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At the ceremony to open the new offices of Agency France Trésor, Laurent Fabius, the Minister of the Economy, Finance and Industry, announced a set of innovations in the management of France's government debt.
The government is to reduce the average maturity of its debt from 6 years and 4 months today to 5 years and 6 months by the end of 2002. Agency France Trésor will achieve this objective through trading on the interest-rate swap market. Its transactions will be surrounded by safeguards and strict limits. The trading schedule will be as regular as possible and transactions will be suspended during periods of excessive volatility.
In addition, the government will buy back bonds worth some 12.5 billion euro in the second half of 2001. The buybacks should help to achieve the objective of reducing the average maturity of French government debt. The government will buy back bonds through over-the-counter transactions and reverse auctions.
Finally, the French government has decided to issue the first OAT indexed on European inflation (excluding tobacco). This decision is intended to continue the development of the European market for inflation-indexed bonds, which France started in 1998 with the launch of the OATi. The new issue will attract a wider group of investors by using the European inflation index.
The development of the Agency France Trésor, which manages the government's treasury and debt, is a good example of the reforms taking place within the Ministry of the Economy, Finance and Industry. The Agency was officially inaugurated in February 2001. Its transparent and efficient action ensures that the government obtains financing on the best terms and in the best interest of the taxpayer.
Press kit accompanying this news release:
Data sheet no. 1: General principles on the management of government debt and treasury
The government's negotiable debt is managed based on several general principles: simplicity, liquidity, transparency and risk control.
1. Simplicity: the government's negotiable debt can currently be broken down into three basic categories of standardised euro-denominated securities that are distinguished by their maturity at the time of issue: fungible Treasury bonds with maturities greater than 5 years (OAT); 2 to 5-year Treasury notes with fixed rates and annual interest (BTAN); and less than 1-year fixed-rate Treasury bills (BTF).
2. Liquidity: investors may wish to sell the securities they hold prior to their maturity date or, conversely, purchase securities on the secondary market. For this reason, the existence of a large, active secondary market for all the securities that constitute the government debt (debt liquidity) is a central component of the market and helps assure the best issuing terms and, therefore, lower borrowing costs for the taxpayer. Assuring this liquidity is one of the basic functions of the primary dealers in government securities (SVT[1]).
3. Transparency: the transparency of the government's issuing policy is one condition of the success of the issues, because it determines, to a large extent, the ability of the SVTs to subscribe the issues and thus to fulfil their basic function. The effort to achieve this transparency is based primarily on the principle of regular auctions, which place subscribers in public competition. Another important factor is the presentation at the end of year "n-1" of the government's indicative medium and long-term funding program for year "n", as well as the ongoing publication of information about the issue and management of government debt through a variety of media, including written publications, the webside, Reuters and Bloomberg pages, etc.
4. Risk control: Despite the specificity of its activities, the government, in its capacity as treasurer and borrower, is exposed to risks similar to those affecting financial institutions. There are three basic types of risk: the risk intrinsic to projections/actual gaps; market and credit risk; and operational and computer risk.
In order to manage these risks and pursuant to Article 5 of the ministerial decision of 8 February 2001, Agency France Trésor is now equipped with a procedures guidebook and an ethics charter published in a decision dated 18 September 2001. The procedures guidebook is based on the general principles defined in Regulation 97-02 of the Comité de la réglementation bancaire et financière (CRBF) on internal control systems for credit institutions. It has been adapted to the agency's specific characteristics and missions, and defines the general framework within which the agency operates.
5. A culture of innovation must be a constant objective backing up each of these principles so as to strengthen the government's position as the benchmark issuing entity. In recent years, the search for innovation, a guiding principle of the government's issuing policy, was expressed:
- in 1999, by the creation of the inflation-indexed OATi[2] with a 30-year maturity;
- in 2000, by the establishment of a major buy-back programme through OTC operations and reverse auctions;
- in 2001, by the set-up of a swap portfolio (interest rate swaps) and the initiation of a study regarding issuing an OAT linked to a European inflation index.
[1] These are 21 French and foreign financial institutions chosen by the government to help it invest its debt securities. The most recent selection was made on 16 July 2001.
[2] The OATi is a fixed-rate interest-bearing bond; its principal is guaranteed to be repaid at par, and it is protected against inflation since it is indexed on a daily inflation reference calculated using the INSEE consumer price index exclusive of tobacco.
