monetary policy aims.

#### Outcomes

Debt cost outcomes are driven in large part by the level of bond yields, which remained near historic lows during 2020‑21, and the volume of issuance. Yields out to three years were anchored by the RBA’s yield target regime. Longer-dated rates rose across developed economies at the beginning of calendar 2021 as part of a ‘reflation trade’, before remaining steady for the rest of the year (Chart 6).

Chart 6: Evolution of Treasury Bond benchmark yields

The weighted average maturity of Treasury Bond issuance in 2020‑21 was considerably longer than in 2019-20. Last year large volumes of shorter-dated bonds were issued to assist with the sudden and massive increase in the funding requirement upon the onset of the pandemic; there was also several months of market recovery during which the AOFM found it difficult to issue long dated maturities. The average issuance yield remained below 1 per cent (Chart7).

Chart 7: Treasury Bond issuance — average yield and maturity

Chart 8 shows the funding cost profile of the LTDP and the net cost outcome (incorporating short term assets and liabilities) over the past decade. These profiles are compared to the cash rate and 10‑year moving average of the 10‑year bond yield. Interest rates on the LTDP and for the net cost outcome have declined significantly over the decade. Given the largely fixed cost structure of the LTDP and net cost outcome, changes in funding cost rates lag changes in the cash rate (changing only when debt securities or assets mature or new securities are issued/investments made).

Chart 8: LTDP and net portfolio cost of funds analysis

The structure and effective yield on the Treasury Bond portfolio are a product of issuance undertaken since 2009‑10 because most current outstanding debt has been issued since then. Furthermore, around 45 per cent of the current portfolio was issued in the last two financial years at average yields significantly below the portfolio average of 2.07 per cent (Chart 9).

Chart 9: Treasury Bond portfolio — composition and average yield by issuance year, at 30 June 2021

#### Long‑Term Debt Portfolio risk outcomes

The average maturity of the Treasury Bond portfolio lengthened by 0.28 years to 7.67 years over 2020‑21. Duration was higher by 0.08 years (finishing at 6.74 years). The low level of issuance yields meant Treasury Bond portfolio lengthening was achieved with a lower cost of funds (Chart 10).[3]

Chart 10: Treasury Bond portfolio — modified duration, average maturity and cost of funds

Changes to portfolio risk over time in terms of funding, refinancing and interest rate risk are represented in Chart 11. The chart reflects a steady decline in the three- and five-year Treasury Bond refinancing tasks measured as a proportion of the stock of Treasury Bonds on issue, but higher absolute refinancing tasks over time as the stock of Treasury Bonds on issue has increased.

Chart 11: Treasury Bond portfolio — maturity profile

More than half of all outstanding Treasury Bonds were issued with an original maturity between nine and 12 years. Around three quarters of the portfolio was issued with an original term to maturity of nine years or longer (Chart 12). The predominance of longer-term bonds reflects long‑dated issuance biases over the past decade. This has contributed to investor diversity and reduced funding risk and the potential for high volatility in future interest cost outcomes.

Chart 12: Treasury Bond portfolio — composition and average yield by original term to maturity, at 30 June 2021

#### Inflation exposure outcomes

Managing the indexed bond portfolio centres on sufficient supply to meet demand while supporting liquidity and continuing development of the TIB market (for which the focus is largely on understanding domestic investor mandates). Issuance of TIBs in 2020‑21 totalled $2.5 billion (compared with$207billion of nominal Treasury Bonds).

The effective yield on TIBs fell noticeably compared to the previous year. This was driven by low inflation outcomes and issuance of TIBs at historically low yields. Real yields were negative for most tenors throughout 2020-21. TIBs were only issued at positive real yields twice during the year, on each occasion this was a tender for ultra-long TIBs.

Break‑even inflation (essentially the difference between nominal and real yields), rose as the outlook for inflation improved. 10‑year break‑even inflation ended the year at 2.1 per cent, double the level at the beginning of the year.

Chart 13: Evolution of Treasury Indexed Bond benchmark break‑even inflation

TIBs comprised around 6 per cent of total term debt (nominal and indexed bonds) on issue at the end of 2020-21 (in book value terms). This proportion has declined as annual TIB issuance has been relatively steady while Treasury Bond programs have increased significantly to meet the increased Budget requirements. The TIB market does not offer sufficient depth, liquidity, or demand to support large and sudden uplifts in AOFM issuance, which is why Budget funding is focused on Treasury Bond issuance.

