Archived - Debt Management Report 2003–2004 : 1

- Table of Contents - Next -

Foreword by the Minister of Finance

I am pleased to table before Parliament the Government of Canada’s Debt Management Report for fiscal year 2003–04. It provides accountability by outlining in detail the financial management of Canada’s debt.

Canadians today are reaping the rewards of sustained fiscal responsibility. The previous "vicious cycle" of annual deficits, rising debt, higher interest rates and high taxes has been replaced by a "virtuous circle" of seven consecutive budget surpluses, a declining debt burden, rising consumer and business confidence, the largest tax reductions in Canadian history, low interest rates and consistently strong economic performance. This has enabled us to reduce the federal debt by more than $61 billion since we balanced the budget in 1997–98, while maintaining the resources needed to deal with recent security threats, health emergencies like severe acute respiratory syndrome (SARS) and the impact of bovine spongiform encephalopathy (BSE). This fiscal responsibility also enabled the Government to provide $36.8 billion in funding over five years under the 2003 First Ministers’ Accord on Health Care Renewal—funding that will be key to ensuring timely access to quality health services for all Canadians.

Such prudence with a purpose means our debt-to-GDP (gross domestic product) ratio today stands at 41.1 per cent, its lowest level since 1983–84. In the process we have freed up $3 billion in reduced interest charges every year that can now be invested in national priorities. As I indicated in the 2004 budget, we will maintain this responsible, prudent approach with a goal of reducing Canada’s debt-to-GDP ratio to 25 per cent within 10 years.

This year’s Debt Management Report highlights ongoing efforts to improve the management of our debt. Examples over the past year include:

• Reducing debt costs by beginning to gradually lower the fixed-rate debt component from two-thirds to 60 per cent.
• Maintaining an efficient, well-functioning market for Government of Canada securities through such measures as a bond buyback program.
• Encouraging a broad group of market investors in Government of Canada securities.
• Continually ensuring the federal debt program is well managed.

By never wavering from the "bottom line" of balanced budgets, the hard-earned rewards of fiscal responsibility will continue to ensure a prosperous future for our country.

The Honourable Ralph Goodale, P.C., M.P.
Minister of Finance
Ottawa, December 2004

Purpose of This Publication

The Debt Management Report provides a detailed account of the Government of Canada’s borrowing, cash and foreign exchange reserves management operations over the fiscal year from April 1, 2003 to March 31, 2004.

It provides a comprehensive report on the environment in which the debt is managed, its composition and changes during the year, and strategic plans set out in the 2003–04 Debt Management Strategy, published in March 2003. A set of reference tables containing statistics on the operation of debt programs is also provided.

The information contained in this report is designed for a range of interested parties to ensure transparency and public accountability in the Government’s borrowing and cash management activities. The Debt Management Strategy and the Debt Management Report are tabled annually in Parliament and are available on the Department of Finance Web site at www.fin.gc.ca.

Federal Debt Management Strategic management of the federal debt focuses on two key elements: market debt, and liquid financial assets of the Government of Canada. As of March 31, 2004, the Government had $440.2 billion of market debt composed of marketable bonds, Treasury bills, retail debt, foreign currency debt, Canada Pension Plan (CPP) bonds and obligations related to capital leases, and $61.7 billion of liquid financial assets composed of domestic cash balances and foreign exchange assets.    (C$ billions) Market Debt    Payable in Canadian currency     Marketable bonds      (fixed-rate bonds with 2-, 5-, 10- and 30-year maturities     and real return bonds with 30-year maturities) 278.8   Treasury bills    (zero-coupon securities with 3-, 6- and      12-month maturities) 113.4   Retail debt    (Canada Savings Bonds and Canada Premium Bonds) 21.3   CPP bonds 3.4   Obligations related to capital leases 2.8  Payable in foreign currency     Marketable bonds and foreign currency notes    (fixed-rate bonds, Canada notes and Euro     Medium-Term Notes) 17.1     Canada bills   (zero-coupon securities with 1- to 9-month maturities) 3.4 Liquid Financial Assets     Cash 20.5   Foreign exchange reserves 41.2

This document is structured as follows:

• Part I describes the fiscal environment in which the debt is managed and the composition of market debt, which the Government strategically manages.
• Part II reports on the 2003–04 debt strategy by major theme: risk/cost, liquidity, participation and governance.
• Part III provides details on activity in the individual domestic and foreign debt programs during 2003–04.
• Annexes explain the composition of the federal debt and the Government’s framework for managing financial risk.
• Reference tables provide historical information on the funding activities of the Government.

Overview

In 2003–04 the Government continued to reduce its level of indebtedness. On a full accrual basis of accounting the federal debt was reduced to $501.5 billion, down $61.4 billion from its peak in 1996–97. The 2003–04 budgetary surplus of $9.1 billion was used primarily to increase financial assets, which rose by $9.5 billion. Market debt declined by $2.2 billion while obligations to pensions and other accounts increased by $2.6 billion. Both other liabilities and non-financial assets increased by $0.6 billion. Debt-servicing charges were down $1.5 billion from fiscal year 2002–03 as a result of a 20-basis-point reduction in the average interest rate paid on the public debt. Since 1996–97 the cumulative reduction in indebtedness and reduction in the average interest rate have reduced debt charges by $11.5 billion. Lower debt-servicing charges benefit all Canadians.

The advent of a period of federal budgetary surpluses in the second half of the 1990s ushered in a new area in federal debt management—one focused on maintaining a well-functioning market for debt or fixed-income securities in an environment of declining borrowing needs. Over the past several years the primary focus of adjustments to government borrowing programs has been in this domain.

Debt, cash and reserve management actions in 2003–04 included the beginning of the orderly reduction in the fixed-rate share of the debt from a target of two-thirds to 60 per cent by 2007–08, with resulting adjustments to the sizes of the Treasury bill and bond programs. The fixed-rate share fell from 66 per cent to 64 per cent over the course of the year. The stock of Treasury bills increased by $9.0 billion to $113.4 billion, while the stock of bonds declined by $10.9 billion to $258.2 billion. Bond repurchases totalled $10.7 billion.

Operational refinements continued to be made to the debt program to improve its functioning, including moving the time of Treasury bill auctions to the morning (when the market is most active) and reducing the target size for the 10-year benchmark bond to maintain an annual benchmark cycle.

As part of good governance and management, different aspects of the debt program are reviewed periodically. These reviews are conducted internally at the Department of Finance and Bank of Canada or by external specialists. In 2003–04 reviews were undertaken on the governance framework, the retail debt program and the real return bond program.

This report also features indicators that are intended to provide interested parties with an understanding of some of the key measures that debt managers follow with respect to debt management programs and well-functioning securities markets.

Debt Strategy Framework Purpose Raise stable, low-cost funding for the Government of Canada. Principles and Objectives Well-functioning market Emphasize transparency, liquidity and regularity in the design and implementation of domestic debt programs in order to maintain a well-functioning domestic government securities market. Work with market participants and regulators to enhance the integrity and attractiveness to investors of the market for Government of Canada securities. Cost-effectiveness Manage the structure of the debt by balancing cost and risk to help protect the Government’s fiscal position from unexpected increases in interest rates. Minimize the cost of carrying reserves (i.e. the difference between interest paid on foreign currency liabilities and interest earned on reserve assets). Prudence Raise funding for domestic operational needs in Canadian dollars, and immunize currency and interest rate risks arising from the management of the foreign reserves by matching foreign liabilities to reserve assets. Manage the Receiver General cash position to ensure that cash balances are maintained at reasonable cost to the Government. Control credit risks through diversification. Borrow using a variety of instruments, a range of maturities and a diversified investor base. Consultations Seek input from market participants on major adjustments to the federal debt, cash and reserves management programs. Best practices Ensure that the operational framework and practices are in line with the best practices of other comparable sovereign borrowers and the private sector.

Part I: Debt Management Context

Since the annual debt-servicing cost is the largest single budget expense of the Government, effective management of the federal debt is especially important for all Canadians. This section provides an overview of the Government’s fiscal plan and the composition of the debt stock. The Government’s fiscal position sets the context within which debt management decisions are taken. One of the key decisions of debt management relates to the composition of the debt stock, which directly affects debt costs.

The Fiscal Plan

Budgetary Outcome

Canada has experienced a remarkable turnaround in its fiscal position in recent years: the Government recorded a budgetary surplus of $9.1 billion in 2003–04, its seventh consecutive budgetary surplus; the federal debt has been reduced by $61.4 billion from its peak in 1996–97; the federal debt-to-GDP ratio has fallen 27.3 percentage points from its peak of 68.4 per cent in 1995–96 to 41.1 per cent in 2003–04, its lowest level since 1983–84 (see Chart 1); and fiscal and monetary policy credibility have contributed to lower interest rates. For detailed information, see the 2003–04 Annual Financial Report of the Government of Canada at www.fin.gc.ca/toc/2004/afr_-eng.asp.