Data sheet no. 2: Tools traditionally used to manage the government debt and treasury
In order to ensure, under all circumstances, that the government is in a position to fulfil its obligations and that its account on the books of Banque de France does not show a debit at the end of the day, which would violate the provisions of the Maastricht Treaty, Agency France Trésor has recourse to cash flow forecasting instruments as well as a variety of traditional financial instruments ranging from "day to day" bank loans to the issue of 30-year bonds. These instruments are supplemented by risk control tools.
a) cash flow forecasts: Agency France Trésor provides a focal point for the government's short-, medium- and long-term cash flow forecasts in order to fine-tune, in particular, the programme for the issue of BTFs over the next 12 months and to optimise short-term investment opportunities (delivered repos, money market deposits, transactions with euro-zone Treasuries, short-term buy-backs, etc.). Thanks to a major interdepartmental effort, the extended scope of preliminary announcements by Treasury correspondents and authorising officers is resulting in increasingly accurate forecasts.
b)market instruments:
• the funding programme: the following table provides an estimate for 2002 of the government's borrowing requirement and of the funding programme.
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(*): Excluding effect of 2001 buy-backs
(+) IBA: Initial Budget Act
• cash management instruments: BTF issues, an important tool for managing intra-year cash-flow slippage, are supplemented by a wide range of instruments designed to refine this management and to minimise the cost to the taxpayer as much as possible. These include reverse government securities repos since 1995; government securities repos since 1998; borrowings on the euro interbank market or from other European governments since 1999; deposits on the euro interbank market or with other European governments since the beginning of 2000; and short-term buy-backs of securities becoming due.
c) management and risk control instruments:
A contractual audit report describing the precautionary procedures implemented by the Agency is published each year. Various instruments have also been developed:
• Accounting: The set-up of an accounting framework based on bank accounting and related controls (use of an audit trail, periodic reconciliation between accounting and the back office, counter-analysis of the results) is a major element of the risk control system. It is currently being finalised.
• Information system: An audit of the information system was conducted by a specialised firm. This firm recommends the creation of a modular structure that responds to the specific needs of the agency's different activities.
• Margin calls and internal limits when carrying out the swap programme: They must allow the swap programme to be carried out with the highest degree of security (see data-sheet).
• Lines of credit have been negotiated with a number of banks that can be used at the end of the day in the event that the agency does not receive the expected amounts from its counterparts.
Data sheet no. 3: New policies and objectives
The objectives outlined below concern the management of government debt (A) and treasury (B).
a/ Issue and management of government debt
The goal of the government's issuing policy is to ensure that its borrowing requirement is always covered by having recourse to the market under the best rate conditions possible in order to minimise the burden of debt service for the taxpayer. In addition to the principles laid out and implemented for more than fifteen years (simplicity, liquidity, transparency and risk control), the creation of Agency France Trésor at the beginning of 2001 and the decision to set up a portfolio of interest rate swaps have helped modernise this policy.
Indeed, the need for liquidity and for risk control on refinancing had for many years resulted in a debt structure with a relatively long average maturity. An econometric model used to simulate various changes in interest rates was created by the Agency in close cooperation with financial market professionals in order to determine the effects of changing the average maturity of the government's debt. Reducing the average maturity of the debt makes it possible a priori to decrease the average burden; this results, however, in greater potential variation, i.e. the likelihood that the burden will rise or fall sharply from one year to the next. This conclusion is based on the observation historically and empirically that, on average, short-term rates are lower (existence of a risk premium). It would be difficult to achieve the goal of reducing the average maturity of the debt simply by changing the policy on primary issues, as this would risk jeopardising the quest for liquidity and decreased exposure to sharp fluctuations in the market. The use of a swap portfolio, which provides an additional degree of freedom, makes it possible to separate, in part, the maturity of the government securities issued from the average maturity associated with the rates at which the government debt is repaid.
Based on the conclusions drawn from this model, the Minister of the Economy, Finance and Industry has targeted a decrease in the average maturity of the government debt. This goal of reducing the average debt maturity is shared by many other governments: Germany has announced its intention to reduce the average maturity of its debt from 5.3 years to 4.5 years. The Netherlands, Belgium and Spain also appear to be ready to commit to such policies. The average maturity targeted by the Minister is 5 years and 6 months by the end of 2002.
