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Foreword by the Minister of Finance

I am pleased to table the Government of Canada’s Debt Management Report for fiscal year 2004–05. It provides a full accounting of how Canada’s debt is managed.

Thanks to eight consecutive budget surpluses since the Government balanced its books in 1997–98, we have been able to reduce the federal debt by some $63 billion. These debt reduction efforts have freed up an additional $3 billion, on an annual basis, to deal with the priorities of Canadians in areas such as health care, education, improving our infrastructure and promoting a cleaner and greener environment.

This is a clear example of prudence with a purpose. Furthermore, our debt-to-GDP (gross domestic product) ratio has declined from 68.4 per cent in 1995–96 to 38.7 per cent in 2004–05. This represents the lowest debt-to-GDP ratio since 1983–84, and we remain on track to meet the Government’s target of achieving a debt-to-GDP ratio of 25 per cent within 10 years.

The Government’s improved financial position has ushered in an era of federal debt management where the key challenge is to maintain a liquid and efficient government securities market in the face of declining borrowing requirements. This year’s Debt Management Report highlights ongoing efforts to meet this challenge and to improve the management of our debt. Examples of initiatives taken over the past year include:

Through effective management of our debt and a sustained commitment to fiscal responsibility and prudence, our government continues to do everything it can to ensure that Canada’s economy remains strong and prosperous, both now and in the years to come.

The Honourable Ralph Goodale, P.C., M.P.
Minister of Finance
Ottawa, November 2005

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 fiscal year April 1, 2004 to March 31, 2005.

It provides a comprehensive report on the environment in which the debt is managed, its composition and changes during the year, and performance against the strategic plan set out in the 2004–05 Debt Management Strategy, published in March 2004. 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 and to ensure transparency and 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 website at www.fin.gc.ca.

Federal Debt Management

Management of the federal debt involves two major activities: actively managing the portion of the debt that is borrowed in financial markets; and investing part of the proceeds of borrowing in liquid assets until needed by the Government. As of March 31, 2005, the Government had $435.5 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 $59.5 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)
266.6
 Treasury bills
  (zero-coupon securities with 3-, 6- and 12-month maturities)
127.2
 Retail debt 19.1
  (Canada Savings Bonds and Canada Premium Bonds)
 CPP bonds 3.4
 Obligations related to capital leases 2.9
 Payable in foreign currency
 Marketable bonds and foreign currency notes 12.4
  (fixed-rate bonds, Canada notes and Euro 
   Medium-Term Notes)
 Canada bills 3.9
   (zero-coupon securities with 1- to 9-month maturities)
Liquid Financial Assets
  Cash 20.6
  Foreign exchange reserves 38.9

This document is structured as follows:

Overview

In 2004–05 the Government continued to reduce its level of indebtedness. On a full accrual basis of accounting the federal debt was reduced to $499.9 billion, down $63 billion from its peak in 1996–97. The federal debt fell $1.6 billion in 2004–05. With a budgetary surplus of $1.6 billion and a net source from non-budgetary transactions of $3.2 billion, there was a financial source of $4.8 billion in 2004–05. With this financial source, the Government retired $4.8 billion of its market debt and increased its cash balances by $49 million. Debt-servicing charges were down $1.7 billion from fiscal year 2003–04 as a result of a 30-basis-point reduction in the average interest rate paid on the public debt. The reduction in the debt since 1996–97 has resulted in savings of over $3 billion annually. Lower debt-servicing charges benefit all Canadians.

Debt, cash and reserve management actions in 2004–05 continued the process begun in 2003–04 of reducing 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 63.8 per cent to 63.1 per cent over the course of the year. The stock of treasury bills and cash management bills increased by $13.8 billion to $127 billion, while the stock of nominal bonds declined by $13.9 billion to $244 billion.

An important initiative undertaken in 2004–05 was the reduction in the time in which auction and operational results are made public (turnaround time). On April 1, 2004, the Government reduced the turnaround time for auctions and operations in which bonds are repurchased from fixed times (10 and 15 minutes respectively) to a "best efforts basis" (i.e. when ready). Since the change, turnaround times have averaged less than 3 minutes for auctions and less than 7 minutes for buybacks. The reduction in turnaround time has helped reduce market risk for auction participants and has improved the efficiency of the auction process.

One of the key challenges for the Government in recent years has been to maintain a liquid, well-functioning government securities market in the face of declining borrowing requirements and reduced bond issuance. The Government has an interest in sustaining a liquid and efficient market for Government of Canada securities for the purpose of providing stable low-cost funding. A liquid and efficient government securities market also provides key pricing and hedging tools for market participants, thereby contributing to the effective functioning of the broader Canadian fixed-income market.

While liquidity remained at high levels in 2004–05, consultations with market participants suggest that the sizes of nominal bond auctions, particularly in the 10- and 30-year maturities, and benchmark bond sizes, may be approaching their lower limit. The Government may need to adjust the structure of the bond program in the near future to ensure continued liquidity in the government securities market. Accordingly, in 2005–06, it plans to assess potential structural changes to the bond program and to further consult with market participants on the topic.

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 2004–05 a review of the debt distribution framework was conducted.

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.

Governance

Part IV of the Financial Administration Act empowers the Minister of Finance to borrow money on behalf of Her Majesty in right of Canada. The Minister is authorized to issue securities and do any other thing related to the borrowing of money that the Minister considers appropriate. Section 49 of the act requires the Minister to table in the House of Commons, within 45 sitting days after the tabling of the Public Accounts of Canada, a report on the activities of the Minister in relation to the management of the public debt.