Financial Source/Requirement

The key budgetary measure for market debt management is the financial source/requirement. While the budgetary balance is presented on a full accrual basis, recognizing revenues and expenses when they are incurred, the financial source/requirement is a cash flow measurement that captures the current- and prior-year budgetary items, as well as the cash implications of non-budgetary transactions. As such, the financial source/requirement determines the changes in the market debt and in the level of financial assets.

The budgetary surplus of $9.1 billion and a net requirement of funds from non-budgetary transactions of $2.8 billion produced a financial source of $6.2 billion in 2003–04. This compares to a financial source of $7.6 billion in 2002–03 and a requirement of $0.3 billion in 2001–02.

The Government has recorded a financial source in six of the past seven years (see Chart 2). The financial source in 2003–04 was used to increase cash balances by $4.1 billion and to reduce market debt by $2.2 billion.

Public Debt Costs

In 2003–04 the Government spent 19 cents of every dollar of revenue to pay interest on the public debt, down from a peak of almost 39 cents in 1990–91. Public debt charges as a percentage of GDP declined to 2.9 per cent in 2003–04 from 3.2 per cent in 2002–03 (see Chart 3). In 2003–04 the average interest rate paid on the public debt declined to 5.8 per cent from 6.0 per cent in 2002–03.

Composition of the Debt

The Government’s gross debt is made up of market debt and non-market debt. Market debt is funded in the capital markets and is strategically managed by the Government. Non-market debt comprises liabilities held by the Government outside capital markets. The chart on the next page illustrates the relationships between the components of government debt, based on the 2003–04 fiscal year. See Annex 1 for a more detailed description of the composition of the federal debt.

There are two types of market debt: domestic debt, which is denominated in Canadian dollars, and foreign currency debt (see Chart 4). (See www.fin.gc.ca/invest/instru-eng.asp for a detailed description of the Government of Canada’s market debt instruments.) The Government borrows in Canadian dollars using wholesale and retail funding. Wholesale funding is conducted through issuance of marketable securities, which include nominal bonds, real return bonds and Treasury bills. These securities are sold via auctions to Government of Canada securities distributors and end-investors. (The names of and details on the framework for government securities distributors and primary dealers can be found at www.bankofcanada.ca/en/auct.htm.) Retail funding is raised through sales of Canada Savings Bond products to individuals who are Canadian residents.

Funds raised in Canadian dollars are used primarily to meet the Government’s operational requirements. A small portion of Canadian-dollar wholesale debt is swapped to foreign currencies to fund the Government’s foreign exchange reserves. The Government also borrows in foreign currencies for the reserves, which are held in the Exchange Fund Account (EFA). The EFA provides a source of foreign currency liquidity and is used to promote orderly conditions in the foreign exchange market for the Canadian dollar. Details on the operations of the EFA can be found in the 2003 Report on the Management of Canada’s Official International Reserves, located at www.fin.gc.ca/toc/2004/oir04_-eng.asp.

Table 1 shows the change in the composition of federal market debt in 2003–04 by domestic and foreign debt programs. Further details of the changes in programs and indicators of debt management operations and activities can be found in Part III. Total domestic debt was reduced by $1.7 billion while foreign currency debt declined by $0.6 billion.

Table 1
Change in Composition of Federal Market Debt, 2003–04

	April 1, 2003 Outstanding	March 31, 2004 Outstanding	Change
	($ billions)
Domestic debt	415.2	413.5	-1.7
Foreign currency debt1	21.1	20.5	-0.6
CPP bonds and notes	3.4	3.4	0.0
Obligations related to capital leases	2.7	2.8	0.1
Total market debt	442.4	440.2	-2.2
Note: As at March 31, 2004, the total amount of interest rate ($1.6 billion) and cross-currency ($24.6 billion) swaps outstanding stood at $26.2 billion. Cross-currency swaps convert C$-denominated government debt into foreign currency obligations for the purpose of funding the foreign reserves portfolio. 1 Liabilities are stated at par value at the March 31 exchange rate. Source: Public Accounts of Canada.

Part II: Report on 2003–2004 Debt Strategy

The federal debt strategy covers the management of federal market debt and operational activities related to it, including the management of Canadian-dollar cash balances and the funding and investment of Canada’s foreign exchange reserves. Annual debt strategy planning sets out the objectives for the year in each of these domains and provides for a series of initiatives.

A well-functioning wholesale market in Government of Canada securities benefits the Government as well as a wide range of market participants. For the Government as a debt issuer, a well-functioning market attracts investors and ensures that funding costs are kept low. For market participants, a liquid and active secondary market in government debt provides credit-risk-free assets for investment portfolios, a pricing benchmark for other debt issues and swaps, and a primary tool for hedging risk.

In 2003–04 a large number of initiatives were undertaken to enhance the effectiveness of the Government of Canada’s debt management. This document reports on these initiatives organized around four key themes: cost and risk; maintaining a well-functioning government securities market; encouraging participation in the government securities market; and enhancing governance.

Cost and Risk

The Government’s objective of maintaining stable, low-cost financing involves managing an exposure to a range of financial risks and managing the balance between lower cost and lower risk. The Government has implemented a comprehensive financial risk management framework related to the debt program in line with the increased attention paid to risk management by financial market participants in recent years. The key risk for the Government relates to changes in interest rates and their effect on domestic borrowing costs (interest rate risk). A lesser risk is the Government’s credit exposure to financial institution counterparties with which it transacts (credit risk). There are also exposures to other types of risk, such as operational risks like the August 2003 blackout.

On August 14, 2003, the Bank of Canada took steps to ensure that the Government’s cash and debt operations would continue to function throughout the period of the blackout. The Bank conducted several Government of Canada term deposit and debt operations from its backup facility operating on emergency generators. All operations were conducted smoothly from the Bank of Canada’s backup facility.

This section provides an overview of the main considerations in balancing interest rate risk and cost. See Annex 2 for information on the management of the credit risk associated with the management of cash balances and international reserves.

Debt Structure

The Government has access to a variety of instruments to fund its debt, with maturities ranging from 3 months to over 30 years. As does any other borrower in the financial markets, the Government generally faces a trade-off between cost and risk when selecting the instruments it issues. Borrowing costs of longer-term instruments tend to be higher, but are fixed for long periods. On the other hand, borrowing costs of shorter-term instruments tend to be lower on average, but more volatile. By choosing the proportion of each instrument it issues, the Government can establish a debt structure that strikes an appropriate balance between keeping costs stable and low.

The main operational target used to manage the debt structure is the fixed-rate share, which measures the proportion of interest-bearing debt having fixed rates—debt that does not mature or need to be repriced within one year—relative to total interest-bearing debt. In the February 2003 budget, the Government announced its intention to reduce the fixed-rate share target from two-thirds to 60 per cent by 2007–08 (see Chart 5).

The decision to lower the fixed-rate share is based on positive economic and fiscal developments in Canada in recent years. Financial simulation modelling indicates that a 60-per-cent fixed-rate share would result in lower borrowing costs under a large number of interest rate scenarios without compromising debt cost stability.

In 2003–04 the Government began to reduce the fixed-rate share, with the share declining from 65.8 per cent to 63.8 per cent over the fiscal year. The change in debt structure will continue to be implemented gradually, in an orderly and transparent manner, over the next few years.

As a consequence of the adjustment in the fixed-rate share, the stock of outstanding Treasury bills and cash management bills increased from $104.4 billion to $113.4 billion in 2003–04, while the stock of outstanding bonds declined from $269.1 billion to $258.2 billion, increasing the share of floating-rate debt in the debt structure by 2.0 per cent. See Part III for more details on Treasury bill and bond program changes.

In addition to the fixed-rate share, the Government uses other indicators to track the exposure to risk inherent in the debt stock. The average term to maturity (ATM) represents the average length of time before debt instruments mature and become subject to refinancing risk. The ATM of marketable debt has stabilized at around 61⁄2 years in recent years, having increased from roughly 4 years in 1990 (see Chart 6). A longer ATM means that debt instruments are rolled over less frequently, which implies less uncertainty regarding future debt costs.

Duration, which is often used by other sovereign issuers, is another measure of the average length of time before refinancing risk occurs. Duration considers the time value of all cash flows (coupon payments and principal repayments) through the life of debt instruments. From an issuer’s perspective, a longer duration is associated with lower refinancing risk. At the end of March 2004, the Government’s marketable debt had a duration of 4.8 years,^[1] up from 4.5 years at the end of March 2003.

Maturity Profile

A related strategy to reduce the risk of higher borrowing costs is the maintenance of a stable maturity profile. A well-distributed maturity profile limits the need to refinance a large portion of the debt in any given period when borrowing conditions may be unfavourable.

One instrument used by the Government to help stabilize the maturity profile within the upcoming year is the cash management bond buyback (CMBB) program, introduced in 2001 on a trial basis. Given its success at reducing peaks in bond maturities, the CMBB program was implemented in 2003–04 on an ongoing basis. By reducing the need to accumulate high cash balances leading up to large bond maturities, the CMBB program also smoothes out seasonal fluctuations in Treasury bill issuance (see Part III for activity in 2003–04).