Objective: to reduce the average maturity of the negotiable debt
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The goal of reducing the average maturity of the debt will be achieved through the coordination of an interest-rate swap portfolio with, if necessary, a change in the government's issuing policy (without incurring exposure to serious refinancing risks). At this preliminary stage, this action could be presented as follows:
The swap program will mainly be carried out to enable the government to receive a fixed rate on long maturities (10 years and 30 years) and to pay a variable rate on short ones. Transactions in the opposite direction could also be used so that it receives the intra-year variable rate and pays the rate associated with intermediate-term maturities (1, 2 and 5 years), in order to minimise the volatility of the debt burden. The associated budget savings should be approximately 200 million euros in 2002. To meet the goal of reducing the average debt maturity, the nominal outstanding swap amounts could reach the following amounts:
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b/ Management of the government treasury
The Treasury balance on the books of Banque de France must always be in credit. The sums deposited into this account generally receive interest at a lower rate than that of the interbank market (the day-to-day "money market"). It is therefore advisable to keep the outstanding credits on this account to a minimum and to invest the short-term surplus on the market.
Objective: Reduction of the end-of-day amount in the Treasury account at Banque de France: this involves setting up government treasury management that comes as close as possible to a "zero" cash position. This target is reflected concretely in the average daily balance of the Treasury account at Banque de France. Any short-term surplus will be invested on the market (see below). The objective for 2002 is to reduce the average daily balance to 200 million euros (as opposed to 500 million euros currently). Meeting this goal presupposes an improvement in the accuracy of the revenue and expenditure estimates of a large number of government departments and their correspondents. It therefore reflects a major commitment to strict management, especially as regards financial administrations.
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Objective: Investment of any short-term treasury surplus at the best return: The goal is to make use of continuous improvements in the methods of forecasting and intervening on the markets in order to increase the average level of returns on government liquid investments in the interbank market. To do this, the government can make use of repo and reverse repo agreements as well as borrowings and deposits on the interbank market and from and with other European governments. The goal is to obtain returns that are as close as possible to the short-term market rate (EONIA - Euro OverNight Index Average). These policies involving active cash management are based on short-, medium- and long-term estimates of the government treasury. They are also linked to issues of short-term securities.
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(1) The government has been able to make deposits on the interbank market since the beginning of 2000.
Data sheet no. 4: Budgetary impact
a) Net debt service
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b) Resources of Agency France Trésor
The mission of Agency France Trésor, created 8 February 2001 by a decision of the Minister of the Economy, Finance and Industry, is to manage the government debt and treasury. It is a department with national responsibilities that comes under the authority of the Treasury Director, and is responsible for implementing the above-mentioned programme. To this end, it has financial, technical and human resources at its disposal that are funded by the budget of the Ministry of the Economy, Finance and Industry. These operating costs can be broken down as follows:
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Data sheet no. 5: Interest-rate swap program
1- On average, the interest rate curve shows a positive slope over time.
The rate at which the government can incur debt on short maturities (3 months, 1 year, etc.) is, on average, lower than the rate it must pay on longer-term debt. One of the main assumptions of financial theory is that the interest-rate curve increases with maturity, which reflects the existence of risk premiums. Since 1994 (which does not include the periods of monetary crisis during which French short-term rates were especially high in order to defend the franc), the slope in France was positive in 95% of all cases and averaged approximately 160 base points (for 3-month to 10-year rates). The situation in France was not exceptional, and in the United States and Germany the averages were 120 bp and 200 bp, respectively. Recently, of course, the curves have levelled off, particularly in the United States and the United Kingdom.
2- We can use this theoretical assumption, which has been proven statistically, to attempt to reduce the average cost of debt. The trade-off, however, would be an increase in the volatility of interest charges from one year to the next.
The above analysis lends credence to the assumption of a rate curve that grows with maturity. Based on this assumption, reducing average debt maturity should lower the associated interest charges. The reduction will not be systematic, but should have concrete results in the long term. In return, reducing the average maturity of the debt or the rate at which it is repaid means that a larger portion of the debt or of debt rates is renewed annually, which makes for a greater fluctuation in interest charges.
Such a reduction, therefore, implies two risks:
1- Although interest charges are reduced on average, the fact that they are more spread out and subject to greater variation could lead to sharper rises or falls in interest charges.
2- This would also make annual interest charge estimates less reliable, since a larger portion of the debt would depend on shorter-term rates, either directly or indirectly.
3- A simulation exercise was conducted to obtain a better understanding of these issues and to assess the effects of different issuing strategies. The simulations clearly demonstrate the advantage of reducing the average maturity of the debt, which is currently 6 years and 3 months.
Reducing the average maturity of the debt must be based on an analysis of both the expected advantages and the associated risks. Simulations can be used to better understand these different elements and to make it possible to determine the effects of decreasing the average maturity of the debt based on hypotheses on trends in average rates, growth and inflation.