Responsibility for strategic planning and the operational management of the public debt is jointly borne by officials at the Department of Finance and the Bank of Canada. The Bank of Canada acts as fiscal agent for the Minister of Finance in issuing debt and conducting other debt market operations.

The oversight of activity is carried out through the Funds Management Committee (FMC), which comprises senior management from the Department of Finance and the Bank of Canada. The FMC advises the Minister of Finance on policy and strategy, oversees the implementation of approved policy and plans, and reviews performance outcomes.

The FMC is supported by a Risk Committee (RC), whose mandate is to oversee and advise on the risk management policy and to report to the FMC on financial risk positions and exposures. The Financial Risk Office at the Bank of Canada provides analytical support to the RC in this role and is responsible for monitoring and regularly reporting on the financial performance and position of the public debt, including market, credit, operational, liquidity and legal risks.

Debt Strategy Framework

Purpose

  • Raise stable, low-cost funding for the Government of Canada.

Principles and Objectives1

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.

Prudence

  • Raise funding for domestic operational needs in Canadian dollars.
  • Manage the Receiver General cash position to ensure that cash balances are maintained at reasonable cost to the Government and that credit risks are controlled 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 federal debt management policy and 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.

1 For information on the management of foreign reserve assets, see the 2004 Report on the Management of Canada’s Official International Reserves at www.fin.gc.ca/toc/2005/oir05_-eng.asp.

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

The Government recorded a budgetary surplus of $1.6 billion in 2004–05, its eighth consecutive budget surplus. The federal debt has been reduced by $63 billion since its peak in 1996–97. The federal debt-to-GDP (gross domestic product) ratio has fallen 29.7 percentage points from its peak of 68.4 per cent in 1995–96 to 38.7 per cent in 2004–05 (see Chart 1), its lowest level since 1983–84. For detailed information, see the 2004–05 Annual Financial Report of the Government of Canada at www.fin.gc.ca/toc/2005/afr_-eng.asp.

Chart 1 - Federal Debt-to-GDP Ratio

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 $1.6 billion and a net source of funds from non-budgetary transactions of $3.2 billion produced a financial source of $4.8 billion in 2004–05 (see Chart 2). This compares to a financial source of $6.2 billion in 2003–04, and a source of $7.6 billion in 2002–03. The financial source in 2004–05 was used to reduce market debt by $4.8 billion.

Chart 2 - Budgetary Balance and Financial Source/Requirement

Public Debt Costs

In 2004–05 the Government spent 17.2 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 2.6 per cent in 2004–05 from 2.9 per cent in 2003–04 (see Chart 3). In 2004–05 the average interest rate paid on the public debt declined by 30 basis points to 5.5 per cent from 5.8 per cent in 2003–04.

Chart 3 - Public Debt Charges

Composition of the Federal Debt

The federal debt consists of the total liabilities of the Government of Canada (gross debt) minus financial and non-financial assets. Gross debt can be broken down into market debt and non-market debt. Market debt is funded in the capital markets and is actively managed by the Government. Non-market debt comprises liabilities held by the Government outside capital markets and includes the Government’s obligations to public sector pension plans, the CPP, as well as other liabilities, accounts payable and accrued liabilities and allowances. The following diagram illustrates the relationships between the components of the federal debt, based on the 2004–05 fiscal year. See Annex 1 for a more detailed description of the composition of the federal debt.

Federal Debt as at March 31, 2005

There are two types of market debt: domestic debt, which is denominated in Canadian dollars, and foreign currency debt (see Chart 4). 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 Bonds products to individuals who are Canadian residents.

See www.fin.gc.ca/invest/instru-eng.asp for a detailed description of the Government of Canada’s market debt instruments.

Chart 4 - Market Debt, March 31, 2005

Funds raised in Canadian dollars are used primarily to meet the Government’s operational requirements. A portion of Canadian-dollar wholesale debt is swapped to foreign currencies to fund the Government’s foreign exchange reserves. Chart 5 shows market debt taking into account swaps. The Government also borrows in foreign currencies to fund 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.

Table 1 shows the change in the composition of federal market debt in 2004–05 by domestic and foreign debt programs. Further details on the changes in programs and indicators of debt management operations and activities can be found in Part III. Total domestic debt was reduced by $0.7 billion while foreign currency debt declined by $4.1 billion.

Chart 5 - Market Debt (Post Swaps), March 31, 2005

Table 1
Change in Composition of Federal Market Debt, 2004–05

  April 1, 2004 Outstanding March 31, 2005 Outstanding Change
  ($ billions)
Domestic debt 413.5 412.8 -0.7
Foreign currency debt1 20.5 16.3 -4.2
CPP bonds and notes 3.4 3.4 0.0
Obligations related to capital leases 2.8 2.9 +0.1
Total market debt 440.2 435.5 -4.8
Note: Numbers may not add due to rounding.

1 Liabilities are stated at par value at the March 31, 2005, exchange rate.

Source: Public Accounts of Canada.

Part II: Report on 2004–2005 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 interest rate risk.

In 2004–05 a 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 framework reviews.

Cost and Risk

The Government’s objective of maintaining stable, low-cost financing involves managing exposure to a range of financial risks. 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). This section provides an overview of the main considerations in balancing interest rate risk and cost.

Debt Structure

The Government has access to a variety of instruments to fund its debt, with standard maturities ranging from 3 months to 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. The fixed-rate share incorporates both market and non-market 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 6).

Chart 6 - Fixed-Rate Share of the Debt

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 2004–05 the Government continued to reduce the fixed-rate share, with the share declining from 63.8 per cent to 63.1 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 $113.4 billion to $127.2 billion in 2004–05, while the stock of outstanding nominal bonds declined from $258.2 billion to $244.3 billion.