Also to facilitate the management of risk around peaks in maturities, the size of 2-year auctions was reduced in 2003–04 when the bond being issued was fungible (i.e. having the same maturity date) with another large bond issue. These initiatives, in addition to the emphasis on the regularity of its debt operations, have helped the Government to maintain a stable maturity profile and manage cash balances effectively around large maturity dates.

Funding the Foreign Reserves

Foreign currency debt is issued to fund foreign currency assets. In 2003–04 foreign currency funding requirements were lower than in previous years due to the strength of the euro versus the US dollar (foreign currency assets, of which about half are composed of securities denominated in euros, are reported on a market value basis in US dollars). Funding requirements were met entirely through cross-currency swaps, which are particularly cost-effective compared to other funding sources. The Government has in place a collateral management framework to control the credit risk to financial institutions with which it executes swaps (see Annex 2 and the 2002–03 Debt Management Report at www.fin.gc.ca/toc/2003/dmr03_-eng.asp). In addition to cross-currency swaps of domestic obligations, the Government has access to a short-term US-dollar paper program, medium-term note issuance in various markets, international bond issues, and purchases of US dollars in foreign exchange markets.

The Government holds foreign exchange reserve assets in the Exchange Fund Account to provide foreign currency liquidity and to provide the funds needed to help promote orderly conditions for the Canadian dollar in the foreign exchange markets. Further details on the management of international reserves are available in the 2003 Report on the Management of Canada’s Official International Reserves at www.fin.gc.ca/toc/2004/oir04_-eng.asp.

Maintaining a Well-Functioning Market 

The Government supports the maintenance of a liquid well-functioning market for its marketable securities in order to help maintain low funding costs. One way the Government achieves this goal is by building large liquid benchmark bonds and Treasury bills in various maturity sectors on a regular, predictable basis. The use of multiple maturities attracts a wide array of investors, while regular and transparent issuance ensures that there is no uncertainty as to the Government’s plans. Initiatives outlined in the 2003–04 Debt Management Strategy to promote liquidity in the Government of Canada securities market were:

• Benchmark Target Sizes: The targeted new benchmark sizes for nominal coupon-bearing bonds were maintained from the previous year, except in the 10-year sector. After consulting with market participants, the Government adjusted the 10-year target benchmark size from $12 billion-$15 billion to $10 billion-$14 billion and to a one-year cycle. The new target size and one-year cycle ensure that 10-year benchmark bonds will continue to be a key instrument for the swap and futures markets. During 2003–04 the June 2013 10-year benchmark ended its benchmark building cycle with an amount outstanding of $12 billion, within the new target benchmark size range.
• Diversified and Regular Issuance: The Government continued its practice of issuing and building large liquid benchmarks in a variety of instruments and terms to maturity to target a diverse investor base. These instruments include four bond maturity sectors (quarterly 2-, 5- and 10-year auctions and semi-annual 30-year auctions); three Treasury bill maturity sectors (3-, 6- and 12-month maturities with auctions every two weeks); a long-term inflation-indexed bond (quarterly issuance); and debt issued as part of the retail debt program. Regular issuance helps provide certainty for dealers and investors in their preparations for auctions.
• Buybacks: Against the backdrop of debt paydown in recent years, the Government has been using a bond buyback program on both a switch and cash basis to repurchase off-the-run bonds (i.e. securities that are no longer the current market benchmark or the current building benchmark), thereby helping to maintain gross bond issuance at desirable levels and maintain benchmark bond sizes. Unlike buybacks on a cash basis, where bonds offered are exchanged for cash, bonds repurchased on a switch basis are exchanged for the current building benchmark on a duration neutral basis. The 2003–04 Debt Management Strategy outlined the Government’s buyback target of about $13 billion. During the year the Government issued $10.7 billion in new benchmark bonds through the repurchase of $10.2 billion in off-the-run bonds. Steps were taken to maintain the success of buyback operations, which included increasing the range of maturities in some buyback baskets of eligible bonds.

• The scale of switch buyback operations was increased while buybacks on a cash basis were decreased, as the scope of the switch buyback program began to include more maturity sectors. Switch operations are more attractive for market participants as their market risk is lower than for cash buybacks. In 2003–04 the Government repurchased $5.0 billion in bonds through the switch program (in line with the previous year), and $5.2 billion through the cash buyback program (a decrease of $1.9 billion.)

Participation

Active participation at auction and buyback operations from a diverse group of market participants also helps the Government to achieve its key objective of stable, low-cost funding. Over the past few years initiatives to enhance transparency and the bidding process have been undertaken to broaden participation. Initiatives undertaken in 2003–04 include:

• Timing of Treasury Bill Auctions: Beginning June 17, 2003, Treasury bill auctions were moved from 12:30 p.m. to 10:30 a.m., with cash management buyback operations following the auctions at 11:15 a.m. The change was made to coincide with the time of day when the Treasury bill market is most active in order to attract more participants to the auctions. Investors supported the change.
• Participation at AM Receiver General Auctions: In 2002–03 the Government introduced a collateralized framework for the AM Receiver General auctions of cash balances to reduce the exposure to counterparty credit risk and encourage more competitive bidding at cash management auctions. In 2003–04 the Government increased the list of financial institutions eligible to participate at AM auctions by 1 to 21; work is ongoing to further increase the number of participants.
• Turnaround Time: In order to reduce market risk for participants and enhance the efficiency of its operations, the Government took steps in the fiscal year to streamline these operations to further reduce turnaround times. The Government announced that, starting on April 1, 2004, the turnaround time for auctions and buyback operations would be released on a "best efforts basis" (i.e. when ready rather than waiting to release results at the maximum times of 10 minutes for bills and bonds and 15 minutes for buybacks).

Charts 7 and 8 show the dramatic reduction in turnaround times in recent years, from 45 minutes at the end of 1998 to 10 minutes for Treasury bill and bond auctions and 15 minutes for buyback operations starting in 2002.

 

Governance of Treasury Activities

The Government regularly assesses its treasury management policies and programs as part of good governance and management of the debt program. These reviews are conducted internally at the Department of Finance and Bank of Canada or by external specialists. In 2003–04 the Government conducted four reviews: an internal evaluation of the Government’s governance framework for managing treasury activities; an external evaluation of the effectiveness of the governance system over the past five years and design of a modified framework; a review of the retail debt program, which has included an external assessment as well as internal analysis; and an internal review of the real return bond program.

Internal Evaluation of the Governance Framework

In 2003 the Government of Canada reviewed and enhanced the governance framework for its debt management activities, with the result codified in the Treasury Management Governance Framework document. The report on governance, Governance Evaluation: Debt and Reserves Management, is available at www.fin.gc.ca/activty/goveval-eng.asp. The new governance framework is designed to enhance the efficiency of debt management policy implementation; ensure accountability through appropriate performance measurement and reporting; clarify and strengthen the framework for risk management monitoring and control; and enhance operational efficiency and effectiveness.

The framework describes the objectives and operating principles that the Government pursues in managing its financial assets and liabilities. These objectives appear in this document as well as the Report on the Management of Canada’s Official International Reserves and the Canada Investment and Savings annual report. In addition, the framework describes the authorities, roles and responsibilities, coordination and control systems, and performance evaluation systems for managing the Government’s treasury activities.

The governance framework outlines the organizational committees established to govern debt management activities. While the ultimate decision-making authority rests with the Minister of Finance, the design of key strategies, policies and operations and the coordination of funding, investing and liquidity management activities are accomplished through several key committees and working groups. A detailed description of the composition of these committees and their roles and responsibilities is contained in the Treasury Management Governance Framework document.

External Study of the Governance Framework

A study was commissioned in 2003–04 to evaluate the Government’s policies, practices and procedures for managing its debt and reserves, with three objectives: assess how the governance of debt and reserves management has evolved over the past five years; develop a framework for the evaluation of debt and reserves management governance; and test the effectiveness of this framework by using it to evaluate the current governance structure, practices and policies.

The study was delivered in February 2004 and is available at www.fin.gc.ca/treas/goveev/govevrepvol1-eng.asp. At the end of 2003–04 the Department of Finance was evaluating the study’s recommendations; its response can be found at www.fin.gc.ca/treas/goveev/govevres-eng.asp.

Review of the Retail Debt Program

The delivery of the Government’s retail debt program is a collaborative effort between Canada Investment and Savings (a special operating agency of the Department of Finance), the Financial Sector Policy Branch of the Department of Finance and the Bank of Canada.

As part of the Treasury Evaluation Program, the Department of Finance hired Cap Gemini Ernst & Young (CGEY) in September 2003 to assess the retail debt program and to provide advice on strategic options for the future. The CGEY report was delivered in January 2004. This report, along with the departmental response, is available at www.fin.gc.ca/activty/goveval-eng.asp. At the end of 2003–04 the Department was initiating public opinion research to assess the attitudes of Canadians towards the program and potential changes to it. The Department was also undertaking analysis of expected future costs and benefits of the program under a number of different program designs.

Further information on the retail debt program and a report of 2003–04 activities is available at www.csb.gc.ca.

