The UK’s Debt Management Office has more than doubled its intended borrowing schedule since the Covid crisis began. Where once they might not have done, markets have so far shrugged their shoulders, with yields negative to 2027. DMO Chief Executive Officer Sir Robert Stheeman joins OMFIF to explore the mechanics of the new issuance, the role of the Bank of England, and how to maintain an orderly market in disorderly times.
OMFIF: Thank you for joining us, Sir Robert. Could we start by looking at the changes to your borrowing programme in the wake of the Covid-19 crisis?
Sir Robert Stheeman: In early March, the Debt Management Office’s financing requirement was £156bn for the whole financial year, due to start on 1 April. Then Covid-19 hit. To facilitate the government’s immediate financing to support the economy, we announced subsequently that for the month of April alone we would be raising £45bn (almost three times the amount originally envisaged).
At the end of April, we announced that the financial requirements for May through to July would be £180bn. The government did not say anything about the period after that because of the uncertainty of the situation. It became extremely difficult, not just for the government but for any economic forecasting outfit, to work out what the actual economic impact of the pandemic would be.
That meant raising a total of £225bn from April through to July. On 29 June, we said we would raise the minimum total to £275bn, an extra £50bn, up to end-August. And most recently, on 16 July, we announced that our remit from April through to the end of November had been increased to £385bn.
That represents the most certainty that the authorities feel comfortable in giving the market, and we place a premium on doing just that. The next big update will be whenever the chancellor of the exchequer decides to hold the budget in the autumn, traditionally in November, but no date has been announced yet.
At the start of the pandemic, we introduced some operational changes to the way we conduct our programme. Previously, we had never held two auctions on one day. That was not just to make our lives easier, but also the market’s. If we had to raise £45bn in a month, however, there was no way that we could really avoid that unless we did one every working day. Daily gilt operations are not optimal for the market. So instead, we generally now hold two consecutive auctions on two days, averaging four a week.
We introduced other operational changes. We increased the post-auction option facility that allows successful bidders to purchase additional stock. We raised that to 25% from 15% to incentivise market participants not just to buy more at the auction, but also to get involved in the price formation process. The additional proceeds have been welcome: since April we have raised £25.8bn via PAOF.
OMFIF: By November, the chancellor will need to have discovered all sorts of data relating to the speed of the economy, and the total cost of the rescue measures. There are a lot of imponderables, and it may even end up being less expensive than he thinks.
RS: Absolutely. An interesting dynamic in all of this is that at the very beginning, back in March and April, we immediately saw that there would be very big cash outflows, and it wasn’t totally clear to the Treasury or to us what the precise timing of those cash outflows might be.
Our role at the DMO is also to manage what we call the net exchequer position, the cash balance of central government. This is where the option of using the Ways and Means came in: if you are faced with a sudden outflow of cash before you’ve had a chance to get the auction programme kicking in to raise finance in a steady fashion.
And at the same time, we were raising cash in the short term in the money market through increased Treasury bill issuance. If you look at the size of our Treasury bill tenders in April and into May, they were record sizes. For a period we were doing £7bn-8bn each week. At one point, I think we touched £9bn a week – all in addition to the gilt programme. If you look at T-bill tender sizes now, they’ve gone down to around £3bn-4bn. This probably gives you an indication that the immediate pressing cash needs for government have not materialised on the scale or speed originally envisaged, and this has allowed the gilt programme to catch up. And we have been able to successfully finance the government through our own operations: we have not needed to use the Ways and Means facility.
OMFIF: Do you think the financing requirement may be ultimately less than imagined? In the case of the German bail-out fund they might not need anything like as much money as they have hypothecated.
RS: I think that’s one of the reasons why we’ve not been given a full year’s borrowing requirement by the Treasury. The financing requirement for the full year is subject to significant uncertainty, and the overall size will largely depend on the extent and duration of the economic impact of Covid-19 and the associated policy support provided by the government. No one knows exactly how much will be needed, and by setting a full year’s programme now there would be a danger that we could end up borrowing too little or too much.
Does it matter conceptually if we are overfunding? If we were to overfund and raise more cash than was actually needed, some people might argue that we were indirectly having an impact on monetary policy, which would not be the intention and would not be desirable. It’s quite sensible of the Treasury not to give full year guidance in these extraordinary circumstances. However, it’s probably not the way we would normally like to do things for too long because we place such a premium on giving certainty to the market for the whole year.
OMFIF: Looking at the behaviour of the gilt yield curve it seems like the market is not unduly concerned about the huge increase in borrowing. Some people say that’s bad news, because it implies recession, but it seems the market is relatively relaxed about the new debt.
RS: In general, the gilt market has behaved in a very orderly fashion. There is no sign of undue concern if one looks at current yield levels. All gilts are negative yielding to the end of 2027. So I think it is fair to say that the market is taking this all in its stride. I would add that yield movements in our 10-year benchmark gilt seem to be closely correlated to the yield movements in two of the biggest other major bond markets, US Treasuries and Bunds, all of which suggests a strong element of normal market functioning.