In addition to the fixed-rate share, the Government uses other indicators to track the exposure to interest rate 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 6 12 years since 2000, after having increased from roughly 4 years in 1991 (see Chart 7). A longer ATM means that debt instruments are rolled over less frequently, which implies less uncertainty regarding future debt costs.

Chart 7 - Average Term to Maturity of Marketable Debt

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.

The emphasis on the regularity of debt operations, including in particular regular cycles for new bond benchmarks, helps to maintain a stable maturity profile. As well, the cash management bond buyback (CMBB) program, through which benchmark bonds maturing within a year are repurchased before their maturity dates, helps stabilize the maturity profile within a given year and manage cash balances effectively around large maturity dates. 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. Overall, through the CMBB program, large maturities were lowered by 21 per cent in 2004–05, reducing the Government’s cost of holding high levels of cash balances for key coupon and maturity payment dates.

Risk Associated With Funding the Foreign Reserves

The Government borrows in foreign currencies to raise foreign exchange reserve assets for the Exchange Fund Account. These assets provide foreign currency liquidity and help promote orderly conditions for the Canadian dollar in the foreign exchange markets. Foreign exchange funding requirements in 2004–05 were met primarily through cross-currency swaps, which are particularly cost-effective compared to other funding sources.

Collateral management frameworks are used to manage the Government’s credit risk to financial institution counterparties associated with cross-currency swaps. Under these frameworks, high-quality collateral (e.g. cash, securities) is placed with the Government when the Government’s exposure to a counterparty exceeds specified limits.

Risk measures are reported on a monthly basis to management at the Department of Finance and the Bank of Canada.

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 it 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 2004–05 Debt Management Strategy to promote liquidity in the Government of Canada securities market were:

The 2004–05 Debt Management Strategy outlined the Government’s buyback target of approximately $11 billion, similar to 2003–04. During the year the Government issued $11.5 billion in new benchmark bonds through the repurchase of $11.5 billion in off-the-run bonds. The basket of eligible bonds for buyback in the 10-year sector was successfully expanded in 2004–05 to help maintain buyback operations in that sector.

In 2004–05 the Government repurchased $4.7 billion in bonds through the switch program (a decrease of $0.3 billion from 2003–04), and $6.8 billion through the cash buyback program (an increase of $1.6 billion from 2003–04).

Participation

Active participation at auction and buyback operations of 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. A key initiative undertaken in 2004–05 was the reduction in the time in which auction and buyback results are made public (turnaround time).

On April 1, 2004, the Government reduced the turnaround time for auctions and buyback operations from fixed times (10 and 15 minutes respectively) to a "best efforts basis" (i.e. when ready). Lower turnaround time has reduced the market risk for market participants, further enhancing the efficiency of the auction and buyback process. Market participants have indicated their satisfaction with these changes.

Charts 8 and 9 show the reduction in turnaround times in recent years, from 45 minutes at the end of 1998 to an average of less than 3 minutes for treasury bill and bond auctions and an average of less than 7 minutes for buyback operations in 2004–05.

Chart 8 - Turnaround Times for the Release of REsults of Treasury Bill and Bond Auctions, 1998-2005

Chart 9 - Turnaround Times for the Release of the Results of Buyback Operations, 1998-2005

Framework Reviews

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 2004–05 the Government conducted an internal review of the effectiveness of its debt distribution framework. An external study of the borrowing and governance framework of Crown corporations was also undertaken (available at www.fin.gc.ca/toc/2005/mfgbe-eng.asp).

Evaluation of the Debt Distribution Framework

The evaluation of the debt distribution framework for Government of Canada securities was launched in the fall of 2004 and included internal analysis by the Government and consultations with interested parties. A consultation document was posted in October 2004 on the Bank of Canada’s website (www.bank-banque-canada.ca/en/notices_fmd/2004/not181004_review.html).

The purpose of the review was to assess the framework’s effectiveness in raising stable, low-cost funding for the Government and supporting a well-functioning market for Government of Canada securities, and whether changes to the framework were warranted.

The review was considered timely given the evolution of the government securities market since the previous review of the framework in 1998: lower borrowing requirements of the federal government; greater concentration of auction participation and secondary market trading; interest by some investors in direct participation at auctions; and innovation in financial markets through, for example, the development of alternative trading systems.

Following the conclusion of the review, changes to the debt distribution framework were released in a document published in August 2005 on the Bank of Canada’s website (www.bank-banque-canada.ca/en/notices_fmd/2005/not080805.html). The review found that the framework is generally working well, with auctions consistently covered and well bid. The Government identified changes to the framework to promote continued competition and participation in Government of Canada securities auctions. The changes fall into two broad areas: adjustments in auction access for dealers and customers, and changes to minimum bidding obligations of dealers. These changes are scheduled for implementation in early December 2005, following the update of the Terms of Participation and the Standard Terms for Government of Canada auctions.

Debt Strategy Plan and Summary of Actions Taken

The following summary reports on the 2004–05 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.