Review of the Real Return Bond Program

In light of the evolution in the macroeconomic environment and the change in the target debt structure to a lower fixed-rate share, the Government announced in the 2003–04 Debt Management Strategy that it would assess the real return bond (RRB) program. Work was conducted within the Department of Finance and the Bank of Canada to evaluate the RRB program relative to its stated objectives and to other borrowing programs. The report, Real Return Bond Funding Review, is available at www.bankofcanada.ca/en/notices_fmd/rrb2003.htm.

The review found that the program has generally fulfilled its stated objectives. Global issuance of inflation-indexed securities has increased in recent years and is expected to continue to grow. In the context of the overall debt program, continued RRB issuance levels at around current levels should not be an immediate constraint in maintaining issuance levels of nominal bonds and would have little effect on the move to a lower fixed-rate share.

In the 2004–05 Debt Management Strategy, the Government announced that RRBs would remain a part of its debt program, with expected issuance equal to or marginally higher than the $1.4 billion issued in 2003–04.

Debt Strategy Plan and Action

The following summary chart reports on the 2003–04 debt strategy plan initiatives, their purpose and actions taken. All of the strategic objectives for the management of the Government’s debt, cash and reserves were achieved over the course of the year. In addition, complementary initiatives were identified based on consultations with market participants and acted upon.

	Plan (including initiatives identified through mid-year consultations)	Purpose	Actions Taken
Cost and Risk	Gradually reduce the fixed-rate share of debt from a target of two-thirds to a target of 60 per cent over 5 years.	Achieve lower debt charges, while continuing to prudently mitigate the risk to the budget framework.	The fixed-rate share was reduced from 66 per cent to 64 per cent over the 2003–04 fiscal year.
	Implement a gradual reduction to the new fixed-rate target:
	(a) Increase the size of the Treasury bill program from about $105 billion in 2002–03 to approximately $120 billion in 2003–04.		The stock of Treasury bills outstanding increased by about $9.0 billion to $113.4 billion.
	(b) Issue roughly $40 billion of bonds in 2003–04, similar to the amount in 2002–03.		$39.4 billion of bonds were issued. The stock of outstanding bonds declined by $10.9 billion to $258.2 billion due to maturities and buyback operations.
	Implement the cash management bond buyback (CMBB) program on a regular basis.	Smooth cash requirements by reducing peak cash balances needed to redeem upcoming large maturities.	The CMBB program and the reduction in issuance of 2-year bonds helped to reduce peaks in maturities and maintain a stable maturity profile.
	Reduce the 2-year auction size to a minimum of $2.5 billion when the benchmark is fungible with a large outstanding bond.	Limit the need to refinance a large portion of debt in any given period and maintain a stable maturity profile.
	Continue to use cross-currency swaps to fund the reserves.	Maintain a low cost of funding for reserve assets.	Three cross-currency swaps were executed in 2003–04, totalling $0.1 billion.
	Plan (including initiatives identified through mid-year consultations)	Purpose	Actions Taken
	Plan (including initiatives identified through mid-year consultations)	Purpose	Actions Taken
Maintaining a Well-Functioning Market	Maintain current benchmark target sizes for 2-, 5- and 30-year bonds.	Maintain a liquid market for on-the-run issues.	Benchmark bond sizes were maintained.
	Continue regular issues of marketable bonds in four maturity sectors, Treasury bills in three maturity sectors and inflation-linked bonds in wholesale markets.	Provide liquidity across investor segments, instruments and maturities, which contributes to managing both cost and risk.	Issuance schedule and maturities of past years were maintained in Treasury bills, bonds and real return bonds.
	Maintain an annual benchmark cycle.	Support liquidity in the swap and futures market and satisfy international demand.	Target ranges for the new 10-year benchmark bond size were lowered from $12 billion-$15 billion to $10 billion-$14 billion to maintain an annual benchmark.
	Continue a similar level of bond buybacks as in 2002–03 of about $13 billion.	Maintain bond auction sizes and facilitate market adjustment to changes in the bond stock.	Buybacks of 2-, 5-, 10- and 30-year bonds totalled $10.2 billion.
	Modestly increase the amount of buybacks on a switch basis and slightly lower the amount of bonds repurchased on a cash basis.	Support effective operation of the buyback program and total bond issuance.	Bond repurchases through the switch program were in line with the previous year’s amount of $5.0 billion, while repurchases through the cash buyback program fell by $1.9 billion to $5.2 billion.
	Plan (including initiatives identified through mid-year consultations)	Purpose	Actions Taken
	Plan (including initiatives identified through mid-year consultations)	Purpose	Actions Taken
Participation	Continue to borrow on a pre-announced basis, seek input from market participants on major adjustments to programs, and provide timely notices of government policy decisions.	Maintain transparency and efficiency to encourage participation.	The Government’s policy of transparency in debt management activities was maintained with market participants.
	Move Treasury bill auctions from 12:30 p.m. to 10:30 a.m. on a trial basis. Schedule CMBB operations after Treasury bill auctions.	Enhance bidding and participation.	Beginning June 17, 2003, Treasury bill auctions were moved to 10:30 a.m. and CMBB operations were moved to follow Treasury bill auctions at 11:15 a.m.
	Broaden the list of participants in collateralized Receiver General cash management operations.	Reduce exposure to counterparty credit risk and encourage more competitive bidding at cash management auctions.	The number of participants increased by 1 to 21 financial institutions. Work is ongoing to increase further the number of participants.
	Consider further reductions in turnaround times for the publication of the results of operations.	Reduce market participants’ risk.	Following internal work, it was announced in 2003–04 that as of April 1, 2004, turnaround time for auctions and buybacks would be changed to a best efforts basis (i.e. when ready).
	Plan (including initiatives identified through mid-year consultations)	Purpose	Actions Taken
Governance of Treasury Activities	Review the governance framework for funds management.	Streamline decision-making processes, and ensure effectiveness and accountability.	Two reviews were undertaken: Internal Review: The framework was revised to clarify roles and responsibilities and report on performance. External Review: A study has been made available to the public on the Department’s Web site and recommendations are being acted upon.
	Review the retail debt program.	Assess the performance of the retail debt program and strategic options going forward.	An external review was completed in January 2004; the full report, including supporting documentation, has been made available to the public on the Department’s Web site. An internal review of recommendations is continuing.
	Review the real return bond (RRB) program.	Assess effectiveness and fit in the bond program.	The program was reviewed and the report is available to the public on the Department’s Web site. The decision to maintain the RRB program was announced during 2003–04.

Part III: Programs and Indicators 

Part III of this report is divided into three main sections: the outcome of operations and activity with respect to the domestic debt programs; indicators of cash management performance; and measures of reserves funding and investment. It also provides information on the Government’s investor base and reports on external evaluations of the debt program.

The indicators are intended to provide information on the key measures used by government debt managers. As outcomes in virtually all cases are the product of many factors, the measures do not reflect the impact of specific government debt management policies. However, they serve as useful guideposts in helping to understand the results and context of the Government’s debt management initiatives.

Domestic Debt Programs

There are a number of measures of outcomes in the area of domestic debt management. They can be divided into two groups: those associated with the debt issuance process (the primary market) and those dealing with post-issuance trade (the secondary market).

Measures of a well-functioning securities market include the degree to which auctions in the primary market are well bid and the level of liquidity and trading in the secondary market. In 2003–04 the Government’s Treasury bill and bond auctions continued to be well bid. Primary dealers play the major role at auctions except in the case of RRB auctions, where customers’ winnings exceed that of primary dealers. The secondary market for Government of Canada securities continues to experience healthy trading volumes and turnover ratios that compare favourably to those of other countries. Primary dealers also play a major role in secondary markets, with the top 10 participants accounting for about 90 per cent of turnover of Treasury bills and bonds.

The bond buyback program continues to be effective in helping to maintain a liquid issuance program and build new benchmarks within a reasonable time frame.

Primary Market

Program Activity

Nominal Bonds

Gross bond program issuance in 2003–04 was $39.4 billion (see Table 2), lower than the $42.3 billion in 2002–03. Gross issuance consisted of $13.0 billion in 2-year bonds, $10.7 billion in 5-year bonds, $11.5 billion in 10-year bonds and $4.2 billion in 30-year bonds (see Reference Table IX for more information on bond auctions). In 2003–04, $31.7 billion of bonds matured. Taking into account buybacks and maturities, net new issuance declined by $10.9 billion during the year, reducing the stock of outstanding bonds to $258.2 billion as at March 31, 2004.

Regular Bond Buyback Program

The objectives of the bond buyback program are to enhance liquidity and maintain active new issuance in the primary market for Government of Canada securities.

Under cash buybacks, off-the-run bonds are repurchased with cash to sustain larger auction sizes. Buybacks on a switch basis exchange off-the-run bonds with new building benchmark securities, thereby adding to the overall liquidity of the issues.

Bond buyback operations totalled $10.2 billion in 2003–04, consisting of $6.2 billion in 2- and 5-year bonds, $2.5 billion in 10-year bonds, and $1.5 billion in 30-year bonds (see Reference Table XII for more information on buyback operations).

On average, buybacks on a cash basis helped to increase sizes of new benchmarks in 2003–04 by $369 million per auction (see Chart 9). Switch buyback operations in 2003–04 exchanged $5.0 billion of off-the-run bonds for $5.5 billion of new building benchmarks.