OMFIF: We’ve heard that investors and the credit ratings agencies are more interested in the idea that there will be successful economic stimulus. Do you think that’s true? And are you worried that that might suddenly change?
RS: Yes, I think that holds true for us and probably for any major Organisation for Economic Co-operation and Development or G7 country. The world of sovereign credit ratings tends to be a relative game. The fact that neither the UK nor the US have an AAA rating is not that significant in the context of a global pandemic. I would not expect a huge amount of divergence in terms of economic performance and relative ratings between major global OECD economies.
I don’t speak for the ratings agencies, but it seems to me – this is not a criticism, just an observation – the unavoidable limitations of the ratings world are exposed at a time like this. It makes one wonder what the logic is behind the fact that 20 years ago so many developed economies were AAA, but so few are now. It is not clear what this actually tells us.
OMFIF: It’s also different for those, of course, which are unitary states that can issue in their own currency.
RS: I totally agree with you on that. I think that’s a fundamental point which people tend to forget. If I think of the two global crises which occurred since I joined the DMO in 2003, namely the 2008 financial crisis and the pandemic, the fact that the UK is what I would describe as truly sovereign, has played to our strengths.
I am not making a political point. Being sovereign in one’s own currency has significant advantages, and perhaps not in the way some people would automatically assume. It is not a question of having the ability to print money – no sensible country would want to misuse that sovereignty to debase its currency or to pursue deliberately an unnecessarily inflationary policy. The advantages of being a ‘true sovereign’ such as the UK are more subtle. They are about the government issuer being the undisputed issuer of the bond market benchmark and the central bank having the ability to operate monetary policy independently in the interests of that sovereign country’s economy. It is about flexibility and credibility within the institutional framework. It is, therefore, the ability to respond rapidly in a crisis, it’s about the co-operation between the institutions, the key institutions within the jurisdiction.
OMFIF: How do the mechanics of the new auction schedule work in terms of securities type?
RS: We divide up our conventional or nominal issuance into three approximate maturity buckets. First is what we call ‘shorts’, one to seven years. Most jurisdictions wouldn’t deem seven as short, but given our history of successful and consistent long dated issuance, in relative terms it is with us. Seven to 15 years is ‘medium’, and anything longer than 15 years is ‘long’. The UK has a lot of debt that is very long, through to 50 years, and those are maturities we issue in regularly.
We try not to print too much in the same maturity range on the same day. So, for instance, today’s auctions saw a combination of both a ‘short’ and a ‘long’ issued. We try to balance between the two because they represent two fundamentally different investor bases. Shorter maturities tend to have a much wider investor base and are also geographically more spread out. The longer dated sector, although it has some international interest, tends to be the domain of the domestic pension funds and life insurance companies. The idea is to approach the two investor bases with the appropriate products.
OMFIF: Has the proportion increased across the curve – you’re doing greater volumes of all maturities in proportion to pre-crisis?
RS: Absolutely. In proportional terms for conventional gilts, we’re probably doing a little bit more ‘short’ and ‘medium’ compared to 12 months ago. In absolute terms, everything has increased. We’re issuing a record amount of ‘longs’, and we intend to continue issuing them as much as we can – within reason – not least to balance out our issuance as much as possible. The UK is fortunate to have a viable curve all the way out to 50 years, and I stress ‘viable curve’. We have been and will be taking advantage of that longer dated demand. The reason we’ve done more shorts in the first few months of this financial year is that it’s a much deeper and more liquid market, so if you have to raise a lot of cash in a hurry, as we did, you can issue much larger amounts.
OMFIF: You mentioned earlier the international take-up. What proportion of gilt ownership is outside the UK?
RS: The latest numbers we have from the Office for National Statistics show the rest of the world appears to hold 30.1% as of end-March. To put that into perspective, pension funds and the insurance sector come to 32.4%. The pension industry has historically always been the largest sector. But to give you an indication of how markets change, when I joined the DMO, they accounted for more than 60% while the international investor base was merely around 15% or 16%. In relative and absolute terms, the international investor base has increased hugely. From a diversification perspective that’s probably to be welcomed.
OMFIF: Occasionally you’ll read newspaper opinion pieces about UK finances relying on the kindness of strangers. Do you think that that will continue to increase from the 30% you have now? Do you expect problems if the borrowing requirement continues to go up dramatically, and the economic performance goes down?
RS: A recurring feature over the last 15 years has been that any concerns that may have been felt by the international investor base over the macroeconomic picture have not usually had an obvious impact on the bond market. In general, capital flows are more immediately felt in currency markets. This goes back to my earlier remarks about being a sovereign with one’s own currency. In those circumstances the currency tends to act as something of a safety valve or stabiliser. The immediate market impact of the Brexit referendum was all on sterling. Gilt prices rose and yields actually fell.