  Plan Purpose Actions Taken
Cost and Risk Continue to reduce the fixed-rate share of the debt towards the 60-per-cent target. Achieve lower debt charges, while continuing to prudently mitigate the risk to the budget framework. The fixed-rate share was reduced from 63.8 per cent to 63.1 per cent over the 2004–05 fiscal year.
  Increase the size of the treasury bill program from $110 billion-$115 billion in 2003–04 to approximately $130 billion in 2004–05. Facilitate market adjustment to changes in the bond and treasury bill programs. The stock of outstanding treasury bills and cash management bills increased by $13.8 billion to about $127 billion.
  Issue roughly $36 billion of nominal bonds in 2004–05, $4 billion less than in 2003–04. Due to large bond maturities and continued cash management bond buyback operations, the bond stock was expected to decrease by some $16 billion.   $35.5 billion of bonds were issued. The stock of outstanding bonds declined by $13.9 billion to about $244 billion.
  Maintain a stable maturity profile. Limit the need to refinance a large portion of debt in any given period and help maintain stability in debt programs over time. Average term to maturity was maintained above 6.5 years.

$12.9 billion of bonds were repurchased through the cash management bond buyback program.

  Continue to use cross-currency swaps for the majority of foreign reserves funding. Keep the cost of carrying reserve assets low. Sixty-four cross-currency swaps were executed in 2004–05 totalling $5.9 billion.
  Plan Purpose Actions Taken
Maintaining a Well-Functioning Market Continue regular issues of marketable bonds in four maturity sectors, treasury bills in three maturity sectors and a long-dated index-linked bond. 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, nominal bonds and Real Return Bonds.
  Maintain current benchmark target sizes for 2-, 5-, 10- and 30-year bonds. Maintain a liquid market for on-the-run and building benchmark issues. Benchmark bond target sizes were maintained.
  Continue regular bond buybacks at a planned level of about $11 billion, as in 2003–04. Help maintain bond auction sizes and support issuance of large liquid benchmarks. A total of $11.5 billion of bonds were bought back through the regular buyback program.
  Expand the basket of bonds eligible for 10-year cash and switch buybacks to include more long-dated maturities. Promote liquidity by reaching target benchmark sizes within a one-year cycle. Bonds with maturities up to June 2027 were included in the basket of eligible bonds for buyback operations in the 10-year sector.
  Plan Purpose Actions Taken
Participation Beginning April 1, 2004, reduce turnaround time for auctions and buybacks to a best efforts basis. Enhance bidding and participation by reducing market participants’ risk. Turnaround times on a best efforts basis have averaged less than 3 minutes for auctions and less than 7 minutes for buybacks.
Framework Reviews Review the debt distribution framework. Assess the framework’s effectiveness in raising stable, low-cost funding and supporting a well-functioning market for Government of Canada securities.

Changes to the Terms of Participation and Standard Terms for Government of Canada auctions were announced in August 2005 and are scheduled for implementation in early December 2005.

Part III: Programs and Indicators

Part III 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 trading (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 2004–05 the Government’s treasury bill and bond auctions continued to be well bid. Primary dealers, a core group of government securities distributors that maintain a certain threshold of activity in the market for Government of Canada securities, play the dominant role at auctions except in the case of Real Return Bond auctions, where customers have won more than 40 per cent of the bonds on offer in recent years.

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 98 per cent and 91 per cent of the turnover of treasury bills and bonds respectively. For more information on the framework through which the Government distributes its debt, see www.fin.gc.ca/dtman/2001-2002/dmr02_3-eng.asp#Annex1.

Primary Market

Program Activity

Nominal Bonds

Gross bond program issuance in 2004–05 was $35.5 billion (including issuance through switch buybacks), lower than the $39.4 billion in 2003–04 (see Table 2). Gross issuance consisted of $12.0 billion in 2-year bonds, $9.6 billion in 5-year bonds, $10.6 billion in 10-year bonds and $3.3 billion in 30-year bonds (see Reference Table IX for more information on bond auctions). In 2004–05, $32.5 billion of bonds matured. Taking into account buybacks and maturities, the stock of outstanding bonds declined by $13.9 billion during the year to $244.3 billion as at March 31, 2005.

Real Return Bonds (RRBs)

RRB issuance in 2004–05 was at a level similar to the previous year’s issuance of $1.4 billion, increasing the level of outstanding RRBs from $20.6 billion (which includes the Consumer Price Index [CPI] adjustment) to $22.4 billion as at March 31, 2005. In 2004–05 the Government issued its fourth RRB, one with a December 1, 2036, maturity (see Reference Table X for more information on RRB auctions).

Regular Bond Buyback Program

The objectives of the regular bond buyback program are to enhance liquidity and maintain active new issuance in the primary market for Government of Canada securities. Regular bond buyback operations totalled $11.5 billion in 2004–05, consisting of $6.2 billion in 2- and 5-year bonds, $3.9 billion in 10-year bonds, and $1.4 billion in 30-year bonds (see Reference Table XII for more information on buyback operations).

Buybacks on a cash basis resulted in $6.8 billion of new benchmarks being issued. Switch buyback operations in 2004–05 resulted in $4.7 billion of new building benchmarks being issued. Chart 10 shows the impact of regular bond buybacks on benchmark sizes in 2004–05.

Chart 10 -Impact of Regular Buyback Program on Benchmark Sizes

Table 2
Change in Composition of Federal Market Debt, 2004–05

  April 1, 2004 Outstanding New Issues Maturing Repurchase March 31, 2005 Outstanding Change
  ($ billions)
Domestic debt            
Nominal bonds 258.2 35.5 32.5 24.41 244.2 -13.9
Real Return Bonds 20.62 1.4 0.0 22.4 1.8
Treasury bills3 113.4 271.5 257.7 _ 127.2 13.8
Retail debt 21.3 2.0 4.2 19.1 -2.2
Total domestic debt 413.5 412.8 -0.7
Foreign currency debt4            
Canada bills 3.4 13.6 13.1 3.9 0.5
Foreign bonds5 12.9 0.0 2.4 9.6 -3.3
Canada notes 1.3 0.0 0.0 1.1 -0.2
Euro Medium-Term Notes 3.0 0.0 1.4 1.7 -1.3
Total foreign debt 20.5 16.3 -4.2
CPP bonds and notes 3.4 0.0 0.0 3.4 0.0
Obligations related to capital leases 2.8 0.2 0.1 2.9 0.1
Total market debt 440.2       435.5 -4.8
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. Numbers may not add due to rounding.