Real Return Bonds

RRB issuance in 2003–04 was in line with the previous year’s issuance of $1.4 billion, increasing the level of outstanding RRBs from $19.1 billion (which includes the Consumer Price Index [CPI] adjustment) to $20.6 billion as at March 31, 2004 (see Table 2). In 2003–04 the Government issued its fourth RRB, a December 1, 2036, maturity. (See Reference Table X for more information on RRB auctions.) 

Table 2
Change in Composition of Federal Market Debt, 2003–04

	April 1, 2003 Outstanding	New Issues	Maturing	Repurchase	March 31, 2004 Outstanding	Change
	($ billions)
Domestic debt
Nominal bonds	269.1	39.4	31.7	25.81	258.2	-10.9
Real return bonds	19.12	1.4	0.0	–	20.6	1.53
Treasury bills4	104.4	262.4	253.4	–	113.4	9.0
Retail debt	22.6	2.0	3.2	–	21.3	-1.3
Total domestic debt	415.2				413.5	-1.7
Foreign currency debt5
Canada bills	2.6	14.0	13.2	–	3.4	0.8
Foreign bonds6	14.0	0.2	1.3	–	12.9	-1.1
Canada notes	1.2	0.0	0.0	–	1.2	0.0
Euro Medium-Term Notes	3.3	0.0	0.3	–	3.0	-0.3
Total foreign debt	21.1				20.5	-0.6
CPP bonds and notes	3.4	–	0.0	–	3.4	0.0
Obligations related to  capital leases	2.7	0.2	0.1		2.8	0.1
Total market debt	442.4				440.2	-2.2
Note: As at March 31, 2004, the total amount of interest rate ($1.6 billion) and cross-currency ($24.6 billion) swaps outstanding stood at $26.2 billion. Cross-currency swaps convert C$-denominated government debt into foreign currency obligations for the purpose of funding the foreign reserves portfolio. Numbers may not add due to rounding. 1 Includes the bond buyback program on a cash and switch basis, and the pilot cash management bond buyback program. 2 Includes a correction to the calculation of CPI adjustment in previous years. 3 Includes CPI adjustment. 4 These securities are issued at 3-, 6- and 12-month maturities and are therefore rolled over a number of times during the year for refinancing. This results in a larger number of new issues per year than stock outstanding at the end of the fiscal year. These amounts include cash management bills. 5 Liabilities are stated at par value at the March 31, 2004, exchange rate. Increases/decreases shown for foreign currency bonds, Canada notes and Euro Medium-Term Notes are due, either partly or fully, to the exchange rate appreciation/depreciation of the currency of issue versus the Canadian dollar. 6 Includes $492.0 million in securities assumed by the Government of Canada on February 5, 2001, on the dissolution of Petro-Canada Limited. Source: Public Accounts of Canada.

Treasury Bills and Cash Management Bills (CMBs) 

The stock of outstanding Treasury bills and CMBs increased by $9.0 billion during 2003–04 to $113.4 billion at March 31, 2004 (see Table 2), consistent with the orderly move to a lower fixed-rate share of debt. For the entire fiscal year $262.4 billion in Treasury bills and CMBs were auctioned, an increase of $25.7 billion from the previous year (see Table 3). There were $4.0 billion of CMBs outstanding at the beginning of fiscal 2003–04 and $4.7 billion outstanding at the end of the year. Throughout the year the Government issued $28.5 billion of CMBs of various short-term maturities.  

Table 3
Treasury Bill and CMB Program

	1998–99	1999–00	2000–01	2001–02	2002–03	2003–04
	($ millions)
CMBs	25,750	19,700	9,000	7,500	23,750	28,500
3-month Treasury bills	90,800	100,700	88,100	103,300	117,400	129,700
6-month Treasury bills	42,600	46,600	38,600	43,100	47,800	51,900
12-month Treasury bills	39,500	46,600	38,600	43,100	47, 800	51,900
	172,900	193,900	165,300	189,500	213,000	233,450
Total	198,650	213,600	174,300	197,000	236,750	262,416
Note: Sub-categorization of Government of Canada debt is in accordance with Bank of Canada reports, which may vary slightly from Public Accounts categories due to differences in classification methods. The total outstanding market debt may not equal the sum of the parts due to slight differences between the Bank of Canada’s and Department of Finance’s numbers. Sources: Bank of Canada and Public Accounts of Canada.

Retail Debt

The level of outstanding debt held by domestic retail investors—Canada Savings Bonds and Canada Premium Bonds—decreased from $22.6 billion to $21.3 billion in 2003–04. Gross sales and redemptions were $2.0 billion and $3.2 billion, respectively, for a net reduction of $1.3 billion in the stock of retail debt.

Bill and Bond Auction Results Indicators

The two conventional measures of auction performance are the auction coverage and tail. These two measures, combined with the yield of the securities issued, describe the quality of an auction in terms of its competitiveness and its impact on the cost of borrowing.

The auction coverage is defined as the total size of bids received divided by the auction size. A cover statistic of one is essential and a higher statistic is generally better, as it indicates active bidding and therefore lower costs for the Government. The auction tail is the number of basis points between the highest yield accepted and the average yield. In this case, smaller is better as it indicates strong bidding and therefore lower costs.

The terms of participation in government auctions require larger dealers (primary dealers) to bid 50 per cent of their calculated bidding limit at reasonable prices. Maximum coverage ratios from primary dealers (which represent about 85 per cent of winning bids) could reach a maximum of about 2.6 for bond auctions and 2.4 for Treasury bill and CMB auctions, while minimum coverage, assuming that all primary dealers bid at their minimum bidding limit, would total about 1.4 for bond auctions and 1.2 for Treasury bill and CMB auctions.

In 2003–04 coverage remained generally stable for CMB, Treasury bill and bond auctions and declined slightly for RRB auctions compared to the previous fiscal year. Overall, coverage has remained stable over the last four years (see Table 4).

In 2003–04 tails were generally narrower for Treasury bill and bond auctions than in the previous year. Overall, tails were narrower in 2003–04 than the 4-year average for all auctions, indicating relatively more competitive bidding at auctions (see Table 4).

Table 4
Performance at Auctions

	Coverage					Tail
	2000-01	2001-02	2002-03	2003-04	4-yr avg.	2000-01	2001-02	2002-03	2003-04	4-yr avg.
Treasury bills
3-month	2.1	2.0	2.2	2.2	2.1	1.1	1.3	0.6	0.5	0.8
6-month	2.3	2.2	2.3	2.2	2.2	0.9	0.8	0.7	0.5	0.7
12-month	2.2	2.0	2.1	2.1	2.1	1.0	0.9	0.7	0.7	0.8
CMBs	2.0	1.9	2.0	2.0	2.0	2.3	1.4	1.4	1.4	1.5
Nominal bonds
2-year	2.5	2.3	2.3	2.5	2.4	0.6	0.7	0.7	0.5	0.6
5-year	2.6	2.4	2.5	2.6	2.5	0.5	0.7	0.7	0.5	0.6
10-year	2.7	2.5	2.5	2.5	2.5	1.1	0.9	0.8	0.5	0.8
30-year	2.4	2.5	2.5	2.6	2.5	2.81	1.1	0.7	0.4	1.3
Real return bonds2	3.1	2.8	3.2	2.9	3	n.a.	n.a.	n.a.	n.a.	n.a.
Weighted average3	2.3	2.1	2.2	2.2	2.2	1.0	1.1	0.7	0.5	0.8
1 The peak in the average tail for 30-year auctions in 2000–01 is due to one of the two 30-year auctions (April 19, 2000 auction) that had an unusually large tail of 4.4 basis points, which increased the annual average to 2.75 basis points. 2 Auction tails for RRBs are not relevant since RRBs are distributed through single-price auctions. 3 Weighted average excludes CMBs. Source: Bank of Canada.

Participation at Auctions

This section provides information on participation of government securities distributors (primary dealers and other government securities dealers) and customers (institutional investors) in the primary market for Government of Canada securities. Primary market activity shares are calculated using participants’ allotments at auctions during the fiscal year.

Nominal Bonds

In 2003–04 primary dealers (PDs) were allotted 93.4 per cent of nominal bond auctions while customers were allotted 4.7 per cent (see Table 5). The 10 most active participants bought 90.9 per cent of the bonds on average. These percentages show a slight increase in concentration of primary dealer allotments from previous years, continuing a trend of increasing auction shares by the larger participants.

Table 5
Bond Auctions Share of Amount Allotted to Participants
(Excluding Real Return Bonds)

Participant Type	2000–01	2001–02	2002–03	2003–04
	(%)
PDs	91.5	83.7	91.8	93.4
Non-PDs	2.7	6.4	2.5	1.8
Customers	5.8	9.8	5.6	4.7
Top 10 participants	86.1	84.0	88.7	90.9
Source: Bank of Canada.

Bond Buybacks

Primary dealers are the most active participants in bond buyback operations. Customers’ share of allotments at buybacks is shown as zero, but this likely underestimates the level of participation of customers, as they may participate in buyback operations through dealers without identifying themselves (see Table 6).

