Review by the Chief Executive Officer
Context and issuance conditions
The AOFM remains focused on ensuring government expenditure obligations are able to be met at all times and that Budget financing needs are delivered cost effectively without undue risk. A focus is also maintained on ensuring a flawless approach to settlement operations and recording and reporting transactions. Additionally, management of the Australian Government Securities (AGS) portfolio is undertaken with a view to promoting market integrity while balancing a range of medium‑ to long‑term portfolio considerations. The AOFM has also been given responsibility for implementing two investment programs on behalf of government: the Australian Business Securitisation Fund (ABSF) and the Structured Finance Support Fund (SFSF), the latter of which arose from the government’s response to the COVID‑19 pandemic.
The government’s funding requirements were considerably higher than during last year due specifically to the impact of the COVID‑19 pandemic. A balanced Budget was originally forecast for 2019‑20, however the pandemic associated fiscal response packages led to a dramatically increased Budget financing task.
Throughout the first half of 2019‑20, central banks maintained a trend of monetary policy easing in response to persistent low global economic growth outcomes and forecasts, including below target inflation outcomes. Coming into the year AGS yields across all maturities out to 30 years traded below equivalent maturities for US Treasuries. While this reflected a range of global market influences and represented relatively favourable borrowing costs for the Australian Government, it had the effect of dampening offshore investor demand for AGS. This was reflected by a noticeable increase in offshore investor allocations into USD investments — including US Treasuries — during the preceding 18 months. Of particular note was a shift in the preferences of the Japanese investor cohort toward USD investments. While this influence, together with other market dynamics, didn’t make it difficult for AOFM issuance at the time, it resulted in AGS yields trading within a relatively steady range. However, a yield differential reversal between AGS and US Treasuries during May triggered the beginning of notable offshore investor flows again toward AUD (AGS and state‑government bonds).
The second half of 2019‑20 was clearly defined by the global economic, fiscal and market impacts of the COVID‑19 pandemic, which began in late February and fully emerged in mid‑March in the form of severe funding market dislocation. During this period there was a mass sell‑off in equity markets due to concerns about underlying valuations, which in turn led to a sell‑off in bond markets as investors looked for ways to liquidate a range of asset positions. As sovereign bond markets maintained liquidity for longer into this process they became the focus of mass selling by investors, driven in large part by a need to access large amounts of cash (for redemptions and other purposes). The AGS market was drawn into this quickly with very little warning. For several weeks the AOFM effectively lost access to the bond issuance market.
As soon as the US Treasuries market regained a functional trading status other advanced economy sovereign bond markets began to ‘clear’; at the same time the global economic outlook rapidly deteriorated and investors began to focus on buying defensive assets (in the form of a ‘flight to quality’). This together with broad central bank responses in the form of reduced cash rates, announcements of large bond buying programs, and a number of measures to support liquidity in financial markets, resulted in sovereign bond yields reaching historic lows. Yields on AGS did not decline as much as in most other markets, which has left them again trading above US Treasuries; this remains an important factor in having attracted a surge in offshore investor support for AGS issuance since April. Throughout this period the RBA also purchased around $40 billion of AGS with tenors up to 10 years. This market‑clearing operation removed much of the congestion amongst the trading banks, while at the same time supporting the RBA’s monetary policy objective of achieving a three‑year AGS yield of 0.25 per cent.
In the event, the financing task for 2019–20 was met through a combination of $128.2 billion in Treasury Bonds, $1.65 billion in Treasury Indexed Bonds , and a net increase to Treasury Notes outstanding of $56 billion. This compares with planned issuance at the time of the 2019–20 Budget of around $58 billion for Treasury Bonds and $2.5 billion for Treasury Indexed Bonds (with no appreciable change in Treasury Notes outstanding).
Absorption of the materially higher issuance was smooth and achieved via regular weekly tenders, together with some large syndication transactions. Initially the AOFM faced very limited demand for maturities longer than three‑four years, but ‘followed’ the market recovery out along the yield curve as market conditions gradually improved during the period early April to late May. During this period the domestic investor base was relatively quick to re‑engage with the AGS market, with the offshore investor cohort taking longer to re‑engage (and this happening more gradually).