1 Includes the regular bond buyback program ($11.5 billion) and the cash management bond buyback program ($12.9 billion). Some cash management bond buybacks in 2004–05 did not reduce maturities in that year, but in 2005–06.

2 Includes CPI adjustment.

3 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.

4 Liabilities are stated at par value at the March 31, 2005, exchange rate. Changes in outstanding amounts for foreign currency bonds, Canada notes and Euro Medium-Term Notes include the exchange rate appreciation/depreciation of the currency of issue versus the Canadian dollar.

5 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 $13.8 billion during 2004–05 to $127.2 billion at March 31, 2005, consistent with the orderly move to a lower fixed-rate share of debt. For the entire fiscal year $271.5 billion in treasury bills and CMBs were auctioned, an increase of $9.0 billion from the previous year (see Table 3). There were $4.7 billion of CMBs outstanding at the beginning of fiscal 2004–05 and $7.5 billion outstanding at the end of the year. Throughout the year the Government issued $25.0 billion of CMBs of various short-term maturities.

Table 3
Treasury Bill and CMB Program Issuance

Issuance 1999–00 2000–01 2001–02 2002–03 2003–04 2004–05
  ($ millions)
CMBs 19,700 9,000 7,500 23,750 28,500 24,950
3-month treasury bills 100,700 88,100 103,300 117,400 129,700 137,500
6-month treasury bills 46,600 38,600 43,100 47,800 51,900 54,500
12-month treasury bills 46,600 38,600 43,100 47,800 51,900 54,500
Total treasury bills 193,900 165,300 189,500 213,000 233,450 246,500
Total including CMBs 213,600 174,300 197,000 236,750 262,416 271,450
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 $21.3 billion to $19.1 billion in 2004–05. Gross sales and redemptions were $2.0 billion and $4.2 billion, respectively, for a net reduction of $2.2 billion in the stock of retail debt. The decline of the retail debt stock is consistent with the trend in overall government debt and an environment of increased competition from private sector retail instruments. Retail debt stock outstanding has decreased from just under $33 billion in 1993 to the current $19.1 billion.

For more information on Canada Savings Bonds and Canada Premium Bonds, see the annual report of Canada Investment and Savings, the Government’s retail debt agency, available at www.csb.gc.ca/eng/about_report.asp.

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 coverage statistic of one is essential for all securities on offer to be sold 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 for 50 per cent of their auction 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 2004–05 coverage remained generally stable for treasury bill and bond auctions. Coverage has remained stable over the last four years. Tails were narrower in 2004–05 than the 4-year average for treasury bill and bond auctions, indicating relatively more competitive bidding at auctions (see Table 4).

Table 4
Performance at Auctions

  Coverage (Ratio) Tail (Basis Points)
 
  2001–02 2002–03 2003–04 2004–05 4-yr avg. 2001–02 2002–03 2003–04 2004–05 4-yr avg.
Treasury bills                    
3-month 2.0 2.2 2.2 2.1 2.1 1.3 0.6 0.5 0.5 0.7
6-month 2.2 2.3 2.2 2.1 2.2 0.8 0.7 0.5 0.5 0.6
12-month 2.0 2.1 2.1 2.0 2.0 0.9 0.7 0.7 0.6 0.7
CMBs 1.9 2.0 2.0 2.4 2.1 1.4 1.4 1.4 1.7 1.5
Nominal bonds                    
2-year 2.3 2.3 2.5 2.5 2.4 0.7 0.7 0.5 0.3 0.6
5-year 2.4 2.5 2.6 2.5 2.5 0.7 0.7 0.5 0.5 0.6
10-year 2.5 2.5 2.5 2.3 2.4 0.9 0.8 0.5 0.4 0.6
30-year 2.5 2.5 2.6 2.3 2.5 1.1 0.7 0.4 0.7 0.8
Real Return Bonds1 2.8 3.2 2.9 2.5 2.8 n.a. n.a. n.a. n.a. n.a.
Weighted average2 2.1 2.2 2.2 2.1 2.2 1.1 0.7 0.5 0.5 0.7
1 Auction tails for RRBs are not relevant since RRBs are distributed through single-price auctions.

2 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 (in practice institutional investors) in the primary market for Government of Canada securities. Primary market shares are calculated using government securities distributors’ and customers’ allotments at auctions during the fiscal year.

Nominal Bonds

In 2004–05 primary dealers (PDs) were allotted 96 per cent of nominal bond auctions while customers were allotted about 2 per cent. Other government securities distributors (GSDs) won approximately 2 per cent (see Table 5). The 10 most active participants bought about 93 per cent of the bonds on average. These percentages show an 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 2001–02 2002–03 2003–04 2004–05
  (%)
PDs 83.7 91.8 93.4 96.0
Other GSDs 6.4 2.5 1.8 2.2
Customers 9.8 5.6 4.7 1.8
Top 10 participants 84.0 88.7 90.9 92.8
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 2001–02 2002–03 2003–04 2004–05
  (%)
PDs 86.2 96.4 97.9 96.5
Other GSDs 0.0 1.7 2.1 3.5
Customers1 13.8 1.9 0.0 0.0
Top 10 participants 98.4 94.5 97.4 97.9
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. This is largely due to the relative lack of product availability in the secondary market, as many RRB investors are buy-and-hold investors. Allotments to customers decreased from about 63 per cent in 2003–04 to about 46 per cent in 2004–05 as the primary dealers’ share increased from the previous year. The 10 most active participants in RRB auctions were allotted about 67 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 2001–02 2002–03 2003–04 2004–05
  (%)
PDs 39.0 47.9 36.1 53.1
Other GSDs 3.9 0.9 0.8 0.7
Customers 57.2 51.2 63.1 46.2
Top 10 participants 61.2 63.9 69.0 66.6
Source: Bank of Canada.