## Cash management

### Aims

The AOFM manages the Australian Government’s daily cash balances in the OPA[4]. This ensures the Government can meet its financial obligations at all times. Other objectives include minimising the costs of funding and holding cash balances to avoid using the overdraft facility provided by the RBA.[5]

### Approach to achieving the aims

Achieving the cash management objective involves formulating, monitoring and regularly revising forecasts of Government cash flows (revenue and outlays) and developing and implementing appropriate strategies for short term investments and debt issuance.

A precautionary asset balance is maintained to manage the forecasting risk associated with potentially large, unexpected cash requirements (or shortfalls in revenue collections) and the funding risk associated with sudden and severe market constraints.

Until November 2020, cash balances not required at short notice were invested in term deposits at the RBA, with their magnitudes and tenors determined by the AOFM. Maturity dates were selected to efficiently finance net outflows. Term deposit rates reflect rates earned by the RBA in open market operations.

In November 2020, the Cash Management Account (CMA) was created, with entire cash balances, less an overnight buffer, automatically swept to the CMA at the end of each day. This removes overnight forecasting risk. The CMA interest rate is similar to the rate earned by term deposits and again reflects rates earned by the RBA in open market operations.

The volume of Treasury Notes on issue during 2020-21 ranged from a low of $27 billion to a peak of$77 billion, representing a continued upscaling in usage compared to prior years (up to $63 billion in 2019-20). The AOFM relied heavily on Treasury Notes early in the COVID-19 pandemic both for budget financing and re-building liquidity in the cash portfolio. The volume of Treasury Notes on issue decreased through 2020-21 as earlier issuance matured and Treasury Bond issuance was increased. Chart 14: Short‑term financial asset holdings and Treasury Notes on issue 2020-21 ### Outcomes The task of meeting the Government’s financial obligations was met in full. During 2020-21, 154 term deposits were placed with the RBA. No term deposits have been placed since November 2020. The stock of AOFM’s short term assets (Term Deposits and the CMA) fluctuated over the year to maintain sufficient liquidity at all times. The average yield obtained on term deposits and the CMA during 2020-21 was 0.16 percent, compared with 0.85 percent in 2019-20; the decrease reflects the lower average level of short‑dated interest rates that prevailed during 2020-21. The movement in total short term financial assets managed by the AOFM (OPA cash balance plus term deposits with the RBA and the CMA), together with the volume of Treasury Notes on issue during 2020–21 are shown in Chart 14. Chart 15: Short‑term financial asset holdings net of Treasury Notes on issue in 2020-21 ### Market Engagement #### Aims Consistent and regular market engagement assists the AOFM in achieving its core goals. To meet those goals the AOFM maintains a comprehensive understanding of market related issues. Issues include: changing global circumstances; major government announcements and policies; influences on global flow of capital; changing investor preferences; and performance of intermediaries — particularly in the primary AGS market. The AOFM investor and intermediary engagement continues to place strong emphasis on maintaining regular lines of communication with stakeholders. This is done directly with bank intermediaries and investors, and indirectly, with investors through feedback from banks and via the AOFM website. Ongoing engagement assists greatly in understanding how investors are viewing the market, how demand for AGS might be changing, and how intermediaries interact with investors. Frequent liaison provides the AOFM with up‑to‑date assessments that can be used to contribute to weekly operational decisions. #### Approach to achieving the aims The AOFM investor engagement program is year specific and underpinned by a strategy reviewed annually in response to changes in market conditions, investor activity, notable changes to the investor base, and the AOFM’s issuance responsibilities and strategy. The Investor Relations strategy has three themes: • collecting and analysing market intelligence; • managing and maintaining updates to planned AOFM operations, and • focusing on engagement with new or potentially new investors. #### Outcomes Investor engagements were conducted during 2020-21 in a similar manner to those undertaken in the latter part of 2019-20. Conveying Budget and issuance updates and receiving investors’ views via feedback through one-on-one engagement remained key to the investor program. The