Securitisation investment funds
Australian Business Securitisation Fund (ABSF)
The ABSF is a $2 billion investment fund that was established in April 2019. It is backed by a policy aim to enhance access to finance for small to medium enterprises (SMEs) through targeted investments in the securitisation market. Investments from the ABSF will allow for smaller lenders to compete more effectively with the major banks, and to fill niche gaps in the lending market that are otherwise underserved in Australia. A considerable amount of work was undertaken by the AOFM throughout the first half of 2019‑20 to establish arrangements (including legal and specialist technical advice) to support the assessment of proposals for investment by the Fund. This also included detailed liaison with the industry to better understand how the ABSF could be used to develop the market and the development of a set of principles to guide such development. The AOFM also published a market development strategy so that the industry would be clear as to how the AOFM’s approach to implementing the program would link to the underlying policy aim.
At present, the Australian SME securitisation market is constrained by a lack of borrowing and lending ‘scale’. Potential investors are reluctant (and in some cases unwilling) to conduct the due diligence needed to enter the market where only low volume issuance is concerned. The aim is to use the ABSF to invest in SME loan securitisations that will help to establish a track record in lending against types of collateral that are new to the securitisation market, and where the ability to obtain credit ratings and attract broad investor interest is currently very limited.
Structured Finance Support Fund (SFSF)
The SFSF provides for up to $15 billion for investments to ensure continued access to funding markets by SME lenders impacted by the economic effects of the COVID‑19 pandemic. In particular, the policy aim is to compensate for where smaller lenders lose access to reasonably priced funding from markets during the period of pandemic disruption. The program was established very quickly with the primary aim being to complement the support offered through a range of measures announced by the Government and the RBA during the initial stages of the pandemic impact.
The AOFM devised three key elements to the SFSF implementation strategy:
- supporting new issuance of public securitisations sponsored by smaller lenders;
- investing in revolving warehouse facilities of small lenders (to counter the withdrawal of investors from existing facilities and support the call on lenders for credit enhancements); and
- establishing a ‘forbearance trust’ whereby SFSF investments would provide cash flow support to eligible small lenders against loans experiencing temporary COVID‑19 related hardship.
Taken together, by 30 June 2020 the AOFM had invested or committed $2.7 billion of SFSF funds that have either catalysed or maintained private sector investment of $18 billion since the onset of the impacts of the pandemic. This provided support for 21 business and consumer lenders (one ADI and 20 Non‑ADIs).
The financial market outlook continues to be dominated by the potential for periods of extreme volatility. Although the last few years have attracted varied speculation about non‑uniform global economic growth and inflation prospects, there is now heightened uncertainty about the global outlook with no clearly defined path for a recovery out of the COVID‑19 pandemic situation. In addition, global trade tensions remain elevated as do a number of major geopolitical risks that could lead to the outbreak of regional conflicts. These, amongst other factors, remain relevant to the AOFM’s deliberations given how they could impact funding markets and investor preferences. The risk outlook for issuance remains heightened due to the potential for periods of extreme market volatility, and global funding markets will remain ‘crowded’ due to the large financing tasks many governments and businesses need to achieve. Furthermore, the prospect (for a range of reasons) of AGS yield differentials dissipating could reduce the relative attractiveness of AGS to offshore investors.
Much of the AOFM’s planning for risk events was tested and proved effective during the events of late February through until late April. While these were not events anyone would like to see repeated, they did provide a useful opportunity to test AOFM thinking on market access dynamics, including how funding markets recover from sharp and deep dislocations. Managing liquidity risk is something that has already attracted close attention from the AOFM. This, together with maintaining enhanced monitoring of funding markets for signs of stress will remain key amongst our tasks in the year ahead. Revisions to how the long‑term debt portfolio should be shaped to accommodate substantially higher issuance programs over the coming years than were forecast less than even a year ago will also be central to AOFM’s thinking. Furthermore, supporting investor diversity and market liquidity through issuance decisions do not diminish in importance.
Finally, the AOFM will need to continue its monitoring of securitisation markets in order to adjust its expectations about what implications may lie ahead for the smaller lending sector from the ongoing pandemic situation, and how that could translate into additional calls on the SFSF. The corollary to this is that with improved market conditions that would reduce future calls on the SFSF, this will trigger a re‑commencement of the ABSF program that has been in abeyance since the onset of the financial market impacts of the pandemic. A key objective underpinning the AOFM’s expectation of success for this program will be the completion of work being undertaken with industry on a loan‑level data template for SME lending that will facilitate credit agency ratings beyond the more traditional securitisation transactions; this will encourage/support a broader investor base. This project was initiated by the AOFM during 2019‑20 and is being undertaken jointly with the Australian Securitisation Forum, rating agencies, and other industry representatives.