Table 6
Bond Buyback Operations Share of Amount Allotted to Participants   (Excludes Cash Management Bond Buybacks)

Participant Type	2000–01	2001–02	2002–03	2003–04
	(%)
PDs	94.1	86.2	96.4	97.9
Non-PDs	2.4	0.0	1.7	2.1
Customers1	3.5	13.8	1.9	0.0
Top 10 participants	97.1	98.4	94.5	97.4
1 Results may underestimate customer participation. Contrary to Treasury bill and bond auctions, customers do not have to inform the Bank of Canada about their participation at buyback operations. Source: Bank of Canada.

Real Return Bonds

Unlike nominal bond auctions, RRB auctions have more active customer participation. Allotments to customers increased from 51.2 per cent in 2002–03 to 63.1 per cent in 2003–04. This is largely due to the continuing lack of product availability in the secondary market, as many RRB investors are buy-and-hold investors. The 10 most active participants in RRB auctions were allotted 69.0 per cent of the auction, which is in line with historical averages (see Table 7).

Table 7
RRB Auctions Share of Amount Allotted to Participants

Participant Type	2000–01	2001–02	2002–03	2003–04
	(%)
PDs	45.5	39.0	47.9	36.1
Non-PDs	2.7	3.9	0.9	0.8
Customers	51.8	57.2	51.2	63.1
Top 10 participants	68.4	61.2	63.9	69.0
Source: Bank of Canada.

Treasury Bills

For 2003–04 primary dealers accounted for 84.2 per cent of amounts allotted at Treasury bill auctions while customers accounted for 14.5 per cent. Customers have steadily seen their share increase over the last four years, while the share held by primary dealers has decreased slightly. In 2003–04 the 10 most active participants accounted for 93.7 per cent of amounts allotted at Treasury bill auctions (see Table 8).

Table 8
Treasury Bills Auctions Share of Amount Allotted to Participants

Participant Type	2000–01	2001–02	2002–03	2003–04
	(%)
PDs	87.6	86.0	84.1	84.2
Non-PDs	1.5	1.6	2.2	1.2
Customers	10.9	12.4	13.6	14.5
Top 10 participants	92.5	93.0	91.5	93.7
Source: Bank of Canada.

Cash Management Bills

Primary dealers are the most frequent participants at CMB auctions. In 2003–04 primary dealers were awarded 97.8 per cent of the allotted amounts, and the 10 most active participants accounted for 99.2 per cent. The average allotment share of customers fell to 0.8 per cent from 4.5 per cent in the previous fiscal year (see Table 9).

Table 9
CMBs Auctions Share of Amount Allotted to Participants

Participant Type	2000–01	2001–02	2002–03	2003–04
	(%)
PDs	92.9	95.6	93.0	97.8
Non-PDs	4.5	2.3	2.5	1.4
Customers	2.6	2.1	4.5	0.8
Top 10 participants	95.6	97.9	95.5	99.2
Source: Bank of Canada.

Secondary Market

The two conventional measures of liquidity and efficiency in the Government of Canada securities market are trading volume and turnover ratio. These two measures are presented for bonds (Chart 10 and, for international comparison, Chart 11), Treasury bills (Chart 12), bond repos (Chart 13) and Treasury bill repos (Chart 14).

Trading volume, which shows the amount of securities traded per period, is a conventional indicator of liquidity. Large trading volume allows participants to buy or sell in the marketplace without a substantial change in the price of the securities.

Turnover ratio, which is the ratio of securities traded relative to the securities outstanding, is a measure of market efficiency. High turnover implies that a large amount of securities changes hands over a given period of time, a hallmark of an efficient securities market.

A number of factors affect trading volume and turnover ratio, such as the extent to which new information changes views in the marketplace and changes in the stock of outstanding securities. Trends in these two measures can be indicators of changes in market liquidity and efficiency.

The presence of liquid repo markets and liquid futures contracts also complements an efficient Government of Canada securities market. A liquid repo market exists in the Government of Canada securities market for Treasury bills and nominal bonds. There is also an active futures contract based on the benchmark 10-year Government of Canada bond. (On May 3, 2004, the Montreal Exchange launched a new futures contract on the benchmark 2-year Government of Canada bond.)

Trading Volume and Turnover Ratios

The volume of transactions in the Government of Canada bond market has grown significantly since 1990. Total marketable bond trading volume was $4,561 billion in 2003–04, an 18.1-per-cent increase from 2002–03. The average quarterly turnover ratio was 3.8 times the outstanding stock of bonds in 2003–04, compared to 3.1 in 2002–03 (see Chart 10).

The Government of Canada bond market compares favourably with other major sovereign bond markets. The market had an annual stock turnover in 2003 of 15.6, behind only the United States, which had a stock turnover level of 41.8 (see Chart 11).

 

The volume of transactions in the Treasury bill market improved from the previous fiscal year but remains below the highs in the mid-1990s, when the level of the Treasury bill stock was at its peak. In 2003–04 total Treasury bill turnover was $1,290 billion (see Chart 12).

Both Government of Canada bond repos and Treasury bill repos remained active in 2003–04. The total turnover for Government of Canada bond repos in 2003–04 was $17,745 billion, down from $18,164 billion in 2002–03. The average quarterly turnover ratio for bond repos in 2003–04 was 15.0 times compared to 14.8 times in 2002–03 (see Chart 13). The Treasury bill repo market volume in 2003–04 was $2,710 billion and the average quarterly turnover ratio was 6.0 (see Chart 14). Turnover and trading volume were in line with the stock of Treasury bill decreases in the late 1990s.

The trading volume of futures contracts in 2003–04 maintained the levels of previous years. The futures contract based on the 10-year Government of Canada bond (the Canadian Government Bond contract or CGB contract) continues to be actively traded, as trading volume reached 2.4 million in 2003, a 32.9-per-cent increase from 2002.

Trading by Market Participants

Bonds

Primary dealers’ share of bond trading decreased from 2002–03 while non-primary dealers’ share increased, but the levels have remained fairly stable over the last four years. The 10 most active participants in the bond secondary market represent 95.1 per cent of trading activities (see Table 10).

Table 10
Bonds Trading: Market Share of Participants

Participant Type	2000–01	2001–02	2002–03	2003–04
	(%)
PDs	93.5	94.0	93.3	92.6
Non-PDs	6.5	6.0	6.7	7.4
Top 10 participants	91.6	96.0	95.9	95.1
Source: Bank of Canada.

Treasury Bills

Primary dealers have become the main traders in the Treasury bill secondary market and represent 98.4 per cent of total trading volume. The 10 most active participants in the Treasury bill secondary market represent 99.2 per cent of trading activities (see Table 11).

Table 11
Treasury Bill Trading: Market Share of Participants

Participant Type	2000–01	2001–02	2002–03	2003–04
	(%)
PDs	98.3	98.3	98.4	98.4
Non-PDs	1.7	1.7	1.6	1.6
Top 10 participants	98.3	99.4	99.5	99.2
Source: Bank of Canada.

Cash Management

Receiver General (RG) cash balances, the Government’s Canadian-dollar balances, fluctuate widely over the year with variations in the Government’s financial operations, periodic large maturities of Government of Canada bonds, the operations of the Bank of Canada and changes in market conditions. The primary objective is to hold the lowest level of cash balances, consistent with ensuring funds are available to meet daily requirements with an appropriate margin for uncertainty.

Treasury managers use a number of indicators with respect to cash management activities, including the average level of cash balances, coverage and tail at RG auctions, the performance of participants at RG auctions, effectiveness of the cash management bond buyback program, and the cost of carry.

Average Daily Cash Balances

Average daily cash balances increased in 2003–04 to $7.9 billion (see Table 12) as a result of larger bond maturities relative to the previous fiscal year.

Table 12
Average Daily RG Cash Balances Held at Financial Institutions

	1999–00	2000–01	2001–02	2002–03	2003–04
	($ millions)
Average daily cash balances	9,021	10,188	7,921	6,139	7,854
Source: Bank of Canada.

Coverage and Tails

In 2003–04 RG coverage improved from the previous fiscal year for both AM and PM auctions, and was above the rolling four-year average (see Table 13). The results are a continuation of the trend from the previous year, when the new RG collateralization framework was introduced to encourage more participation in AM auctions.

In 2003–04 AM auction tails widened by more than half a basis point from the previous year but were roughly in line with the four-year average. PM auction tails remained stable, below the average of the last four years.

Table 13
Performance at Receiver General Auctions

	2000–01	2001–02	2002–03	2003–04	4-yr. avg.
AM auctions
Coverage	2.53	2.42	3.29	3.38	2.83
Tail	1.18	2.28	0.91	1.68	1.51
PM auctions
Coverage	1.78	2.27	2.31	2.53	2.17
Tail	4.81	2.58	3.04	3.09	3.54
Source: Bank of Canada.