AOFM has not been travelling to meet investors since the onset of the pandemic and has relied on the use of video and teleconferencing, and webinars (some arranged and hosted by banks and other market organisations). The annual Business Economists (ABE) speech, together with updates and releases on the AOFM website, remain useful conduits for information dissemination. Two ABE speeches were given by the CEO during the year. The first, in late July 2020, was an important opportunity to provide guidance on the planned approach by AOFM to a range of operational issues, particularly the substantial increase in funding for the year ahead, operational flexibility and increased use of Treasury Notes, and a concentrated schedule of syndications to achieve the large issuance task. This was at a time of widespread uncertainty in anticipation of Australia’s response to the previously announced fiscal and monetary policy measures, and how the underlying Budget position would be impacted. Although updates had much shorter application than in previous years, the increased frequency was received well by intermediaries and investors. In a second ABE speech on 8 June 2021 the AOFM provided guidance on learning from the previous year, as well as issuance plans for the six months ahead. Investors are increasingly interested in discussing topics relating to green bond issuance or Environmental, Social and Governance (ESG) related issues. In mid-September the AOFM undertook several meetings with investors on this topic. These included smaller domestic Authorised Deposit-taking Institutions and a couple of larger fund managers. Increasingly through the year investors approached the AOFM regarding the Government’s commitments and policies towards climate change, carbon emission reductions, and renewable energy development and implementation. Several organisations with specific green or sustainable fund mandates requested meetings, along with ESG units of some larger mainstream funds. It is clear from these discussions that financial markets will continue extending analysis and consideration of climate change related policies to guide investment decisions. In October, the AOFM conducted a campaign to provide a 2020-21 Budget update to investors. This included a four-week program of one-on-one investor calls beginning in mid-October with 58 offshore primary investors. The meetings covered a range of investor types and included all the major global regions - Asia, the Americas, Europe, the UK and Japan. The campaign also included a 10-minute webinar posted on the AOFM website; and release of a comprehensive investor chart pack (for the first time also translated into Japanese, reflecting the importance of this investor group). A second program of investor calls was conducted in February 2021 following the MYEFO and a market guidance update released early in the new year. This campaign focused on 25 major domestic investors. Given the suspension of many regular global market conferences, there were limited opportunities to present or speak to larger audiences in the first half of the year. Some opportunities opened in the second half of 2020-21. The AOFM presented at a bank ‘virtual investor’ seminar (to approximately 200 investors) in March. Two roundtable forums were also conducted; the first in January 2020 was a virtual event (usually held annually face-to-face) that included the AOFM with state Government borrowing authorities. The second roundtable was a further update later in the year in Sydney. Table 5: Summary of investor relations activities in 2020-21  Activity Details Investor Calls: Primary Investor Campaigns: Video/Teleconferencing Investor Calls: One off Tele/ Video Offshore 58 meetings Domestic 25 meetings Offshore/Domestic 17 meetings Presentations: large engagements 3 presentations (ABE speeches, ANZ virtual Investor Tour) Roundtables 2 Kanganews AOFM staff participating in investor relation activities CEO, Head of Investor Relations, Head Funding & Liquidity, Head Portfolio Strategy & Research, Senior Analyst - Investor Relations, Communications Manager Hosting banks: Investor roadshows, conferences, roundtable discussions ANZ, Commonwealth Bank of Australia, JP Morgan, Toronto Dominion, UBS ### Establishing the Structured Finance Support Fund (SFSF) #### Aim The SFSF was established in March 2020 to enable eligible smaller lenders to access finance via investments in structured finance products, such as residential and commercial mortgage‑backed securities (RMBS, CMBS), asset backed securities (ABS), and securities issued by revolving warehouse finance facilities. This section sets out how the AOFM has approached the task of utilising the SFSF as a vehicle to achieve the Government’s objective of maintaining access to finance for eligible lenders, namely Non‑ADI lenders and ADIs