These simulations were carried out by Agency France Trésor, in an ongoing collaboration with the primary dealers in government securities ("SVT"). The results clearly demonstrate that reducing the average maturity of the debt helps reduce debt costs over the long term without engendering excessive risk. This average maturity, which is currently 6 years and 3 months, could be reduced gradually by almost 2 years. The goal is to make half this reduction by the end of 2002.
4- This reduction cannot be achieved merely by changing the policy on primary issues, but also requires the use of interest rate swaps.
The purpose of primary issues is to satisfy long-term borrowing requirements in a way that ensures the liquidity of the securities market. This goal places restrictions on the size of the lines, which limits the possibility of adjusting average debt maturity simply by using the policy on primary issues.
The creation of a swap programme, which changes the overall structure of exposure to rates having different maturities, will make it possible to achieve the target for average debt maturity set by the Ministry. Agency France Trésor will agree interest rate swaps with financial counterparts selected from the list of SVTs. The swaps will mainly be carried out to enable the government to receive a fixed rate on long maturities (10 years and 30 years) and to pay a variable rate on short ones. Transactions in the opposite direction could also be used so that it receives the intra-year variable rate and pays the rate associated with intermediate-term maturities (1, 2 and 5 years), in order to minimise the volatility of the debt burden.
Several European countries have also taken measures to reduce the maturity of their debt, which will lead to more interest rate swap transactions. Thus, in the next few months many governments will be taking similar action on the market. Although the European market appears to be large enough to handle this demand, the programme set up by the Agency will be phased in gradually and will be closely tied to market reaction.
Data sheet no. 6: Buy-back programme
In the second half of the year, Agency France Trésor is redeeming approximately 12.5 billion euros in government bonds as part of its active management policy.
These buy-backs are enabling the Agency to increase its gross issuing programme to 91.5 billion in order to ensure sufficient liquidity for the new benchmarks, specifically the January 2004 and 2007 BTANs and the October 2011 OAT, while adhering to the net issuing programme of 79 billion.
The terms and conditions of the buy-back programme for the end of 2001 are identical to those applied in 2000:
1 - AFT is focusing its buy-back programme on bonds that are in demand from market players and offer advantageous prices. It is, however, making sure that the liquidity of all its securities is maintained.
2 - These buy-back operations contribute to the goal of reducing durations in the medium-term. Thus they involve the bonds included in the attached list.
3 - AFT uses both OTC transactions and reverse auctions. OTC transactions are used exclusively for securities with a maturity of less than 18 months. Other securities are traded through reverse auctions based on market conditions.
4 - AFT will hold all its reverse auctions before mid-December, following the same principle used for traditional auctions. The dates of the auctions will be announced one week beforehand.
5 - Up to 6 bonds will be offered at each auction. The securities involved and the maximum buy-back amount will be specified five banking days prior to the auction date. Of course, Agency France Trésor reserves the right to not carry out the buy-back of a security if, in its opinion, the bids offered are not advantageous.
AFT has already issued 71 billion in OATs and BTANs since the beginning of the year and buy-backed 3.5 billion in November 2002 OATs and July 2002 BTANs.
List of bonds subject to buy-backs
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Data sheet no. 7: Launch of the OAT indexed on the European price index
Laurent Fabius, Minister of the Economy, Finance and Industry, recently decided to launch in October a new OAT indexed on the euro-zone price index excluding tobacco (the harmonised CPI, or "HCPI", excluding tobacco) established by Eurostat. This decision was made upon the recommendation of Agency France Trésor and in light of the studies conducted by the three consultant banks appointed in July: Barclays, Deutsche Bank and Société Générale.
This new OAT, the first bond indexed on the HCPI, will be the initial point on the curve reflecting actual euro-zone rates, and therefore an indisputable benchmark for all European sovereign debt. Its unique characteristics - full protection against inflation and "benchmark" status - account for the enthusiasm expressed during the first phase of the consultation in France by investors from both inside and outside the euro zone.
The HCPI-indexed OAT is a natural but crucial phase in the development of the indexed market initiated in 1998 with the launch of the 2009 OATi. It bears out AFT's ongoing pursuit of innovation and falls under the heading of modernising debt management. This new OAT will thus play a role in reducing the debt burden, promoting government securities and broaden the range of those holding French government bonds.
The exact details of the operation will be provided to French and foreign investors at the start of a promotional phase scheduled to take place 8-18 October. The operation will be completed by the end of October. During and following the launch of the HCPI-indexed OAT, AFT will ensure that the OATi market continues to function properly and will offer current OATi holders the option of exchanging their 2009 OATi's for the new HCPI-indexed OAT, subject to conditions still to be defined.