Stheeman: DMOs must maintain health of primary dealer system

Departing UK bond chief highlights ‘ongoing challenge’ of supporting banks

Robert Stheeman, the departing chief executive of the UK Debt Management Office, has called on his peers to work ‘very, very closely’ with their primary dealers to ensure the model is fit to last. This follows ongoing concerns of the costs and constraints for banks facilitating government debt.

Speaking to OMFIF in a podcast ahead of his retirement at the end of June 2024, Stheeman said one of the biggest challenges for DMOs is to maintain the health of the primary dealership model.

‘That’s something we are very focused on because each time we go to the market with an offering, we are effectively leveraging off the balance sheet capacity of the primary dealers,’ said Stheeman. ‘We need them to intermediate our supply and the demand coming from the investor base. They have to effectively put their balance sheets – their risk capital – at our disposal. That is going to be an ongoing challenge in the future.’

Stheeman added this challenge ‘can be met’. However, ‘it does point to the need for the [UK] DMO and for other DMOs globally, to work very, very closely with their primary dealers to ensure that distribution capacity is facilitated as far as we can’, he added.

Since the Covid-19 pandemic, the debt issued by many governments has stayed at a high level. As a result, primary dealers – the banks that buy and trade these bonds – have had to increase their commitment and obligations, adding to the costs and pressures for banks. Evidently, in the current fiscal year, the UK DMO is planning its second highest annual sale of gilts with £277.7bn of issuance planned.

To help their primary dealers, DMOs in recent years have been looking to add incentives for their dealer banks to keep the system financially viable. But smaller sized banks are still struggling and as a result, are exiting the business.

Hedge funds stepping up

It is not just the costs associated with managing government debt, but the balance sheet constraints of banks limiting the liquidity provisions and risk-taking capacities they can make. This has led to hedge funds taking a more active approach in both the primary and secondary markets, leading to speculation that they could become primary dealers alongside investment banks.

‘One of the perhaps unsung roles that a hedge fund can play is to take a contrarian view sometimes in the market,’ said Stheeman. ‘If the market is all positioned one way, unsurprisingly, you’re going to see movement going in one way. A one-way position does not necessarily mean greater liquidity. A hedge fund that takes a contrarian view to the dominant market view at a given time, is effectively taking the other side of the trade and that, in itself, can aid liquidity enormously.’

In addition to hedge funds, another increasingly important set of investors for the UK government bond market is international accounts – which have become the biggest segment of the overall gilt portfolio. The growth of international investors has occurred in parallel with gilts having a bigger share in global bond indices as well as an increased share of sterling in central bank reserves.

Appointment of Jessica Pulay

After over 20 years of UK government debt management and oversight, Stheeman will be succeeded by Jessica Pulay, who will become the first female chief executive of the UK DMO. Pulay brings with her a wealth of experience in debt capital markets, such as being co-head of policy and markets at the UK DMO since 2015.

‘The ability that the Treasury has, in terms of cyclical continuity, is massively enhanced by her appointment,’ said Stheeman. ‘I also know that she will understand the value of engaging with the market very closely, staying very, very close to the market. If somebody says what is important to us in the future, it is the ability to make sure that we are never captured by the market but that our decisions are informed by really good experience and market knowledge. As far as her appointment is concerned, she fits the bill exactly.’

Listen to the full podcast featuring Robert Stheeman reflecting on over 20 years of managing UK government debt, including dealing with crises, how the gilt market has evolved, the state of liquidity and more.

Burhan Khadbai is Head of Content, Sovereign Debt Institute, OMFIF.

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