Treasury Bills

For 2004–05 primary dealers accounted for about 86 per cent of amounts allotted at treasury bill auctions while customers accounted for about 11 per cent and other GSDs accounted for about 2 per cent. The share won by primary dealers has been relatively steady in the last four years in a narrow range of 84-86 per cent. In 2004–05 the 10 most active participants accounted for about 94 per cent of amounts allotted at treasury bill auctions (see Table 8).

Table 8
Treasury Bill Auctions Share of Amount Allotted to Participants

Participant Type 2001–02 2002–03 2003–04 2004–05
  (%)
PDs 86.0 84.1 84.2 86.4
Other GSDs 1.6 2.2 1.2 2.3
Customers 12.4 13.6 14.5 11.3
Top 10 participants 93.0 91.5 93.7 93.6
Source: Bank of Canada.

Cash Management Bills

Primary dealers are the most frequent participants at CMB auctions. In 2004–05 primary dealers were awarded about 96 per cent of the allotted amounts, and the 10 most active participants accounted for about 98 per cent. The average allotment share of customers increased to about 2 per cent from less than 1 per cent in the previous fiscal year (see Table 9).

Table 9
CMB Auctions Share of Amount Allotted to Participants

Participant Type 2001–02 2002–03 2003–04 2004–05
  (%)
PDs 95.6 93.0 97.8 95.5
Other GSDs 2.3 2.5 1.4 2.6
Customers 2.1 4.5 0.8 1.9
Top 10 participants 97.9 95.5 99.2 98.1
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 11 and, for international comparison, Chart 12) and treasury bills (Chart 13).

Trading volume and turnover ratios for bond repos (Chart 14) and treasury bill repos (Chart 15) are also provided. A repo, or repurchase agreement, is a transaction in which a party sells a security and simultaneously agrees to repurchase it at a given price at a given time in the future. These transactions provide short-term collateralized loans of cash and low-risk securities to finance or support dealer inventory. As such, they represent an index of the scale of market activity.

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 amount of 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 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 Montréal 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 $4,721 billion in 2004–05, a 3.5-per-cent increase from 2003–04. The average quarterly turnover ratio was 4.2 times the outstanding stock of bonds in 2004–05, compared to 3.8 in 2003–04 (see Chart 11).

Chart 11 - Government of Canada Bonds Trading Volume and Turnover Ratio]

At an annual stock turnover of 17 in 2004, the Government of Canada bond market compares favourably with other major sovereign bond markets, with the exception of the United States (see Chart 12).

Chart 12 - Sovereign Bond Turnover Ratios

The volume of transactions in the treasury bill market was comparable to the previous fiscal year and remains below the highs in the mid-1990s, when the level of the treasury bill stock was at its peak. In 2004–05 total treasury bill trading volume was $1,364 billion (see Chart 13). The average quarterly turnover ratio increased slightly to 2.89 in 2004–05 from 2.87 in 2003–04.

Chart 13 - Government of Canada Treasury Bills Trading Volume and Turnover Ratio

Both Government of Canada bond repos and treasury bill repos remained active in 2004–05. The total trading volume for Government of Canada bond repos in 2004–05 was $17,594 billion, down from $17,745 billion in 2003–04. The average quarterly turnover ratio for bond repos in 2004–05 was 15.7 times compared to 15.0 times in 2003–04 (see Chart 14). The treasury bill repo market volume in 2004–05 was $3,582 billion compared to $2,710 billion in 2003–04 and the average quarterly turnover ratio was 7.6 compared to 6.0 in 2003–04 (see Chart 15).

Chart 14 - Government of Canada Bond Repos Trading Volume and Turnover Ratio

Chart 15 - Government of Canada Treasury Bill Repos Trading Volume and Turnover Ratio

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 3 million contracts in 2004, a 25-per-cent increase from 2003.

Trading by Market Participants

Bonds

Primary dealers’ share of bond trading decreased slightly from 2003–04 while other government securities distributors’ share increased, continuing the trend since 2001–02. The 10 most active participants in the bond secondary market represent about 94 per cent of trading activities (see Table 10).

Table 10
Bond Trading: Market Share of Participants

Participant Type 2001–02 2002–03 2003–04 2004–05
  (%)
PDs 94.0 93.3 92.6 91.3
Other GSDs 6.0 6.7 7.4 8.7
Top 10 participants 96.0 95.9 95.1 93.9
Source: Bank of Canada.

Treasury Bills

Primary dealers maintain a dominant share of the treasury bill secondary market, representing about 98 per cent of total trading volume. The 10 most active participants in the treasury bill secondary market represent close to 100 per cent of trading activities (see Table 11).

Table 11
Treasury Bill Trading: Market Share of Participants

Participant Type 2001–02 2002–03 2003–04 2004–05
  (%)
PDs 98.3 98.4 98.4 98.1
Other GSDs 1.7 1.6 1.6 1.9
Top 10 participants 99.4 99.5 99.2 99.5
Source: Bank of Canada.