unable to access the RBA’s Term Funding Facility (TFF). #### Approach to achieving the Aim The legislation, rules and directions set out the eligibility requirements and provide guidance to the delegate (CEO of the AOFM) on investment prioritisation. Importantly, the delegate must aim to receive a positive return on investments after expected credit losses. In addition, the directions require the delegate to place a high priority on investments that catalyse rather than displace private sector investment. The AOFM identified three distinct priorities for the SFSF: • maintaining access to primary (term) securitisation markets for Non‑ADI lenders across all collateral types (RMBS, CMBS and ABS); • maintaining eligible smaller lenders’ access to finance via supporting revolving warehouse facilities; and • supporting the establishment of a mechanism that will assist eligible smaller lenders to provide forbearance to their client base. Maintaining access to primary funding markets provided confidence to eligible lenders that they could continue to originate new loans and to warehouse financiers that a natural exit strategy to their investments remained open. A dual approach was taken to keeping primary markets open: (1) direct investment in term transactions to fill gaps as required; and (2) providing third party investors with capacity to ‘switch’ out of existing investments to recycle proceeds into primary market transactions. During 2020 the warehouse finance market experienced significant disruption, with some senior financiers restricting lending to existing clients and in some cases seeking additional credit enhancement at a time when mezzanine financiers[6]had been unwilling or unable to increase their commitments; some had been exercising their option to withdraw finance at the earliest opportunity. Consistent with the Directions, the SFSF investments have been used to fill gaps in these facilities, typically but not exclusively within mezzanine tranches, consistent with the objective of maximising the extent to which private sector investment is retained. In addition the AOFM worked with industry via the Australian Securitisation Forum (ASF) to establish a ‘forbearance special purpose vehicle’ (fSPV). This allowed participating lenders to maintain an income stream from loans granted a payment holiday due to COVID‑19 related hardship. The fSPV was designed to mitigate yield strain, buffer returns on securitisation trusts, and to support participating originators’ income flows. Support was provided retrospectively from 1 March 2020 and concluded on 31 March 2021. The arrangement advanced up to 90 per cent of missed interest payments on loans in COVID‑19 hardship. Since April 2021 participating originators have been required to start repaying drawn amounts from excess spread. Consistent with SFSF Rules the SFSF is the senior financier and does not hold the ‘first loss’ securities issued by the fSPV. #### Outcomes Australian securitisation market conditions improved considerably during 2020‑21. Despite improvements in conditions, eligible lenders gained additional confidence from the AOFM’s preparedness to fill gaps in their primary market book-building processes. This resulted in continued inquiries for support of issuance throughout the first half of the year. Further improvements in market conditions in early 2021 meant that no requests for AOFM public market support were received in the second half of the financial year. From inception 16 eligible lenders benefited from SFSF support in public markets bringing 31 term securitisation transactions to market with a total issuance volume of$16.69billion.[7]Of these 31 transactions the SFSF was called on to invest either directly in the primary market transaction, the secondary market, or both, in 11 instances, with total investments of $1.35billion. Of these, just two transactions were supported (in July 2020) with associated secondary market investments of$0.17 billion. At 30 June 2021, public market investments held by the SFSF had reduced to $0.95 billion; a result of amortisation and exercising call options. The SFSF continued to receive warehouse proposals in 2020-21, predominantly in the first half of the year. Peak SFSF warehouse commitments reached$2.34billion, reflecting investments in 45 warehouses from 34 eligible lenders.[8]The improvement in market conditions assisted replacement of the SFSF by private sector investment, particularly in the second half of the financial year. By 30 June the SFSF had been fully replaced in 10 warehouses and partially replaced in a further three. At this time the SFSF had active investments in 26 warehouses across 21 eligible lenders. The approved SFSF limits within these facilities totalled $1.1 billion and the total drawn amount across these facilities stood at around$770 million.