Participation

In the first full year under a collateralized framework, the participant base at RG auctions widened, with non-LVTS (Large Value Transfer System) institutions, which were not eligible participants under the previous framework, becoming more active. The top 10 LVTS participants won 76 per cent of RG auctions on average in 2003–04, while other participants gained 24 per cent of the amount allotted (see Table 14).

Table 14
Receiver General Auctions Share of Amount Allotted Between LVTS and Other Participants

Participant Type	2000–01	2001–02	2002–03	2003–04
	(%)
Top 10 LVTS	97.4	98.5	91.0	76.0
Top 10 others	0.0	0.0	7.1	23.8
Source: Bank of Canada.

Cash Management Bond Buyback Program

The cash management bond buyback (CMBB) program helps manage the Government’s cash requirements by reducing the high levels of government cash balances needed. The program also helps to smooth variations in Treasury bill auction sizes over the year.

In 2003–04 the total amount of bonds repurchased through the CMBB program was $15.7 billion, compared to $12.9 billion in 2002–03. The CMBB program lowered the December 2003 maturity by 48 per cent to $6.7 billion. The program also repurchased $5.4 billion in bonds from the June 2004 bond, reducing the maturing amount to $10.0 billion. Overall, large maturities in 2003–04 were lowered by 46 per cent, dropping the Government’s cost of holding high levels of cash balances for key coupon and maturity payment dates (see Chart 15).

Cost of Carry

The key measure for the management of cash balances is the net return on cash balances: the difference between the return on government balances auctioned to financial institutions (typically around the overnight rate) and the average yield paid on Treasury bills. A normal upward sloping yield curve results in a cost of carry, as financial institutions pay rates of interest for government deposits based on an overnight rate that is lower than the rate paid by the Government to borrow funds. Conversely, under an inverted yield curve, short-term deposit rates are higher than the average of 3- to 12-month Treasury bill rates, which can result in a net gain for the Government.

In 2003–04 the financial impact of holding RG cash balances was a net cost of $0.4 million, compared to a net cost of $12.4 million for the prior fiscal year (see Chart 16). The cost of carry was offset by gains during the year made due to shifts in the short end of the yield curve from a normal upward sloping shape to an inverted shape.

Foreign Currency Debt Programs

Canada Bills

In 2003–04 the level of outstanding Canada bills increased from $2.6 billion (US$1.8 billion) to $3.4 billion (US$2.6 billion)—see Table 2. In 2003–04 Canada bills were issued, on average, at an all-in cost of US$LIBOR less 15-25 basis points.

Foreign Currency Bonds

There was no new foreign bond issuance and there were no maturities in 2003–04. The total outstanding was $12.9 billion (US$9.8 billion).

Canada Notes

There was no new Canada note issuance and there were no maturities in 2003–04. The total outstanding was $1.2 billion (US$1.0 billion).

Euro Medium-Term Notes

In 2003–04 no new Euro Medium-Term Notes were issued, while a total of $0.09 billion (US$0.07 billion) matured. The total outstanding decreased from $3.3 billion (US$2.2 billion) to $3.0 billion (US$2.4 billion).

Cross-Currency Swaps

In 2003–04 the Government of Canada raised $0.14 billion (US$0.1 billion) to fund the foreign exchange reserves by entering into three cross-currency swaps. A limited number of cross-currency swaps were issued compared to previous fiscal years due to the Government’s small funding requirements in 2003–04. A total of $3.3 billion (US$2.5 billion) of swaps matured in 2003–04. At the end of the 2003–04 fiscal year, the outstanding amount of cross-currency swaps totalled $24.6 billion (US$18.8 billion) (see Reference Table XI for transaction details). Taking into account the effect of cross-currency swaps, foreign currency obligations were 10.0 per cent of market debt.

Funding and Investment of Reserves

The main measures in the area of the funding and investment of reserves are the costs of the liabilities and the cost of carry on the asset/liability portfolio.

Liability Costs

: In 2003–04 the sources of reserve funding were Canada bills and cross-currency swaps. Canada bills were issued, on average, at an all-in cost of US$LIBOR less 15-25 basis points—generally in line with funding levels of recent years.

In the case of cross-currency swaps, the Government raised reserve assets at US$LIBOR less 34 basis points on average in 2003–04, in line with recent years.

Carry

: One objective in managing the Exchange Fund Account (EFA) is to minimize the cost of carrying reserves. The EFA must be invested in liquid, high-quality, fixed-income securities, which provide a relatively low rate of return. In recent years policy changes have been made to broaden the eligible asset mix, within prudent limits, and to invest more in euro-denominated assets. These measures have helped to increase portfolio returns. Further means used to minimize the carry of the EFA have been the use of cross-currency swaps, which are highly cost-effective compared to other sources of funds, and the securities-lending program.

The carry on the foreign reserves is currently assessed by subtracting the interest paid on Canada’s foreign currency liabilities from interest earned on the reserve assets (i.e. the net interest earned or paid) and expressing this value as a percentage of total assets held. When net realized gains (due to gains on US-dollar and euro asset sales) are taken into consideration, the overall carry of the total EFA portfolio in 2003–04 is estimated at +50.3 basis points compared to +64.5 basis points in 2002–03.^[2] (The 2003 Report on the Management of Canada’s Official International Reserves, available at www.fin.gc.ca/toc/2004/oir04_-eng.asp, provides further information on the performance of the EFA.)

Holdings of Government of Canada Debt

A diversified investor base helps to keep funding costs low by ensuring there is active demand for Government of Canada securities. The Government pursues diversification of its investor base by maintaining a domestic wholesale debt program that is attractive to a wide range of investors, offering a retail debt program that provides savings products to suit the needs of individual Canadians, and using a broad array of funding sources in its foreign borrowings.

In 2003 life insurance companies and pension funds accounted for the largest share of holdings of Government of Canada market debt (21.9 per cent). This is followed by public and other financial institutions such as investment dealers and mutual funds (19.6 per cent) and foreign investors (15.9 per cent)—see Chart 17. Taken together, they accounted for close to 60 per cent of total holdings.

Reference Table IV shows the evolution of the distribution of domestic holdings of Government of Canada debt since 1976, and illustrates that the holdings have become more diversified over that period.

External Evaluations of Debt Management Policies and Activities

The Department of Finance has an ongoing treasury evaluation process to assess debt management effectiveness. The Department uses external evaluations to assess policies and operational decisions in the area of debt management in order to inform future decision making and contribute to public transparency and good governance. Independent evaluators are contracted to carry out the evaluations.

As noted earlier in Part II in the section entitled "Governance of Treasury Activities," two evaluations were undertaken in 2002–03, focusing on the retail debt program and on the governance of debt and reserves management. Table 15 lists all of the external studies undertaken of the debt management program.

Table 15
Treasury Evaluation Reports, 1992–2004

Area	Year
Debt Management Objectives	1992
Debt Structure—Fixed/Floating Mix	1992
Internal Review Process	1992
External Review Process	1992
Benchmarks and Performance Measures	1994
Foreign Currency Borrowing—Canada Bills Program	1994
Developing Well-Functioning Bond and Bill Markets	1994
Liability Portfolio Performance Measurement	1994
Retail Debt Program	1994
Guidelines for Dealing With Auction Difficulties	1995
Foreign Currency Borrowing—Standby Line of Credit and FRN	1995
Treasury Bill Program Design	1995
Real Return Bond Program	1998
Foreign Currency Borrowing Programs	1998
Initiatives to Support a Well-Functioning Wholesale Market	2001
Debt Structure Target/Modelling	2001
Reserves Management Framework	2002
Bond Buybacks	2003
Funds Management Governance Framework	2004
Retail Debt Program	2004
Note: The last two reports are available online at www.fin.gc.ca. Source: Department of Finance.

Annex 1—Composition of the Federal Debt 

Gross Debt

Gross debt is made up of market debt and non-market debt. At the end of March 2004 gross debt totalled $701.1 billion, up $1.0 billion from the previous year and down $14.7 billion from its peak of $715.8 billion in 1999–2000.

Market Debt

Market debt is the portion of gross debt that is funded in the capital markets and managed by the Government. Market debt consists of marketable bonds, Treasury bills, foreign currency denominated bonds and bills, retail debt, bonds held by the Canada Pension Plan (CPP) and obligations related to capital leases. Foreign currency debt is issued on an opportunistic basis. At March 31, 2004, market debt outstanding was $440.2 billion, down $2.2 billion from the previous year (see Chart A1).

Non-Market Debt

Non-market debt includes liabilities held by the Government, outside the capital markets. This includes money owed to public sector pensions, the CPP, and employees and veterans for future benefits, as well as other liabilities, accounts payable and accrued liabilities and allowances. In 2003–04 non-market debt amounted to $260.9 billion, up $3.2 billion from 2002–03.

Net Debt

Net debt is gross debt minus financial assets. Financial assets include cash, foreign exchange accounts and loans. Net debt declined by $8.5 billion, from $564.8 billion in 2002–03 to $556.3 billion in 2003–04. The Government’s financial assets increased by $9.5 billion to $144.8 billion, as the decrease in foreign exchange reserves was more than offset by increases in the Government’s cash balances, tax receivable, loans, investments and advances.