Cash Management

Receiver General (RG) cash balances, the Government’s Canadian-dollar balances, are invested in a prudent, cost-effective manner through auctions with private sector financial institutions to minimize the cost to the Government of holding cash. Auctions take place twice per day, in the morning (AM auction) and in the afternoon (PM auction). RG cash 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 security.

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, the cost of carry and the profile of treasury bill operations.

Total Receiver General Cash Balances

As indicated earlier, RG cash balances fluctuate widely over the year for a variety of reasons. RG balances reached a peak of $22.0 billion and a low of $2.3 billion in 2004–05 (see Chart 16).

Chart 16 - Total Receiver General Balances

Average Daily Cash Balances

Average daily cash balances increased in 2004–05 to $8.2 billion (see Table 12) as a result of larger bond maturities relative to the previous fiscal year. Larger maturities require that larger cash balances be held in advance of the maturities.

Table 12
Average Daily RG Cash Balances Held at Financial Institutions

  2001–02 2002–03 2003–04 2004–05
  ($ millions)
Average daily cash balances 7,921 6,139 7,854 8,193
Source: Bank of Canada.

Coverage and Tails

In 2004–05 coverage at RG auctions improved from the previous fiscal year for the AM auction, and was above the rolling four-year average (see Table 13). This is a continuation of the trend from the previous year, when the new RG collateralization framework was introduced to encourage more participation in AM auctions (for details on the RG collateralization framework see www.fin.gc.ca/dtman/2003-2004/dmr04_1e.html#Annex2). Coverage for the PM auctions, while weaker than in the previous year, was in line with the rolling four-year average.

In 2004–05 AM and PM auction tails narrowed from the previous year, with the AM auction tail below the average of the last four years.

Table 13
Performance at Receiver General Auctions

  2001–02 2002–03 2003–04 2004–05 4-yr. avg.
AM auctions          
  Coverage (ratio) 2.42 3.29 3.38 4.16 3.28
  Tail (basis points) 2.28 0.91 1.68 1.26 1.58
PM auctions          
  Coverage (ratio) 2.27 2.31 2.53 2.35 2.36
  Tail (basis points) 2.58 3.04 3.09 2.96 2.92
Source: Bank of Canada.

Participation

The top 10 participants in the Large Value Transfer System (LVTS), the electronic system for the transfer of large payments, won about 74 per cent of RG auctions on average in 2004–05, while the top 10 other participants gained about 24 per cent of the amount allotted, amounts in line with the previous year (see Table 14).

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

Participant Type 2001–02 2002–03 2003–04 2004–05
  (%)
Top 10 LVTS 98.5 91.0 76.0 74.3
Top 10 others 0.0 7.1 23.8 24.3
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 2004–05 the total amount of bonds repurchased through the CMBB program was $12.9 billion, compared to $15.7 billion in 2003–04. The CMBB program reduced the size of the December 2004 maturity by 27 per cent to $9.4 billion. The program also repurchased $2.0 billion in bonds from the September 2005 bond maturity, reducing the maturing amount to $9.3 billion. Overall, large maturities were lowered by 21 per cent in 2004–05, reducing the Government’s cost of holding high levels of cash balances for key coupon and maturity payment dates (see Chart 17).

Chart 17 - Impact of CMBB Operations on the Government<s Large Payments

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 2004–05 the cost of carry of holding RG cash balances was a net cost of $13.1 million, compared to a net cost of $0.4 million for the prior fiscal year (see Chart 18). In 2003–04, there were periods when the yield curve at the short end was inverted as market participants expected the Bank of Canada to lower interest rates, which resulted in the lower cost of carry in that year.

Chart 18 - Cost or Gain of Carry for Cash Balances

Profile of Treasury Bill Operations

As the cost of carry is largely determined by the shape of the yield curve, an indicator of cash management activities is the profile of treasury bill operations (amount issued per auction date less amount maturing per auction date). Smooth profiles provide certainty of supply for market participants and help reduce the cost to the Government associated with large operations. The profile of treasury bill operations continued to be smooth in 2004–05, ranging from -$2 billion to +$4 billion per operation, with a standard deviation of $1.2 billion (see Table 15). The net size of new issues was also reasonably smooth with a standard deviation of $2.2 billion (see Chart 19).

Table 15
Profile of Net Size of Treasury Bill Issues

  2000–01 2001–02 2002–03 2003–04 2004–05
  ($ billions)
Range -3 to 3 -3 to 3 -4 to 4 -2 to +6 -2 to +4
Standard deviation of new issues less maturities 1.4 1.3 1.9 2.3 1.2
Source: Bank of Canada.

Chart 19 - New Issues, and Net Size of Treasury Bill Auctions

Foreign Currency Debt Programs

The Government borrows in foreign currency to fund the foreign exchange reserves, which are held in the Exchange Fund Account. The Government has at its disposal a variety of instruments to meet its foreign currency funding requirements.

Canada Bills

In 2004–05 the level of outstanding Canada bills increased from $3.4 billion (US$2.8 billion) to $3.9 billion (US$3.2 billion). In 2004–05 Canada bills were issued, on average, at an all-in cost of US$LIBOR less 25 basis points.

Foreign Currency Bonds

In 2004–05 no new foreign currency bonds were issued, while a total of $2.4 billion (US$2.0 billion) matured. The total decline in the stock of outstanding foreign bonds, including exchange rate changes, was $3.3 billion. The total outstanding was $9.6 billion (US$7.9 billion) at the end of 2004–05.

Canada Notes

There were no new Canada note issues or maturities in 2004–05. The total outstanding was $1.1 billion (US$0.9 billion) at the end of 2004–05.