Arrangements for the fSPV were finalised early in the financial year. Total limits of $101.6 million for eight participating eligible lenders were approved by the SFSF delegate. Of these, six eligible lenders called on the facility. The availability period ceased on 31 March 2021 as planned, and the fSPV moved into amortisation on 1 April 2021. One participating eligible lender repaid its loans in full in the last quarter of the year and the total drawn amount of the facility stood at circa$39 million on 30 June 2021.

Across the three SFSF components 41 eligible lenders had received at least one form of support by 30 June 2021. The call on SFSF investments ranged from in‑principle support for a public deal in which the SFSF was ultimately not required to invest (in two cases), through to the full suite of support across public transactions (in primary and/or secondary markets), warehouses and the fSPV (in five cases).

Through 2020-21 the SFSF held a weighted average investment of $2.06billion and earned gross accrual revenue of$59.3 million, implying a gross yield of 2.87 per cent on the average invested amount held across all investment types.[9]To date there have been no credit losses on SFSF investments.

### Establishing the Australian Business Securitisation Fund (ABSF)

#### Aim

In November 2018, the Government announced plans to establish the ABSF to increase competition within the small and medium enterprise (SME) lending market by improving access to securitisation for smaller SME lenders.

The ABSF enabling legislation was enacted in April 2019. The first investment tranche of $250 million (of a total$2 billion) was credited to the ABSF’s special account on 1 July 2019. A second tranche of $500 million was credited on 1July 2020. This section sets out how the AOFM has approached the task of establishing the ABSF as a vehicle to achieve the Government’s objective of opening securitisation markets to SME lenders. #### Approach to achieving the Aim Following announcement of the ABSF, the AOFM and Treasury undertook extensive market engagement to gain insights into SME lending. This included detailed assessment of barriers to investment activity that might explain the under-representation of SME loans within collateral pools supporting Australian securitisation products. One potential barrier was lack of standardisation in arrangements supporting securitisation of SME loans. Examples included absences of standard documentation of revolving warehouse finance facilities, and a standardised SME loan performance reporting template. Other contributing factors are seen as the lack of homogeneity in lending products offered to SMEs and a lack of scale within specialist lenders (constraining their ability to price loans at close to the marginal risk‑adjusted cost of delivery). The AOFM’s efforts have focused on establishment of a track record for various types of SME lending that would be available to investors. In time, it is expected this will support rating agency and investor assessments, attract new capital, and facilitate expansion of existing collateral types underpinning the Australian asset backed securities (ABS) market to include new types of SME lending. The Australian Securitisation Forum (ASF) has supported the data template initiative by establishing a working group to undertake its development. The working group comprised industry‑wide representation including trustees, data analytics firms, rating agencies, originators, and investors. In parallel, the AOFM will seek to use ABSF investments to subsidise the costs for participating lenders in updating their systems to adequately capture loan level data for the reporting template. #### Outcomes The ASF working group expects finalisation toward the end of the year of a live SME receivables reporting template.[10] Following the pandemic driven pause in ABSF activities, improved market conditions enabled the AOFM to issue a second‑round call for proposals in January 2021, which closed in late March 2021 and attracted 16 proposals. Assessments were in progress at 30 June 2021. The sole investment of the ABSF continues to be in securities issued by a warehouse sponsored by Judo Bank, with a limit of$250 million. At 30June2021 ABSF investment stood at $102.2million. Gross earnings of the ABSF in 2020-21 were$0.76 million, on an average through-the-year drawn investment of \$46.6 million, implying a gross yield of 1.63 per cent. This compares favourably with the ABSF’s benchmark return of 0.18 per cent.[11]

[1]   Debt servicing cost includes net interest expense (measured on an accruals basis and includes realised gains and losses on the disposal of assets or liabilities) plus foreign exchange revaluation gains and losses (now minimal). Unrealised changes in the market valuation of domestic debt and assets are not part of this measure.

[2]   Refinancing risk, also referred to as rollover risk or re‑pricing risk, is the risk that borrowing to replace maturing debt occurs on unfavourable terms (or is not possible at all).

[3]   These are point-in-time measures at 30 June each year, in contrast to debt servicing cost incurred throughout the year captured in Table 3. Figures are calculated by weighting Treasury Bond issuance yields by book volume.

[4]   The OPA is the collective term for the core bank accounts maintained at the RBA for Australian Government cash balance management.

[5]   The overdraft facility is more costly than equivalent short term borrowing (for example, issuance of Treasury Notes). The terms of the facility provide it is to cover only temporary shortfalls of cash and is to be used infrequently and, only to cover unexpected events.

[6]   Mezzanine financiers are typically specialist credit investors who provide additional credit enhancement between the ‘skin in the game’ or ‘first loss’ equity investment retained by the (eligible lender) originator and the senior note held by the warehouse provider (typically a bank).

[7]   The maximum number of public market transactions for which an individual originator received support was five.

[8]   This includes warehouse proposals subsequently withdrawn or that lapsed, or were yet to be finalised by 30 June 2021.

[9]   These numbers exclude provisions for expected credit losses and mark-to-market gains on public transactions.

[10] The template was published by the ASF in August 2021 and will be subject to periodic review.

[11] The benchmark is designed to approximate the Government’s borrowing costs on short term liabilities, given the floating rate instruments held by the ABSF, and is constructed from Australian Government Bonds with less than one year to maturity.