1.   Whether the new framework for managing cash and debt established since 1997 will be coherent and effective and whether any further changes are needed?

  a.  CSFB endorses the current framework for the UK debt management, and we believe that the framework for cash management will also be successful. We believe that this framework is transparent, yet sufficiently flexible to allow the Debt Management Office to introduce new products and new mechanisms, as appropriate.

  b.  Within the framework, the Debt Management Office has chosen (or chosen to continue with) certain products and certain market mechanisms. We agree with most (but not all) of these: but the framework itself allows the DMO to evolve to meet the Treasury needs in the most price-efficient manner.

  c.   Example 1. We have long argued for switch-auctions. We suggested that these would have two-fold benefits. They would help avoid the market dislocation as large gilts drop through the 15-year boundary (and allow the taxpayer to benefit from these dislocations). Switch-auctions also allow the government to avoid paying large bullet cashflows when gilts mature: in the last few years before maturity, some or even most of large stocks could be moved longer as their maturity approaches. The debt management framework is sufficiently flexible to allow these switch-auctions, and the DMO conducted its first in October.

  d.   Example 2. Again, we have long argued for a permanent non-discretionary repo facility. This too is allowed by the debt management framework, and the DMO is consulting about such a facility.

  e.   Example 3. The mechanism by which debt is auctioned imposes unnecessary risks on GEMMs, who charge for these risks by bidding less. A better mechanism (described in the enclosed[1]) would reduce the risks inherent in the auction (for both seller and buyer), and thus improve the sale price. The current framework allows the DMO to adopt a more modern auction mechanism—we hope that it will.

  f.   Example 4. The DMO could further reduce the risk taken by the market, and thus improve its average sale price, by selling call options on debt; the debt itself being sold via exercise of these options. This would reduce market volatility and thus increase market participation. Again, the current framework is sufficiently flexible.

  g.  In short, we believe that the framework for the management of the debt is coherent, and that the DMO is implementing it well.

  h.  However, there is a substantial distortion in the UK gilt market, caused by the huge excess of demand over supply for long-dated gilts.

  i.  A contributory cause, in our opinion, is the Minimum Funding Requirement. This requires that pension funds be solvent, and that they measure their liabilities using gilt yields. These requirements push funds into ensuring that their assets are valued using gilt yields—ie, that their assets are gilts.

  j.  As funds have purchased gilts, gilts have outperformed other near-gilt assets (such as long-dated non-gilt sterling debt issued by top-rated borrowers). This gilt outperformance has made the other debt an even worse substitute for gilts, so pushing more pension funds into gilts.

  k.  This self-reinforcing cycle has driven the yield of the 6 per cent December 2028 gilt to a mere 4.22 per cent. Note that the government receives very little benefit from this low yield, as it sells very little debt.

  l.  And non-government borrowers don't benefit fully, as their credit spreads (the additional yield that a non-government borrower must pay) have increased hugely. For example, the European Investment Bank sold a 6 per cent December 2028 bond in March 1998, at 0.25 per cent over the 6 per cent 28 gilt, it is now 0.95 per cent over. As a second example, in July 1998 the British Airports Authority issued a 6.375 per cent August 2028 bond at 1.03 per cent over the 6 per cent 28 gilt: it is now 1.64 per cent over.

  m.  An important part of the solution, in our opinion, is a change to the MFR regulations. We note that US law values liabilities using "reasonable actuarial assumptions". Our preferred wording for the UK would have liabilities discounted at "any prudent combination of the yields of gilts, interest-rate swaps, corporate debt, and the debt of other sound borrowers". Indeed, the Accounting Standards Board, in its Financial Reporting Exposure Draft 20, published on 4 November, mooted valuing liabilities at the yield of an AA corporate bond, inflation-adjusted where appropriate (paragraphs 20 and 27).

  n.  However, we recognise that any change to the MFR cannot happen quickly. But fortunately, there is an action that the government could take sooner, that would benefit both the government's own finances and also the other users of the markets.

  o.  The government has an overdraft (the "Ways and Means account") with the Issue Department of the Bank of England, which is to be frozen at an expected £17 billion. Rather than funding this overnight (the BoE charges daily interest at its repo rate) it would be cheaper for the government to fund or part-fund this debt with long-dated gilts.

  p.  It should be noted that, repayment of this overdraft is necessary for EMU membership (though repayment in securities is permitted under EC Regulation 3603/93). However, repayment of the overdraft could be construed as a prudent step, irrespective of EMU plans.

2.   Whether the government has sought an appropriate balance between gilts and National Savings products in financing debt?

  a.  No submission.

3.   How appropriate and attractive are the products offered by the DMO and National Savings to the needs of government and the relevant consumers?

  a.  At a micro level, we fully support the DMO's continuing to issue strippable conventional debt, paying fixed coupons on 7 June and 7 December. Stripping of debt will become more active when the yield curve next turns positive.

  b.  As already remarked, we believe that there are possible improvements to the primary issuance mechanisms.

  c.  There is also a broader portfolio question: what the maturity structure of a government's debt should be? We believe that a sovereign government issuing debt in its own currency should overweight the issuance of long-dated debt. We recommend this because maximising the average life of outstanding government debt acts counter-cyclically on the real economy, softening recessions and dampening inflationary spikes.

  d.  During recessions interest rates are cut and bonds rally, effectively transferring wealth from the government to the financial sector. On the other hand, when inflation is high, bonds fall in price, thus transferring wealth from the financial sector to the government. This transfer of wealth is counter-cyclical. Maximisation of this counter-cyclical wealth transfer occurs when the outstanding debt is as long-dated as possible.

  e.  However, there is an important caveat. If the UK is to enter EMU (now or later), then why should the UK take upon itself now the burden of acting counter-cyclically in the future on the whole euro zone? Instead, in a pooled-sovereignty arrangement, the UK's optimal strategy is to issue in whichever manner minimises the cost of funding. But, by chance, because of the demand-side distortions caused by pension-fund regulation, the lowest-cost issuance for the UK at the moment is long-dated paper.

  f.  Hence, whether the UK be in or out of EMU, we advocate over-supplying long-dated gilts.

4.   How transparent is the system by which the Government's cash and debt requirements are managed and what improvements in transparency could be made to facilitate parliamentary scrutiny?

  a.  We believe the system by which the Government's debt requirement is managed is highly transparent. The gradual increase in detail (from the annual remit, via the quarterly funding statement, to the individual auction announcements) works well, and is used elsewhere.

  b.  We have no reason to believe that cash management will be less transparent than debt management.

  c.  Indeed, it seems that any substantial increase in transparency would necessitate more frequent PSBR forecasts from the Chancellor.

5.   How does the Treasury carry out its monitoring role and how could this be improved?

  a.  No submission.

6.   What impact has the privatisation of the former Paymaster Agency and the National Savings partnership with Siemens Business Services had on the services provided by these departments?

  1.  No submission.

November 1999