We’re not the world’s largest reserve currency, that is still obviously the dollar. Sterling also forms a much smaller part of the global reserves than the euro does. But sterling is not totally insignificant, either. Reserve managers globally have increased their holdings of sterling over the last 20 years or so. If there is a fall in the value of the currency, one thing we’ve always seen is that the demand for gilts actually tends to increase because international investors and reserves managers then have a need to rebalance their portfolios to maintain the same percentage holding relative, for instance, to the dollar. There’s an interesting dynamic at play here and one which is perhaps a little counter-intuitive.
OMFIF: Speaking of reserves managers, what proportion of those gilts is owned by central banks, to your knowledge?
RS: I can’t give you an exact figure. I can only refer to the 30% internationally. But I would say, in my opinion, that more than half of that 30% is likely to be owned by central banks or official institutions.
OMFIF: On to the Bank of England and its quantitative easing activities with respect to UK sovereign securities. How important is that in respect of your funding requirements?
RS: I don’t think it is of direct significance to the actual funding mechanism per se. But I do think it is of indirect importance in as much as it acts as a stabilising influence on the wider market. It is really important to emphasise that QE in the UK as carried out by the Bank of England is done independently, decided by the monetary policy committee, completely independent of anything we or the Treasury do. We only can watch with interest.
QE is not done to fund the government in any way, as the BoE has made abundantly clear. A significant factor in the QE that was announced in March was that it was also about stabilising financial markets, which is of course what you’d expect a central bank to do if it deemed it necessary or if it feared that an important part of its monetary policy transmission mechanism might otherwise be impaired. I think that distinction is really important. The BoE does not and never has in its QE operations bought directly from us. It even deliberately excludes from its QE purchases any gilt that we happen to be issuing, not just on the day, but for a full week before and after.
In other words, the Bank operates only in the secondary market, it has helped to stabilise market functioning – not just for us as an issuer but also for the investor base. Serious market participants would not want to get involved in a market that in their view doesn’t function properly or was being improperly influenced.
It would be wrong to say, as some do, that ‘you couldn’t fund yourself without the Bank of England in there’. We might theoretically not be able to finance ourselves at exactly the same yield levels than at present, but the market would certainly be able to find a clearing price somewhere, in the absence of the BoE.
It’s also important to remember that the monetary policy committee – at the time of their choosing – can always unwind QE. We don’t know when that will be. We have no input in that, quite correctly.
I would also note that when we issued a new 2061 bond via syndication some weeks ago, we had the biggest, most diverse order book we have ever seen for such an operation. The BoE was not involved at all. That order book in no way represented demand from our central bank. What we saw were real private sector gilt investors buying, and it’s important to emphasise that.
OMFIF: If the Bank of England were to start reversing QE and that process put upward pressure on yields, and if the fiscal deficit was very large, and interest payments were large, would the Treasury and DMO have to break the traditional boundaries of communication and co-operation with the Bank of England? Or is the current framework robust enough to deal with that situation?
RS: I generally think it’s robust enough. Having said that, it’s never been tested in that way, so far. But there’s no reason why it wouldn’t be the case. The independence that the BoE enjoys over the operational implementation of monetary policy is written in statute.
I would add that the one thing the BoE has always said, and obviously we talk to them about operational matters, is that if and when it comes to unwinding QE, they will do so in coordinated way for the purposes of supporting a well-functioning market. I want to stress from where we sit as debt managers: we don’t try to target an absolute level of yield for our operations. We are a price taker, not a price maker.
OMFIF: The BoE, Treasury and DMO have their reaction functions, and you get a bit of a headache trying to think through different scenarios and how the different reaction functions will feedback on each other. But if you have monetary sovereignty, then you have the flexibility to co-operate within current frameworks, but it’s co-operation rather than collusion.
RS: You phrase it well. Market credibility is hard won but lost very easily. The market tends to be sceptical and would immediately pick up on what you describe as collusion, which I can assure you does not take place.
It would anyway be most self-defeating. The institutional boundaries are important, and if these are respected then markets are more likely to give us the benefit of the doubt, which also enables the BoE to implement monetary policy in the way that it does. That’s not because the market is credulous. You can’t survive in the market by being credulous. It is because the market assigns credibility to those institutional boundaries.
OMFIF: What is the scope for green or environmental, social and governance-related issuance from the UK DMO?
RS: We’re watching this area with interest, especially the broader ESG category. I would say that governments are in an ideal position when compared to the private corporate sector. A corporate may feel the need to underline their ‘green’ credentials through the issuance of a green bond. A government can arguably do more. It can make environmental regulations and pass legislation that supports a wider ESG agenda. There is no doubt that the investor base is changing in this arena. For that reason, I would rule nothing out in this area.
OMFIF: Many thanks for taking the time to talk to us today.