Euro Medium-Term Notes

In 2004–05 no new Euro Medium-Term Notes were issued, while a total of $1.4 billion (US$1.1 billion) matured. The total outstanding decreased from $3.0 billion (US$2.4 billion) to $1.7 billion (US$1.4 billion).

Cross-Currency Swaps

In 2004–05 the Government of Canada raised $5.9 billion (US$4.6 billion) to fund the foreign exchange reserves by entering into 64 cross-currency swaps. A total of $3.1 billion (US$2.5 billion) of swaps matured in 2004–05. At the end of the 2004–05 fiscal year, the outstanding amount of cross-currency swaps totalled $24.5 billion (US$19.7 billion) (see Reference Table XI for transaction details). Taking into account the effect of cross-currency swaps, foreign currency obligations were 8.9 per cent of market debt.

Funding and Investment of Reserves

As the foreign exchange reserves are managed on an integrated asset-liability basis, the key measures of portfolio performance include both assets and liabilities. The main measures in the area of the funding and investment of reserves are the cost of carry, the total return earned on the asset-liability portfolio, and the costs of the liabilities.

The reserves are invested in liquid, high-quality, fixed-income securities, which have generally provided 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 foreign reserves have been the use of cross-currency swaps, which are highly cost-effective compared to other sources of funds, and the lending of securities in the reserves portfolio.

Carry

Historically, the net return of the asset-liability portfolio has been measured by using the cost of carry methodology. The carry on the foreign reserves is calculated 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), plus realized gains (due to gains on US-dollar and euro asset sales). The overall carry of the reserves portfolio in 2004–05 is estimated at +27.6 basis points compared to +50.3 basis points in 2003–04. The net cost of carry declined primarily due to higher US yields in 2004–05, which in turn caused a decrease in asset prices and lowered market values of US securities sold.

Total Return

In 2004–05 a new measure of performance, total return, was calculated for both the assets and the liabilities, and for each currency, with the return on the liability portfolio being used as a benchmark for the assets (since liabilities fund the assets and assets must match liabilities in currency and duration). Total return is based on the market value of both reserve assets and liabilities, and captures the following key variables: realized gains/losses on sales of assets, unrealized gains/losses on existing portfolio assets and liabilities, and net interest income. The Government earned a net return of 11 basis points on the reserves portfolio in 2004–05.

Liability Costs

In 2004–05 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$LIBOR less 25 basis points, generally in line with funding levels of recent years. In the case of cross-currency swaps, the Government raised reserve assets at US$LIBOR less 42 basis points on average in 2004–05, in line with recent years.

The 2004 Report on the Management of Canada’s Official International Reserves, available at www.fin.gc.ca/toc/2005/oir05_-eng.asp, provides further information on the performance of the reserves portfolio.

Risk Measures

In 2004–05 the Government introduced several new risk measures to enhance measurement of the reserves’ exposure to market risk. The new risk management tools include Value at Risk (VaR), a measure of possible portfolio losses due to normal market movements over a given time period. As of March 31, 2005, the foreign reserves had a 99-per-cent 10-day VaR of $11 million, which implies that, 99 per cent of the time, the value of the portfolio would not be expected to decline by more than $11 million (or less than a tenth of one per cent), on a net basis, over a 10-day period.

Stress testing, which gives a sense of unexpected impacts on the reserves portfolio at times of extreme market turbulence, was also added in 2004–05. Moreover, hypothetical scenarios that mimic market conditions which occurred during four previous extraordinary events were constructed. Testing revealed that the reserves portfolio would be expected to perform well during periods of market turmoil, as investors would purchase the same high-quality assets as those held in the reserves portfolio in these circumstances.

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 2004, based on Statistics Canada surveys, life insurance companies and pension funds accounted for the largest share of holdings of Government of Canada market debt (22.9 per cent), followed by public and other financial institutions such as investment dealers and mutual funds (21.2 per cent) and foreign investors (14.1 per cent) (see Chart 20). Taken together, these three sectors 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.

Chart 20 - Distribution of Holdings of Government of Canada Market Debt As of March 31, 2005

External Evaluations

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.

Table 16
Treasury Evaluation Reports, 1992–2005

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 Framework1 2004
Retail Debt Program1 2004
1 Available 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 2005 gross debt totalled $705.7 billion, up $4.6 billion from the previous year and down $10.1 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 CPP and obligations related to capital leases. Foreign currency debt is issued on an opportunistic basis. At March 31, 2005, market debt outstanding was $435.5 billion, down $4.8 billion from the previous year (see Chart A1).

Chart A1 - Evolution of Gross Debt and Market Debt

Non-Market Debt

Non-market debt includes liabilities held by the Government outside the capital markets. This includes the Government’s obligations to public sector pension plans, the CPP, as well as other liabilities, accounts payable and accrued liabilities and allowances. In 2004–05 non-market debt amounted to $270.3 billion, up $9.4 billion from the previous year.

Net Debt

Net debt is gross debt minus financial assets. Financial assets include cash, foreign exchange accounts and loans. Net debt declined by $1.6 billion from $556.3 billion in 2003–04 to $554.7 billion in 2004–05. The Government’s financial assets increased by $6.2 billion to $151.0 billion.

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 $1.6 billion, from $501.5 billion in 2003–04 to $499.9 billion in 2004–05. The Government’s non-financial assets increased by $48 million to $54.9 billion.

Annex 2: 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.

LIBOR:

London Interbank Offered Rate. An interest rate charged among banks in London for short-term loans denominated in a specific currency.

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 3: 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

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