Federal Debt

Federal debt, or the accumulated deficit, is net debt minus non-financial assets. Non-financial assets include tangible capital assets, inventories and prepaid expenses. Federal debt declined by $9.1 billion, from $510.6 billion in 2002–03 to $501.5 billion in 2003–04. The Government’s non-financial assets increased by only $0.6 billion to $54.8 billion, as the increase in tangible capital assets was offset somewhat by a decrease in prepaid expenses.

Annex 2—Managing the Risks of Holding Cash and Reserves

In recent years the Government has put in place frameworks to manage financial risk, particularly its exposure to the financial institution counterparties with which it transacts in the management of its Receiver General cash balances and foreign exchange reserves.

The Government’s risk management policies, supported by a financial risk office at the Bank of Canada, call for prudent management of treasury risks based on best practices. Risk tolerances are low, calling for market risk to be immunized to the greatest extent possible and the maintenance of high credit quality and portfolio diversification standards.

Foreign currency reserve assets and the liabilities financing these assets have been managed together on a portfolio basis since 1998, based on principles used by private sector financial institutions. The Government uses an asset-liability matching framework, whereby assets and liabilities financing these assets are matched (as closely as possible) in currency and duration, so that the Government is not exposed to currency and interest rate risks. The risk of material loss arising from interest and/or currency risk is very low.

In the late 1990s the Government also developed a rigorous, comprehensive credit risk system that is consistent with best practices and includes credit exposure limits pertaining to issuers and counterparties across all lines of business. The management of Canadian-dollar cash balances and the investment of reserve assets are governed by detailed investment and credit guidelines approved by the Minister of Finance. The guidelines limit the Government’s credit exposure to commercial financial institution counterparties and to the issuer of securities held by the Government in the foreign currency reserve portfolio.

More recently the Government has further strengthened its risk management framework by implementing collateral management frameworks. Collateral management systems are increasingly the norm in capital markets as a way of managing credit risk. Under these frameworks, high-quality collateral (e.g. cash, securities) is posted to the Government when credit risk to financial institution counterparties exceeds specified limits.

Collateral Framework for Investment of Canadian-Dollar Cash Balances

A collateralized framework for AM auctions was implemented in September 2002. The new framework strengthens the management of the credit risks involved in the investment of cash balances through the use of credit ratings, credit lines and collateral agreements, and increases competition in the auction of cash balances by opening the AM auctions to a wider range of participants. The number of eligible participants has increased from 13 to 21 institutions. The PM auction remains unchanged. Please see the Bank of Canada Web page at

www.bankofcanada.ca/en/auction/rec_general.pdf for further information.

Collateral Framework for Swaps and Foreign Currency Cash Balances

Cross-currency swaps of domestic obligations have been used since March 1995 to fund the foreign exchange reserves. Swaps are highly cost-effective compared to other sources of foreign currency funding. The Government’s swap portfolio has increased significantly and as of March 31, 2004, it stood at $24.6 billion.

To mitigate the counterparty credit risk associated with swaps, the Government implemented a collateral management framework in April 2002. High-quality collateral is posted to the Government if individual credit exposures, arising from changes in the mark-to-market values of swap contracts, exceed pre-set limits. As of March 31, 2004, the swap collateral framework included 12 financial institution counterparties.

In addition to the swap collateral framework, in the latter part of 2002–03, the Government developed a US-dollar repo program to reduce the use of uncollateralized short-term US-dollar deposits with commercial banks. Under the repo framework, collateral is posted to the Government to protect US-dollar cash invested with financial institution counterparties. As of March 31, 2004, the Government had signed seven counterparties to its US-dollar repo framework.

Amendment of Investment and Risk Guidelines

With the implementation of a collateral management framework for the Government’s cross-currency swap program, in 2002 the Government modified its credit guidelines to accept A-rated financial institutions as eligible counterparties for foreign currency deposits and swaps. This change helped the Government further diversify its investments across financial institution counterparties without increasing risk significantly. Credit exposure to A-rated financial institutions is maintained within prudent standards, consistent with best practices of comparable sovereigns and major market participants.

The investment guidelines governing the management of the reserves asset portfolio were also modified in 2002 to allow a limited amount of securities of A-rated sovereigns to be held within prudent limits (previously the Government could only invest in AA- and AAA-rated sovereigns), mirroring the change to allow limited exposure to A-rated financial counterparties involved in reserves management. This change is in line with the investment practices of a number of Organisation for Economic Co-operation and Development sovereigns and allows the Government to further diversify its reserves investment portfolio.

Maintenance of Supplementary Liquidity

In August 2002 the Government successfully renegotiated its existing US$6-billion standby credit facility with international banks. The standby facility provides supplementary liquidity to meet the Government’s needs in the event that market disruption makes borrowing through securities markets impossible. Under the renewal of the facility, the composition of the banks in the facility was changed, and the maturity date was extended from 2003 to 2007. No other changes were made to the terms of the facility.

Annex 3—Glossary

basis point:

One-hundredth of a percentage point (0.01 per cent).

benchmark bond:

Specific issue outstanding within each class of maturities. It is considered by the market to be the standard against which all other bonds issued in that class are evaluated.

bid:

Price a buyer is willing to pay.

bid-offer spread:

The difference between bid and offer prices. It is typically measured in basis points.

budgetary surplus:

Occurs when government annual revenues exceed annual budgetary expenses. A deficit is the shortfall between government annual revenues and annual budgetary expenses.

cash management:

Control by the Bank of Canada of settlement balances through increases or decreases in the amount of cash balances supplied to LVTS participants in relation to the amount demanded in order to reinforce the Bank’s target interest rate.

compound interest bond (C-bond):

A Canada Savings Bond or Canada Premium Bond on which interest accrues and is compounded annually to maturity or until redeemed.

Exchange Fund Account:

A fund maintained by the Government of Canada for the purpose of promoting order and stability of the Canadian dollar in the foreign exchange market. This function is fulfilled by purchasing foreign exchange (selling Canadian dollars) when there is upward pressure on the value of the Canadian dollar and selling foreign exchange (buying Canadian dollars) when there is downward pressure on the currency.

financial source/requirement:

Measures the difference between the cash coming in to the Government and the cash going out. In the case of a financial requirement, it is the amount of new borrowing required from outside lenders to meet the Government’s financing needs in any given year.

foreign exchange reserves:

Stocks of foreign exchange assets (e.g. interest-earning bonds) held by sovereign states to support the value of the domestic currency. Canada’s foreign exchange reserves are held in the Exchange Fund Account.

Government of Canada securities auction:

A process used for selling Government of Canada debt securities (mostly marketable bonds and Treasury bills) in which issues are sold by public tender to government securities distributors.

government securities distributors (GSDs):

Members of a group of investment dealers and banks through which the Government distributes Government of Canada Treasury bills and marketable bonds.

inflation:

A persistent rise over time in the average price of goods and services.

interest-bearing debt:

Consists of unmatured debt, or market debt, and the Government’s liabilities to internally held accounts such as federal employees’ pension plans.

Large Value Transfer System (LVTS):

An electronic system for the transfer of large-value or time-critical payments.

marketable bond:

A Canadian government debt security that is non-cashable prior to maturity, but whose ownership may be transferred from one holder to another on the open market.

marketable debt:

Market debt that is issued by the Government of Canada and sold via public tender or syndication. These issues can be traded between investors while outstanding.

monetary policy:

A policy that seeks to improve the performance of the economy by regulating money supply and credit.

money market:

The market in which short-term capital is raised, invested and traded using financial instruments such as Treasury bills, bankers’ acceptances, commercial paper, and bonds maturing in one year or less.

offer:

Price at which a seller is willing to sell.

overnight rate; overnight financing rate; overnight money market rate; overnight lending rate:

The rate at which major participants in the money market borrow and lend one-day funds to each other.

primary dealers (PDs):

Members of the core group of government securities distributors that maintain a certain threshold of activity in the market for Government of Canada securities. The primary dealer classification can be attained in either Treasury bills or marketable bonds, or both.

primary market:

The market in which securities are initially sold or offered.

regular interest bond (R-bond):

A Canada Savings Bond or Canada Premium Bond on which interest is paid annually by cheque or by direct deposit to maturity or until redeemed.

repo; repurchase agreement:

A transaction in which a party sells a security and simultaneously agrees to repurchase it at a given price after a specified time.

secondary market:

The market in which previously issued securities are traded, as distinguished from the new issue or primary market.

turnover ratio:

Volume of securities traded as a percentage of securities outstanding.

yield curve:

The levels of interest rates from short- to long-term maturities.

Annex 4—Contact Information

Department of Finance Canada

Financial Sector Policy Branch
Financial Markets Division
140 O’Connor St., 20th Floor, East Tower
Ottawa, Canada K1A 0G5
Telephone: (613) 992-9031
Fax: (613) 943-2039

¹ Duration is calculated according to the modified duration formula, and includes the effect of cross-currency and interest rate swaps. [Return]

² These numbers are higher than the numbers reported in previous years due to a change in the methodology to include realized gains/losses on the sale of assets. [Return]

- Table of Contents - Next -